The ECJ’s Case Law on Direct Taxation in Swedish Tax Courts

1. Individual Income Tax and Exit Taxation

Both capital gains deferral on shares and on the sale of permanent housing24 have generated a number of domestic cases even before the issue was settled by the ECJ in the C-9/02 de Lasteyrie case.

Regarding capital gains on the sale of permanent housing, the starting point is a case of Court of appeals of Gothenburg dated 29 October 2001, refusing to grant roll-over of capital gain tax arising for the sale of property in Sweden (exit to Denmark, 47:3 IL). The internal law provision requires that both the owner-occupied property sold and the replacement property be located in Sweden for the tax to be deferred. The Malmö county Court had declared (23 May 2000) the provision compatible with article 58.1 EC, and on appeal, the Court of appeal in Gothenburg referring to ECJ cases Wielockx (C-80/94), Asscher (C-107/94), Verkooijen (C-35/98), Baars (C-251/98) in conjunction with the Bachmann case (C-204/90) found the provision justified. According to the decision, the purpose of this law is to protect against erosion of the tax base, in a proportionate fashion. The Supreme Administrative Court did not grant any leave to appeal to that case, and until now, the law stands still25. Nevertheless, the Commission brought an action in enforcement against Sweden to the ECJ (case C-104/0626) on the grounds of articles 18, 39, 43, 56 EC and 28, 31, 40 EEA. The Swedish Government expressed on 11 May 2006 its intention to amend the law, and adapt to EC law, after a refusal to adjust its position after the first reasoned opinion issued in July 2005. A couple of cases are still pending in Sweden about this question. In a pending case at the Stockholm county Court (Sandford) the taxpayer suggested to the county Court to refer the issue to the ECJ, and the Court has not reached any decision yet27. Yet, some legislative changes are under current discussions28, extending the roll-over to acquisition of non-Swedish property, which should put an end to judicial activity in this respect.

The roll-over of capital gains tax on exchange of shares29 raised by far the largest number of European law cases in Swedish courts. The challenged internal law provision is an extension of the Merger Directive’s roll-over of capital gains tax arising on the exchange of shares in the shareholder’s hands after a merger between two EU companies for instance. For individuals, Swedish law provides the same tax relief as in the Merger Directive provided they are resident of Sweden. As soon as taxpayers leave Sweden, the roll-over is not applicable any more and capital gains tax is due on the value of the exchange of shares granted earlier. The first case dealing with the incompatibility of this rule with the EC fundamental freedoms arose on 30 September 200330. In this case, a taxpayer holding shares in Astra AB had moved to the UK for reasons connected with his employment at the moment when Astra AB was merged into Astra Zeneca Plc. The exchange of shares gave rise to a capital gain of 1 600 ÄÄ for which he applied for roll-over in his tax return (2000). This was refused by the tax authorities applying the law. The county Court of Stockholm allowed for deferral on the grounds of article 39EC. The tax authorities did not lodge any appeal. The courts’ positions are, however, divided. The deferral of tax was granted subsequently on several occasions by different county courts and courts of appeals31, and in some other cases, refused32 as Swedish provision was justified for reasons of tax coherence as stated in the Bachmann case, C-204/90. None of these cases has reached the Supreme Administrative court, and not one single court referred the issue to the ECJ, although taxpayers in their claims showed the need to obtain clarification.

On 10 April 200533, the tax authorities expressed some doubts in an official standpoint as to the compatibility of these rules with the fundamental freedoms, which normally should allow taxpayers their right to tax deferral and no additional processes should occur on this issue.

Although no case seems to have reached the Swedish tax courts on this topic yet, it is submitted in doctrine and by the tax authorities that the general exit taxation of non-residents for shares held in Swedish companies within the last ten years after expatriation may be incompatible with EC law34. Indeed, even though Sweden negotiates in bilateral tax treaties a less stringent exit rule their compatibility with the fundamental freedoms arising from the ECJ’s reasoning in de Lasteyrie C-9/02 is more than questionable. Therefore the tax authorities extended the above-mentioned roll-over for exchange of shares to these taxpayers falling under the general exit rule35.

The taxation of stock options for departing taxpayers has given rise to an interesting case reaching the Supreme Administrative Court in 2004 but not referred to the ECJ36. The right for an employee to purchase shares in the future at a fixed (and by hypothesis advantageous) price is as a rule and according to Swedish tax rule taxed at the moment of its exercise37, as a fringe benefit in the category of employment income (approx. 57 % tax), on the difference between the market value of the share purchased and the exercise price (if beneficial). However, should the taxpayer leave Sweden after the option has been vested and before exercising the option, he would be taxed at this moment on the value of the option as if it were exercised. This kind of exit taxation should fall under article 39EC and be disregarded by domestic judges as the de Lasteyrie case C-09/02 suggests. In the above mentioned case, the Board for Advance Rulings was requested by a taxpayer to determine whether and if so how he would be taxed for his options, when moving to the UK. He required specifically the Board not to take position on the compatibility of exit taxes with EC law (probably to avoid a preliminary ruling at ECJ that takes two more years). The Board therefore provided a ruling on the basis of the exit provision, and on appeal, the Supreme Administrative Court contested the Board’s decision, as it should have applied EC law and refused to leave a ruling on the question. It seems therefore quite clear that the Supreme Administrative Court applies the de Lasteyrie case and suggests that this exit tax provision is not in compliance with the fundamental freedoms.

What is not clear is the conclusion for the taxpayer, as the law stands still and as he obtained no permission to exit without being taxed on his vested options. On 14 October 2005, however, the tax authorities recognized in a statement the incompatibility meaning that they will not require capital gains taxation on exit any more. All practical questions relating to the application of bilateral tax treaties and further capital gains taxes due on the sale of shares acquired abroad by taxpayers are not solved yet though38.

2. Individual income tax cases on deductions for expenses incurred in the EU and insurance premiums

We found a couple of interesting and contradictory cases dealing with the right to deduct insurance premiums. For instance, in a case of 18 October 200439 case, the Supreme Administrative Court granted a leave to appeal in a case on the grounds of EC law (art. 39 EC) without referring to the ECJ (quite unique). The issue was indeed straightforward and led to legislative amendment in the subsequent years40. In this case, a Swedish tax resident working in Denmark was refused on the grounds of internal Swedish law41 a deduction for contributions paid to a Danish unemployment insurance. Whereas the county Court and the appeals Court refused to apply EC law, the Supreme Administrative Court allowed the deduction on 18 October 2004, applying the ECJ’s finding in de Groot (C-385/00).

In another case of 15 June 200442, the Supreme Administrative Court had also applied EC law in a case where a Swedish resident was refused to include in his reference income used for the assessment of unemployment insurance his taxable income from a Norwegian source. The law referred to Swedish taxable income only, which was easy for the Supreme Administrative Court to declare in breach with the fundamental freedoms of the EC and EEA treaties.

Regarding taxation of insurance proceeds and deduction of insurance premiums, two Supreme Administrative Court cases have come to our attention. In a case of 7 September 200443 for instance, a Swedish tax resident subscribed to a private insurance company in the UK for retirement coverage. She asked to the Swedish Board for Advance Rulings the extent of her liability to tax on proceeds and net wealth. Among other questions, she needed to know whether this kind of private pension expenses would be deductible for income tax purposes (IL kap. 58, 59).

The Supreme Administrative Court concurred with the analysis of the Swedish Board for Advance Rulings with respect to the taxpayer’s situation, and applied the coherence justification from the Bachmann case, while disregarding the Danner case in this situation: the distinct treatment of payments to foreign insurance companies is clearly needed for the sake of internal coherence. This reasoning even found support in the doctrine44. The outcome in the C-150/04 case against Denmark should, however, change this view, especially if ECJ follows the AG’s opinion (1 June 2006).

The Swedish position in this case is close to the Danish. Firstly, Sweden stood on the same side and supported Denmark in this direct enforcement action as the same issue arises due to Swedish tax rules. Secondly, and as stated in § 59 of the AG’s opinion in C-150/04, Sweden still defends and applies the coherence justification arising from the Bachmann case, according to which tax deduction may be granted only to the extent that the capital reversed later on does not escape taxation. By contrast, the AG’s opinion seems to require member States to find more proportionate protection against erosion of tax bases than a systematic refusal of deduction just because there might be a risk that the taxpayer will move to another member State with which a bilateral treaty does not allow Sweden to tax at source.

It is hardly conceivable that the Swedish lawmaker will consequently extend the deduction right to all kinds of insurance premiums (ie Swedish or not) due to the large financial implications (600 billion SEK, 54 billion euros total value of private pension insurances of Swedish source as estimated by the authorities45). A solution would be a review of bilateral tax treaties and giving up article 18 of the OECD model treaty and a coordinated taxation within the EU.

Several cases (see two cases of the Supreme Administrative Court of 14 February 200546 or of 17 September 200447, and of Court of appeals of Stockholm on 10 October 2005 (where EC law arguments where dismissed), deal with the yield tax on pension funds, that arguably should be reduced by the amount of withholding tax levied on outgoing dividends (30 % reduced by tax treaties) when the foreign insurance company invests in Swedish shares. The cases lead to different conclusions that may not ensure a legally secured position for taxpayers who intend to invest in foreign insurance companies.

3. Individual income tax, closely held companies

As explained earlier, closely held companies are quite numerous in Sweden as incorporating a single-partner’s company is inexpensive and easy. The Swedish tax law is nevertheless showing endless imagination to limit the use of such companies for tax purposes only48. As soon as 2000, several cases reached the Supreme Administrative court49, arising from the Swedish Board for Advance Rulings, questioning the validity of these rules when part of the activity is carried out in another member State (Denmark in one case). Indeed, part of the dividends arising from closely held companies was taxed in the shareholder’s hands at a favourable 30 % tax rate (now 20 %) within the limit of a percentage of the total amount of wages paid during the tax year of reference, and above a specific threshold. One of the questions directed to the Swedish Board for Advance Rulings in one of the cases was to know whether internal law was compatible with free movement of capital as it allowed only Swedish source wages in the computation of this threshold50. The Board recognized the restriction but found it justified on the basis of article 73b of the Rome treaty (then applicable). The Supreme Administrative Court cancelled the ruling, stating that internal law was in clear breach with 43 EC, referring to the ECJ’s case law.

In the other case, a Swedish tax resident owned shares in a Finnish closely held company distributing annual dividends, and the question was to know whether the wages paid in Finland by this Finnish company could increase the amount of the favorable capital gains taxation of dividends. Whereas the Swedish Board for Advance Rulings also found the provision restricting the free movement of capital but justified, the Supreme Administrative Court applied the Verkoojien case’s reasoning and declared the internal law provision incompatible with 56 EC and not justified.

In both cases, the Supreme Administrative Court applied the EC treaty without referring to the ECJ as the breach was clearly established and left no place to any doubt.

In another case of 4 May 200551, the Supreme Administrative Court ex officio and arguably declared article 56EC not to be applicable for allowing capital gains taxation of in a case of sale of shares partly held by a Canadian shareholder, and increased the part of the gain taxable at a progressive rate as employment income. This case is interesting as it arose from the traditional judicial path and once again, the EC law arguments are not showing up before the very last words in the court’s decision, as an attempt to create binding case law and prevent subsequent cases on the same issue. Further, it shows that from time to time the Supreme Administrative Court applies EC law arguments ex officio against taxpayers, which is arguable52.

4. Corporate income tax and Group taxation

Swedish corporate income tax is not as protective as individual income tax and is instead constructed in an ”attractive” tax competitive spirit, which might explain the small amount of cases reaching the courts and arising from cross-border business in that respect.53 Further, several issues are dealt with by the Board for Advance Rulings and remain unchallenged or are not followed up in a process, which explains the reduced number of court cases regarding corporate taxation.

A couple of pending cases on burning issues on CFC54 and group contributions55 have already been adequately reported elsewhere and will not be further discussed here. The outcome of the challenge of protective CFC/group taxation rules with the fundamental freedoms in the ECJ will shape new legislation all over the EU and it seems unnecessary to add more to the sea of literature on the topic.

Regarding group taxation several interesting issues reaching the Court of appeals of Stockholm and Gothenburg in 2005 deserve attention56. According to domestic case law57, internal transactions within groups of companies may not need to follow the arm’s length principle. Interest on loans between interrelated companies may therefore be paid under market value under certain conditions, such as the existence of actual business relations between the companies allowing margin profits to be realized on other transactions than the loan. According to the transfer pricing correction rule (14:19 IL), this rule may not be applied when one of the companies is incorporated abroad (among -others in the EU) as under-market-priced transactions may lead to tax base erosion. After an extensive discussion on the ECJ case law relating to restrictions of free movement of capital, the Stockholm Court of appeals ruled that the transfer pricing correction rule was not restrictive in an 11 November 2005 case, based on the county court’s findings that the Bachmann case (C-204/90) allows protection against erosion of tax bases within the EU. In two previous cases on the same legal questions, a couple of months earlier, none of the parties or of the judges took up the question.

Along the same line of thought, and precisely as for group contributions, subsidies paid within interrelated companies are deductible to the extent that they contribute to taxable income for the beneficiary. When the beneficiary is a company incorporated abroad, the payment is therefore not deductible. In a case of 5 September 2005, the Court of appeals of Gothenburg refused deduction of such a subsidy from a Swedish company to a Danish subsidiary on the ground that the right to deduct group contributions is reserved for inbound payments, and that the lawmaker acknowledged the compatibility of the group contribution system with EC law58.

The issue of group contributions is expected to evolve dramatically during the next few years, firstly due to the ECJ cases law (Marks & Spencer C-446/03 and the pending AA, former Esab C-231/05) and to internal proceedings still pending. On 29 September 2006, the Board for Advance Rulings issued two rulings challenged by the tax authorities before the Supreme Administrative Court, the first one allowing a Swedish parent company to deduct a group contribution sent to its Dutch subsidiary in liquidation (as in Marks & Spencer), and the second one refusing a Swedish subsidiary of a Finnish company the right to deduct a contribution sent to Finland (based on the the territoriality principle arising from Marks & Spencer C-446/03 and Futura C-250/99 cases).

In a case of 6 July 200559, the Court of appeals of Gothenburg reversed the Malmö county court’s ruling that was favourable to the taxpayer on the basis of the fundamental freedoms. The Swedish Yves Rocher incorporated company had a branch in Denmark suffering losses for quite some time. Since the Nordic multilateral tax treaty exempted foreign PE’s (permanent establishment) income in the residence State, the Swedish head office could not offset the Danish losses against Swedish income. The tax treaty was amended in 1999 and changed the exemption method to the credit method for foreign PE. In other words, the losses incurred by the (PE) Danish PE could be offset against the Swedish income as from this date, but not earlier losses. The company maintained that this impossible offset linked to a method change in a tax treaty was a restriction on its right of establishment (art. 43EC) just as in the AMID case, (C-141/99). Had the PE’s losses been incurred in Sweden, then the offset had been possible; According to the company and confirmed by the county court, losses incurred prior to the treaty change should be taken into consideration.

The company lost on appeal and did not ask for a leave to appeal at the Supreme Administrative court. The issue of interaction between tax treaties and right of establishment would have deserved a decision of the Supreme Administrative Court and a preliminary ruling from the ECJ, since the case arose at the same time as the then pending Marks and Spencer case. Now we know more on the conditions for cross-border loss relief within a corporate group that could have helped the Swedish judge to find a different outcome.

These cases show the unfortunate reluctance of lower courts to refer to ECJ. Due to the large number of cases where judges still use the coherence of the tax system to justify discriminatory or restrictive tax provisions, this is regrettable.