Harmonization of corporate taxation rates in the European Union took a small step forward with a ruling by the European Court of Justice in favor of Cadbury Schweppes, where the ECJ found against the British government's policy of applying its own higher national tax rates to a company's subsidiaries in another, lower-taxed, EU member nation.However, despite the positive implications of the ruling for the British confectionery and soft drinks company, observers said that any move towards a serious union of corporate tax policy in Europe still faces a long road.

The court battle stems from taxation levied on profits generated by the Ireland subsidiary of Cadbury Schweppes Overseas Ltd. in 1996. The position of the British Inland Revenue was that a British company was subject to corporation tax on its worldwide profits.

As a result, in 2000, the British Inland Revenue claimed that it was owed £8.6 million, or $16.6 million, in taxes from Cadbury under its controlled foreign company legislation.

The ECJ's recent ruling was predicated upon Article 43 EC of the European Community Treaty, which specified a state's obligations concerning the right of an individual, or a company, "not to be disadvantaged" by internal borders within the EU. Under this, borders cannot be used as barriers to the rights of both citizens and companies.

The court's ruling in the Cadbury case found that, under EU treaty articles, the tax regime of the subsidiary company's national government must apply, unless there were in place "wholly artificial arrangements intended to escape the national tax normally payable."

Significantly, the ECJ noted that establishing a company in a member state for the purpose of benefiting from more favorable legislation did not in itself constitute an abuse of the freedom of the principle of establishment. As background in the case, it was noted that the corporation tax in the U.K. is 30 percent, whereas Ireland is at 12.5 percent.

Beyond Cadbury

In fact, there are a host of cases similar to Cadbury currently on the docket of the Luxembourg-based ECJ, including one pending from Vodafone. Overall, the cases contribute to a painstaking unraveling of the EU's spiderweb structure of discordant national corporate taxation systems.

Also in focus in Luxembourg is a variant on the Cadbury Schweppes legal theme, this one involving Denkavit International BV, an animal feeds company headquartered in the Netherlands. In this case, the French Conseil d'Etat is asking the court for its views on whether an EU member state can levy withholding tax on the dividends of a company (in this case, French subsidiaries) that is paying out dividends to a parent company located in another EU member state. It claims that the withholding tax would not apply if the parent company were located in the same EU member state, or in this instance, France.

A temporary ruling on the case has already been rendered by Advocate General Leendert Geelhoed, who drafted an opinion in favor of the Dutch company. That ruling aligns with earlier comments from the European Federation of Accountants, which discovered that in 2004, Finland, France, Germany, Hungary, Italy, Poland, Spain and Sweden, as well as the U.K., had been applying CFC legislation to subsidiaries in other member states.

While support for the advocate general's opinion by the full ECJ remains uncertain, in 80 to 90 percent of cases the court upholds the interim rulings.

For example, according to Chas Roy-Chowdhury, head of taxation at the London-based Association of Chartered Certified Accountants, the court decision will probably not result in significant claims for tax wrongly paid in the past.

A final court decision on Denkavit is expected before the end of 2006. That, said experts, could lead to a cascade of interpretations of EU law. These could spill into other fields, ranging over such areas as life insurance and pensions.

Peter Schonewille, principal administrator of the direct taxation unit at the European Commission, pointed out that cross-border intra-EU investments accounted for an important share of the total investments of European pension funds.

Another expert, Peter Cussons, international corporate tax partner at PricewaterhouseCoopers, foresees that the Denkavit outcome could go so far as to have a domino effect on the free movement of capital in a portfolio situation, and also to unit trusts.

Where is Europe's Delaware?

Taxation is often described as the last bastion of the sovereignty of national governments in Europe. Critics say that by holding out against pooling their common interests, the governments are undermining economic development in the EU. One result is that nearly one in five in the 18-to-25-year-old age bracket is unemployed.

On a broader scale, the court findings could be seen as a move in the EU against the American "Delaware Effect," which refers to how out-of-state corporations in the U.S. opt to incorporate in Delaware, a state known for its liberal guidelines. In the EU, a more significant factor concerns "competitive de-taxation." For instance, Estonia, the small Baltic state, levies a zero-rate corporation tax to entice inward investment.

A warning against Europe's Delaware and the EU's "race to the bottom" was issued recently in Brussels by the International Confederation of Free Trades Unions. Average corporate tax rates in industrialized countries have fallen from 45 percent to 30 percent in two decades due to tax competition, it stated. In Europe, corporate taxes have, since the 1980s, dropped by 15 percent in the U.K., 22 percent in Italy, and 41 percent in Germany. Lower corporate taxes in both industrialized and developing countries worldwide could lead to major public funding crises, the ICFTU warned.

The delicate matter of bringing corporation tax into line across the EU's single market is illustrated by the tentative approach that the European Commission feels forced to take on steps towards its less vital precursor - a common consolidated corporate tax base. A CCCTB would at least enable companies to follow the same rules for calculating the tax base for all their EU-wide activities, said László Kovács, the EU's commissioner for taxation and customs, adding that the CCCTB would support economic growth, partly by reducing compliance costs for companies operating across the EU. The commission plans to hold back its legislative proposal until 2008.

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