Belgian Inheritance Tax Rules for Family Companies Incompatible with EC Treaty, ECJ Says by Tom O'Shea The European Court of Justice on October 25 issued its ruling in Geurts and Vogten (C-464/05) (see Doc 2007-23781 [PDF] or 2007 WTD 208-13 ), finding that the Belgian inheritance tax rules relating to the transfer of a family undertaking owned by the deceased indirectly discriminate between taxpayers "on the basis of the place of employment of a certain number of workers in a certain period," and that that discrimination violates the EC Treaty principle of freedom of establishment. The main issue in the case concerned an exemption from Belgian inheritance tax on the transfer of shares in a family company in which at least 50 percent of the shares were held by the deceased (or were held jointly, with his close family members). The exemption applies only if, in the three years preceding the death of the deceased, the undertaking or company employed at least five full-time workers in the Flemish region of Belgium. In the case of Dennis Vogten, the family companies employed more than five full- time workers, but in the Netherlands, not in the Flemish region of Belgium. Consequently, Vogten's heirs were denied the tax exemption. Which Freedom Applied? The ECJ, recalling its judgment in N (C-470/04) (see Doc 2006-18757 [PDF] or 2006 WTD 174-9 ), observed that article 43 of the EC Treaty (on the freedom of establishment) applied to persons who transferred their residence from the Netherlands to Belgium and continued to hold the majority of the shares in Dutch companies. Therefore, the freedom of establishment also was the applicable freedom in Geurts and Vogten. Any restrictive effects on the free movement of capital were "an unavoidable consequence of any restriction on freedom of establishment and do not justify an independent examination of that measure in the light of Articles 56 EC to 58 EC," the ECJ said. Discrimination or Restriction? The ECJ found that the Belgian inheritance tax rules treat owners of family companies (and their heirs) differently depending on whether the family undertakings employed workers in Belgium or in another EU member state. The Court, recalling its judgment in Baars (C-251/98), noted that "legislation of a Member State which provides for a difference in treatment between taxpayers on the basis of the place where the company of which those taxpayers are shareholders has its seat is in principle contrary to Article 43 EC." The Court found that the same is true when the tax rules provide for different treatment based on "the place where the company owned by those taxpayers employs a certain number of workers for a certain period of time." In the eyes of the ECJ, this is indirect discrimination on grounds of nationality, because discrimination on the basis of a company's seat leads to a result similar to overt discrimination on grounds of nationality. The Court explained that a company established in Belgium can fulfill the condition in the Belgian inheritance tax rules "more easily." Accordingly, the Court decided that the Belgian tax rules indirectly discriminate between taxpayers "on the basis of the place of employment of a certain number of workers in a certain period," and that that discrimination is "liable to hinder the exercise of the freedom of establishment by those taxpayers." Justifications The Belgian government put forward a number of justifications in support of its discriminatory tax rules. It said that the legislation does not refer to the establishment of an undertaking in Belgium, just to the employment of some workers there, and that undertakings with seats in other EU member states can enjoy the tax advantage at issue if they employ the specified number of workers in Belgium. The government also argued that the rules are justified by the need for effective fiscal supervision and the need to safeguard the survival of small and medium-size enterprises and to maintain employment in SMEs in the event of the death of their owners. The ECJ rejected all of those arguments. It accepted that safeguarding the survival of SMEs and the employees of those enterprises might constitute an acceptable justification for the Belgian rules. However, that justification has to be measured against the principle of proportionality. Belgium did not demonstrate the need to limit the inheritance tax advantage to enterprises that have the requisite number of employees in Belgium, the Court said. It commented that "in relation to the objective of preventing inheritance tax from jeopardizing the continuation of family undertakings, and therefore the jobs which they bring, undertakings having their seat in another Member State are in a situation comparable to that of undertakings established" in Belgium. The Court also observed, in relation to the effectiveness of fiscal supervision, that even though the EU mutual assistance directive1 does not apply to inheritance tax situations, "that difficulty cannot justify the categorical refusal to grant the tax benefits in question since the tax authorities could request the taxpayers concerned to provide . . . the evidence which the authorities consider necessary to be fully satisfied that those benefits are granted only where the jobs in question fulfill the criteria set out under national law." Conclusion The ECJ therefore held that the Belgian rules are incompatible with article 43 of the EC Treaty because they exclude from the inheritance tax exemption family undertakings that employ workers in other EU member states and grant the tax exemption when comparable undertakings employ the relevant workers in Belgium. Analysis The Geurts and Vogten decision is another significant ECJ judgment concerning the compatibility of the member states' domestic inheritance tax rules with EU law. Those rules remain within the competence of the member states but must comply with EU law. Barbier In the ECJ's Barbier case (C-364/01), the free movement of capital was at stake. The appellant had moved from the Netherlands to Belgium and had purchased some properties in the Netherlands, from which he received rent. He then conducted a series of transactions involving the transfer of the financial ownership of his properties to private Dutch companies that he controlled. Dutch rules allowed the legal title to immovable property to be split from its financial ownership. Consequently, the transactions resulted in some tax advantages for the appellant and, after his death, for his estate. The Dutch inheritance tax valuation rules treated the appellant differently than a Dutch resident because he died while he was resident in another member state. The ECJ found that those tax rules restricted the free movement of capital. More significantly, it went on to point out that "a Community national cannot be deprived of the right to rely on the provisions of the [EC] Treaty on the ground that he is profiting from tax advantages which are legally provided by the rules in force in a Member State other than his State of residence." Free Movement of Capital or Freedom of Establishment? In Geurts and Vogten, the Belgian tax rules clearly fall within the scope of the freedom of establishment because they relate to the shareholdings of deceased persons in family undertakings that give the shareholders definite control or influence over those family businesses. In Baars the ECJ determined that "a national of a Member State who has a holding in the capital of a company established in another Member State which gives him a definite influence over the company's decisions and allows him to determine its activities is exercising his right of establishment." Applying that reasoning to Geurts and Vogten, it is clear that the Belgian inheritance tax rules apply only to shareholdings where a "definite influence" or "control" is at stake. Therefore, the ECJ was entitled to select the freedom of establishment as the main fundamental freedom at play, and also was entitled to find that any effects of the Belgian inheritance tax rules on the free movement of capital are "an unavoidable consequence of any restriction on the freedom of establishment." The Court was merely following its now-established case law in that area when both the free movement of capital and the freedom of establishment are potentially breached by the Belgian inheritance tax rules. (For a related story, see Doc 2007-9386 [PDF] or 2007 WTD 83-9 .) Extension of Tax Advantages Cross-Border The ECJ judgment in Geurts and Vogten is also significant because of the Court's reminder to the member states that their tax rules cannot discriminate, particularly in an area without internal frontiers. The inheritance tax rules in question favored the transfer of family undertakings that employed workers in Belgium, and not in other member states. In other words, the Belgian rules are protectionist in nature, granting a tax advantage to residents who employed residents through their family business. The Belgian government's justification for maintaining those rules was the need to prevent those inheritance tax rules from jeopardizing the continuation of family undertakings. The Court pointed out that family undertakings employing workers in other member states could be equally affected by those inheritance tax rules. In an internal market comprising an "area without internal frontiers," the Court has shown a reluctance to accept justifications offered by member states for limiting some tax advantages to domestic situations and refusing to grant them to residents in cross- border situations. This has become clear from the Court's decisions in cases such as Manninen (C-319/02), Marks & Spencer (C-446/03), and Keller Holding (C-471/04). (For the ECJ judgments in those cases, see Doc 2004-7814 [PDF] or 2004 WTD 174- 17 ; Doc 2005-25015 [PDF] or 2005 WTD 239-16 ; and Doc 2006-3710 [PDF] or 2006 WTD 38-7 , respectively.) Manninen In Manninen, Finland failed to extend an imputation tax credit granted to its residents when they received dividends from Finnish companies. When Finnish residents received dividends from Swedish companies, no imputation tax credit was granted in Finland. The consequence was (usually) additional taxation for Finnish residents who invested their capital in Swedish companies. The ECJ found that those rules were a restriction on the free movement of capital and rejected Finland's justifications that their rules conformed to the principle of territoriality and were necessary to ensure the cohesion of its tax system. The Court noted that the purpose of the Finnish rules was to prevent economic double taxation of a company's profits. This could be encountered by both Finnish investors investing in Finland or elsewhere, if the state of investment did not provide some form of relief for economic double taxation. This might occur in a situation when the state of investment imposed corporation tax only on profits of the company that were not distributed. In those circumstances, the Finnish investor investing in a Finnish company and a Finnish investor investing in the nonresident company might not be in the same situation (and hence are not comparable). However, in other situations when the state of investment imposed corporation tax on the company paying the dividend, the Finnish investor receiving dividends from such a company suffered economic double taxation. Consequently, those Finnish resident investors were comparable and were entitled to not less favorable treatment. The Court went on to note, "Having regard to the objective pursued by the Finnish tax legislation, the cohesion of the tax system is assured as long as the correlation between the tax advantage granted in favor of the shareholder and the tax due by way of corporation tax is maintained. . . . Therefore . . . the granting to a shareholder who is fully taxable in Finland and who holds shares in a company established in Sweden of a tax credit calculated by reference to the corporation tax owed by that company in Sweden would not threaten the cohesion of the Finnish tax system and would constitute a measure less restrictive of the free movement of capital than that laid down by the Finnish tax legislation." The Court used similar reasoning in Marks & Spencer in relation to the United Kingdom's group relief rules and in Keller Holding in relation to German rules concerning the financing of subsidiaries. Marks & Spencer In Marks & Spencer, the ECJ was faced with U.K. tax rules that granted loss (group) relief when a U.K. parent company had established a subsidiary in the United Kingdom that incurred losses, but not when the subsidiary was established in another member state. The United Kingdom argued that those rules were justified because the United Kingdom did not tax the subsidiary established in another member state. The Court rejected that argument, saying, "In order to ascertain whether such a restriction is justified, it is necessary to consider what the consequences would be if an advantage such as that at issue in the main proceedings were to be extended unconditionally." The outcome was that the United Kingdom's group relief rules had to be extended cross-border in situations when the subsidiary was unable to obtain loss relief in the member state of establishment. That ensured the equal treatment of U.K.-resident parent companies. Keller Holding Similarly, in Keller Holding, German rules restricted the deduction of financing costs for subsubsidiaries to companies resident in Germany; if the subsubsidiary was resident in another member state, Germany denied the deduction (tax advantage). In Keller Holding's situation, it was clear that the German parent company received dividends from its Austrian subsubsidiary on a tax-free basis through a combination of the Austria-Germany income tax treaty, which exempted taxation on those dividends in Germany, and through German domestic rules, which exempted dividend payments from a German resident subsidiary to a German resident parent company. Consequently, Keller Holding was comparable to another German parent company with a subsidiary in Germany that received dividends from its subsidiary also resident in Germany. In both instances, the German parent companies received dividends on a tax-free basis from their subsubsidiaries, but the German tax rules at issue allowed a deduction for the financing costs related to the subsubsidiary only when it was resident in Germany and not in another member state such as Austria. The Court found that to be a restriction of the freedom of establishment. Germany argued that its tax rules were necessary to ensure the coherence of the German tax system. However, the Court disagreed and said, "The legislation at issue in the main proceedings does not establish any relationship between the deductibility of the financing costs relating to the shareholdings of the parent company and the profits in respect of which the indirect subsidiary is liable to tax. Moreover, the profits realized by that indirect subsidiary, which enabled it to distribute dividends, are subject to corporation tax in Austria, just as the profits of an indirect subsidiary which has its registered office in Germany are taxable in that Member State, since the place of establishment of the parent company is of no importance in that regard." Consequently, Germany was obliged to grant not less favorable treatment to German parent companies such as Keller Holding whose subsubsidiaries were resident in Austria. Final Thoughts The ECJ decision in Geurts and Vogten represents an application of the migrant/nonmigrant test (see Doc 2006-3391 [PDF] or 2006 WTD 95-10 ), whereby a resident of an origin member state who chooses to exercise a fundamental freedom (in this case, the freedom of establishment) is disadvantaged by a tax rule of the origin member state when compared with another resident of the origin member state who is in a comparable situation. Those persons are entitled to not less favorable treatment when they exercise their fundamental freedom rights. The Belgian inheritance tax rules clearly do not guarantee that result and consequently were found to be incompatible with the freedom of establishment. Tom O'Shea, lecturer in tax law, Centre for Commercial Law Studies, Queen Mary, University of London FOOTNOTE 1 Council Directive 77/799/EEC of December 19,1977, concerning mutual assistance by the member states in the field of direct taxation.