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What is meant by the term “freedom of establishment” and what would be the tax implications for an Irish company?

Posted on: Thursday, January 08, 2015

What is meant by the term “freedom of establishment” and what would be the tax implications for an Irish company?


Freedom of Establishment


What does it mean?

The EC Treaty provides that restrictions on the freedom of establishment of nationals of one Member State in the territory of another Member State are PROHIBITED. This also applies to restrictions on the setting up of agencies, branches or subsidiaries by nationals of any Member State established in the territory of any Member State.


Who does it apply to?

Freedom of establishment applies to (a) individuals and (b) companies.

It includes the right to:
• take up and to pursue activities as self employed individuals
• to establish and manage undertakings/businesses under the conditions laid down for its own nationals/citizens by the law of the country where such establishment is effected. 
• It also applies to companies.


Why is this important from a tax perspective?

1. It protects the rights of non-residents wishing to establish themselves in a Member State, i.e. foreign nationals and companies in a host Member State must be treated in the same way as nationals of that Member State.
2. It protects the rights of residents who wish to establish themselves abroad in any Member State i.e. that the Member State of origin is prohibited from hindering the establishment in another Member State of one of its nationals or companies.


What does that actually mean?

Each Member State must facilitate companies wishing to establish a business in that State (inbound), or companies in that State wishing to establish a business in any other Member State (outbound).


This is clearly a situation where you should know your Case Law.  When faced with these types of questions give a brief account of the case and focus on the outcome from a tax point of view.

In order to accurately explain the above term “Freedom of Establishment”, it is necessary to analyse the Marks & Spencer Case:

• This case dealt with the availability of group relief for losses between EU group companies.
• The UK did not allow loss relief for losses incurred by a non resident company.
• It was held that the restriction of loss relief should not apply if the non resident company has exhausted all possibilities available in the State of residence for using the losses and there is no possibility of the losses being utilised in that country in the future.


What are the tax implications of the decision?

Section 420C Taxes Consolidated Acts 1997 was added to our legislation which allowed group relief for losses provided it met the following conditions:

1. The loss must be of a type that would be allowed under “Irish rules”
2. The loss must be computed under the EEA Country’s tax law.
3. It must not be attributable to a branch or agency in the state.
4. It must not be available for use otherwise in the state.
5. It must be a trapped loss (in other words the company in the member state wouldn’t otherwise be in a position to use it and the possibilities for relief in the member state have been exhausted)
6. It must not be available for surrender, relief or offset in a territory outside the state or the surrendering state (in other words horizontally under a different rule in another member state).


Any other cases to consider?

The FII GLO Case deals with the Freedom of Establishment and the Free Movement of Capital and was taken as a result of the situation in the UK where dividends from UK subsidiaries were exempt while dividends from EU subsidiaries were taxable.

In the FII GLO case, the ECJ held that there was nothing to stop Member States from using an exemption system for nationally sourced dividends while using a credit system for foreign sourced dividends as both methods would ensure that the dividends were not liable to a series of tax charges.

The ECJ held that the credit system was only acceptable where the rate of tax on the foreign sourced dividends is equal to the rate of tax on nationally sourced dividends.


What does the decision mean in terms of Irish tax?

The issue of foreign dividends being taxed at 25% and Irish dividends being taxed at 12.5% was contrary to EU law. 


To really WOW the Examiner you could go further and include:

Section 21B TCA 1997 was introduced to allow for a  12.5% rate of tax on dividends received from EU subsidiaries where two conditions were met, notwithstanding that a part of the dividend may not be paid out of trading profits:
1. The first condition is that 75% of the dividend paying company’s profits must be trading profits, either trading profits of that company or dividends received by it out of trading profits of lower tier companies that are resident in EU Member States; in countries with which Ireland has a double tax treaty  in force or in countries with which Ireland had signed a double tax treaty which has yet to come into force or in a country which has ratified the Convention on Mutual Assistance in Tax Matters or in a non-treaty country where the company is owned directly or indirectly by a quoted company.
2. The second condition is an asset condition that must be satisfied on a consolidated basis by the company receiving the dividend and all companies that are its subsidiaries. The aggregate value at the end of the period concerned of the trading assets of those companies must not be less than 75% of the aggregate value of all of their assets.


FINAL POINTS

You may have a strong understanding of these sections of legislation and the relevant Case Law but it's essential that you show the Examiner how much you know.

When answering this type of exam question you should provide the amount of detail as outlined above to ensure you gain the maximum amount of marks possible.