French Corporate-Tax Loophole Ruled Illegal

(CN) - A tax loophole that allows French companies to receive tax-free dividends from shares in other companies located in France only runs afoul of the EU constitution, Europe's highest court ruled on Wednesday.

Under the French tax scheme, parent companies with shares in other subsidiaries are exempt from paying taxes on dividends save a 5 percent proportion of the costs and expenses related to the shares.

However, the same law allows companies belonging to the same tax-integrated group to deduct the costs and expenses from their profits - meaning they pay no taxes on the dividends.

The scheme only applies to French companies with holdings in subsidiaries located in France. This prompted information-technology services giant Steria - which operates in 16 nations - to sue France's finance ministry for overpayment of taxes between 2005 and 2008. The company argued that the scheme violated the EU constitution's freedom of establishment clause since it was denied favorable tax treatment simply because it has subsidiaries in other member states and worldwide.

In a ruling issued Wednesday, the European Court of Justice agreed - finding the scheme unfairly disadvantages multinational companies and makes it less attractive for them to exercise their right of establishment in setting up subsidiaries outside of France.

And the differential treatment is not justified by France's desire to "safeguard the cohesion of the tax system," the Luxembourg-based court said.

"For an argument based on such justification to succeed, a direct link has to be established between the tax advantage concerned and the offsetting of that advantage by a particular tax levy, the direct nature of that link falling to be examined in the light of the objective pursued by the rules in question," the court wrote in its 5-page opinion.

"However, it has not been possible to identify any direct link between the tax advantage at issue in the main proceedings and a tax disadvantage resulting from the neutralization of intragroup transactions.

"Even if, as the French government submits, the neutralization of the add-back of the proportion of costs and expenses results from the fact that the group comprising the parent company and its subsidiaries is treated in the same way as a single undertaking with a number of establishments, that neutralization does not entail any tax disadvantage for the parent company at the head of the tax-integrated group; on the contrary, as is apparent it confers on it the tax advantage at issue in the main proceedings," the court wrote.

The court also rejected arguments that EU law gives member states the right to structure corporate-tax codes as they see fit.

"It is evident from settled case-law that the decision EU law leaves in the hands of the member states may be exercised only in compliance with the fundamental provisions of the EU constitution," the court concluded.

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