IT WAS contrary to Community law on freedom of establishment to tax a parent company on the profits of a subsidiary established in another country where a lower rate of taxation prevailed, unless not only was there an intention to avoid taxation but also the arrangements made were wholly artificial in that the subsidiary carried on no genuine economic activities.

The Grand Chamber of the Court of Justice of the European Communities so held on a reference under article 234 EC for a preliminary ruling by the Special Commissioners of Income Tax, London.

The legislation in the United Kingdom on controlled foreign companies was designed to defeat the practice whereby a United Kingdom resident company transferred its taxable profits to a company it controlled established in another state which applied a much lower rate of taxation than that in effect in the United Kingdom.

The normal rule in United Kingdom law was that parents were not taxed on the profits of their subsidiaries as they arose, but under sections 747 to 756 of, and Schedules 24 to 26 to the Income and Corporation Taxes Act 1988, the profits of a controlled foreign company, defined at the material time as a foreign company in which the parent owned a holding of more than 50 per cent, of a parent established in the United Kingdom were regarded as accruing to the parent and taxed accordingly if those profits were subject in the foreign company’s state to a lower level of taxation, namely less than three quarters of the rate that would have been charged if the profits had arisen in the United Kingdom. Allowance was made for tax paid in that state.

There were four specific exceptions, and also a further “motive” exception, whereby the parent had to show that (i) it was not the purpose of the foreign company’s transactions to reduce United Kingdom tax and (ii) it was not the main reason for the foreign company’s existence to divert profits from the United Kingdom.

Cadbury Schweppes plc, a company resident in the United Kingdom, was the parent company in a group and had a number of subsidiaries in various countries, at the head of which was the second claimant, Cadbury Schweppes Overseas Ltd.

Two subsidiaries, established at the International Financial Services Centre in Dublin, Ireland, carried on the business of raising finance and providing it to subsidiaries in the group.

It was common ground that they were established in Dublin in order to benefit from the favourable tax conditions there, where they were taxed at the rate of 10 per cent.

The profits of those subsidiaries were charged to tax in the United Kingdom under the aforementioned provisions of the 1988 Act. In their appeal, the claimants maintained that those provisions contravened, inter alia, the principle of freedom of establishment in articles 43 and 48 EC.

The special commissioners stayed proceedings and sought a preliminary ruling on the issue.

Article 43 EC provides: “. . . restrictions on the freedom of establishment of nationals of a member state in the territory of another member state shall be prohibited . . .”

Article 48 provides: “Companies . . . having their registered office . . . within the Community shall, for the purposes of this Chapter, be treated in the same way as natural persons who are nationals of member states . . .”

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