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If the shareholder is not liable to tax on 6. By agreement of 1 December 1996, receipts within the meaning of Heads 1 to 3 LT BV granted Lankhorst-Hohorst a loan of Paragraph 20(1) or Head 2a of of DEM 3 000 000, repayable over 10 Paragraph 20(2) or if, under Head 1 or 2 years in annual instalments of DEM 300 000 of Paragraph 50(1), those receipts are not from 1 October 1998. The variable interest included in the taxable amount, there can rate was 4.5% until the end of 1997. be no tax credit or offsetting of corporation Interest was payable at the end of the year. tax under Head 3 of Paragraph 36(2) of the LT BV thus received interest of DEM Einkommensteuergesetz (Law on Income 135 000 in 1997, and then DEM 109 695 Tax).' in 1998.

7. The loan was intended as a substitute for I I— The facts capital. It was accompanied by a 'Patron- atserklärung' (letter of support) under which LT BV would waive repayment of the loan if third party creditors made claims against Lankhorst-Horhorst. 4. Lankhorst-Hohorst GmbH (hereinafter 'Lankhorst-Hohorst'), a limited liability company incorporated under German law, whose registered office is in Rheine, Ger- many, is engaged in the sale of boating equipment, goods for water sports, leisure and craft items, leisure and work clothing, furnishings, hardware and similar goods. In 8. The loan enabled Lankhorst-Hohorst to August 1996 it increased its share capital to reduce its borrowing from AMRO-Bank DEM 2 000 000. Münster from DEM 3 702 453.59 to DEM 911 174.70 and therefore to reduce its interest burden.

11. According to the referring court, the 14. Lankhorst-Hohorst adds that it is exception in the second sentence of necessary to have regard to the spirit and Paragraph 8a(1) of the KStG, for cases purpose of Paragraph 8a of the KStG, where the company in question could have which is to prevent evasion of tax payable obtained the loan capital from a third party on the assets of companies limited by under identical terms, could not apply. In shares. In the present case, however, the view of the plaintiff's excessive indebted- loan was granted with the sole objective of ness and its inability to provide security, it minimising Lankhorst-Hohorst's costs and could not in fact have obtained a similar it enabled it to make significant savings on loan (granted without security and with a bank interest. The plaintiff points out in letter of support) from any third party. that regard, that, before modification of the bank loan, the interest was twice as high as that thereafter payable to LT BV. This is accordingly not a case in which a share- holder which is not entitled to deduct the tax paid by its subsidiaries is seeking to circumvent tax on true distributions of 12. By a decision of 14 February 2000, the profits by authorising payments of interest tax authorities rejected the objection to itself. lodged by the plaintiff against the corpor- ation tax assessment notices.

13. In support of its action before the 15. The Finanzamt Steinfurt (Steinfurt Tax referring court, Lankhorst-Hohorst states Office) recognises that application of that the grant of the loan by the Nether- Paragraph 8a of the KStG could exacerbate lands shareholder was a rescue attempt by the situation of firms and companies in it and that the interest paid to that share- difficulties. However, the clear wording of holder could not be classified as a covert the provision, in its view, precludes any distribution of profits. It argues, further, other interpretation in the light of its spirit that Paragraph 8a of the KStG is discrimi- and purpose. In that connection, the refer-

ring court likewise accepts that the wording 19. The Finanzgericht Münster, citing the of the paragraph does not suggest that, in case-law of the Court of Justice, 2expresses addition to the factual requirements, there doubts as to whether Paragraph 8a of the must also be evasion in order for the KStG is compatible with Article 43 EC. It provision to apply. draws attention to the fact that, according to the case-law of this Court, a national of a Member State who has a holding in the capital of a company established in another Member State which gives him definite influence over the company's decisions and allows him to determine its activities is 16. The tax authorities take the view that exercising his right of establishment. 3 Paragraph 8a of the KStG does not conflict with the Community principle of non-dis- crimination. Many countries have provi- sions with a similar objective, primarily in relation to abuse in specific cases, based on the proportion of equity capital to debt 20. According to the referring court, there capital. is infringement of the right to freedom of establishment where the different tax treat- ment of a subsidiary is based solely and without further objective justification on the fact that its sole shareholder, the parent company, has its corporate seat in a different Member State from that in which the subsidiary is established. 17. The Finanzamt states that the distinc- tion made in Paragraph 8a of the KStG between those who are entitled to the tax credit and those who are not does not entail covert discrimination on the basis of nationality since Paragraph 51 in conjunc- tion with Paragraph 5 of the KStG (on 21. It observes, in that connection, that the exemption from corporation tax) also rule in Paragraph 8a of the KStG is not excludes several categories of German tax- linked directly to nationality but to able persons from entitlement to the tax whether the taxable person enjoys the tax credit. credit. Legal persons not entitled to tax credit are essentially, under the KStG, German corporations which are exempt from corporation tax and foreign share- holders who do not have their holding in the capital of a German limited company in the form of German operating assets. 18. Lastly, according to the Finanzamt, the principle of once-only taxation and the 2 — Sec, in particular, Case 270/83 Commission v France [1986] coherence of the German tax system justify ECR 273, Case C-311/97 Royal Bank of Scotland (1999) applying Paragraph 8a of the KStG in the ECR I-2651, and Case C-294/97 Eurowings Luftverkehr [1999] ECR I-7447. circumstances of the main proceedings. 3 — Case C-251/98 Baars [2000] ECR I-2787.

25. It is necessary to examine, first of all, whether Article 43 EC applies to a case III— The question referred for a prelimi- such as that now under consideration. nary ruling

24. In view of the foregoing, the Finanz- 26. The plaintiff argues that the arrange- gericht Münster, by order of 21 August ments e s t a b l i s h e d by H e a d 2 of Paragraph 8a(1) of the KStG have the effect, essentially, of taxing subsidiaries 4 — Judgment of the Bundesfinanzhof of 30 December 1996, IB differently according to whether their par- 61/96, Bunderssteuerblatt PartII 1997, p. 466, and Eurow- ings Luftverkehr, cited above. ent company is resident or not.

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of the proposition that the Member 30. The referring court states that those State in which a company seeks to shareholders which are not entitled to the establish itself may freely apply to it a tax credit 'are essentially, under Article 51 different treatment solely by reason of of the KStG, German corporations which the fact that its corporate seat is are exempt from corporation tax and situated in another Member State foreign shareholders who do not have their would thus deprive Article 52 of all holding in the capital of a German limited meaning (Commission v France, cited company in the form of German operating above, paragraph 18).' assets'.

28. Specifically, it is therefore necessary to examine whether, as was the case in 31. According to the German Government, Metallgesellschaft and Others 6 for subsidi- the fact that a significant number of aries established in the United Kingdom, German taxpayers are also excluded from subsidiaries established in Germany are the right to the tax credit proves that the treated differently according to whether or criterion based on entitlement to the tax not their parent company has its corporate credit is not discriminatory. seat in Germany.

The existence of a difference of treatment 32. This argument is not, however, com- arising from the criterion used in Head 2 of pelling. Paragraph 8a(1) of the KStG

37. In the present case, likewise, the legis- lation at issue in the main proceedings 36. The Court of Justice, however, rejected amounts to the establishment of different that argument and stated as follows: tax rules according to whether the parent company, that is to say, the shareholder in the subsidiary, is established in Germany or in another Member State.

'35 In that regard, it is to be noted that in the main action the obligation to make the a d d - b a c k s provided for in Paragraph 8(7) and Paragraph 12(2) 38. Head 2 of Article 8a(1) of the KStG, of the [Gewerbesteuergesetz] is always therefore, invariably applies, ratione per- applicable for German undertakings sonae, where a resident subsidiary such as leasing goods from lessors established Lankhorst-Hohorst has obtained loan capi- in another Member State, since the tal from its non-resident parent company, latter are never liable to pay the trade whereas that is not true, under the same circumstances, for a resident subsidiary which has received loan capital from its 7 — Paragraph 25. resident parent company.

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43. Even though, in the present case, Lankhorst-Hohorst did obtain such a letter from its parent company, the fact remains that it was subject to reclassification not by Wherever a shareholder declares that "he reason of that 'Patronatserklärung', but on wishes to be taken into account for the the basis of Head 2 of Paragraph 8a(1) of purposes of his claim only after satisfaction the KStG.

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44. Since subsidiaries in the same position of Paragraph 8a(1) of the KStG are satis- as Lankhorst-Hohorst, but whose parent fied, a subsidiary which has obtained loan company is resident, cannot be subject to capital from a non-resident parent com- such a reclassification — the provision in pany is subject to taxation in respect of the issue not applying to them — the German interest in question, whereas a subsidiary Government cannot claim that Lankhorst- which has obtained loan capital from a Hohorst received the same treatment as resident parent company is not. those subsidiaries.

45. Having therefore established that there 49. Furthermore, according to the expla- is a difference of treatment, it is necessary nation given by the referring court, where a now to examine its consequences. It seems shareholder is entitled to the tax credit, the to me beyond doubt that the difference tax on the distribution of dividends is set operates solely to the detriment of a resi- dent subsidiary which has obtained loan against its personal income tax. That is not capital from a non-resident parent com- so where the shareholder is not entitled to a pany. tax credit, which, as has already been seen, is invariably the position with shareholders resident abroad.

subsidiary (Lankhorst-Hohorst), is likewise 56. The effect of Head 2 of Paragraph 8a(1) liable to infringe Article 43 EC. of the KStG is, consequently, such that, if the requirements for application of that provision are satisfied, a non-resident par- ent company can no longer usefully opt to finance its subsidiary by using loan capital. Its freedom of financing is therefore, in 52. As the referring court rightly points out practice, more limited than that of a resi- with reference to the Baars judgment, a dent parent company. national of a Member State who has a holding in the capital of a company estab- lished in another Member State which gives him definite influence over the company's decisions is exercising his right of establish- ment. That is indisputably true of LT BV which holds 100% of the capital in Lank- Existence of an overriding requirement of horst-Hohorst. general interest justifying the difference of treatment

53. Lastly, unlike the German Govern- ment, I am of the view that freedom of financing is in fact more restricted as regards the options for financing the resi- 57. Since it seems to me to have been dent subsidiary of a non-resident parent established that the second sentence of company than as regards the options for Paragraph 8a(1) of the KStG does give rise financing the resident subsidiary of a resi- to a difference of treatment, whether to the dent parent company. detriment of the resident subsidiary of a non-resident parent company or of the non-resident parent company itself, it is necessary to examine whether there is an overriding requirement of general interest which justifies that difference. 8 54. The German Government maintains, on that point, that the loan to which Head 2 of Paragraph 8a(1) of the KStG relates none the less remains loan capital and is not reclassified as equity capital.

60. The Danish Government states that such rules were adopted in a series of countries, both inside and outside the European Union, as economies become 63. The governments which lodged obser- increasingly internationalised and as the vations are thus in agreement that, since the need to prevent tax avoidance makes itself rules on thin capitalisation are intended to increasingly felt. prevent the arbitrary transfer of the tax debt from one country to another and to ensure that the tax is charged in the place where the profit was actually made, there can be no finding of discrimination between the tax arrangements applicable to cross-border operations and those appli- 61. That Government submits that by their cable to domestic operations. very nature the rules on thin capitalisation only relate, in fact, to cross-border trans- actions. In the situation of a transaction between two fully-taxable domestic com- panies, the tax-deductible interest expense of one company will be equal to the earnings from taxable interest of the other 64. Those same governments refer to and the net result will be fiscally neutral for Article 9 of the model convention drawn the group. It is only where the transactions up by the Organisation for Economic take place between companies having their Cooperation and Development (hereinafter registered offices in different countries that the 'OECD model convention') for the

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67. However, according to the Commis- sion, the rule in Paragraph 8a of the KStG must also comply with the principle of proportionality. The Commission points out that the rule prescribes the proportion 66. The Commission also believes that the of loan capital to equity capital and makes difference of treatment deriving from an exception where loan capital could also Paragraph 8a of the KStG can be justified have been made available by an uncon- nected third party on the same conditions. 9 — According to Article 9 of the OECD model convention, '1. Where (a) an enterprise or a Contracting State participates directly or indirectly in the management, control or capital of an enterprise of the other Contracting State, or (b) the same persons participate directly or indirectly in the management, control or capital of an enterprise of a Contracting State and an enterprise of the other Contracting State, and in either case conditions are made or imposed between the two enterprises in their commercial or financial relations 68. However, the Commission refers to the which differ from those which would be made between independent enterprises, then any profits which would, but risk of double taxation in this case: the for those conditions, have accrued to one of the enterprises, German undertaking is subject to German but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed corporation tax on profits distributed accordingly. 2. Where a Contracting State includes in the profits of an whilst the foreign shareholder still has to enterprise of that State — and taxes accordingly — profits declare in the Netherlands, as earnings, on which an enterprise of the other Contracting State has been charged to tax in that other State and the profits so amounts it has received in the form of included are profits which would have accrued to the enterprise of that first-mentioned State if the conditions interest. In the view of the Commission, a made between the two enterprises had been those which Member State which classifies an interest would have been made between independent enterprises, then that other State shall make an appropriate adjustment payment as a covert distribution of profits to the amount of the tax charged therein on those profits. In determining such adjustment, due regard shall be had to the must also ensure that there is liaison on the other provisions or this Convention and the competent matter with the State in which the parent authorities of the Contracting States shall if necessary consult each other.' company is registered, so that a cor-

76. That purpose is confirmed not only by the explanations of the referring court and 73. That is what the German Government those expounded by the interveners, but is suggesting in asserting that 'a shareholder also by academic commentary on Head 2

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of Paragraph 8a(1) of the KStG and on the 80. Indeed, assuming that such compliance thin capitalisation rules in general. 10 were established, 12 it must still be pointed out that the fact that the rules are con- sistent with the provisions of the OECD model convention does not also mean that they comply with Article 43 EC. Neither the provisions nor the objectives of the OECD model convention, on the one hand, 77. It does not seem to me, however, that or of the EC Treaty, on the other, are in such an objective can amount, in the fact the same. context of Article 43 EC, to an overriding requirement of general interest justifying a difference of treatment.

81. Admittedly, nothing precludes an inter- pretation the EC Treaty, so far as possible, in accordance with an OECD model con- 78. It is settled case-law that 'diminution of vention. 13 However, I take the view that it tax revenue cannot be regarded as a matter is not possible to do so in the present case, of overriding general interest which may be always assuming that a provision such as relied upon in order to justify a measure Head 2 of Paragraph 8a(1) of the KStG which is, in principle, contrary to a funda- does comply with Article 9 of the OECD mental freedom'. 11 model convention.

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83. The German and the United Kingdom 87. The German Government also submits Governments also consider that Head 2 of that the rule in Paragraph 8a of the KStG is Paragraph 8a(1) of the KStG is justified by justified as a measure intended to combat the overriding requirement of general inter- abuse. est consisting of the need to ensure the coherence of the applicable tax systems. 14

88. It refers, in that regard, to paragraph 24 of the Centros judgment, 16 which states 84. In that connection, however, it must be that '... according to the case-law of the pointed out, as did the referring court, that Court a Member State is entitled to take the Court of Justice has stated that such an measures designed to prevent certain of its overriding requirement exists only if the nationals from attempting, under cover of fiscal coherence is 'established in relation to the rights created by the Treaty, improperly one and the same person by a strict to circumvent their national legislation or correlation' between a tax advantage and to prevent individuals from improperly or unfavourable tax treatment. 15 fraudulently taking advantage of provisions of Community law...'.

91. The fact that the provision at issue 'does not have the specific purpose of preventing wholly artificial arrangements, 95. I therefore take the view that the need set up to circumvent [the] tax legislation' 19 to combat tax avoidance does not, in the of the Federal Republic of Germany is, present case, constitute an overriding moreover, confirmed by the facts of the requirement of general interest justifying present case. the difference of treatment deriving from a rule such as the provision at issue.

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accounts in compliance with certain rules views on the relevance which Council in the Member State in which tax is to be Directive 90/435/EEC of 23 July 1990 on charged so that the tax authorities of that the common system of taxation applicable Member State can ascertain the amount of in the case of parent companies and taxable income. subsidiaries of different Member States 23 may have for resolution of the dispute in the main proceedings.

98. Having regard to the foregoing, I am therefore of the view that there is no overriding requirement of general interest justifying the difference of treatment deriv- 101. The Danish Government states that, ing from a rule such as the provision at were this an instance of an overt distribu- issue. Such a rule is therefore, in my view, tion of dividends, that distribution would, contrary to Article 43 EC. by virtue of Article 5(1) of Directive 90/435, be exempt from withholding tax. Accordingly, a covert distribution should receive the same treatment.

99. It falls to the German authorities to determine whether the provision in issue should be replaced by, for example, a provision extending to subsidiaries with a resident parent company the rules on the 102. In contrast, the German Government, reclassification of interest as dividends. 21 the United Kingdom Government and the In the meantime, however, the provision at Commission consider that Article 5(1) of issue cannot be applied. 22 Directive 90/435 does not relate to the tax at issue. In their view, that tax is not a withholding tax but normal taxation of the profits of the subsidiary, in the form of corporation tax.

107. By the same token, in my view the fact that classification of the tax at issue as a withholding tax within the meaning of 106. As the Court of Justice held in Athi- Article 5(1) of Directive 90/435 would, as the Commission claims, have the effect of naïki Zythopoiia, 24 completely prohibiting any 'thin capitalisa- tion' rules does not preclude such a clas- sification.

'26 [I]n order to determine whether the taxation of distributed profits pursuant to the Greek legislation at issue in the main proceedings falls within the scope of Article 5(1) of the directive, it is necessary, first, to refer to the wording 108. Article 5(1) of Directive 90/435 does of that provision. The term "withhold- not provide for any exceptions allowing ing tax" contained in it is not limited to non-application of that provision in order certain specific types of national tax- to protect the 'thin capitalisation' rules. ation (see Case C-375/98 Epson Europe [ 2 0 0 0 ] ECR I - 4 2 4 3 , paragraph 22).

27 Second, it is settled case-law that the 109. I endorse the Danish view that nature of a tax, duty or charge must be Article 5(1) of Directive 90/435 does apply determined by the Court, under Com- to the tax at issue.

24 — Case C-294/99 [2001] ECR I-6797. 25 — My emphasis.

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115. The Commission further suggests that 112. Further, according to the Court, '... Head 2 of Paragraph 8a(1) of the KStG [t]he taxation relates to income which is could fall within the exception in taxed only in the event of a distribution of Article 1(2) of Directive 90/435, according dividends and up to the limit of the divid- to which that directive '... shall not pre- ends paid. That is shown by the fact (inter clude the application of domestic or agree- alia) that, as the applicant in the main ment-based provisions required for the proceedings and the Commission have prevention of fraud or abuse'. pointed out, the increase in the basic taxable amount generated, in accordance with Article 106(2) and (3) of the Income Tax Code, by the distribution of profits cannot be offset by the subsidiary using negative income from previous tax years, 116. That argument cannot, however, be contrary to the fiscal principle enabling accepted. losses to be carried forward which is nevertheless laid down in Greek law'. 27

117. If, as indicated above, Head 2 of 113. In the instant case, the event giving Paragraph 8a(1) of the KStG and the rise to the taxation is likewise the payment difference of treatment deriving from that provision are not justified by an overriding requirement of general interest consisting 26 — Athinaïki Zythopoiia, cited above, paragraph 28. of the need to combat tax avoidance, it 27 — Athinaïki Zythopoiia, cited above, paragraph 29. necessarily follows that the same provision

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cannot be found to be justified by the need tion of profits within the meaning of Head 2 to combat fraud and abuse, as permitted by of Paragraph 8a(1) of the KStG, that would Article 1(2) of Directive 90/435. not necessarily remove the discrimination for the purposes of Article 43 EC.