EU Tax Alert > 73 EU Tax Alert

December 2009

Loyens & Loeff is the first firm where attorneys, tax lawyers and civil-law notaries collaborate on a large scale to offer integrated professional legal services in the Benelux countries. Loyens & Loeff is an independent provider of corporate legal services. Our close cooperation with prominent international law and tax law firms makes Loyens & Loeff the logical choice for large and medium-size companies operating domestically or internationally. Editorial board for contact, mail: eutaxalert@loyensloeff.com: - René van der Paardt (Loyens & Loeff Rotterdam) - Thies Sanders (Loyens & Loeff Amsterdam) - Dennis Weber (Loyens & Loeff Amsterdam;University of Amsterdam) Editors: - Renata Fontana (Loyens & Loeff Amsterdam) - Patricia van Zwet Correspondents: - Peter Adriaansen (Loyens & Loeff Rotterdam) - Séverine Baranger (Loyens & Loeff Luxembourg) - Gerard Blokland (Loyens & Loeff Amsterdam) - Alexander Bosman (Loyens & Loeff Rotterdam) - Kees Bouwmeester (Loyens & Loeff Amsterdam) - Joke Brabants (Loyens & Loeff Brussels) - Renata Fontana (Loyens & Loeff Amsterdam) - Alexander Fortuin (Loyens & Loeff Frankfurt) - Raymond Luja (Loyens & Loeff Amsterdam; Maastricht University) - Patrick Vettenburg

1. Top News ECJ holds Italian dividend withholding tax on intra-Community distributions incompatible with EC law (Commission v Italy) Advocate General concludes that Netherlands rules providing for option to be taxed as resident are incompatible with EC law (Gielen) Advocate General Kokott accepts restriction of cross-border losses (X Holding) ECJ rules on deduction of VAT on costs relating to the sale of shares in subsidiaries and controlled companies (AB SKF)

2. State Aid/WTO

ECJ rules Sardinian airport tax to be both an infringement of freedom of services and State aid (Presidente del Consiglio dei Ministri v Regione Sardegna) Hungarian intra-group tax regime declared existing aid Spanish goodwill scheme declared illegal aid and is to be recovered in part Italian urban tax-free zones authorised as State Aid Commission continues two infringement proceedings against Spain Developments in the Netherlands: Netherlands government abandons plans for mandatory group interest box and proposed limitations on interest deduction

3. Direct Taxation

ECOFIN seeks agreement on Directive on administrative cooperation in the field of taxation European Economic and Social Committee publishes opinion on proposal for Council Directive amending the Savings Tax Directive Commission requests Belgium to change its legislation implementing the Parent-Subsidiary Directive Commission requests France to abolish tax discrimination against foreign public interest and not-for-profit bodies Commission takes steps against Lithuania on taxation of interest and royalties Developments in Belgium: Belgian tax authorities publish further Circular on the implementation of ECJ’s decision in Cobelfret Developments in UK: High Court holds UK thin capitalization rules incompatible with EC law (Thin Cap Group Litigation follow up) Developments in Luxembourg: Amendments to the implementation of the Savings Directive Developments in Luxembourg: Donations to non-profit institutions in EU and EFTA Member States

4. VAT

ECJ holds supply of land with partially demolished dilapidated building can be taxed with VAT by virtue of law (Don Bosco Onroerend Goed) ECJ holds sale of self-constructed real estate by building business is not an incidental transaction (NCC Construction Danmark A/S) ECJ concludes Finnish VAT exemption for of public legal aid compatible with Sixth VAT Directive (Commission vs Finland) The Commission tackles eight Member States over the application of the VAT grouping rules Commission requests France to change its legislation on building land and no longer to exempt supplies to natural persons Commission calls on Greece to apply a uniform VAT rate to the provision of bowling facilities Commission starts infringement procedure against Poland regarding the refund of VAT to non-established taxable persons Commission pursues infringement procedure against Austria regarding the deduction of VAT on construction costs of mixed-use buildings Commission requests the Netherlands to change its legislation on fundraising

activities Commission requests France to bring its tax representative (répondant fiscal) provision into line with the VAT Directive

5. Customs Taxes and Excise Duties

The Heraklion declaration Agreement on reform of excise duties on cigarettes and other tobacco products ECJ rules upon classification of frozen cuts or offal of cocks and hens and transitional measures related to surplus stocks (Rakvere Lihakombinaat) Advocate General opines on preferential treatment of goods originating in Israeli-occupied settlements (Brita) Commission requests France to abolish its strict quantitative limits on private individuals' tobacco purchases in other Member States Commission requests France to change a discriminatory aspect of its legislation relating to the 'malus tax' for second-hand vehicles imported from other Member States

6. Capital Duty

ECJ holds Polish taxation of conversion of loans into share capital incompatible with EC law (Elektrownia Patnów)

(Loyens & Loeff Eindhoven) Although great care has been taken when compiling this newsletter, Loyens & Loeff N.V. does not accept any responsibility whatsoever for any consequences arising from the information in this publication being used without its consent. The information provided in the publication is intended for general informational purposes and can not be considered as advice.

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1. Top News ECJ holds Italian dividend withholding tax on intra-Community distributions incompatible with EC law (Commission v Italy)

On 19 November 2009, the ECJ rendered its judgment in the Commission v Italy case (C-540/07), concerning the compatibility of the Italian dividend withholding tax with the free movement of capital vis-à-vis Member States and EEA countries (Articles 56 EC and 40 EEA) and the freedom of establishment with respect to EEA countries (Article 31 EEA), since Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States (the ‘Parent-Subsidiary Directive’) is not applicable to the latter.

In essence, the Commission criticized the fact of the dividends distributed by Italian companies to resident companies being subject to a lower tax burden when compared to dividends paid to companies established in other Member States or EEA countries. Under article 89(2) of Testo unico delle imposte sui redditi approved by Presidential Decree no. 917 of 22 December 1986 (‘TUIR’), Italian companies are entitled to a 95% exemption on the dividends received and the remainder (5%) is taxed at 33%, resulting in an effective tax burden of 1.65%. Pursuant to article 27(3) of Presidential Decree no. 600 of 29 September 1973 (‘DPR 600/73’), a 27% dividend withholding tax is levied from non-resident beneficiaries, and up to 4/9 of this tax can be reimbursed upon request, amounting to an effective tax burden of 15%. When a double tax treaty applies, the dividend withholding tax is partially reduced to 5% and 10%, but it is still higher than the taxation applicable to purely domestic situations.

Following Advocate General Kokott’s Opinion of 16 July 2009 (see EU Tax Alert edition no. 69, August 2009), the ECJ ruled that the difference in treatment between domestic and cross-border dividends created by the Italian dividend withholding tax represents a restriction to the free movement of capital within the EU, in violation of Article 56 EC. Against the argument put forward by the Italian government that double tax treaties neutralize the restriction imposed by the source State, the ECJ observed that the difference in treatment can only be neutralized by the resident State where the company receiving the dividends is established, when it imposes enough tax to absorb the ordinary credit resulting from the tax withheld at source. When the resident State does not tax the dividends or taxes them at a lower rate, the difference in treatment is not neutralized by the ordinary credit provided under a double tax treaty. Furthermore, the ECJ noted that this argument did not hold true in relation to dividends distributed to companies established in Slovenia since Italy had not concluded a treaty with that country.

The ECJ rejected all the justifications presented by Italy, based on fiscal coherence, allocation of taxing powers and risk of tax evasion or avoidance, and concluded that

had Italy failed to fulfil its obligations under Article 56 EC by imposing a higher burden on companies residing in other Member States and receiving dividends from Italian companies. As to the dividends paid to EEA countries, the ECJ concluded that the violation of Articles 31 and 40 EEA imposed by the Italian legislation at issue must be regarded as justified for the overriding reason in the public interest concerning the fight against tax evasion, and as appropriate to ensure the realisation of the objective in question without going beyond what it necessary in order to attain it. The Court noted that the framework of cooperation between the competent authorities of the Member States established by Council Directive 77/799/EEC of 19 December 1977 (the ‘Mutual Assistance Directive’) does not exist with respect to a non-Member State (such as EEA countries) when the latter has not entered into any undertaking of mutual assistance. Italy has not signed a double tax treaty nor an exchange of information treaty with Liechtenstein and the double tax treaties concluded with Iceland and Norway do not contain provisions laying down an obligation to supply information.

^ top Advocate General concludes that Netherlands rules providing for option to be taxed as resident are incompatible with EC law (Gielen)

On 27 October 2009, Advocate General Colomer issued his Opinion in the Gielen case (C-440/08). A non-resident self-employed individual (the ’Interested Party’), who was a resident of Germany, had a permanent establishment in the Netherlands. Although in the relevant tax year the Interested Party had spent more than 1,225 working hours in his business, he had spent less than 1,225 hours in his permanent establishment located in the Netherlands. In his tax return filed in the Netherlands, the Interested Party deducted an amount, which is granted to entrepreneurs who spend more than 1,225 working hours in their business. The tax inspector refused to grant this deduction, since the taxpayer had spent less than 1,225 working hours in the Netherlands. The Interested Party disagreed with this approach.

Following litigation, the Dutch Supreme Court referred the preliminary questions of whether this difference of treatment is precluded by Article 43 EC and whether a restriction (if present) can be removed as a non-resident can opt to be taxed as a resident taxpayer.

The Advocate General is of the opinion that the Dutch legislation resulted in a different treatment of non-residents, as non-resident entrepreneurs were required to work for at least 1,225 hours in the Netherlands in order to benefit from the deduction for the self-employed, whereas residents could take into account both the number of hours worked in the Netherlands and abroad to meet that threshold. In addition, Advocate General Colomer considered that the deduction at issue related to an activity generating taxable income, rather than the taxpayer's personal and family circumstances. Therefore, in respect of the deduction at issue, the situation of a non-resident self-employed individual was comparable to that of a resident self-employed individual, in the light of ECJ’s judgment in the Gerritse case (C-234/01).

Accordingly, the Advocate General was of the view that the provision at issue was discriminatory, as, unlike residents, non-resident self-employed individuals could not take into account the number of hours worked abroad, in order to claim the deduction. Advocate General Colomer further examined whether or not the discriminatory treatment of non-residents could be justified by the option to be taxed as a resident taxpayer, which was available to non-residents. In the Advocate General's view, the option was not capable of neutralizing the discriminatory treatment of non-residents. Advocate General Colomer also reviewed whether or not non-resident taxpayers using the option were in the same position as residents. That was not the case, due to a higher administrative burden for a non-resident and certain recapture rules. Unlike residents, a non-resident taxpayer making use of the option at issue had to declare his worldwide income in two Member States and, accordingly, his accounting had to comply with the requirements of two different tax systems.

^ top Advocate General Kokott accepts restriction of cross-border losses (X Holding)

On 19 November 2009, Advocate General Kokott issued her Opinion in the proceedings before the ECJ in the X Holding case (C-337/08). According to the Advocate General, the Netherlands is not obliged to allow a cross-border fiscal unity for Dutch corporate income tax purposes for the sake of horizontal carry-over losses. The Advocate General does, however, leave open the possibility that other advantages of the fiscal unity do have to be allowed to Netherlands parent companies of foreign subsidiaries.

In 2003, X Holding BV, a company resident in the Netherlands, requested to be included in a fiscal unity for corporate income tax purposes with its subsidiary F, a company resident in Belgium. The Netherlands tax authorities refused the fiscal unity, since F does not meet the applicable requirements that it is either resident in the Netherlands for tax purposes, or that it has a permanent establishment in the Netherlands. According to X Holding BV, the refusal to allow a (cross-border) fiscal unity is incompatible with EC law.

According to the Advocate General, the fact that only domestic subsidiaries may be included in a fiscal unity whereas foreign subsidiaries cannot constitutes, in principle, a restriction on the freedom of establishment (Article 43 in conjunction with Article 48 EC). With regard to the justification of this restriction, the Advocate General found the following

The refusal of a cross-border fiscal unity with the view to excluding cross-border loss relief is justified by safeguarding of the allocation of the power to impose taxes The refusal to allow (by refusal of cross-border fiscal unity) a fiscally neutral reorganisation and to transfer assets free of tax could also be justified by safeguarding of the allocation of the power to impose taxes, but the Netherlands rule must be suitable and necessary in order to achieve this object. The Advocate General leaves this up to the Supreme Court to decide. The Advocate General stated the same about the taxing of internal transactions as a consequence of the refusal of a cross-border fiscal unity.

Preliminary comments The emphasis in the Advocate General’s Opinion lies strongly on the question of whether it should be possible to set off losses of a foreign subsidiary against profits of a Netherlands parent company. By answering this question separately, apart from the other aspects of the fiscal unity mentioned, the Advocate General follows the approach taken in the recent case law of the Netherlands Supreme Court, whereby the justification of the discrimination in the Netherlands fiscal unity legislation is tested element-for-element.

The Advocate General has now thus come to the conclusion that a fiscal unity may be refused in order to exclude cross-border loss relief In the ‘element-for-element’ approach, however, all other aspects of the fiscal unity will have to be tested separately – where necessary in new proceedings – as to whether they constitute a disproportionate restriction. This applies, for example, to the possibility already referred to by the Advocate General to carry through tax free reorganisations within the fiscal unity, but equally to the mitigating effect that the fiscal unity has on the interest deduction measures which were proposed in the Consultation Document of 15 June 2009.

Please note that the Advocate General’s Opinion only represents an advice to the ECJ. The ECJ is not required to follow this advice. The ruling of the ECJ is expected in the first half of 2010.

^ top ECJ rules on deduction of VAT on costs relating to the sale of shares in subsidiaries and controlled companies (AB SKF)

On 29 October 2009, the ECJ rendered its long-awaited decision in the AB SKF case (C-29/08). AB SKF is a Swedish company holding of an industrial group that is active in various countries. The holding company intended to sell one of its subsidiaries and a minor part (26,5%) of the shares it held in another controlled company, which company had been fully owned by AB SKF in the past. AB SKF supplies services for consideration both to the subsidiary and to the controlled company in the field of management, administration and marketing policy. Those services are subject to VAT. Relating to the sale of the subsidiary and the sale of shares in the controlled

company, AB SKF wished to purchase various services for which it would be charged with VAT. To have certainty about the VAT issues, AB SKF requested the Swedish Revenue Law Commission for a preliminary decision on the right to deduct that input VAT.

The Revenue Law Commission decided that a right to deduct the input VAT related to both sales existed. However, the Swedish Tax Agency appealed the decision and brought the case before the Swedish Court. The Swedish Court decided to refer the following preliminary questions to the ECJ:

1. Are Articles 2 and 4 of the Sixth VAT Directive (currently Articles 2 and 9, EC VAT Directive) to be interpreted as meaning that, where a taxable person liable for VAT on supplies of services to a subsidiary disposes the shares in that subsidiary, that disposal is a transaction subject to VAT?

2. If so, is the disposal covered by the exemption provided for by Article 13 B under d, 5 of the Sixth VAT Directive (currently Article 135, first paragraph under f, EC VAT Directive) in respect of transactions in shares?

3. Regardless of the answers to the first two questions, can there be a right to deduct input VAT on costs directly attributable to the disposal of shares, in the same way as there is a right to deduct input VAT on general costs?

4. Is it of significance for the answers of the first three questions if the disposal of shares in a subsidiary takes place not at once but in stages?

In the light of its case law on the VAT position of holding companies, the ECJ decided to answer the first question such that, where a parent company disposes of all of the shares in a fully owned subsidiary or controlled company that was previously fully owned, and the parent company had supplied VAT taxable services to those subsidiaries, the sale of shares is deemed to be an economic activity for VAT purposes. However, the ECJ also indicated, without being asked in the preliminary questions, that the transfer of shares in such situation might be considered as a transfer of a going concern as mentioned in Article 5, eight paragraph, Sixth VAT Directive and Article 19, EC VAT Directive. Whether or not such is the case, is a question for the national courts to decide in the case the relevant Member State has chosen to exercise the option provided in the aforementioned articles.

Regarding the second question, the ECJ answered, rather briefly, that if the disposal of the shares constitutes an economic activity, the disposal itself is always exempted from VAT pursuant to Article 13 B, under d, 5 of the Sixth VAT Directive and Article 135, first paragraph under f of the EC VAT Directive. As to the third question, the ECJ decided to answer that a right to deduct input VAT on costs for the sale of shares exists if there is a direct and immediate link between the costs associated with the input services and the overall economic activities of the taxable person. The ECJ then addressed the national courts by deciding that it was up to them to take account of all of the circumstances surrounding the share transactions, such as in this case, and to determine whether the costs incurred are likely to be incorporated in the price of the sold shares or whether they are among only the cost components of transactions within the scope the taxpayers’ economic activities. Finally, the ECJ ruled that the foregoing answers to the preliminary questions were not affected by the fact that the disposal of shares is carried out at once or by way of several successive transactions.

^ top 2. State Aid/WTO ECJ rules Sardinian airport tax to be both an infringement of freedom of services and State aid (Presidente del Consiglio dei Ministri v Regione Sardegna)

On 17 November 2009, the ECJ rendered its judgment in the Presidente del Consiglio dei Ministri v Regione Sardegna case (C-169/08), concerning the compatibility of the Sardinian airport tax with EC law. In 2006, Sardinian regional authorities introduced a tax on stopovers of aircraft and boats from June through September, i.e. during the tourist season. Vessels excluded from this tax are, amongst others, boats normally lying in local harbours. First, the ECJ ruled that, given the environmental objective of the stopover tax, it is unwarranted to make a difference between local operators (who pay general taxes) and operators from outside Sardinia that would be paying the stopover tax. The service recipients – the natural or legal persons using the stopover service (i.e. tourists) – are considered to be in an objectively comparable situation. As

a result, the difference in taxation is deemed disproportional in light of the environmental justification of the tax. Given the differences between general taxes in Sardinia and the specific tax on stopovers, the cohesion of the tax system can also not be accepted as a justification of the infringement of the freedom to provide services vis-à-vis the undertakings whose tax domicile is outside of Sardinia.

Moreover, the ECJ ruled that the exclusion of local undertakings from the stopover tax would also amount to State aid. Since the undertakings performing the stopover service are in a comparable situation whether their tax domicile is inside or outside Sardinia, the tax exemption would confer a benefit in favour of local undertakings.

Preliminary comments It should be noted that the ECJ’s latter finding is disputable given that the facts of the case do not clarify whether the majority of stopovers were provided by non-resident undertakings. It does seem that the ECJ assumed, without referring the matter back to the national court, that the majority of undertakings would be paying the stopover tax – the benchmark – while local companies would profit from being exempted from such tax, in which case, this would indeed have resulted in a financial advantage. If the ECJ meant to establish that, given that all companies are in a comparable situation, any exemption of the tax would lead to aid (even if all but few companies would actually be exempted), the State aid definition of Article 107(1) of the Treaty on the Functioning of the European Union (‘TFEU’) which came into effect on 1 December 2009 (i.e. identical to the former Article 87(1) EC), would have been changed substantially overnight. Future ECJ rulings, therefore, will have to be awaited in order to clarify this issue.

^ top Hungarian intra-group tax regime declared existing aid

On 30 October 2009, after more than 2½ years, the State aid investigation into a Hungarian 2003 intra-group interest incentive was closed. The incentive would allow for a tax deduction of 50% of net interest received from affiliated companies, while the affiliated company would have to add that same amount to the tax base. This, therefore, would result in a shift in tax base between the interest recipient and the interest payer. The Commission found the incentive to be State aid, but given its introduction prior to Hungary’s accession to the EU in 2004 and uncertainties regarding its State aid character, the Commission deemed the regime to be existing aid. As a result, there will be no recovery of aid already granted. The Commission will also not initiate proceedings to bring the regime to an end since Hungary is to repeal the scheme as from 1 January 2010.

Preliminary comments It should be noted that the Commission referred to the ‘pre-accession’ context of the Hungarian regime and the Commission’s own decision-making practice in respect of the Belgian Coordination Centre (‘BCC’) regime back in 1984 and 1987 to establish special circumstances warranting non-recovery by deeming the regime to be existing aid. Although the Commission’s final ruling in respect of the BCC regime dated from February 2003, its opening of a formal investigation in 2001 would normally have been considered a signal to other parties that relying on any previous assessment could not be done without restraint. While this again seems to establish a dangerous precedence for the adherence to State aid recovery procedures – given that Hungary had a chance to bring up the regime during accession negotiations and thereafter – there would seem to be a second contradiction. According to the final decision, the exclusion of small and medium-sized enterprises from the regime in itself constituted unwarranted ‘selectivity’ of the regime, which should have been clear to all those involved even prior to the introduction of the Hungarian regime in 2003. This would have allowed for an alternative ruling of new aid which, given that it had been granted unlawfully, could have been the subject of a recovery order all the same.

Some attention should also be given to the Commission’s finding that the optional character of the Hungarian regime contributed to its selectivity because of a differentiated treatment between group companies, since such regime would not apply to all group companies but only to those that decided to opt-in for the fiscal year concerned. Regretfully, the Commission did not provide grounds to substantiate this claim, while it has not been disputed that those companies that did not opt-in could have chosen to do so anyway. Hopefully, future decisions will clarify this matter.

^ top

Spanish goodwill scheme declared illegal aid and is to be recovered in part

On 28 October 2009, the Commission ruled that a Spanish allowance to write off goodwill that arose when acquiring non-Spanish companies constitutes State aid. It would allow Spanish companies an advantage in competitive takeover bids. In respect of takeovers within Spain, amortisation would only be allowed upon full consolidation of businesses into one entity, which would not be required in an EU context. Any write off allowed on European acquisitions since 21 December 2007 will be subject to a recovery order while the Commission continues its investigation into non-EU takeovers. According to the press release, recovery will not cover the period between 2002 and 21 December 2007 (the date at which the formal investigation into the scheme was opened), due to the existence of (unspecified) legitimate expectations.

^ top Italian urban tax-free zones authorised as State Aid

On 28 October 2009, the Commission approved of an Italian plan to introduce tax-free zones in 22 deprived areas, allowing micro and small enterprises to start up new business activities and be eligible for a number of tax exemptions (among which income tax, municipal real estate taxes and levies from wages). Given, amongst others, the combating of social exclusion, the size of businesses covered and the very limited geographical scope of the measure (given the deprivation of the areas selected, covering <1% of total population), the Commission concluded that the effect on intra-Community trade would be very limited and acceptable in light of the intended upgrading of deprived urban areas.

^ top Commission continues two infringement proceedings against Spain

On 20 November 2009, the Commission decided to continue two infringement proceedings against Spain in respect of potential non-compliance with State aid recovery decisions. One decision concerned action taken for not executing a 1989 recovery order against members of the Magefesa Group which received fiscal aid. In 2002, the ECJ had confirmed that Spain had failed to implement the decision effectively and in a timely manner. The Commission now asks for information about measures taken to comply in order to assess whether Spain has fulfilled its duty to recover. If, based on this information, it becomes clear that Spain has not fully complied, the Commission may again issue a reasoned opinion formally requesting Spain to comply, which can be followed by a second reference to the ECJ in order to have fines imposed until such time the order to recover has been complied with. The Commission had already issued such an opinion in respect to the non-compliance with a 2001 order to recover fiscal aid granted by means of a corporate tax exemption for newly created firms in two Basque Provinces back in 1997. After a 2007 ruling by the ECJ that Spain had failed to implement the recovery decision, the Commission has now decided to issue this second opinion as a result of information it received after a request in April 2009, establishing that the aid had not been recovered in full.

^ top Developments in the Netherlands: Netherlands government abandons plans for mandatory group interest box and proposed limitations on interest deduction

On 5 December 2009, the Netherlands government sent a letter to Parliament, as a follow-up to the Consultation Paper released on 15 June 2009, in which it announced that it had abandoned plans to introduce a long anticipated mandatory group interest box and certain measures to restrict the deductibility of interest in the near future. The feasibility of these measures may be taken into account in a broader study of the Dutch tax system which is currently under the scrutiny of a specific Study Committee.

Mandatory group interest box Pursuant to the anticipated mandatory group interest box, the balance of qualifying items, such as group interest income and interest expenses, would be subject to an effective tax rate of 5%. Further to the response to the Consultation Paper, it has become clear to the government that a mandatory group interest box could possibly

have negative consequences for (foreign) investment in the Netherlands. If the proposal is amended to counter this effect, it is questionable whether the revised proposal would still fall within the scope of the European Commission’s approval of the mandatory group interest box. The government wishes to introduce a mandatory group interest box only if the negative effects on the investment climate for (foreign) investment in the Netherlands can be avoided. Based on the current insights, however, the government has significant doubts as to whether this will be possible and, therefore, has abandoned plans to introduce the mandatory group interest box for the time being.

Other interest deduction limitations The introduction of two alternative measures, as discussed in the Consultation Paper, to partially disallow the deduction of (third party and group) financing expenses (i.e. deductibility of interest on loans attributable to participations and a general ‘earnings stripping’ measure) has been abandoned. After further consideration, the government has doubts as to whether (certain aspects of) both measures are compatible with EC law.

^ top 3. Direct Taxation ECOFIN seeks agreement on Directive on administrative cooperation in the field of taxation

During the ECOFIN meeting held in Brussels on 10 November 2009, the Council examined a draft directive aimed at strengthening cooperation between the Member States in the field of taxation. The Council reached agreement on the text of the directive, whilst noting political reservations made by the Austrian and Luxembourg delegations and the need for further work on the automatic exchange of information. It asked the Permanent Representatives Committee to re-discuss these issues so that a final position can be taken at the Council meeting on 2 December 2009.

Background As previously reported (see EU Tax Alert no. 63, February 2009), the Commission presented, on 2 February 2009, a proposal for a Council Directive on administrative cooperation in the field of taxation, especially as regards direct taxation. The draft directive is aimed at fulfilling the Member States' growing need for mutual assistance in tax matters, especially as regards the exchange of information. With greater taxpayer mobility, a growing volume of cross-border transactions and the internationalisation of financial instruments, it is intended to enable the Member States to better assess taxes due. One of a number of measures implementing the EU's strategy, launched in 2006, to better combat tax fraud and tax evasion, the text provides for an overhaul of Directive 77/799/EEC, on which administrative cooperation has been based since 1977.

^ top European Economic and Social Committee publishes opinion on proposal for Council Directive amending the Savings Tax Directive

In September 2008, the Commission presented a report to the Council on the impact of Directive 2003/48/EC on taxation of savings income in the form of interest payments (the ‘Savings Tax Directive’), based on consultations with the Member States' tax administrations, with regard to the first two years of implementation (see EU Tax Alert edition no. 59, October 2008). The positive findings of this report encouraged the Commission to press on with refining the original Savings Tax Directive, whilst extending its scope. Thus, new definitions of beneficial owner and paying agent have been introduced, the Savings Tax Directive has been extended to cover the benefits of a wider range of financial products, and numerous procedural aspects have been revised or amended. On 2 December 2008, the Council decided to consult the European Economic and Social Committee (the ‘Committee’), under Article 94 EC, on the Proposal for a Council Directive amending the Savings Tax Directive (see EU Tax Alert edition no. 61, December 2008).

On 17 November 2009, the Committee published Opinion 2009/C 277/23 endorsing proposed amendments to the Savings Tax Directive but called for changes to the proposed amendments to ensure that they lessened the administrative burden on

operators and achieved other objectives. According to the Committee, the cost should be borne not only by the operators, and thus the market in general, but also by the tax administrations, because of both the management element and the need for more accurate and extensive controls. Simplification is not always easy but, however, it remains a necessity. The Committee pointed out, however, that an issue of greater concern than the cost should be the quality of the resulting information: difficult or complicated rules often give rise to poor quality information. The Committee also emphasized the need to avoid a situation where the new rules are to be applied unilaterally by the EU: lack of agreements with third countries and the agreement countries could trigger a large-scale shift of operations away from Europe to other areas. At the same time, this would risk greatly distorting competition between Europe and the rest of the world. Therefore, the Committee is of the opinion that the EU should enter into negotiations to agree the simultaneous adoption of similar measures in the main global financial markets.

^ top Commission requests Belgium to change its legislation implementing the Parent-Subsidiary Directive

On 20 November 2009, the Commission sent a reasoned opinion to Belgium requesting it to amend its rules implementing the Parent-Subsidiary Directive. If Belgium does not reply satisfactorily to this reasoned opinion within two months, the Commission may refer the matter to the ECJ.

Article 3 of the Parent-Subsidiary Directive provides that it must be applied when a company has a minimum shareholding of 10% in the capital of a company of another Member State, leaving no room for further conditions. Belgian legislation, however, also requires that this shareholding must be considered a so-called ’fixed financial asset‘ for the Parent-Subsidiary Directive to apply. Hence, the Belgian rules implementing the Parent-Subsidiary Directive introduce an additional condition to the conditions specified in Article 3 thereof.

^ top Commission requests France to abolish tax discrimination against foreign public interest and not-for-profit bodies

On 20 November 2009, the Commission formally requested France to change its tax regime for donations to public interest bodies and not-for-profit bodies based in other EU or EEA Member States. France grants public bodies and public interest bodies, including charities, an exemption from dividend tax and transfer duties on donations only if they are established in France. In addition, France grants tax deductions to donors only for donations or contributions paid to not-for-profit bodies carrying out their activities in France. The Commission has sent the French authorities a ‘reasoned opinion’, which is the second stage of the infringement procedure laid down in Article 226 EC. If France does not agree to amend its legislation within the two months following the Commission's letter, the Commission may decide to refer the matter to the ECJ.

The French tax legislation currently in force lays down a system of exemptions for public bodies and public interest bodies based in France and for not-for-profit bodies carrying out their activities in France from dividend tax and transfer duties on donations and bequests. By contrast, similar bodies established or active in the other Member States and EEA countries are subject to tax at 60% of the value of the donations or bequests received (calculated net of an allowance of EUR 1,520). However, by way of exception, some bilateral agreements entered into by France allow for the application of these tax advantages on a reciprocal basis. There is also a fiscally advantageous regime for French taxpayers who make donations or contributions to public interest bodies as defined by law that carry out their activities (philanthropic, cultural, religious, educational, etc.) in France. According to ECJ case law, particularly the judgment of 27 January 2009 in the Persche case (C 318/07), the different tax regimes for donations to French bodies and those to foreign bodies constitute an unjustifiable obstacle to the free movement of capital.

^ top Commission takes steps against Lithuania on taxation of interest and royalties

On 20 November 2009, the Commission sent an additional reasoned opinion (the second step of the infringement procedure of Article 226 EC) to Lithuania about its rules under which interest paid to foreign variable capital investment companies and closed-end investment companies (including investment funds and pension funds) is taxed more heavily than interest paid to comparable domestic recipients. The additional reasoned opinion extends the scope of a reasoned opinion that had been sent to the Lithuania on 28 February 2008 (see EU Tax Alert edition no. 54, April 2008), dealing in greater detail with the higher taxation of interest income paid by Lithuanian companies to non-resident variable capital investment companies and closed-end investment companies. The additional reasoned opinion also addresses the taxation of royalty payments to non-resident companies. Lithuania is requested to reply within two months, or the case might be brought before the ECJ.

If a Member State levies a higher tax on interest paid to foreign investors this may dissuade these investors from investing in its companies. Equally, companies established in that Member State might face increased difficulties in attracting capital from non-residents. The higher taxation of non-resident companies may thus result in a restriction of the free movement of capital. In the case of interest and royalty payments, where resident companies can deduct expenses related to such income from their taxable income whereas non-resident companies are denied such deduction, this may also result in a restriction of the freedom to provide services. The Commission is not aware of any justification for such restrictions.

^ top Developments in Belgium: Belgian tax authorities publish further Circular on the implementation of ECJ’s decision in Cobelfret

On 12 October 2009, the Belgian tax authorities published a second Circular on the implementation of the ECJ’s decision in Cobelfret (C-138/07). This second Circular is complementary to the first Circular of 23 June 2009 (see EU Tax Alert edition no. 68, July 2009), and specifies which dividends qualify for the carry forward of the non-deductible part of the (foreign) dividend deduction.

The first Circular stated that the carry forward applies to dividends received from

1. Belgian resident companies as from 1 January 1992; 2. companies resident in another EU Member State as from 1 January 1992, or (if

later) as from the date on which the Member States joined the EU; and 3. companies resident in another EEA Member State as from 1 January 1994.

Dividends received from Liechtenstein, however, do not qualify for the carry forward as Liechtenstein does not exchange information.

The second Circular now specifies the conditions under which the carry forward also applies to dividends received from third countries. It should be noted, however, that the Belgian tax authorities accept that, when applying the dividend participation exemption, first dividends received from third countries may be deducted. Hence, this question becomes less relevant as the risk that the (foreign) dividend deduction for these dividends is lost, is reduced significantly.

The second Circular states that the carry forward might also apply to dividends received from

1. a third country with which Belgium has entered into a double tax treaty, provided that the carry forward would have applied had both companies been established in Belgium. The application of this so-called ‘equal treatment clause’ is not automatically accepted but has to be requested by way of a tax complaint, a request for an official exoneration or the procedure for mutual agreement (if provided for by the treaty). In this case, the carry forward is applicable as from the day on which the double tax treaty became effective.

2. another third country if the free movement of capital was applicable, i.e. if the parent company has a participation that does not allow it to influence the business decisions of its subsidiary nor determine its activities. The tax authorities refer in this regard to the ECJ’s judgment in the joined cases KBC Bank (C-439/07) and Beleggen, Risicokapitaal, Beheer NV (C-499/07). However, the Circular does not explicitly state that there is a restriction of the free movement of capital but only that, in such case, it should be examined whether or not a restriction to the free movement of capital would exist.

The above order is also the order that should be followed when requesting the carry forward. The carry forward should thus first be requested on the basis of the double tax treaty and, but only if that is not possible, it should be examined whether the freedom of capital can be invoked.

^ top Developments in UK: High Court holds UK thin capitalization rules incompatible with EC law (Thin Cap Group Litigation follow up)

On 17 November 2009, the UK High Court rendered its judgment in the Test Claimants in the Thin Cap Group Litigation, following the ruling of 13 March 2007 given by the ECJ on case C-524/04 (see EU Tax Alert edition no. 48, April 2007).

The question before the ECJ in the Thin Cap Group Litigation case concerned the compatibility of the UK thin capitalization legislation with the EC Treaty provisions on the freedoms. The UK legislation under consideration covered four periods:

until 1995, Sec. 209 of the Income and Corporation Taxes Act 1988 (‘ICTA’) provided that any interest paid to any non-UK resident lender that was a member of the same group was treated as a distribution: this treatment was modified by the provisions of certain double tax conventions (‘DTCs’) concluded by the UK. in 1995, the law was amended to provide that interest paid between group members was treated as a distribution to the extent that it exceeded the arm's length amount, except if both payer and payee were subject to corporate income tax (‘CIT’) in the UK. in 1998, the transfer pricing rules, which apply to companies under common control, were extended to interest payments; these rules did not apply, inter alia, if both parties were liable to the UK CIT. in 2004, the transfer pricing regime was extended to transactions where both parties were subject to UK CIT.

Each of the test cases involved loans to a UK resident subsidiary that was, directly or indirectly, at least 75% owned by a parent company established in another Member State or in a third State (i.e. outside the EU), granted either by the parent or by another lending company belonging to the same group, established in another Member State (directly or through a permanent establishment in a third State) or in a third State.

On 13 March 2007, the ECJ held that the UK thin cap rules, as applied before 2004, constituted a breach of Article 43 EC and that such restriction may be justified where it specifically targets wholly artificial arrangements, which do not reflect economic reality, with a view to escaping the tax normally due. Accordingly, in order to meet the proportionality test, the UK thin cap legislation must (i) give the taxpayer an opportunity, without being subject to undue administrative constraints, to provide evidence of any commercial reasons there may have been for entering into a transaction; and (ii) if the re-characterisation of interest paid as a distribution is limited to the proportion of the interest which exceeds that which would have been agreed had the relationship between the parties been at arm’s length.

The ECJ concluded that, between 1988 and 1995, the UK legislation did not satisfy those conditions where a DTC was not applicable. By contrast, where a DTC was applicable, and between 1995 and 2004, the second condition was indeed satisfied. In that context, the ECJ left it up to the national court to determine whether the UK legislation satisfied the first condition mentioned above. Furthermore, the ECJ resolved that freedom of establishment does not prevent the UK thin cap legislation from applying to the situations where the ultimate parent company, the lending company (which does not itself control the borrowing UK company) or its permanent establishment are located in a third State.

The High Court had to further examine whether the UK thin cap rules, as applied before 2004, were proportionate to achieve the purpose of preventing abusive tax avoidance (i.e. first condition mentioned above). It is common ground that the arm's length test endorsed by the OECD and applied by the UK (via DTCs prior to 1995, and directly by section 209(2)(da) of the ICTA thereafter) is an appropriate and EC law-compliant tool to use for this purpose. The dispute, in essence, is whether (as submitted by the UK Revenue) the arm's length test is the only one that needs to be applied, or whether (as submitted by the claimants) the taxpayer must also have the

opportunity to demonstrate that there was a commercial justification for the impugned loan arrangement, even if it fails the arm's length test.

After an extensive analysis of the ECJ case law, the High Court concluded that UK thin capitalization provisions at all material times infringed Article 43 EC, because of their failure to provide a separate and independent defence of genuine commercial justification, afforded in good faith and of which the taxpayer can in practice take advantage, even if the terms of the transaction are not at arm's length. The effect of the infringement is that the UK thin cap provisions must be disapplied in relation to transactions which had a genuine commercial justification, either in whole or in any relevant part, since the UK arm's length test cannot be interpreted as purporting to be, or in itself being subject to, a further subjective test of commercial justification. Furthermore, if the UK Revenue wished to establish the contrary in any given case, the High Court ruled that the onus is on them to do so by positive evidence, and not merely as an inference to be drawn from the fact that the arm's length test under the rules in force at the relevant time was not satisfied.

The High Court went on to examine the factual circumstances of the cases at dispute in the main proceedings and concluded that none of the transactions entered into by the test claimants were, either wholly or in any relevant part, purely artificial arrangements devoid of any commercial justification, nor had the Revenue sought to establish that they were. It followed that the UK thin cap provisions must be disapplied in relation to all of these transactions.

In line with the ECJ ruling of 13 March 2007, the High Court observed that Article 43 EC was not engaged, and there was no breach of it, in a situation where the UK subsidiary to which a loan is made has an EU resident parent, but the lending company is neither itself an EU resident nor the subsidiary of an EU resident parent.

As to the remedies available under English law, the High Court ruled that, apart from claims for the recovery of additional corporation tax or ACT actually paid as a result of the operation of the thin cap provisions (together with associated claims for interest or loss of use of the money so paid), the only claims which are properly to be characterised as restitutionary claims under Community law were the ones based on the use of trading losses or capital allowances to set off against unlawful tax. The High Court then ruled that the UK's breaches of Community law were regarded as sufficiently serious as of 12 December 2002, when the ECJ delivered its judgment in the Lankhorst-Hohorst case (C-324/00), and that the extended limitation period section 32(1)(c) of the Limitation Act 1980 should begin to run from this date.

Finally, the High Court rejected IBM's separate claim based on the non-discrimination article in the 1975 DTC between the USA and the UK.

^ top Developments in Luxembourg: Amendments to the implementation of the Savings Directive

Following a notification from the Commission of 25 June 2009, the Luxembourg Tax Administration published on 12 October 2009 a circular on the extension of the scope of application of the Savings Tax Directive to beneficial owners who benefit from the ‘non-domiciled resident’ status in their country of residence. The Circular removed point 3 of Circular 29 June 2005, according to which, the Savings Tax Directive did not apply if the beneficiary of the interest was fully exempt from individual income tax or exempt from the interest income. Accordingly, the Savings Tax Directive will also apply from 1 January 2010 if (i) the paying agent has proof that the beneficial owner of the interest is generally exempt from tax in his Member State or another State in which he is resident; or (ii) the interest is not taxed pursuant to the application of a remittance clause.

^ top Developments in Luxembourg: Donations to non-profit institutions in EU and EFTA Member States

Following the judgment of the ECJ of 27 January 2009 (C-318/07), the Luxembourg tax authorities issued Circular no. 112/2 LIR, according to which, donations to non-profit institutions resident in EU and EFTA Member States are deductible, subject to certain conditions and administrative requirements, up to the lesser of 20% of the

total income of the donor or EUR 1 million.

^ top 4. VAT ECJ holds supply of land with partially demolished dilapidated building can be taxed with VAT by virtue of law (Don Bosco Onroerend Goed)

On 19 November 2009, the ECJ rendered its judgment in the Don Bosco Onroerend Goed case (C-461/08), without an Opinion of the Advocate General. In principle, this case pending before the Netherlands Supreme Court, does not concern VAT but real estate transfer tax.

In the Netherlands, the acquisition of real estate the supply of which is taxed with VAT by virtue of law is exempted, in principle, from real estate transfer tax. Don Bosco Onroerend Goed BV acquired real estate consisting of land still occupied by a dilapidated building that was to be demolished. Part of the demolition had taken place before the supply; the vendor had undertaken to pay for the complete demolition. Don Bosco Onroerend Goed BV intended to replace the old building with a new one after the demolition.

Because of the fact that at the time of the supply a building was still on the land, although partially demolished, the Dutch tax authorities argued that it concerned a supply of existing real estate as mentioned in Article 13 B under g of the Sixth VAT Directive, and not a supply as mentioned in Article 4, third paragraph under a of the Sixth VAT Directive. As a consequence, in principle, the supply was exempted from VAT and therefore, the acquisition was subject to real estate transfer tax. However, Don Bosco Onroerend Goed BV did not agree with this point of view and argued that the whole supply, including the obligation for the vendor to pay for the further demolition after the supply, had to be qualified as a supply of building land as mentioned in Article 4, third paragraph under b of the Sixth VAT Directive and therefore, was subject to VAT by virtue of law. After a series of proceedings, the Dutch Supreme Court decided to refer preliminary questions to the ECJ.

The ECJ decided that Article 13 B under g in conjunction with Article 4, third paragraph under a of the Sixth VAT Directive must be interpreted as meaning that the VAT exemption provided in the first article does not cover the supply of land still occupied by a dilapidated building that is to be demolished and replaced by a new building and whose demolition, paid for by the vendor, had already begun before the supply took place. According to the ECJ, supply and demolition such as in this case form one single transaction due to the fact that the aim of the transactions was not to supply a land with an existing building but to supply land that has not been built on, regardless of how far the demolition of the old building had progressed at the moment the land was actually supplied. Furthermore, the ECJ considered that it was up to the national court to decide whether or not the supply consisted of a supply of building land as mentioned in Article 4, third paragraph under b of the Sixth VAT Directive, given that it is for the Member States to define what land is to be regarded as such.

^ top ECJ holds sale of self-constructed real estate by building business is not an incidental transaction (NCC Construction Danmark A/S)

On 29 October 2009, the ECJ rendered its decision in NCC Construction Danmark case (C-174/08). NCC is a Danish building and contracting company engaged in carrying out construction projects for third parties and also for itself. The sale of self-constructed buildings, however, was not its principal activity. The construction of buildings, even for own purposes, is a VAT taxed activity. In Denmark, however, the subsequent sale is VAT exempt. The Danish tax authorities have the policy that construction companies were granted an unlimited right to deduct input VAT relating to the building activity and to sale of the buildings. This policy ended mid 2002 and the input VAT on common costs could in future only be deducted in part based on the argument that the turnover from the sale of the buildings would in future be regarded as a result of VAT exempted turnover. NCC did not agree with this policy and appealed against the limited refund of input VAT. The national court decided to refer questions to the ECJ as to whether or not the sale of self-constructed buildings such

as in the case at hand should be regarded as a incidental real estate transaction as mentioned in article 19, second paragraph of the Sixth EU VAT Directive, whether or not the fact that only a small part of costs can be related to the sale and if the principle of neutrality has any effect on this issue.

The ECJ ruled that sales by a building business of buildings constructed on its own account cannot be qualified as an incidental transactions as mentioned in Article, 19, second paragraph of the Sixth VAT Directive, when the sales are the direct, permanent and necessary extension of the business. Furthermore, it decided that in the subject circumstances it was not necessary to assess to what extent that sales activity, viewed separately, entailed a use of goods and services on which VAT is payable. Finally, the ECJ ruled that the principle of fiscal neutrality cannot preclude a building business, paying VAT on supplies relating to construction effected on its own account, from being unable to deduct the whole VAT relating to general costs incurred thereby, since the turnover from the sale of buildings thus constructed is exempt from VAT.

^ top ECJ concludes Finnish VAT exemption for of public legal aid compatible with Sixth VAT Directive (Commission vs Finland)

On 29 October 2009, the ECJ rendered its judgment in the Commission vs Finland case (C-246/08). The Commission was of the opinion that the VAT treatment of public legal aid is not compatible with the EC VAT legislation. In Finland, a person with limited financial means can choose to obtain legal aid from private attorneys or from public legal aid offices. In the case of the latter situation, and the financial position of the person requesting assistance is such that the person is obliged to pay a part contribution, the part contribution is not regarded as VAT taxable. According to the Commission, this situation is precluded by the provisions of the Sixth VAT Directive, especially since a public body is deemed to perform VAT taxable transactions if it performs those transactions in competition with other bodies according Article 4, fifth paragraph thereof.

The ECJ first investigated whether or not the activities of the public legal aid offices are to be regarded as economic activities. According to the ECJ, they are not, due to the fact that there is no direct sufficient link between the legal aid services and the payment that had to be made by the petitioners. Furthermore, the Commission did not bring forward any other argument. Moreover, because the services by the public legal aid offices cannot be regarded as economic activities in the scope of VAT, Article 4, fifth paragraph of the Sixth VAT Directive was not applicable. As a consequence, the action was dismissed by the ECJ.

^ top The Commission tackles eight Member States over the application of the VAT grouping rules

On 20 November 2009, the Commission formally requested the Netherlands, Ireland, Spain, the UK, Denmark, the Czech Republic, Finland and Sweden to amend their legislation regarding the application of the VAT grouping scheme. The Commission was of the opinion that these eight Member States did not apply correctly the EC VAT grouping scheme, based on Article 11 of the EC VAT Directive. These requests took the form of a reasoned opinion, which is the second stage in the infringement proceedings provided for in Article 226 EC. If these Member States fail to comply with the reasoned opinion within two months, the Commission may refer the matter to the ECJ.

Article 11 of the EC VAT Directive gives Member States the option, for the purpose of administrative simplification, to regard as one single taxable person those who, while legally independent, are closely bound to one another by financial, economic and organisational links. In July 2009, the Commission adopted a communication on the VAT grouping option provided for in the EC VAT Directive. The Communication set out the Commission's view on how the provisions of Article 11 of the EC VAT Directive should be translated into practical arrangements whilst respecting the basic principles of the Community VAT system and ensuring that the effects of using the option scheme remain restricted to the Member State applying it.

In the view of the Commission, the Netherlands had failed to comply with its

obligation to notify changes to the Netherlands national fiscal unity scheme to the VAT Committee. The proceedings against Sweden and Finland concern the fact that these Member States limit the VAT grouping system to financial and insurance services. According to the Commission, the VAT grouping rules in the VAT Directive do not allow for such a sectoral limitation. Further, the other grievance in the proceedings against Finland, Ireland, the Netherlands, Spain, the UK, Denmark and the Czech Republic concerns the fact that these Member States allow the inclusion of non-taxable persons in a VAT group. All these Member States allow non-taxable persons to join a VAT group, which is not in line with the proper application of Article 11 of the EC VAT Directive.

^ top Commission requests France to change its legislation on building land and no longer to exempt supplies to natural persons

On 20 November 2009, the Commission announced that it had formally requested France to amend its VAT legislation on the supply of building land. In principle, the supply of immovable goods is exempted from VAT. However, Article 135, first paragraph under k of the EC VAT Directive clearly states that the supply of building land cannot be exempted from VAT. In France however, the VAT exemption is also applicable to supplies of building land to natural persons who intend to construct a building for their own residential use. Based on the view that the French approach is not in line with EC VAT legislation, the Commission has requested France to amend its VAT legislation accordingly. If France fails to amend its legislation within two months, the Commission may decide to refer the matter to the ECJ.

^ top Commission calls on Greece to apply a uniform VAT rate to the provision of bowling facilities

On 29 October 2009, the Commission formally requested Greece to amend its VAT scheme regarding bowling facilities. In Greece, providing bowling facilities is, in principle, taxed with the normal rate of VAT. However, if the bowling facilities are provided to members of clubs of the Hellenic Bowling Federation, the reduced rate of 9% VAT is applicable. In the view of the Commission, the providing of sport facilities is the same in the situation that the facilities are provided to a Federation bowler as in the situation that the facilities are provided to a non-Federation bowler. This because the same facilities are used and bowling, whether it be recreational or competitive bowling, is a sports activity promoting physical health and involving competition. As a consequence, the Commission is of the opinion that the same VAT rate should be applicable in both situations. Therefore, it has requested Greece to amend its VAT legislation within two months. If Greece fails to comply with the reasoned opinion, the Commission may decide to refer the matter to the ECJ.

^ top Commission starts infringement procedure against Poland regarding the refund of VAT to non-established taxable persons

On 29 October 2009, the Commission requested Poland to change its administrative practice for the refund of VAT to taxable persons established in another Member State. The request takes the form of a reasoned opinion, which is the second stage of the infringement procedure as laid down in Article 226 EC.

On the basis of the Eighth VAT Directive, the refund of VAT to taxable persons established in another Member State must be made within six months following the request for the refund. The Commission concluded that refunds in Poland are taking longer than this prescribed period. Furthermore, the Polish authorities grant a period of seven days in order to amend any formal defects in a request for a VAT refund. After this period, the right to a VAT refund is lost. The Commission takes the view that such a short period renders the timely correction of formal defects impossible or excessively difficult. Therefore, Poland has been requested to change its administrative practices. If Poland fails to amend its legislation within two months, the European Commission may decide to refer the matter to the ECJ.

^ top

Commission pursues infringement procedure against Austria regarding the deduction of VAT on construction costs of mixed-use buildings

On 29 October 2009, the Commission formally requested Austria to amend its legislation in order to allow for the deduction of VAT on construction costs of buildings that are partly used for private purposes. Based on the ECJ’s judgment in the Sandra Puffer case (C-460/07), taxpayers may deduct all such VAT immediately. However, on the basis of a standstill clause, Austria retained the right to exclude the deduction of input VAT in such cases in the past.

Following a change in Austrian VAT legislation in January 2004, on the basis of which the partially private use of a building became taxable, the input VAT on the construction costs became fully deductible. In May 2004, however, the exclusion of the right to deduct this input VAT was reintroduced into Austrian VAT legislation.

Considering that the ECJ has ruled that Member States benefiting from a standstill clause are only entitled to modify the exclusions in order to abolish or reduce their scope, the Commission takes the view that Austria was not allowed to reintroduce the exclusion. Therefore, the Commission has requested Austria to amend its VAT legislation within two months. If Austria fails to do so, the Commission may, based on the infringement rules of Article 226 EC, decide to refer the matter to the ECJ.

^ top Commission requests the Netherlands to change its legislation on fundraising activities

On 29 October 2009, the Commission formally requested the Netherlands, by means of a reasoned opinion (second stage of the infringement procedure of article 226 EC), to amend its legislation regarding the VAT exemption for fundraising activities.

The supply of services and goods in connection with fundraising events is exempted from VAT on the basis of Article 132, first paragraph of the EC VAT Directive. However, in the Netherlands, organisations whose primary activities are exempted on other grounds than those mentioned in this article may benefit from the exemption. Therefore, the Commission is of the opinion that the Netherlands applies the exemption too widely. Furthermore, Netherlands legislation provides for an exemption for organisations that perform fundraising activities for other organisations that are active in the social, recreational, or cultural sphere. The Commission takes the view that such organisations may not benefit from the exemption, since they themselves are not active in the social, recreational or cultural sphere. If the Netherlands fails to amend its legislation within two months, the Commission may decide to refer the matter to the ECJ.

^ top Commission requests France to bring its tax representative (répondant fiscal) provision into line with the VAT Directive

On 29 October 2009, the Commission formally requested France to change its legislation regarding an optional derogation from the reverse-charge mechanism. On the basis of the derogation, a vendor in France may declare the VAT, which his client is owed on the basis of the reverse-charge mechanism, in his own VAT return and offset this VAT from the VAT he owes. To be able to do so, the vendor must register in France for VAT purposes, and designate a tax representative who declares and pays VAT on his behalf.

The Commission is of the opinion that the derogation is not compatible with the VAT Directive and case law of the ECJ. This, because taxable persons established in the European Union and in certain third countries may not be obliged to designate a tax representative. Furthermore, under the reverse charge-mechanism, a vendor may not be obliged to register for VAT in the country where he supplies the goods. If France fails to amend its legislation, the Commission may decide to refer the matter to the ECJ.

^ top

5. Customs Taxes and Excise Duties The Heraklion declaration

On 15-16 October 2009, the Director Generals/Commissioners of the Customs Administrations of Asian and European ASEM Member States met in Heraklion, Crete.

They agreed to focus on the following activities for the next two years (2010-2011):

1. Trade Facilitation & Supply Chain Security Review the Trade Facilitation Action Plan (‘TFAP’) on customs matters to cover the period 2010-2012, recommend this to Ministers and implement it subsequently; Identify in response to the proposal on promoting Asia-Europe Trade Security and Facilitation adopted at the ASEM 7 concrete steps to support ASEM Members in addressing gaps and needs in relation to their trade partnership programmes;

2. Combating Infringement on Intellectual Property Rights (‘IPR’) cooperate to the extent possible in implementing agreed joint activities (e.g. JCO Diabolo 2) analyse and evaluate results and lessons learned to prepare recommendations for improvement and follow-up; Prepare a paper with an overview of ’good practices‘ of customs IPR enforcement, including co-operation with right holders, coordination with other agencies responsible for IPR enforcement, mutual assistance against counterfeit fraud, best use of existing control mechanisms and technology, statistics and information exchange on seizures and trends;

3. Protection of Society and Environment Prepare a paper on ’good practices‘ and the role of customs in enforcing environmental law; Further explore the role of ASEM customs in enforcement of legislation governing the protection of the environment, evaluate results and lessons learned and prepare recommendations; contribute to ASEM studies, e.g. the relevant EU study;

4. Involving business Engage with the business community in the ASEM process, in particular in the context of trade facilitation by organising an ’ASEM Customs-Trade-Day‘ to give the opportunity to the ASEM business community to discuss priorities and input; Prepare a paper on ’good practices‘ for setting up a dialogue with traders for consultation and information sharing, bearing in mind initiatives already undertaken within ASEM in this respect.

Appropriate coordination will be ensured in Asia and the European Union.

The DGs/Commissioners of the Customs Administrations of the ASEM Member States will make every effort possible to implement the above agreed activities and to promote their visibility, convinced that they will lead to fruitful initiatives and outcomes and agree to evaluate results achieved at the next meeting. They also engage in using opportunities as the Asia-Europe-Business-Forum (‘AEBF’) to inform about actions and progress of work in the ASEM customs fora.

^ top Agreement on reform of excise duties on cigarettes and other tobacco products

The Council has reached political agreement on a draft directive aimed at updating EU rules on the structure and rates of excise duties on tobacco products. The directive is intended to ensure a higher level of public health protection by raising minimum excise duties on cigarettes, whilst bringing the minimum rates for fine-cut tobacco gradually into line with those for cigarettes.

The outcome of a fourth four-yearly review of tobacco taxation under directives 92/79/EEC, 92/80/EEC and 95/59/EC, it is aimed at modernising and simplifying the rules and making them more transparent.

Agreement was made possible by a compromise with regard to:

cigarettes. The Council agreed to increase, by 1 January 2014, the monetary minimum excise rate to EUR 90 per 1000 cigarettes and the proportional minimum to 60% of the weighted average sales price, from EUR 64 per 1000

and 57% at present; transitional period for cigarettes. The compromise allows for transitional arrangements until 1 January 2018 for Member States that have not yet achieved, or only recently achieved, the current minimum rates, namely Bulgaria, Greece, Estonia, Latvia, Lithuania, Hungary, Poland and Romania; quantitative restrictions for cigarettes. The compromise allows Member States not benefiting from the transition to impose a quantitative limit of at least 300 cigarettes on the number of cigarettes that may be brought into their territory from Member States applying transitional arrangements. It also allows Member States applying those arrangements, once their rates have reached EUR 77 per 1000 cigarettes, to apply quantitative limits with regard to Member States whose rates have not yet reached an equal monetary level; fine-cut tobacco. The Council agreed to increase the minimum excise duty requirements for fine-cut tobacco as follows: Member States will comply with either a proportional minimum or a monetary minimum, amounting to 40% of the weighted average sales price and EUR 40 per kg on 1 January 2011, 43% and EUR 47 /kg on 1 January 2013, 46% and EUR 54 /kg on 1 January 2015, 48% and EUR 60 /kg on 1 January 2018 and 50% and EUR 60 /kg on 1 January 2020.

The directive will be formally adopted without further discussion at a forthcoming Council meeting, once the legal text has been finalised.

^ top ECJ rules upon classification of frozen cuts or offal of cocks and hens and transitional measures related to surplus stocks (Rakvere Lihakombinaat)

On 29 October 2009, the ECJ gave its judgment in the Rakvere Lihakombinaat case (C-140/08) (hereinafter ‘RLK’), concerning the levying of charges on surplus stocks of frozen chicken meat. The case has regard to the classification in the Combined Nomenclature (‘CN’) of frozen cuts or offal of cocks and hens and the interpretation of Commission Regulation (EC) No 1972/2003 of 10 November 2003 on transitional measures to be adopted in respect of trade in agricultural products on account of the accession of the Czech Republic, Estonia, Cyprus, Latvia, Lithuania, Hungary, Malta, Poland, Slovenia and Slovakia.

RLK is an Estonian undertaking active in the food processing sector. In preparing its products, it uses frozen cuts of poultry meat, deboned using mechanical means, called MSM. By decision of 30 March 2007, the Minister for Agriculture fixed the surplus stock of frozen chicken cuts held by RLK at 83 462 kilos. On 30 April 2007, the Eastern Tax and Customs Centre of the Tax and Customs Office (‘MTA’) accordingly issued a tax notice for EEK 1 337 237 (approximately EUR 90,000 at the current exchange rate) pursuant to the charge on surplus stocks.

In the context of the action which it brought against the tax notice in the national court, RLK claimed that the products concerned did not fall under subheading 0207 14 10, but under subheading 0207 14 99, so that they could not be subject to that charge. In effect, those products are not frozen chicken cuts, but are presented in the form of stock composed of cuts of meat and soft tissue obtained from the mechanical treatment of chicken bones. In addition, RLK claimed that Regulation No 1972/2003 was counter to certain provisions of the ÜLTS concerning the calculation of surplus stocks.

Having doubts as to the tariff classification of the products concerned in the main proceedings and the interpretation of Regulation No 1972/2000, the Tallin Administrative Court decided to stay the proceedings and refer the following questions to the Court for a preliminary ruling:

1. Must MSM be classified as from 1 May 2004 under CN code 0207 14 10 or CN code 0207 14 99?

2. If the product described in Question 1 must be classified under CN code 0207 14 10:

a. Does Article 4(1) and (2) of Regulation No 1972/2003 preclude the ascertainment of the amount of the operator’s surplus stock by automatically deducting (as transitional stock) the operator’s average stock as at 1 May of the four years of activity preceding 1 May 2004, multiplied by 1.2?

b. If the answer is in the affirmative, would the answer be different if in determining the amount of the transitional stock and the surplus stock it were possible also to take into account the growth of the operator’s production, processing or sales volume, the maturation period of the agricultural product, the time when the stocks were built up, and other circumstances independent of the operator?

3. Is it compatible with the objective of Regulation No 1972/2003 to levy the surplus stock charge where the operator is found to have a surplus stock as at 1 May 2004 but the operator shows that he has not obtained a real advantage in terms of a price difference from marketing the surplus stock after 1 May 2004?

The ECJ ruled that:

1. Products such as those at issue in the main proceedings constituted of frozen mechanically separated meat obtained after the mechanical deboning of fowls and destined for human consumption must be classified in subheading 0207 14 10 of the Combined Nomenclature.

2. Article 4(2) of Commission Regulation (EC) No 1972/2003 of 10 November 2003 does not preclude national legislation such as Article 6(1) of the Law on the surplus stock charge (Üleliigse laovaru tasu seadus), under which an operator’s surplus stock is determined by deducting from the stock actually held on 1 May 2004 the transitional stock defined as the average stock on 1 May of the previous four years of activity multiplied by a coefficient of 1.2 corresponding to the growth of agricultural production observed in the Member State in question during that four year period.

3. Regulation No 1972/2003 does not preclude the levying of a charge on an operator’s surplus stock even if he is able to prove that he obtained no advantage when marketing that stock after 1 May 2004.

^ top Advocate General opines on preferential treatment of goods originating in Israeli-occupied settlements (Brita)

On 29 October 2009, Advocate General Bot delivered his Opinion in the Brita case (C-386/08). The case concerns the preferential treatment of a drinks manufacturer of sparkling water including accessories and syrups manufactured by the company, Soda Club Ltd, based in Mishor Adumin in the West Bank, to the east of Jerusalem.

Under the Israeli-Palestinian Agreement, that territory, which was occupied by the State of Israel in 1967, is among the territories in Area C. Between February and June 2002, Brita applied for release into free circulation of the goods supplied by Soda Club. To that end, it filed 62 customs declarations stating that the State of Israel was the country of origin for those goods. The invoices produced by Soda-Club also stated that the products at issue in the main proceedings originated in Israel.

The German customs office, provisionally, allowed Brita’s application and granted the preferential tariff to those products, in accordance with the EC-Israel Agreement. At the same time, it requested subsequent verification of the proof of origin of the products. That request was made following a ministerial order of 6 December 2001, stating that requests for subsequent verification must be made in relation to all preferential certificates issued in Israel where there was good reason to suspect that the deliveries of goods concerned might be from Israeli-occupied settlements in the West Bank, the Gaza Strip, East Jerusalem or the Golan Heights.

The request for subsequent verification was forwarded to the Israeli customs authorities. In reply, the latter told the German customs authorities that ‘the verification which they had carried out had proven that the goods in question originate in an area that is under Israeli Customs responsibility. As such, they are originating products pursuant to the Israel-EU Agreement and are entitled to preferential treatment under that agreement’.

Taking the view that the information provided by the Israeli customs authorities was insufficient, the German customs authorities again asked the Israeli customs authorities to indicate, whether the goods referred to in the preferential certificates had been manufactured in Israeli-occupied settlements in the West Bank, the Gaza Strip, East Jerusalem or the Golan Heights.

The Israeli customs authorities failed to reply to that request. Consequently, the

Hauptzollamt (Principal Customs Office), Hamburg-Hafen, refused to grant entitlement to preferential treatment on the ground that it could not be established conclusively that the imported goods fall within the scope of the EC-Israel Agreement.

Post-clearance recovery of customs duties in the amount of EUR 19,155.46 was therefore sought. Brita brought an appeal against that recovery before the Hauptzollamt, Hamburg-Hafen. That appeal was dismissed.

Brita brought an action before the referring court. Being uncertain as to how to interpret the EC-Israel Agreement, that court stayed its proceedings and referred a number of questions to the ECJ for a preliminary ruling.

The following questions were referred to the Court:

1. Should the importer of goods which originate in the West Bank be granted the preferential treatment requested in any event in light of the fact that preferential treatment is provided under two agreements which come under consideration in the present case – namely the EC-Israel Agreement and the EC-PLO Agreement – for goods originating in the territory of the State of Israel or in the West Bank, even if only a formal certificate of origin from Israel is submitted?If Question 1 is to be answered in the negative:

2. Is the customs authority of a Member State bound under the [EC-Israel Agreement], vis-à-vis an importer who is requesting preferential treatment for goods which have been imported into Community territory, by a proof-of-origin certificate issued by the Israeli authority – and the verification procedure under Article 32 of Protocol 4 to the EC-Israel Agreement has not been opened – as long as the customs authority has no doubt as to the originating status of the goods other than that as to whether the goods originate in an area which is merely under Israeli control – that is, pursuant to the terms of the [Israeli-Palestinian Agreement] – and as long as no dispute-settlement procedure was carried out pursuant to Article 4 to the EC-Israel Agreement? If Question 2 is to be answered in the negative:

3. May the customs authority of the country of importation refuse automatically to grant preferential treatment for the following reason alone, namely that, pursuant to its request for verification under Article 32(2) of Protocol 4 to the EC-Israel Agreement, it was confirmed by the Israeli authorities (only) that the goods were manufactured in an area which is subject to Israeli customs jurisdiction and that they were for that reason of Israeli origin, and where the subsequent request by the customs authority of the country of importation for further specification by the Israeli authorities remained unanswered, in particular without the actual origin of the goods having to be taken into account? If Question 3 is to be answered in the negative:

4. May the customs authorities refuse automatically to grant preferential treatment under the EC-Israel Agreement in the case where – as has become clear in the meantime – the goods originate in the West Bank, or should preferential treatment also be granted under the EC-Israel Agreement for goods originating in that area, in any event as long as no dispute-settlement procedure has been carried out under Article 33 of Protocol 4 to the EC-Israel Agreement concerning the interpretation of the expression “territory of the State of Israel” used in the EC-Israel Agreement?’

The Advocate General has proposed that the Court should reply as follows to the Finanzgericht Hamburg:

1. The customs authorities of the importing State are not bound by the result of the subsequent verification carried out by the customs authorities of the exporting State as part of the verification procedure provided for in Article 32 of Protocol 4 to the Euro-Mediterranean Agreement establishing an association between the European Communities and their Member States, of the one part, and the State of Israel, of the other part, where the dispute existing between the customs authorities of the States parties to that agreement relates to the extent of the territorial scope of that agreement.

2. Furthermore, the German customs authorities were not under an obligation to submit the dispute between them and the Israeli customs authorities to the Customs Cooperation Committee.

3. Goods certified by the Israeli customs authorities as being of Israeli origin but which prove to originate in the occupied territories, more specifically the West Bank and the Gaza Strip, are not entitled either to the preferential treatment under the Euro-Mediterranean Agreement establishing an association between

the European Communities and their Member States, of the one part, and the State of Israel, of the other part, or to that established by the Euro-Mediterranean Interim Association Agreement on trade and cooperation between the European Community, of the one part, and the Palestine Liberation Organisation (PLO) for the benefit of the Palestinian Authority of the West Bank and the Gaza Strip, of the other hand.

^ top Commission requests France to abolish its strict quantitative limits on private individuals' tobacco purchases in other Member States

On 20 November 2009, the Commission requested France to amend, within two months, its legislation and administrative practice regarding the movement and holding of manufactured tobacco purchased by private individuals in other Member States for their own needs. The legislation and practice in question form an obstacle to applying the principle of free movement of goods in the internal market. The request has been made in the form of a reasoned opinion, the second stage of infringement proceedings under Article 226 EC. If France fails to amend its legislation and practice within the time limit stipulated, the Commission may decide to refer the matter to the ECJ.

French legislation lays down strict quantitative limits on the movement (1 kg) and holding (2 kg) of manufactured tobacco on French territory. The checks carried out are especially aimed at products bought by private individuals in other Member States. The free movement principles governing the internal market and Directive 92/12/EEC provide for the possibility of private individuals buying in one Member State products subject to excise duties, such as manufactured tobacco, and transporting them to another Member State without having to pay additional tax, provided that the products are intended for the private individuals' own needs and are transported by them. By contrast, goods held for commercial purposes are subject to excise duties in the country where they are held.

In order to determine whether tobacco is being held for a private individual's own needs or for commercial purposes, the Member States must take into account a number of criteria. They may establish indicative quantitative levels, but only as an element of proof and as one criterion amongst others.

The Commission considers that France is infringing Community law:

by using a purely quantitative criterion to assess whether private individuals are holding manufactured tobacco from another Member State for commercial purposes; by applying that criterion to each vehicle (not each person) and generally for all tobacco products; by providing for disproportionate penalties; and by simply preventing private individuals from importing tobacco products from another Member State if the quantity exceeds 2 kg per individual vehicle.

Citizens who wish to obtain redress in individual cases may if necessary have their rights enforced before the relevant national courts. The purpose of the proceedings instituted by the Commission is to have the national provisions which do not comply with Community law amended for the future.

^ top Commission requests France to change a discriminatory aspect of its legislation relating to the 'malus tax' for second-hand vehicles imported from other Member States

On 20 November 2009, the Commission requested France to amend, within a period of two months, a specific aspect of its legislation relating to its 'malus tax', which the Commission considers discriminatory in respect of second-hand vehicles imported from other Member States. This request takes the form of a reasoned opinion (second stage of the infringement procedure provided for in Article 226 EC). If France fails to amend its legislation within the time limit stipulated, the Commission may decide to refer the matter to the ECJ.

The Commission supports initiatives that help to protect the environment. However,

legislative developments introduced in Member States must be compatible with Community law and, in particular, the non-discrimination principle with regard to products from other Member States (Article 90 EC).

The French legislation provides for a 'malus tax', due when the most highly polluting passenger cars are registered in France for the first time. The Commission does not object to this scheme as applied to new vehicles, nor to its intended purpose. However, it considers that one aspect of the French legislation is not compatible with Article 90 of the EC Treaty as it has been consistently interpreted by the ECJ with regard to the taxation of second-hand vehicles imported from other Member States. The provision in question relates to the method adopted by France to take account of the depreciation of second-hand vehicles which are brought into France from other Member States and are subject to this tax (10% reduction for every year since the initial registration).

The Commission considers that this method is discriminatory on account of:

the application of a linear depreciation of 10% per year, which does not reflect the actual depreciation incurred, particularly over the first few years. the use of one single criterion (and disregarding other criteria, such as the odometer reading), which does not enable account to be taken of above-average use; the impossibility of challenging the application of this flat-rate method of calculation by reference to the actual depreciation of the vehicle based on an expert's report, for example.

Where taxpayers wish to obtain reimbursement of taxes levied in contravention of Community law, they must enforce their rights before the competent national courts, as appropriate. The objective of the procedure initiated by the Commission is to ensure that national provisions which may be incompatible with Community law are changed for the future.

^ top 6. Capital Duty ECJ holds Polish taxation of conversion of loans into share capital incompatible with EC law (Elektrownia Patnów)

On 12 November 2009, the ECJ rendered its judgement in the Elektrownia Patnów case (C-441/08). The case concerns the interpretation of the second indent of Article 5(3) of Council Directive 69/335/EEC (the ‘Capital Duty Directive’), which provides that the amount of capital duty that is charged in the case of an increase in capital shall not include the amount of the loans taken up by a capital company which are converted into shares in the company and which have already been subjected to capital duty.

Prior to Poland’s accession to the EU, Polish domestic law provided for taxation of civil law transactions in respect of, inter alia, loans taken up from shareholders. In this case, the Polish company Elektrownia Patnów had taken up a series of loans from its (Polish resident) parent company between 2002 and 2004. In accordance with the domestic law at that time, Elektrownia Patnów had paid the tax on civil law transactions on the loans it had taken up. With effect from 1 May 2004, Poland became a Member State. In 2005, the loans taken up by Elektrownia Patnów were converted into share capital. This transaction was subject to the tax on civil law transactions, which had been amended in order to comply with the Capital Duty Directive, without taking account of the earlier taxation of the loans. Elektrownia Patnów filed a complaint with the tax authorities on the basis that it had incurred double taxation. In the ensuing legal proceedings, the Polish administrative court referred to the ECJ the question whether the second indent of Article 5(3) of the Capital Duty Directive (cited above) also applies in a situation in which the conversion into shares took place after the accession of a Member State to the EU, even though the loans predated that accession and had been taxed in accordance with the national law which was in force at that time.

The ECJ considered that the second indent of Article 5(3) of the Capital Duty Directive should be regarded as a new rule which applies immediately to transactions which are carried out after its entry into force in Poland and which come within its scope.

Therefore, in determining the amount of capital duty due on the conversion into shares of loans taken up prior to Poland’s accession to the EU and converted after Poland’s accession, the previous taxation of those loans on the basis of the national law in force at that earlier time should be taken into account (thus reducing the double taxation in this case).

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