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EU law and tax differentials

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EU law offers a number of different ways in which taxpayers can seek to complain about differences in tax treatment. The principle of fiscal neutrality is very much in the news, as a result of the recent judgment of the CJEU in Rank, dealing with the different UK VAT treatment of certain types of gambling, and the decision of the Upper Tribunal earlier this month that the FTT had erred in applying the principle in that case. But EU law also offers possible relief in the form of State aid law (which potentially applies to situations where there are different levels of taxation as between different types of product) and Article 110 of the TFEU (the focus of which concerns the different tax treatment of imported as opposed to domestic products).

Both small children and taxpayers instinctively feel that if someone else is getting a benefit, they should have it too. Small children will appeal to their parents: taxpayers may well try to appeal to EU law. How likely are taxpayers to succeed?

EU law offers a number of ways in which taxpayers can seek to complain about differences in tax treatment. The principle of fiscal neutrality (PFN) is very much in the tax news, as a result of the recent judgment of the CJEU in Rank (Joined Cases C-259/10 and C-260/10, judgment of 10 November 2011), dealing with the different UK VAT treatment of certain types of gaming. But EU law also offers possible relief in the form of State aid law and Article 110 of the Treaty on the Functioning of the EU (TFEU).

Fiscal neutrality

The concept of fiscal neutrality was familiar in economics long before it started to appear in tax law. For economists, ‘fiscal neutrality’ is the principle that a tax system should avoid distorting economic choices. A non-fiscally neutral tax system leads to a loss of welfare (see the Mirrlees report, volume 2, chapter 9, published in November 2010).

EU VAT law started using the concept of fiscal neutrality in the late 1980s. By 2006, when the CJEU gave judgment in LuP (Case C-106/05, [2006] ECR I-512), the PFN was being described as the reflection in the world of VAT of the general principle of equal treatment: ‘the principle of equal treatment, which is reflected, in the field of VAT, by the PFN’. That description was repeated by the CJEU in Rank.

In the meantime, the content of the PFN, in the VAT field, had become fixed in what has been until now a standard formulation: ‘That principle in particular precludes treating similar goods, which are thus in competition with each other, differently for VAT purposes’ (the phrase was first used in Commission v France (Case C-481/98, [2001] ECR I-3369, at 2).

Those quotations reveal two aspects of the PFN as it has been developed by the CJEU. The first is fiscal neutrality as an aspect of the principle of equal treatment: the second is fiscal neutrality as an economic principle, with a reference to the concepts of ‘similarity’ and ‘competition’. The ‘equal treatment’ aspect came to the fore in Marks & Spencer (Case C-309/06, [2008] ECR I-2283), where the CJEU found unlawful the UK’s application of an ‘unjust enrichment’ defence to VAT reclaims by ‘payment traders’ when no such defence applied to reclaims by ‘repayment traders’: though payment and repayment traders were not necessarily in competition with each other (or supplying similar products), for the purposes of the principle of equal treatment they were in a similar position. The ‘similarity/competition’ aspect has come to the fore in cases such as Rank.

A number of uncertainties continue to surround the concept of fiscal neutrality. One important question is the extent to which a difference in treatment may be objectively justified. If the PFN is seen as an aspect of the principle of equal treatment, then, as in any other equal treatment case, the Member States should be able to run an objective justification argument (as was recognised in principle in Marks & Spencer). But in the ‘similarity/competition’ cases there is so far little trace of such a possibility: notably, in TNT Post (Case C-357/07, [2009] ECR I-3025) where the CJEU held that the different VAT treatment of postal services supplied by Royal Mail as part of its universal service obligation (exempt) compared to postal services supplied by TNT Post (standard-rated) was consistent with the PFN notwithstanding the evident competition between those services. Advocate General Kokott and the CJEU did not employ the notion of ‘objective justification’, instead approaching the matter on the basis that the services were not similar because of the different regulatory context applying to each.

For taxpayers, the PFN offers a promising basis for complaining about differences in VAT treatment, where it is available. It does not assist in cases where the VAT Directives themselves mandate a difference in treatment (see Idéal Tourisme (Case C-36/99, [2000] ECR I-6049). Nor does it apply to non-EU taxes such as corporation tax. But where Member States exercise power under the VAT Directives to restrict the application of an exemption in breach of the principle, the consequence of breach is that the restriction falls away and tax paid as a result of the restriction has to be repaid to the taxpayer on the basis that the supplies in question should have been exempt (see Linneweber Joined Cases C-453/02 and C-462/02 [2005] ECR I-1131, at 37-38). That is plainly a gratifying result for the taxpayer concerned.

State aid: Articles 107 and 108 TFEU

In the field of State aid, a decision by a Member State to subject one operator, A, to higher tax than another operator, B, can amount to State aid to B. If it does amount to State aid then, unless it has previously been notified to, and cleared by, the Commission, the State aid is unlawful.

The State aid rules therefore potentially apply to situations where there are different levels of taxation as between different types of product.

For present purposes, a number of differences may be noted between the State aid position and the PFN in VAT.

  • State aid law potentially applies to any tax measure, including not only VAT (largely harmonised across the EU) but also ‘domestic’ taxes such as corporation tax or insurance premium tax. Fiscal neutrality is limited to ‘Euro-taxes’ such as VAT.
  • Unless the different tax treatment causes both a potential distorting effect on competition and a potential effect on trade between Member States, the different treatment cannot amount to State aid. But it is now clear after Rank that competition is not an element of the test for infringement of the PFN.
  • Even a difference of tax treatment between similar or competing operators will not be a State aid if the difference is justified by the logic of the tax system. On that basis, in GIL Insurance (Case C-308/01, [2004] ECR I-4777), the UK successfully defended its system of applying a higher (17.5%) rate of insurance premium tax to extended product warranties sold by retailers than to equivalent insurance sold through other channels (3%), on the basis that that it tackled ‘value-shifting’ by retailers, namely loading the price onto the insurance element in order to benefit from IPT at 3% rather than VAT at 17.5%.
  • Further, even where a tax differential is State aid, it may be cleared by the Commission under Article 107(3) after a notification by the Member State. The Commission may do so on the basis of wide policy considerations. Once the Commission has cleared an aid, its implementation in the Member State concerned cannot be challenged under the State aid rules except on the basis of challenging the Commission’s clearance decision itself.
  • Finally, the consequence of a finding of (un-notified) State aid is not that the higher tax rate is unlawful but, rather, that the advantage conferred on the lower taxed undertaking is unlawful: the appropriate remedy is therefore not to refund the tax paid by the adversely-treated party but to require the State to recover an amount equal to the tax advantage from the favoured party (see Banks (Case C-390/98, [2001] ECR I-6117, at 80) and Air Liquide (Joined Cases C-393/04 and C-41/05, [2006] ECR I-5293, at 43)). Undertakings are therefore likely to take a State aid point only if they consider that the difference in tax treatment is genuinely having a damaging effect on their competitive position: if it is, then the remedies available (an order that the advantaged party lose the benefit in future and pay back the aid plus interest, plus a remedy against the State for damages for competitive harm suffered as a result of the difference in treatment) will provide a good incentive to complain.

Article 110 TFEU

Article 110 TFEU provides that:

‘[1] No Member State shall impose, directly or indirectly, on the products of other Member States any internal taxation of any kind in excess of that imposed directly or indirectly on similar domestic products.

‘[2] Furthermore, no Member State shall impose on the products of other Member States any internal taxation of such a nature as to afford indirect protection to other products.’

The focus of Article 110 is different tax treatment of imported as opposed to domestic products. That reflects one of the central aims of the EU, namely market integration and the reduction of barriers to the flow of trade between Member States. However, Article 110 applies in principle to any kind of taxation, including ‘domestic’ taxes. Its field of application is therefore rather different to that of the PFN.

There are other important differences compared to the PFN. In particular:

  • The CJEU has held that infringement of Article 110(1) is established only if the difference of treatment has the likely effect of disadvantaging imported products: Commission v Greece (Case 132/88, [1990] ECR I-1567). Under Article 110(2), infringement is established only if the products are in competition and the difference in treatment is likely to have a protective effect on the (generally domestic) class.
  • Despite the absence of any reference to justification in either paragraph 1 or paragraph 2 of Article 110, the CJEU’s case law makes it clear that indirect discrimination (i.e. different tax treatment of generally imported products as opposed to generally domestic products) may be justified for ‘legitimate social or economic purposes’ and hence not fall within Article 110: see, for example Bergandi (Case 252/86, [1988] ECR 1343).


Small children know that an appeal to their parents about differences in treatment may or may not work: it all depends on context. Taxpayers may well feel the same about EU law;  it can produce gratifying results in the right context, but will not always do so.

George Peretz, barrister, Monckton Chambers