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INTERNATIONAL TAX NEWSLETTER

Issue # 3 - May 2, 2005

EUROPEAN UNION

ECJ SET TO CONFIRM THE PRINCIPLE OF NON DISCRIMINATION BETWEEN TAXATION OF BRANCHES AND SUBSIDIARIES LOCATED IN A EU MEMBER STATE AND OWNED BY A FOREIGN TAXPAYER RESIDENT IN ANOTHER EU MEMBER STATE.

On April 14, 2005 the Advocate General with the ECJ Mr. Philippe Léger concluded in the CLT-UFA case (CLT-UFA v. Finanzamt Koln-West (C-253/03) that a EU member state’s domestic tax laws that subject a permanent establishment (PE) located in that state and owned by a foreign taxpayer resident in another EU member state to a higher tax burden than the tax burden that applies to a domestic subsidiary owned by a foreign EU parent company violates the freedom of establishment principle of articles 43 and 48 of the EC Treaty. In the CLT-UFA case, Germany taxed the business profits attributable to a German PE of a Luxembourg company, CLT-UFA, at the rate of 42 per cent instead of the rate of 33.5 that would apply if the Luxembourg company established a subsidiary in Germany that distributed dividends to its parent. According to the Advocate General, Articles 43 and 48 of EC Treaty mandate that same tax treatment for PEs and domestic subsidiaries located a EU member state and owned by companies organized in other EU member state.

The ECJ has ruled several times in the past in favor of non discrimination in taxation of PEs and subsidiaries located in a EU member state and owned by taxpayers resident in another EU member state. The two most immediate precedents are Saint-Gobain andRoyal Bank of Scotland. In Saint-Gobain (Compagnie De Saint-Gobain, Zn Deutschland v. Finanzamt Aachen-Innenstadt, Case number C-307/97), the Court ruled that the same tax reliefs (foreign tax credit and exemption for certain items of foreign source-income subject to foreign tax) that a EU member state grants to domestic subsidiaries owned by other EU taxpayers pursuant to a tax treaty between that state and a third country must be granted also to PEs located in that state and owned by taxpayers based in other EU member states. In Royal Bank of Scotland (Royal Bank of Scotland Plc vs. Elliniko Dimosio (Greek State), Case number C-311/97), the Court struck down the domestic law provision of a member state (Greece) that applied a higher income tax rate to profits attributable to PEs located in that stated owned by companies organized in other EU member states, compared to the ordinary tax rate charged on profits of domestic subsidiaries owned by EU companies.

THE DUTCH SUPREME COURT RULED THAT THE RIGH TO RECEIVE SHARES TO BE ISSUED AT A FUTURE TIME FALLS WITHIN THE SCOPE OF THE DUTCH PARTICIPATION EXEMPTION.

On April 22, 2005 the Dutch Supreme Court ruled that the right to receive shares to be issued at a future date falls within the scope of the Dutch participation exemption rules. In the past, the Court had ruled that the participation exemption regime does not apply to gains realized on conversion of convertible bonds and an that interest in a company still to be incorporated and not yet come into existence.

By comparison, with respect to the Italian participation exemption rules there is a bifurcation: for companies subject to corporate income tax and individual taxpayers carrying on a trade or business and subject to tax on their business income (or PEs in Italy of foreign companies or individuals), the participation exemption rules apply only to gains on sales of corporate stock or partnership interests and financial instruments classified and treated as stock for tax purposes, issued by either domestic or foreign taxpayers. For individuals not engaged in the conduct of a trade or business, the participation exemption rules cover also gains on sales of any other rights or instruments incorporating a right to purchase corporate stock or partnership interests (such as options, warrants and convertible debt securities).
ITALY

ITALIAN TAXATION OF FOREIGN TAXPAYER'S ITALIAN PE.

The Advocate General’s opinion in the CLT-UFA gives the opportunity to briefly discuss Italian domestic tax law applying to foreign taxpayers’ Italian PEs. Generally speaking, Italy taxes income attributable to foreign taxpayers’ PEs in Italy according to the same rules that apply to domestic taxpayers, without discrimination. Income attributable to a foreign company’s Italian PE is subject to corporate income tax according to the same rules that apply to taxation of domestic corporations, and income attributable to a foreign individual’s Italian PE is subject to individual income tax according to the same rules that apply to taxation of resident individuals’ business income.

The use of a PE in Italy may serve interesting tax planning purposes, in a sense that by establishing a PE in Italy and carrying out certain transaction through its Italian PE a foreign taxpayer may be able to benefit from favorable tax rules that apply to domestic taxpayers. For example,

    * dividends received by a foreign company's Italian PE are not subject to the Italian 27 per cent withholding tax on outbound dividends (reduced under tax treaties) and 95 per cent of the dividend amount is excluded from the Italian corporate income tax on income attributable to the Italian PE under the new Italian participation exemption rules;

    * gains from sale of corporate stock or capital interests in partnerships or other entities realized by a foreign company's Italian PE are exempted from Italian corporate income tax on income attributable to the Italian PE under the new Italian participation exemption rules;

    * domestic SRLs or SPAs owned by a foreign company’s Italian PE can elect to be treated as partnerships for tax purposes under the new Italian check-the-box rules;

    * domestic companies owned by a foreign company’s Italian PE may elect to be taxed on a consolidated basis under the Italian new domestic tax consolidation rules.

Interestingly, a foreign company that owns stock in non-Italian subsidiaries through an Italian PE is not allowed to consolidate its non-Italian subsidiaries for Italian tax law purposes, even though it may satisfy all other conditions required for Italian worldwide tax consolidation. This specific rule may be deemed to create an unlawful discrimination in violation of the EC Treaty.

A tradeoff of using a PE in Italy is that the foreign taxpayer would be obligated to keep the books and records and file a financial statement with respect to the business transactions of its Italian PE and to file and income tax return in Italy with respect to income attributable to its Italian PE, and for such income it would be subject to certain Italian anti-avoidance rules including thin capitalization, transfer pricing and CFC rules.

UNITED STATES

FLASH UPDATE.

At the April 28 meeting of the International Fiscal Association's (IFA) US and UK branches in New York the IRS anticipated that by the time of the American Bar Association (ABA) Tax Section spring meeting to be held in Washington, D.C. from May 19 through 21 new administrative guidance on certain aspects of IRC § 965 rules on repatriation of foreign profits at a reduced tax rate, and namely those concerning mergers and acquisitions and base period, and foreign tax credit and expense allocation issues, will be provided. By the same time ,enhanced regulations on dual consolidated losses should also be provided. The IRS also said that § 482 cost-sharing regulations should be finalized by the end of the business plan year, while § 482 services regulations might have to be re-proposed.