EU High Court Says UK Trust Fund Exit Tax Violates Freedoms
Law360, London (September 14, 2017, 6:56 PM BST) — The European Union’s highest court said on Thursday that the so-called exit taxes imposed by the U.K. on trustees that move from Britain to another EU member state infringe on the fundamental freedoms set out in the bloc’s laws, such as the free movement of capital.
The Court of Justice of the EU ruled in a case referred up to it by the U.K.’s tax tribunal that a profit-driven trust can legally “act in its own right” and thus is protected by the freedom of establishment, freedom to provide services and free movement of capital set out in the Treaty on the Functioning of the European Union.
The freedoms overrule the U.K.’s ability to levy a tax on unrealized capital gains on trust migration under its Taxation of Chargeable Gains Act 1992, the court said.
“All measures which prohibit, impede or render less attractive the exercise of the freedom must be considered to be restrictions on freedom of establishment,” the ECJ said.
At the heart of the dispute are four trusts created by Cypriot national Panico Panayi in 1992, when he and his family resided in the United Kingdom. The trusts were deemed to have lost their U.K. residencies when Panayi and his wife returned to Cyprus in 2004, resigned as trustees and appointed three Cyprus-residents in their place, alongside one U.K. resident trust company. The trustees did not file self-assessments for an exit charge and so HMRC opened up an inquiry and demanded payment.
The capital gains tax charge is levied if trustees, or the majority of trustees, cease to be U.K.-residents, and is based on a deemed disposal of trust assets at market value.
The Panayi trustees brought the proceedings before the U.K.’s First-tier Tribunal (Tax Chamber), arguing that the charges were not compatible with the freedoms of movement and establishment under EU law.
The Tribunal considered that none of the freedoms were applicable to the case due to the legal status of a trust under the law of England & Wales, which does not have the same advantages as an individual or a company, but decided to stay proceedings in 2015 and refer the case up to the ECJ for a preliminary ruling on the matter.
If any of the freedoms were held by the ECJ to apply, the HMRC accepted that the immediate payment of the exit tax would then need to be proved justified and proportionate, according to court documents.
In an opinion published Dec. 21, 2016, Advocate General Juliane Kokott of the Court of Justice said that that taxation on migration is a restriction on the freedom of establishment but it could be justified on the grounds of preserving the allocation of taxation powers between member states.
She urged for proportionality of the tax charge on a case-by-case basis, and also said that the Panayi case is a first for the ECJ. Only the court of the European Free Trade Agreement had previously ruling on a similar case.
The ECJ’s reasoning in its judgment Thursday focused on the fact that a member state of the EU was treating a citizen from another member state differently from its own citizens.
“That difference in treatment is liable, first, to discourage the trustees, who manage the trust, from transferring the place of management of the trust to another member state and, second, to deter the settlor, in so far as the trust instrument permits, from appointing new non-resident trustees. That difference constitutes, therefore, a restriction on freedom of establishment,” the ECJ said.
A restriction on freedom of establishment is only permissible, according to the court, in situations that are not “objectively comparable” or if it is justified by overriding reasons in the public interest that are recognized by EU law.
“It is apparent from the documents submitted to the court that the legislation at issue in the main proceedings provides only for the immediate payment of the tax concerned. It follows that such legislation goes beyond what is necessary to achieve the objective of preserving the allocation of powers of taxation between the member states and constitutes, therefore, an unjustified restriction on freedom of establishment,” the judges said.
The ECJ did not order costs, saying that the proceedings are one step in actions pending before the U.K.’s national court, and so the decision is a matter for that court.
HMRC did not respond to a request for comment by the time of publication.
The case is Trustees of the P Panayi Accumulation & Maintenance Settlements v Commissioners for Her Majesty’s Revenue and Customs, case number C-646/15 in the European Court of Justice.
