One of the features of our tax system has always been that the tax treatment of a person or transaction can vary if that person or transacti...

One of the features of our tax system has always been that the tax treatment of a person or transaction can vary if that person or transaction is located abroad. This is a familiar concept - for example, foreign income is often taxed differently to UK-source income and certain reliefs are only available to UK transactions. Following recent European court decisions it is becoming clear that, under EU law, tax legislation must not discriminate on the basis of the taxpayer’s location within the EU. Any relief or tax charge that is applied to domestic residents must also be extended to other EU residents, and vice versa. European citizens have certain basic human rights under EU law, which include the freedom of establishment and the free movement of persons and capital. In addition, EU law takes priority over domestic law – when the two conflict, the EU position prevails. Certain tax cases that have been brought before the European Court of Justice (ECJ) and have resulted in an astonishing 98% win rate for the taxpayer, and have largely been fought on the principle that the tax legislation in question breached these two rights. For instance, a recent case involved the taxation of foreign dividends in Finland. In that country, when an individual receives domestic dividends they are eligible for a tax credit to reflect the underlying corporation tax paid by the distributing company. The taxpayer in this case received a dividend from a Swedish corporation and claimed a similar credit. Finnish law clearly stated that only domestic dividends were eligible. The ECJ stated that, since Finland allows individuals a tax credit on domestic dividends, it must also allow a tax credit on dividends from other EU countries. There is comparable legislation in the UK, where a notional 10% tax credit is available for UK dividends only, leading to a lower effective tax rate on UK dividends than on overseas dividends. It is perhaps the case that, following the above decision, UK taxpayers could claim the 10% tax credit in respect of foreign dividends also, in anticipation of an EU ruling on this point. The above case dealt with the movement of money, but there is now a growing body of European case law that deals with the movement of people also. The concept of an ‘exit charge’ is a feature of the tax systems of several EU countries. The UK, for example, taxes the emigration of trusts and companies. Other countries have exit charges which apply to individuals – France charges tax in some circumstances on the unrealised capital gain on securities held by an individual leaving the country. This was held to be illegal under EU law, where the ECJ stated that the principle of free movement: “must be interpreted as precluding a Member State from establishing … a mechanism for taxing as yet unrealised increases in value … where a taxpayer transfers his tax residence outside that state.” It is often the case that if a particular transaction is motivated entirely by a desire to avoid tax, a UK court will ‘look through’ the scheme, to tax what it sees to be the underlying transaction. The ECJ has recently ruled that, even if the sole motivation behind a transaction was to avoid tax, this is not sufficient reason for the fundamental human rights of the taxpayer to be ignored, and so even in this case discrimination is not allowed. It is difficult to see how our domestic tax legislation will change to take account of these EU developments. There are many areas of UK tax legislation that are incompatible with the developing European case law. The Marks & Spencer case, for example, which is being heard by the ECJ this month, involves the allocation of losses between groups of companies and it has been estimated that a decision in favour of the taxpayer could cost the Exchequer around £6bn in tax terms. The options for HM Treasury seem to be to amend UK legislation to be compliant with EU human rights law, which would involve a root and branch review of UK tax law; or to negotiate a tax carve-out from the EU treaty, which may or may not be acceptable to our EU partners.