The principle of proportionality initially appeared within the EU framework as a general principle of law, but has been assimilated by the ECJ in the course of interpretation and application of Community law.152 The analysis of the principle of proportionality is of fundamental importance because restrictive tax measures are often rejected by the ECJ not on the absence of a legitimate ground of justification, but on the disproportionality of their restrictive effects.153 According to ECJ case law, national tax measures which are liable to make less attractive the exercise of fundamental freedoms guaranteed by EU law may nevertheless be allowed in special circumstances, provided that:
(i) they pursue an objective in the public interest; (ii) they are appropriate to attaining that objective; (iii) they do not go beyond what is necessary to attain the objective pursued.154 Thus, on the assumption that a restriction to fundamental freedoms may be justified based on the grounds examined above, the question arises as to whether the national anti-hybrid rules are in accordance with the principle of proportionality. In this paper, it is impossible to reach a definitive conclusion on the fulfillment of the proportionality test, since it depends on the analysis of the actual wording of the anti-hybrid rule introduced by each Member State.155 For this reason, this section will cover some controversial aspects of anti-hybrid rules which may eventually be taken into consideration by the ECJ in its analysis of proportionality.
Appropriate: The national tax measure must be adequate, appropriate, capable, or suitable for the production of the effects intended by the national legislator. It must clearly contribute for the attainment of the purpose, objective, and scope desired by the Member State with the text of the law.156 On
152 A. Zalasiński, Proportionality of Anti-Avoidance and Anti-Abuse Measures in the ECJ’s Direct Tax Case Law, Intertax 2007, p. 310.
153 B. J. M. Terra/P. J. Wattel, European Tax Law, p. 45.
154 B. J. M. Terra/P. J. Wattel, European Tax Law, pp. 44-45.
155 N. Strelnikova, Master Thesis, p. 32, FN 38.
156 A. Zalasiński, Intertax 2007, p. 312, FN 152.
this matter, anti-hybrid rules introduced by Member States will probably achieve the objective of avoiding double non-taxation generated by hybrid financial instruments within the scope of the Parent-Subsidiary Directive, although other forms of hybrid mismatches are technically still possible within the European Union.
Necessary: From a theoretical perspective, the national tax measure should be the least restrictive among available alternatives to the fundamental freedoms or to the affected rights granted by EU law.157 Apart from contributing to the gradual promotion of its purpose, the domestic tax rule introduced by the Member State must be the least restrictive among all other tax measures available and equally effective to attain the objective pursued by the legislator.158 However, the ECJ does not always recognize that the Member State has the obligation to choose the least restrictive means,159 as can be inferred from the Alpine Investments case (C-384/93), where it held that “the fact that one Member State impose less strict rules than another Member State does not mean that the latter’s rules are disproportionate and hence incompatible with Community law”.160 From a theoretical perspective, it is only possible to agree with the ECJ decision if the two options available are not equally effective to attain the objective pursued, even though this may be difficult to evaluate in some circumstances. Thus, in the author's opinion, among all equally effective tax measures, Member States should choose the least restrictive161 means of preventing double non-taxation obtained under the Parent-Subsidiary Directive.
This criterion, which is usually disregarded by the ECJ in practice,162 would lead to the discussion of alternative solutions for tackling hybrid mismatches within the European Union, in particular through the harmonization of domestic laws and the introduction of the Common Consolidated Corporate Tax Base (CCCTB).
Unfortunately, this long debate requires a specific analysis that cannot be accommodated within the limits of this paper. Despite this, it is important to
157 A. Zalasiński, Intertax 2007, p. 312, FN 152.
158 B. J. M. Terra/P. J. Wattel, European Tax Law, p. 44.
159 C. HJI Panayi, Double Taxation, Tax Treaties, Treaty Shopping and the European Community (Alphen aan den Rijn: Kluwer Law International, 2007), p. 206.
160 Judgment in Alpine Investments, C-384/93, EU:C:1995:126, para. 51.
161 U. Schreiber, International Company Taxation (Berlin/Heidelberg: Springer Verlag, 2013), p. 103.
162 A. Zalasiński, Intertax 2007, p. 312, FN 152.
emphasize that, in order to comply with the proportionality test, the domestic anti-hybrid rule should grant to the taxpayer the opportunity to provide evidence of genuine economic reasons that justify the use of hybrid financial instruments.163 As the parent company already has the onus of proving that the payment was non-deductible at the level of the subsidiary in order to qualify for the exemption or credit,164 the acceptance of evidence connected with the business reasons for using hybrid instruments does not overly increase the existing administrative burden.165
Proportionality in the narrower sense: The tax measure adopted by the Member State should confine itself to the minimum required to achieve its objectives and not go beyond what is necessary for attain that purpose.166
Against this background, the problem is that anti-hybrid rules go beyond what is necessary to attain the objective of avoiding double non- taxation. Considering the existence of differences in statutory tax rates among EU Member States, anti-hybrid rules may create overkill or underkill effects that negatively affect cross-border transactions. For example, the overkill effect may occur where the payment is deducted at the level of the subsidiary at a 15% rate, whereas the corresponding amount is taxed at the level of the parent company at a 35% rate. In contrast, the underkill effect may occur where the payment is deducted at the level of the subsidiary at a 35% rate, whereas the corresponding amount is taxed at the level of the parent company at a 15% rate.167 In the judgment in the Schempp case, the ECJ did not attach weight to the tax rate applicable to the income against which the expense was deducted, in comparison to the tax rate charged on the income by the Member State of the beneficiary of such payment. Indeed, the ECJ decided that the disallowance of the deduction of expenses derived from cross-border alimony payments in one Member State does not contravene EU law if the amount received by the beneficiary of the payment is not taxed in another Member State, regardless of
163 N. Strelnikova, Master Thesis,p. 32, FN 38.
164 O. Thömmes/A. Linn, Intertax 2014, p. 34, FN 39.
165 N. Strelnikova, Master Thesis, p. 32, FN 38.
166 A. Zalasiński, Intertax 2007, p. 312, FN 152.
167 R. de Boer in: R. de Boer/M. Nouwen (eds.), The European Union’s Struggle with Mismatches and Agressive Tax Planning, pp. 67-68.
any differences between the tax rates applicable. This implies that these differences in statutory tax rates are considered by the ECJ to an inescapable consequence of the sovereignty of the Member States in the field of direct taxation. However, it gives rise to practical implications, as the exemption method and the indirect credit method will seldom lead to the same result.169 Several factors may have an influence on the final result, such as tax rates, maximum credit, timing aspects, carry-forward of tax credits, per-country or overall limitation, multi-tier indirect credit, administrative burden, among other things.170 The economic impact may be aggravated if the profits are earned by a sub-subsidiary resident in another Member State.171 Although the differences between the exemption method and the indirect credit already existed prior to the amendment of the Parent-Subsidiary Directive, it must be acknowledged that taxpayers will still be able to exploit, with hybrid financial instruments, the tax policy chosen by the Member States in the implementation of the directive. This may represent a serious obstacle to anti-hybrid rules in light of the proportionality test, mainly because, if it were assumed that the ECJ is right in its claim that EU law does not require the prevention of double taxation in the first place, then it would be difficult to oblige a Member State to adopt the credit method in a certain detailed manner.172
In addition, it should be noted that Article 4(1) of the Interest and Royalty Directive allows the source Member State to exclude certain payments from its material scope, especially hybrid financial instruments that fall between equity and debt.173 In this case, the interest expense is deductible from the taxable profit of the subsidiary, but the source state keeps the right to impose the withholding income tax on the remittance. The application of this provision simultaneously with the new rule introduced in the Parent-Subsidiary Directive may end up in juridical double taxation, due to the levy of the withholding
168 Judgment in Schempp case, C-403/03, EU:C:2005:446.
169 B. J. M. Terra/P. J. Wattel, European Tax Law, pp. 312-313.
170 For more information, see: W. Loukota, The Credit Method and Community Law, in:
M. Lang/ J. Schuch/C. Staringer (eds.) Tax Treaty Law and EC Law (Vienna: Linde, 2007), pp. 125-149.
171 C. Marchgraber, European Taxation 2014, p. 136-138, FN 14.
172 B. J. M. Terra/P. J. Wattel, European Tax Law, p. 131.
173 D. Hristov, The Interest and Royalty Directive in: M. Lang/P. Pistone/J. Schuch/C.
Staringer (eds.) Introduction to European Tax Law on Direct Taxation, 3rd edition (Vienna: Linde, 2013), p. 185.
income tax on the payment made by the subsidiary and the taxation of the amount received at the level of the parent company.174 Even if the parent company grants a tax credit on the withholding income tax charged in the country of the subsidiary, the sum of the withholding income tax and the underlying tax paid by subsidiary may exceed the amount of corporate income tax due in the country of the parent company. In this scenario, the tax credit granted to the parent company may be limited, because Member States that rely on the credit method do not carry their capital export neutrality principle to the point of refunding the foreign tax credit.175 It follows that the concomitant application of both rules may cause an overkill effect, thereby infringing the principle of proportionality.
Moreover, the anti-hybrid rule introduced in the Parent-Subsidiary Directive linked the tax treatment applicable to the profit distribution to the deduction or not of the corresponding amount at the level of the first-tier subsidiary. Thus, it disregards the fact that considering only the first-tier subsidiary may often lead to an unintended consequence: economic double taxation. In a vertical line of investment, the profits generated by the second-tier subsidiary and distributed to the first-tier subsidiary as dividends may be taxed again at the level of the parent company, in case the payment made by the first- tier subsidiary has been characterized as deductible interest expense under the domestic law of that state. This result seems incompatible not only with the proportionality test, but also in conflict with the objective and purpose of the Parent-Subsidiary Directive.