The European Court of Justice has ruled that firms who take advantage of lower tax rates in countries like Ireland are not abusing EU law but could be subject to paying taxes in their home country if the arrangement is "wholly artificial".
The verdict came in a case taken against the British government by UK-resident Cadbury Schweppes, which claimed that charging UK tax levels on profits from its two Irish subsidiaries breaches EU rules on "freedom of establishment" - the right to set up in any member state.
In 2000 the British treasury took the view that Cadbury Schweppes had set up two Irish subsidiaries "solely in order that intra-group lending treasury activities could benefit from the regime of the International Financial Services Centre Dublin for group treasury companies in Ireland", said the court.
The treasury therefore claimed more than £8.6 million (€12.66 million) in corporation tax from the company on its Irish subsidiaries' profits for 1996.
Cadbury Schweppes complained in court that having to make up the difference between UK tax rates and the lower 10 per cent
tax in Ireland was contrary to EU rules.
The British government won a partial victory as the court said it could stop companies from making wholly artificial arrangements to avoid tax by setting up foreign units.
However, the European court said there should be an objective assessment of what constitutes wholly artificial tax arrangements - an intention to obtain tax relief is not enough to conclude there is a wholly artificial arrangement, the court said.
The ruling was welcomed in Ireland with Director of Taxation of the Institute of Chartered Accountants in Irelan Brian Keegan saying: "We are very pleased that the Court has effectively blocked a restrictive tax regime which could put Irish established businesses at a disadvantage.
The Court's proviso that restrictive tax measures to counter wholly artificial cross border arrangements remain legal is both fair and workable."
Today's court ruling found the legislation on "controlled foreign companies" (CFCs) does not conflict with EU rules.
"In order to determine whether a CFC is carrying on a genuine activity, the national authorities should take account of objective factors which are ascertainable by third parties, and not only subjective considerations," the court said. The ruling follows an opinion from an adviser to the court.
There must be objective and ascertainable circumstances produced by the company as to the extent the CFC physically exists as regards premises, staff and equipment, it added.
Experts have said that trying to prove in court that tax arrangements were wholly artificial may be difficult and could force Britain to amend its tax laws.
It was up to the UK's Special Commissioners of Income Tax to show that a subsidiary's activities did not reflect economic reality.
It was the Special Commissioners of Income Tax, to whom Cadbury Schweppes had appealed against the tax claim, that sought a ruling from the EU court on whether the UK tax arrangements for subsidiaries complied with EU law.
Additional reporting: Agencies
