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29 July 2007

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ECJ: Finnish group contribution regime compatible with EC Law – details

On 18 July 2007, the European Court of Justice (ECJ) gave its decision in the case of Oy AA (Case C-231/05, formerly know as the Oy Esab case) regarding the compatibility of the Finnish group contribution regime with the EC fundamental freedoms. Details of the judgment are summarized below.

(a) Facts and Issue. The Finnish resident company Oy AA contemplated giving a group contribution to its grand-grand-parent company, AA Ltd., which was resident in the United Kingdom. According to the Finnish Group Contribution Act (GCA), such a contribution is, in domestic situations and under certain conditions, tax deductible for the distributor and taxable income for the recipient. Accordingly, the regime may be used within a Finnish group to offset losses or to distribute profits. In the case in question, the requirement that the recipient had to be resident in Finland was not fulfilled and, therefore, the contribution would not have been taxable in Finland.

Oy AA received an advance ruling from the Finnish Central Tax Board (Keskusverolautakunta, KVL) stating that the group contribution would not be tax deductible for Oy AA. The taxpayer appealed to the Finnish Supreme Administrative Court (Korkein hallinto-oikeus, KHO), which in turn referred a question to the ECJ for a preliminary ruling, in the following terms:

Are Articles 43 and 56 of the Treaty establishing the European Communities, having regard to Article 58 of the Treaty and Council Directive 90/435/EEC on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States, to be interpreted as precluding a system such as that of the Finnish group subsidy legislation in which a condition for the deductibility in taxation of a group subsidy is that both the donor and the donee of the group subsidy are companies resident in Finland?

Scope of analysis

The Court first stated that the question referred must be answered in the light of the freedom of establishment (Art. 43 of the EC Treaty) alone. In the case at hand, any restrictions on the free movement of capital (Art. 56 of the EC Treaty) would be consequences of such an obstacle to Art. 43 and do not therefore justify an independent examination from the point of view of Art. 56.

The Court further stated that since Directive 90/435/EEC (Parent-Subsidiary Directive) does not concern the first taxation of income arising from a business activity of a subsidiary and does not govern the financial consequences for the subsidiary of an intra-group financial transfer such as that at issue in the main proceedings, it cannot constitute a basis for supplying an answer to the national court.


According to the Finnish rules on financial transfers, a transfer made by a subsidiary in favour of a parent company with its corporate seat in Finland is deductible from the taxable income of the subsidiary, while a transfer by a subsidiary in favour of a parent company not established in Finland is not deductible from such income. Thus, the subsidiaries of foreign parent companies receive less favourable tax treatment than that enjoyed by the subsidiaries of Finnish parent companies.

Applying the discrimination test, the Court first examined the comparability of the situation of a subsidiary having its parent company in the same Member State and that of a subsidiary the parent company of which is resident in another Member State. The Court held that the mere fact that parent companies which have their corporate establishment in another Member State are not subject to tax in Finland, does not differentiate the subsidiaries of those parent companies from the subsidiaries of parent companies which have their establishment in Finland, and does not render the positions of those two categories of subsidiary incomparable.

The Court went on to state that a difference in treatment at hand constitutes an obstacle to the freedom of establishment as it makes it less attractive for companies established in other Member States to exercise that freedom.


When investigating the existence of possible justifications on the above said restriction, the Court first recalled that the need to safeguard the balanced allocation of the power to impose taxes between the Member States was accepted by the Court in conjunction with two other grounds of justification, based on the risks of the double use of losses and of tax avoidance in the Marks and Spencer case.

The Court pointed out that the need to safeguard a balanced allocation of the power to tax between Member States cannot justify a Member State systematically refusing to grant a tax advantage to a resident subsidiary, on the ground that the income of the parent company having its establishment in another Member State is not capable of being taxed in the first Member State. However, this justification may be allowed, where the system in question is designed to prevent conduct capable of jeopardizing the right of the Member States to exercise their taxing powers in relation to activities carried on in their territory.

Concerning the prevention of tax avoidance, the Court acknowledged that the possibility of transferring taxable income of a subsidiary to a parent company with its establishment in another Member State carries the risk that, by means of purely artificial arrangements, income transfers may be organized within a group of companies towards companies established in Member States applying the lowest rates of taxation or in Member States in which such income is not taxed.

Finally, as regards the prevention of double use of losses, the Court noted that the Finnish group contribution system does not concern the deductibility of losses.

Thus, the Court concluded that the need to safeguard the balanced allocation of the power to tax between the Member States and the need to prevent tax avoidance in combination are capable of justifying the Finnish system.


When examining whether such a system goes beyond what is necessary to attain all of the objectives pursued, the Court stressed that expanding the Finnish group contribution system to cross-border situations would have the effect of allowing groups of companies to choose freely the Member State in which their profits would be taxed. This would jeopardize the right of the Member State of the subsidiary to tax profits generated by activities carried out on its territory. The Court emphasized that such detriment could not be prevented by less restrictive measures, for example, by allowing a deduction of the cross-border transfer only (i) where it constitutes taxable income of the transferee company, or (ii) where the opportunities for the transferee company to transfer its losses to another company are limited, or (iii) where the intra-group financial transfer is specifically justified by the economic situation of the transferee when the transferee is established in a Member State applying a lower rate of tax than that of the state of the of the transferor. Therefore, the measure at hand is not disproportionate.

In summary, the Court held that the Finnish system, although restrictive on the freedom of establishment, is justified by overriding reasons in the public interest (balanced allocation of taxing rights as between the Member States, prevention of tax avoidance) and is appropriate to ensuring the attainment of its objectives as well as proportionate to those objectives. As such that system is not precluded by Art. 43 of the EC Treaty.

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