UK vs Cadbury- Schweppes, September 2006, European Court of Justice, Case C-196/04

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The legislation on ‘controlled foreign companies’ in force in the United Kingdom provided for the inclusion, under certain conditions, of the profits of subsidiaries established outside the United Kingdom in which a resident company has a controlling holding.

The UK tax authorities thus claimed from the parent company of the Cadbury Schweppes group, established in the United Kingdom, tax on the profits made by one of the subsidiaries of the group established in Ireland, where the tax rate was lower.

The Court was asked to consider whether this legislation was compatible with the provisions of the Treaty on freedom of establishment (Articles 43 and 48 EC).

The Court recalled that companies or persons could not improperly or fraudulently take advantage of provisions of Community law. However, the fact that a company has been established in a Member State for the purpose of benefiting from more favourable tax legislation does not in itself suffice to constitute abuse of the freedom of establishment and does not deprive Cadbury Schweppes of the right to rely on Community law.

The Court then analysed the legislation in terms of freedom of establishment.

According to settled case-law, although direct taxation falls within the competence of the Member States, they must none the less exercise that competence consistently with Community law.

The Court noticed the difference in the treatment of resident companies depending on whether the CFC legislation was or was not applicable: in the first instance the company is taxed on the profits of another legal person, whereas this is not the case in the latter instance (that is, when a resident company has a subsidiary taxed in the United Kingdom or a subsidiary established in another Member State where the tax rate is higher than in the United Kingdom).

The Court noted that the separate tax treatment is such as to hinder the exercise of freedom of establishment, dissuading a resident company from establishing, acquiring or maintaining a subsidiary in a Member State with a lower tax rate.

The Court pointed out that a national measure restricting freedom of establishment may be justified only where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned and does not go beyond what is necessary to achieve that purpose. In order to find that there is such an arrangement there must be, in addition to a subjective element, objective and ascertainable evidence – with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment – that the incorporation of this subsidiary does not reflect economic reality, that is to say it is not an actual establishment intended to carry on genuine economic activities in the host Member State. The tests conducted under the national legislation must incorporate these factors if they are to be compatible with Community law.

The Substance Test

67 As suggested by the United Kingdom Government and the Commission at  the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment.

68 If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a ‘letterbox’ or ‘front’ subsidiary (see Case C-341/04 Eurofood IFSC [2006] £CR 1-3813, paragraphs 34 and 35).

69 On the other hand, as pointed out by the Advocate General in point 103 of his Opinion, the fact that the activities which correspond to the profits of the CFC could just as well have been carried out by a company established in the territory of the Member State in which the resident company is established does not warrant the conclusion that there is a wholly artificial arrangement.



Cadbury Schweppes