European and International Tax Law Case: Thin Cap Group Litigation C-524/04 Christian Näkki k90408

ParentCo ParentCo 75% 75% 2 3 75% Branch Loan 75% 75% Loan Loan ”Borrowers” 75% 75% Loan Loan ParentCo ParentCo 75% 1 75%

Facts UK Income and Corporation Taxes Act: Interest payments between same group of companies (control 75% or more) non- deductible for amounts not considered ”arm´s lenght” Not applicable were payor/payee of interest both liable to UK corporate tax (transfer pricing rules amended in 2004 to include purely domestic situations) Not applicable if governed by a Double Tax Convention (DTC) Claimants were refused interest deductions in borrowing subsidiaries Case before the national court to seek restitution and/or compensation for the tax disadvantages suffered Main question to the ECJ: Is such legislation contrary to Art. 43, 49 or 56 EC in the depicted situations 1,2 and 3?

Proceedings in the ECJ: Legislation targeted at relations within a group of companies: Primarily affects the freedom of establishment (Art. 43 EC) Any restrictions on freedom to provide services (49 EC) or free movement of capital (56 EC) are unavoidable consequenses of any restrictions on freedom of establishment Is there a restriction on freedom of establishment? Legislation in force between 1995 and 2004 mainly imposed restrictions on loans granted by non-resident parent companies Provided documents do not show that legislation + DTCs offsets the tax tax disadvantages of denied interest deductions with an equal tax advantage in the loan giving companys home State It is enough that the legal provisions are capable of restricting freedom of establishment;no actual effect on company choices regarding establishment in a member State required Case should be evaluated in light of Art. 43 EC only! A restriction on freedom of establishment exists

Justification Restriction of 43 EC YES Overriding public interest? Cohesion of tax system Direct link between tax levy & advantage (DTC) No evidence of link Preventing tax avoidance Specific objective to prevent artificial arrangements YES Proportionate if: Taxpayer allowed to provide evidence of commercial justification Applied only to interest over ”arm´s lenght”

Outcome 1 UK tax legislation is restrictive on freedom of establishment in unless grounds for justifications can be proved No bearing on application of UK tax laws in 43 EC only applies to Community situations US parent Loan giving companies dont have influence via ownership in borrowers (are not the parent company of) 49 & 56 EC don´t apply because case to be evaluated in light of 43 EC only Classifications of claims etc. to be decided by the national courts. 2 3 &

NATIONAL LEGISLATION AGAINST Art. 43 EC, unless justifications not met ParentCo ParentCo 75% 75% Loan Branch 2 NO EFFECT ON NATIONAL LEGISLATION (freedom of establishment only applies to parent companies in Member States) 3 75% 75% 75% Loan Loan NATIONAL LEGISLATION AGAINST Art. 43 EC, unless justifications not met 75% 75% Loan Loan ParentCo ParentCo 75% 75% 1

Risks & opprtunities Still for the national courts to decide if the breach of Community law has been Serious enough Linked by causality to damages suffered Have the claimants done enough to limit damages Opportunity to arrange future corporate structures (lender-borrower) in line with the rulings Easier to identify possible ”hot-spots” in current financing structures Uncertainty of outcomes on a concrete level remains