Comment: When European Court of Justice advocate general Phillippe Léger gave his opinion in the case of Cadbury Schweppes and the UK inland revenue recently, both sides claimed victory. The question remains as to what the impact of this decision will be for investment into Ireland, not only from the UK but from other jurisdictions with similar legislation to that at the heart of this case.

Controlled foreign companies (CFC) legislation is designed to eliminate the impact of companies' choice of location by assessing profits earned at the tax rate applicable to the ultimate parent company. The UK, France, Germany and many other European countries have such legislation, although they vary in their provisions and thus in their impact on operations establishing in countries, such as Ireland.

The UK inland revenue assessed Cadbury Schweppes Overseas Ltd to UK tax under its CFC legislation in respect of Cadbury Schweppes Treasury International and Cadbury Schweppes Treasury Services, two subsidiaries established in the IFSC in Dublin, on the basis that both companies were paying a rate of tax less than three-quarters of the corresponding rate of UK corporation tax of 30 per cent.

Cadbury Schweppes was not able to avail of any of the exclusions to the rules. Cadbury Schweppes appealed the decision that such an assessment was contrary to the rights as protected by the EC treaty, freedom of establishment, freedom to provide services and free movement of capital.

The UK special commissioners asked the court whether the EC treaty precludes national tax legislation imposing a charge upon a company resident in that member state in respect of the profits of a subsidiary company resident in another member state and subject to a lower level of taxation.

The advocate general opined that EU law does not preclude national tax legislation imposing such a charge, if that legislation applies only to wholly artificial arrangements intended to circumvent national law.

What the opinion does is to request national courts to interpret the motive test with criteria which he suggests are relevant, while maintaining that CFC legislation is not incompatible with community law, which provides great support for countries with CFC legislation.

So what is the impact for UK investment in Ireland for the future? Any Irish trading company owned by a UK parent, the greater part of whose income is taxable at the Irish corporation tax rate of 12.5 per cent will be a CFC.

It is still possible to avoid CFC legislation by falling within one of the exclusions, including satisfying the motive test in the context of the advocate general's opinion - presuming the opinion is confirmed by the full court. The presumption that the existence of an Irish trading company in a UK-owned group means it is involved in UK tax avoidance is, however, difficult to reconcile with the ability of each member state, including Ireland, to decide their own corporate tax rate.

However, if the opinion of the advocate general holds, once a company is not carrying on wholly artificial activities, then it should not be subject to the CFC regime. On our side, the Revenue's published precedents support the application of the 12.5 per cent rate to trading profits of companies, based on substance criteria.

This is small comfort for any Irish subsidiary of a UK company because the UK parent company must establish if one of the exemptions is available to prevent the UK assessing the subsidiary's profits. Even where one of the exemptions is available, the UK parent company must prove that the exemption is applicable.

Leaving aside the potential tax cost of UK companies investing in Ireland, the potential administrative burden and associated uncertainty of availing of an exemption is also a barrier to investment into Ireland, which is being challenged in another member state.

The full European Court of Justice is not bound to follow the opinion of the advocate general. However, we would hope that the court would go back to first principles and apply appropriate tests, namely:

1. Are the rules contrary to the freedom of establishment? In the body of the advocate general's opinion he implied that the UK CFC rules were.

2. If the rules are contrary to the treaty, is there a public policy reason why they should be allowed to stand?

At this point, the tax avoidance argument would suggest that, in theory, a justification was available. Before such a justification could be allowed, the court would need to consider whether the UK rules were proportionate, or whether they were too general.

With respect to the advocate general's opinion, it seems difficult to define the UK tax rules, which will automatically characterise subsidiaries in another member state such as Ireland as controlled foreign companies, as not being too general.

3. Are the rules proportionate - ie, do they achieve the aim that they seek and are there any less restrictive measures which could have achieved the same aim?

Again, surely it is arguable whether the presumption of abuse in the UK rules and the subjectivity of the "motive test" could be deemed to be proportionate.

If the full court gives a decision which holds that the UK rules are inconsistent with community law, we may see UK legislation clarifying the position quickly.

We await with interest to establish the final impact for continuing business and investment into Ireland from the UK and our European affiliates.

Joan O'Connor is vice-president of the Irish Tax Institute