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URL: http://www.bailii.org/uk/cases/UKSPC/2007/SPC00622.html
Cite as: [2008] STC (SCD) 55, 10 ITL Rep 110, [2007] UKSPC SPC622, [2007] UKSPC SPC00622

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Vodafone 2 v Revenue & Customs [2007] UKSPC SPC00622 (26 July 2007)

Spc00622

CORPORATION TAX – Controlled foreign companies – whether domestic legislation (ss 747 to 756 and Schs. 24 to 26) incompatible with freedom of establishment as provided for by arts. 43 EC and 48 EC of the EC Treaty – a reference to ECJ under art. 234 EC had been made by the Special Commissioners – subsequently ECJ delivered judgment in case of Cadbury Schweppes (Case C-196/04) on same general point – registrar of ECJ invited the Special Commissioners to indicate whether they wished to maintain the reference in instant case – submissions of parties invited at a hearing – whether ECJ's judgment in Cadbury Schweppes indicated that the Special Commissioners should consider the CFC legislation as a whole, or specifically only the motive test, in order to ascertain whether judgment in Cadbury Schweppes could be "read down" into the CFC legislation as a matter of conforming interpretation – held that the motive test should be considered – whether as a matter of conforming interpretation judgment in Cadbury Schweppes could, and should, be so "read down" – held by a casting vote that it could and should be – whether the reference should be maintained – held by a casting vote that it should not be – decision accordingly

THE SPECIAL COMMISSIONERS

VODAFONE 2

Applicant

- and -

THE COMMISSIONERS OF

HER MAJESTY'S REVENUE AND CUSTOMS

Respondents

Special Commissioners : JOHN WALTERS QC

THEODORE WALLACE

Sitting in public in London on 7 and 8 March 2007

Peter Whiteman QC, instructed by Linklaters, for the Applicant

Richard Plender QC and David Ewart QC, instructed by the Solicitor for HM Revenue and Customs, for the Respondents

DECISION

Introduction

This Decision concerns a further development in the application by Vodafone 2 (the Applicant) dated 1 October 2004 for a closure notice under paragraph 33 of Schedule 18 to the Finance Act 1998. The previous stage of this application is reported at [2005] STC (SCD) 549. At that previous stage we made a reference to the Court of Justice of the European Communities (the European Court) for a preliminary ruling. Subsequently, the European Court gave judgment in the reference in the case of Cadbury Schweppes (Case C-196/04), which, like the present application, concerned the issue of the compatibility of the legislation on controlled foreign companies (sections 747 to 756 and Schedules 24 to 26 of the Income and Corporation Taxes Act 1988 (ICTA) – "the CFC legislation") with arts. 43 EC, 49 EC and 56 EC (and, as the European Court held – see paragraph 30 – also art. 48 EC). After that, the Registrar of the European Court asked us (the Special Commissioners) to inform him whether in the light of the judgment in Cadbury Schweppes we wished to maintain the reference in this application.

As we had heard full submissions from the parties on the question of whether we should make a reference, we thought it right to invite the parties to make submissions on the response we should give to the Registrar's request. This was despite the fact that the application was generally adjourned pending our receipt of the European Court's response to the reference. Accordingly, a hearing was held for that purpose on 7 and 8 March 2007.

At that hearing, Mr. Whiteman QC, for the Applicant, invited us (as his primary submission) to decide that the European Court's judgment in Cadbury Schweppes gave clear guidance to the effect that the CFC legislation was not compatible with arts. 43 EC and 48 EC and that therefore we should dispose of the application without more ado by directing the Revenue to issue a closure notice. In these circumstances we should withdraw the reference.

Mr. Whiteman submitted that, if we were not with him on his primary submission, we should maintain the reference, unless we were to hold, at this stage, that the arrangements in question in this case were not "wholly artificial arrangements" within the meaning of that phrase as used by the European Court in Cadbury Schweppes. We expand on this last point at paragraph [7] below.

Mr. Plender QC, for the Revenue, invited us to withdraw the reference on the grounds that the European Court's judgment in Cadbury Schweppes gave clear guidance that the CFC legislation was compatible with arts. 43 EC and 48 EC if and to the extent that, in the context of a controlled foreign company (CFC) resident in a Member State (not the UK), it relates only to wholly artificial arrangements intended to escape the national (UK) tax normally payable (see: paragraph 75 and the dispositif). He further submitted that the CFC legislation could, and should, be interpreted by us as the national court, as a matter of conforming interpretation, so that it cannot be applied in circumstances where to do so would infringe Community law as declared by the European Court in Cadbury Schweppes, but otherwise stands and is generally applicable according to its terms.

We indicated at the end of the hearing that in this Decision we would reach a concluded view on two matters, whether or not to maintain the reference, and (at the unanimous request of the parties) whether or not the CFC legislation could, and should, be interpreted by the national court as contended for by Mr. Plender.

Mr. Whiteman also submitted that in the event that we decided that the CFC legislation could, and should, be interpreted as contended for by Mr. Plender (ie. that the European Court's judgment in Cadbury Schweppes could, and should, be "read down" into the CFC legislation), then we already had enough evidence to go further and decide at this stage, in the Applicant's favour, that the relevant arrangements in this case were not "wholly artificial arrangements" as that phrase is employed by the European Court in the Cadbury Schweppes judgment (paragraphs 51 and passim – and see paragraph [15] below), and on that basis we should so hold and, again, direct the Revenue to issue a closure notice, and withdraw the reference.

As we indicated at the hearing, we are not prepared at this stage to make any findings of fact. We recognise that a great volume of written evidence has been supplied to us, but it has not been tested, sufficiently or at all. Moreover, Mr. Plender persuaded us, by his brief reference to the evidence as to the nature of the establishment of Vodafone Investments Luxembourg Sarl in Luxembourg, that the factual question of whether the relevant arrangements in this case were or were not "wholly artificial arrangements" may be an issue of some complexity. Further, it seems to us, that we ought not to embark on any fact-finding exercise, until either we have withdrawn the reference or received the European Court's response to the reference. We ought not to find facts as part of the process of deciding whether or not to maintain the reference.

The European Court's judgment in Cadbury Schweppes

We set out the entire judgment of the European Court in Cadbury Schweppes as an Appendix to this Decision. Reference should be made to the judgment to supplement our account of the parties' rival submissions on its effect, so far as the validity of the CFC legislation in an EC context is concerned. It was accepted by the parties, and is obviously correct, that the Cadbury Schweppes decision has no effect in a case where the CFC is not established in a Member State. When we refer later in this Decision to the validity of the CFC legislation without more, we should be taken to mean its validity in an EC context.

Mr. Whiteman, for the Appellant, submitted that the crucial part of the judgment was paragraphs 72 to 74 (inclusive), and that the validity of the CFC legislation depended on the answer we gave to the question posed in paragraph 72 of the judgment. The paragraphs are as follows:

"72. In this case, it is for the national court to determine whether, as maintained by the United Kingdom Government, the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements or whether, on the contrary, the criteria on which that test is based mean that, where none of the exceptions laid down by that legislation applies and the intention to obtain a reduction in United Kingdom tax is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, despite the absence of objective evidence such as to indicate the existence of an arrangement of that nature.

73 In the first case, the legislation on CFCs should be regarded as being compatible with Articles 43 EC and 48 EC.

74 In the second case, on the other hand, the view should be taken, as submitted by the applicants in the main proceedings, the Commission and, at the hearing, the Cypriot Government, that that legislation is contrary to Articles 43 EC and 48 EC."

Focusing on these paragraphs, he submitted that the validity of the CFC legislation depended on whether the motive test (which is to be found in s.748(3) ICTA) lends itself to an interpretation which enables the taxation provided for by the CFC legislation to be restricted to "wholly artificial arrangements" – in which case, it should be regarded as compatible with arts. 43 EC and 48 EC – or whether, on the contrary, it does not, and in consequence the CFC legislation should be regarded as incompatible with arts. 43 EC and 48 EC, on the basis that on its true construction it falls to be applied to a UK-resident parent company of a CFC established in another Member State even if there is no objective evidence to indicate the existence of "wholly artificial arrangements".

Section 748(3) ICTA provides as follows:

"(3) Notwithstanding that none of paragraphs (a) to (e) of subsection (1) above [exceptions from the application of the CFC legislation] applies to an accounting period of a controlled foreign company, no apportionment under section 747(3) falls to be made as regards that accounting period if it is the case that–

(a) in so far as any of the transactions the results of which are reflected in the profits arising in that accounting period, or any two or more transactions taken together, the results of at least one of which are so reflected, achieved a reduction in United Kingdom tax, either the reduction so achieved was minimal or it was not the main purpose or one of the main purposes of that transaction or, as the case may be, of those transactions taken together to achieve that reduction, and

(b) it was not the main reason or, as the case may be, one of the main reasons for the company's existence in that accounting period to achieve a reduction in United Kingdom tax by a diversion of profits from the United Kingdom,

and Part IV of Schedule 25 shall have effect with respect to the preceding provisions of this subsection."

So far as Part IV of Schedule 25, ICTA is concerned, Mr. Whiteman referred us particularly to paragraph 19 of that Schedule, which provides as follows:

"(1) The existence of a controlled foreign company achieves a reduction in United Kingdom tax by a diversion of profits from the United Kingdom in an accounting period if it is reasonable to suppose that, had neither the company nor any company related to it been in existence–

(a) the whole or a substantial part of the receipts which are reflected in the controlled foreign company's profits in that accounting period would have been received by a company or an individual resident in the United Kingdom; and

(b) that company or individual or any other person resident in the United Kingdom either–

(i) would have been liable for any United Kingdom tax or for a greater amount of such tax; or

(ii) would not have been entitled to a relief from or repayment of any such tax, or would have been entitled to a smaller relief from or repayment of any such tax.

(2) For the purposes of sub-paragraph (1) above, a company is related to a controlled foreign company if–

(a) it is resident outside the United Kingdom; and

(b) it is connected or associated with the controlled foreign company; and

(c) in relation to any company or companies resident in the United Kingdom, it fulfils or could fulfil, directly or indirectly, substantially the same functions as the controlled foreign company.

(3) Any reference in sub-paragraph (1) above to a company resident in the United Kingdom includes a reference to such a company which, if the controlled foreign company in question were not in existence, it is reasonable to suppose would have been established."

Mr. Whiteman's argument was that the motive test on its terms plainly did not lend itself to an interpretation which enables the taxation provided for by the CFC legislation to be restricted to "wholly artificial arrangements" and that, therefore, following paragraph 74 of the judgment in Cadbury Schweppes, the CFC legislation is contrary to arts. 43 EC and 48 EC.

"Wholly artificial arrangements" as that term is used in the judgment in Cadbury Schweppes are such arrangements intended solely to escape tax charged by the Member State where the parent company is resident (in this case, the UK) and, in addition to the subjective element consisting in the intention to obtain a tax advantage, exhibiting objective circumstances showing that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment, as set out in paragraphs 54 and 55 of the judgment, has not been achieved and the arrangements do not reflect economic reality. (Paragraphs 63 to 65 inclusive).

If Mr. Plender argued at all that the motive test, as expressed in the CFC legislation, does lend itself to an interpretation which enables the taxation provided for by the CFC legislation to be restricted to "wholly artificial arrangements" in this sense (as earlier versions of the Revenue's written arguments, not relied on at the hearing, suggested), he did so only faintly.

Mr. Plender's case was that Mr. Whiteman's approach to the guidance provided by the judgment in Cadbury Schweppes was wrong ("not short of absurd") because the thrust of the guidance was that the CFC legislation as a whole is compatible with arts. 43 EC and 48 EC if and to the extent that its application can be interpreted as being restricted to "wholly artificial arrangements". And he submitted that it could (and should) be so interpreted.

A very important point for us to decide, therefore, is whether the guidance requires us to consider the interpretation of the motive test alone (as Mr. Whiteman contends) or whether, as Mr. Plender argues, it puts in issue the interpretation of the CFC legislation as a whole.

In Mr. Whiteman's favour are the very clear terms of paragraphs 72 to 74, and the specific mention of the motive test in paragraph 72.

Mr. Plender submitted that Mr. Whiteman's approach ignored the context of the Cadbury Schweppes case, and the United Kingdom's argument, which placed heavy reliance on the motive test to ensure that there would be an attribution under the CFC legislation only in wholly artificial circumstances, and that paragraphs 72 to 74 reflected the way the case had been argued and did not confine our scope for "reading down" the Cadbury Schweppes judgment into the CFC legislation to a consideration only of the motive test.

Mr. Plender's positive case was that the thrust of the European Court's judgment in Cadbury Schweppes was that the CFC legislation itself posed a restriction on freedom of establishment unless "amended" (by a process of interpretation) to ensure that it was applied only to "wholly artificial arrangements", and, this being the position, it is wrong (absurd) to maintain that such an amendment must be made in the motive test.

In order to decide this point, we consider the judgment as a whole.

We notice, first of all, that the Question referred to the European Court in Cadbury Schweppes concerned the compatibility of the CFC legislation as a whole (paragraphs 28 and 29).

In paragraphs 34 to 38 inclusive, the European Court disposed of the question as to whether the establishment and capitalization of companies in another Member State solely to take advantage of a tax regime more favourable than that in the United Kingdom constituted an abuse of the freedoms introduced by the EC Treaty (cf. paragraph 23) by holding that it did not.

At paragraph 46, the European Court reached the conclusion that the separate tax treatment under the CFC legislation and the resulting disadvantage for resident companies which have a subsidiary subject, in another member State, to a lower level of taxation, constitute a restriction on freedom of establishment within the meaning of arts. 43 EC and 48 EC.

The European Court then proceeded to consider whether the restriction was justified. It concluded that "a national measure restricting freedom of establishment may be justified where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned" (paragraph 51).

It expanded on this conclusion in the next paragraphs, culminating in paragraph 55: "It follows that, in order for a restriction on the freedom of establishment to be justified on the ground of prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory."

The European Court went on (in paragraphs 57 et seq.) to consider whether the restriction on freedom of establishment arising from the CFC legislation may be justified on this ground, and, if so, whether it is proportionate to that objective. It concluded (at paragraph 59) that the CFC legislation may indeed be justified on this ground and went on to consider (in paragraphs 60 et seq.) whether it is proportionate to that objective.

This consideration focused on an examination of the motive test. The European Court concluded that the motive test as it stands does not confine the application of the CFC legislation to wholly artificial arrangements intended solely to escape United Kingdom tax (paragraphs 62 and 63). What is lacking is a condition which restricts the application of the CFC legislation to cases where not only is there a subjective intention to obtain a tax advantage, but also there are "objective circumstances showing that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment … has not been achieved". (See: paragraph 64)

This reasoning is summed up in the conclusion stated at paragraph 65: " … in order for the legislation on CFCs to comply with Community law, the taxation provided for by that legislation must be excluded where, despite the existence of tax motives, the incorporation of a CFC reflects economic reality".

This conclusion is further explained in paragraphs 66 to 69 and guidance is given in paragraphs 70 and 71 as to how the relevant evidential issues are to be approached. The burden of proving that the CFC is actually established and that its activities are genuine is placed on the resident parent company (paragraph 70); the Revenue has the opportunity to check on the CFC's "real situation" by using the provisions for collaboration and exchange of information between national tax administrations which are available to it.

There follow paragraphs 72 to 74, set out at paragraph [10] above. Paragraph 75 gives the answer to the question referred, which is repeated in the dispositif as follows:

"Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a controlled foreign company in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that controlled company is actually established in the host Member State and carries on genuine economic activities there."

From this review it appears to us that the guidance given by the European Court in Cadbury Schweppes is that the CFC legislation itself introduces a restriction on freedom of establishment which can be justified on the basis that it enables the United Kingdom to "thwart practices which have no purpose other than to escape the tax normally due on the profits generated by activities carried on in national territory" (the United Kingdom) (paragraph 59). The restriction must however be proportionate to the achievement of that objective. The CFC legislation is proportionate in relation to that objective if and to the extent that it confines the restriction to wholly artificial arrangements intended to escape the United Kingdom tax normally payable – such wholly artificial arrangements being arrangements in relation to which, in addition to there being a subjective element consisting in the intention to obtain a tax advantage, the resident company has not proved, on the basis of objective factors which are ascertainable by third parties, that the CFC is actually established in the host Member State and carries on genuine economic activities there.

The European Court has stated (at paragraph 72) that the national court must determine which of two alternatives is the true interpretation of "the motive test, as defined by the legislation on CFCs", and has indicated, at paragraphs 73 and 74 the consequences of the adoption of each alternative interpretation.

The following (final) paragraph 75 (which is effectively repeated in the dispositif) starts with the words "In the light of the preceding consideration". The three immediately preceding paragraphs are plainly included in that reference. We understood Mr. Plender to submit that the dispositif is directed to the CFC legislation as a whole, and not to the motive test. We consider that we, as the national court, cannot ignore the questions posed in paragraph 72 (and the consequences set out in paragraphs 73 and 74) even though, of course, the result of our interpretation of "the motive test, as defined by the legislation on CFCs" (cf. paragraph 72) will apply to the compatibility of the CFC legislation as a whole.

Our conclusion, therefore, in agreement with Mr. Whiteman's submissions, is that the guidance in Cadbury Schweppes is that we should consider whether "the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables taxation provided for by that legislation to be restricted to wholly artificial arrangements" (as that phrase is explained by the European Court) – so that the CFC legislation applies, in the case of a CFC established in a Member State, only in a case where there are such wholly artificial arrangements intended to escape the United Kingdom tax normally payable.

Principles of conforming interpretation

Mr. Plender said that the principle of conforming interpretation of national statutes in relation to international obligations can be traced to judicial decisions reached long before the United Kingdom's entry into the European Community. He cited, among other cases, Corocraft v Pan American Airways [1968] 3 WLR 1273, which concerned the Warsaw Convention. However, he submitted that a different principle was introduced, with a firmer statutory basis, in section 2(4) of the European Communities Act 1972 ("ECA 1972").

Section 2(4) ECA 1972 provides "any enactment passed or to be passed … shall be construed and have effect subject to the foregoing provisions of [that] section", in particular s.2(1) which relevantly provides that all such rights from time to time created or arising by or under the Treaties as in accordance with the Treaties are without further enactment to be given legal effect or used in the United Kingdom shall be recognized and available in law, and be enforced, allowed and followed accordingly.

Also relevant is section 3(1) and (2) ECA 1972 which effectively provides for the meaning or effect of the Treaties to be determined for the purposes of all legal proceedings in accordance with the principles laid down by any relevant decision of the European Court and for judicial notice to be taken thereof. Thus, as a matter of national law, UK courts and tribunals are bound by decisions of the European Court.

The principle of statutory interpretation following from section 2 ECA 1972 was set out by Lord Oliver in Litster v Forth Dry Dock & Engineering Co. Ltd. (in receivership) [1990] 1 AC 546. Lord Oliver said (ibid. at p.559 D/E):

"The approach to the construction of primary and subordinate legislation enacted to give effect to the United Kingdom's obligations under the E.E.C. Treaty have been the subject matter of recent authority in this House (see Pickstone v Freemans plc [1989] AC 66) and is not in doubt. If the legislation can reasonably be construed so as to conform with those obligations – obligations which are to be ascertained not only from the wording of the relevant Directive but from the interpretation placed upon it by the European Court of Justice at Luxembourg – such a purposive construction will be applied even though, perhaps, it may involve some departure from the strict and literal application of the words which the legislature has elected to use."

This may (and almost always will) involve the implication of words necessary to achieve that result, into the legislative text – cf. per Lord Keith ibid. at p.554 G/H and Lord Templeman, ibid. at p.558 E/H.

There is, of course, a limit to the scope which we have to depart from the words of the motive test in order to achieve an interpretation of it which conforms with the decision of the European Court in Cadbury Schweppes to the effect that the CFC legislation can validly apply, in the case of a CFC established in a Member State, only in a case where there are wholly artificial arrangements (as that phrase is explained by the European Court) intended to escape the United Kingdom tax normally payable by the UK-resident parent company.

That limit arises from Lord Oliver's use of the words "if the legislation can reasonably be construed so as to conform with those obligations" (emphasis added). In other cases the limit has been differently expressed. In Marleasing SA v La Comercial Internacional de Alimentacion SA (Case C-106/89) ECR [1990] I-04135, the European Court stated that:

".. in applying national law, whether the provisions in question were adopted before or after the directive, the national court called upon to interpret it is required to do so, as far as possible, in the light of the wording and purpose of the directive in order to achieve the result pursued by the latter and thereby comply with the third paragraph of Article 189 of the Treaty." (emphasis added)

Mr. Whiteman cited Webb v Emo Air Cargo (UK) Ltd. [1993] 1 WLR 49 for Lord Keith's observation that "a national court must construe a domestic law to accord with the terms of a directive in the same field only if it is possible to do so" (emphasis added). He also cited Duke v G.E.C. Reliance Ltd. (formerly Reliance Systems Ltd.) [1988] AC 618 for the light it throws on the limited scope available to a court in the matter of conforming interpretation. He relied in particular on Lord Templeman's observation that section 2(4) ECA 1972 does not "enable or constrain a British court to distort the meaning of a British statute in order to enforce against an individual a Community directive which has no direct effect between individuals. Section 2(4) applies and only applies where Community provisions are directly applicable".

Lord Oliver gave guidance in Litster in a passage (at pages 576-7), to which Mr. Whiteman referred us, where he stated the need to have regard to the "manifest purpose" of the legislation being construed (see ibid. at p.577 A/B) and said that he would, as a matter of construction, imply words which were "entirely consistent with the general scheme of the [legislation being considered] and which [were] necessary if they [were] effectively to fulfil the purpose for which they were made of giving effect to the provisions of [a Directive]" (ibid. at p.577 C/D).

Mr. Whiteman submitted that Lord Oliver's principle of interpretation was confined, by the words he (Lord Oliver) used, to the interpretation of domestic legislation which was enacted to give effect to Community law instruments, such as a Directive or framework decision. This is because it is a principle of purposive construction, and a case where legislation gives or purports to give effect to a Community law instrument which, ex hypothesi, has a purpose in accordance with which the legislation can be construed, is to be contrasted with a case of the construction of domestic legislation (such as the CFC legislation) "which starts in the United Kingdom", that is, is not enacted to give effect to any Community law instrument.

Mr. Plender, on the other hand, contended that there was no reason for confining the principle of conforming interpretation to cases of legislation implementing Community law instruments and for not applying it in cases where it is required to bring about compatibility with Treaty obligations. He responded to Mr. Whiteman's point on Duke by pointing out that that was a case where the House of Lords refused to apply a conforming interpretation so as to impose an obligation on an individual. But in this case, Mr. Plender submitted, the Revenue is an emanation of the state (and the application of tax legislation is a responsibility of the state) and a conforming interpretation is required by section 2(4) ECA 1972 in order that the CFC legislation should conform with the United Kingdom's Community obligations not to restrict freedom of establishment in other Member States, as expounded by the European Court in Cadbury Schweppes.

In this connection, both parties relied on the decision of the House of Lords in ICI v Colmer [2000] All ER 129, 72 TC 1.

Mr. Whiteman referred us to a comment on that case made by Arden LJ in Revenue and Customs Commissioners v IDT Card Services Ireland Ltd. [2006] STC 1252, where she said, at ibid. [84], that the House of Lords had held that it was impossible for the direct tax legislation in issue in Colmer to be interpreted so as to distinguish between holding companies holding shares wholly or mainly in other companies established outside the United Kingdom but in other Member States and holding companies holding shares wholly or mainly in other companies established outside the United Kingdom and outside the European Community also. She added: "This case [Colmer] illustrates that there will be cases where the court cannot interpret domestic legislation so as to conform to European Union law".

Mr. Plender's response was that Colmer was not an example of a case where the national court had not found it possible to interpret a domestic statute in conformity with applicable Community law. He said that Arden LJ, in IDT at [84] was referring to Lord Nolan's statement in Colmer (72 TC at p.60 D/F) as follows:

"There is no way such a distinction [between companies resident within and those resident outside the Community] can be read into the words used. It is impossible to construe section 258 [ICTA] as permitting a company such as Holdings to include in the head count non-United Kingdom resident subsidiaries which are established in other Community countries in conformity with article 52, but not to include those established outside the Community, which are unprotected by Community law."

Mr. Plender pointed out that Lord Nolan in Colmer in fact applied section 2 ECA 1972 to read the definition of "holding company" in section 258 Income and Corporation Taxes Act 1970 (ICTA 1970) as if it had been expressly without prejudice to the directly enforceable Community rights of companies established in the Community (see: 72 TC at p.60 I):

"So, in the present case, the effect of s.2 of the Act of 1972 is the same as if a subsection were incorporated in s.258 of the Act of 1970 which in terms enacted that the definition of "holding company" was to be without prejudice to the directly enforceable Community rights of companies established in the Community."

That reading would have allowed consortium relief to a UK-resident company whose business consisted wholly or mainly in holding shares in subsidiaries established in other Member States. But the business of the holding company in Colmer, as a matter of fact, consisted mainly in holding shares in subsidiaries established outside the Community (see: 72 TC pat p.58 E/F), and that holding company was therefore unaffected by any Community law provisions – see: paragraph 33 of the European Court's judgment in Colmer.

On this basis, and having regard to that and the other concluding paragraphs of the European Court's judgment in Colmer (Case C-264/96), Lord Nolan concluded that the application of section 258 ICTA 1970 to companies established outside the Community was not affected (see: 72 TC 60 I – 61 A). Therefore, so Mr. Plender submitted, Colmer was not a case where the national court had been unable to adopt a conforming interpretation of a domestic statute. No conforming interpretation was, on the facts, necessary for a decision in that case. Or, put another way, the interpretation of section 258 ICTA 1970 adopted by the House of Lords was entirely consistent with the European Court's judgment in Colmer.

Both parties accepted that it was a requirement of a conforming interpretation that it must "go with the grain of the legislation" (to adopt the expression of Lord Rodger of Earlsferry in the different, but related, context of section 3, Human Rights Act 1998, in Ghaidan v Godin-Mendoza [2004] 2 AC 557, referred to by Arden LJ in IDT at [85] et seq.).

That is, it is a requirement of a conforming interpretation that it should not be inconsistent with the perceived scheme of the legislation.

However, as might have been expected, that unanimity did not extend to what the perceived scheme of the CFC legislation was. Mr. Whiteman pointed out that the CFC legislation established a specific set of carefully articulated rules designed to impose a charge to tax in prescribed circumstances, but also providing a series of equally carefully drafted exemptions (including the motive test), excluding the charge to tax in prescribed circumstances. He argued that it would be going against the grain of the CFC legislation to include a provision which, effectively, excludes the charge by an amendment to the carefully drafted and complex definition of chargeable profits (see: in particular, section 747(6) and Schedule 24 ICTA).

Mr. Plender, on the other hand, pointed to paragraph 48 of the European Court's judgment in Cadbury Schweppes for an "apt and accurate description" of the "grain" or perceived scheme of the CFC legislation.

Paragraph 48 is in the following terms:

"The United Kingdom Government, supported by the Danish, German, French, Portuguese, Finnish and Swedish Governments, submits that the legislation on CFCs is intended to counter a specific type of tax avoidance involving the artificial transfer by a resident company of profits from the Member State in which they were made to a low-tax State by means of the establishment of a subsidiary in that State and the effecting of transactions intended primarily to make such a transfer to that subsidiary."

Mr. Plender's point, therefore, was that the scheme of the CFC legislation is that it is intended to counter the specific type of tax avoidance involving the artificial transfer of profits, referred to in paragraph 48.

He submitted that a conforming interpretation of the CFC legislation to confine its application (in the case of a CFC established in a Member State) to "wholly artificial arrangements" is precisely consistent with that scheme.

On the basis of our conclusion at paragraph [36] above, we consider that we are obliged by section 2 ECA 1972, to construe the motive test as set out in s.748(3) ICTA if and so far as this is possible (having regard to the need for consistency with the perceived scheme of that legislation) in conformity with the guidance of the European Court in Cadbury Schweppes as we have discerned it.

The scheme of the CFC legislation is it that attributes (apportions) the chargeable profits of a CFC (and its creditable tax (if any)) to the UK-resident controlling person(s), for tax purposes – see: s.747(3) ICTA – provided that none of the exceptions – see: s.748(1) ICTA – applies, and, relevantly, provided also, that the motive test – see: s.748(3) ICTA – is not satisfied. The exceptions and the motive test are intended, broadly speaking, to exclude from the attribution under the CFC legislation profits not transferred artificially for tax avoidance purposes.

Thus, while we accept that paragraph 48 of the European Court's judgment in Cadbury Schweppes accurately describes the scheme of the CFC legislation in countering a specific type of tax avoidance involving the artificial transfer of profits, it does so by laying down a general rule that the chargeable profits of a CFC are attributed for tax purposes to the UK-resident controlling person(s) provided that none of the exceptions, or the motive test, applies. This contrasts with the approach of the European Court in Cadbury Schweppes, which is to regard as a proportionate justification for a restriction on the freedom of establishment, a measure penalizing conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory (see: ibid. paragraph 55). In other words, the scheme of the CFC legislation is to attribute the chargeable profits of a CFC to the UK-resident controlling person(s) unless a non-abusive situation is shown; whereas the European Court would regard as compatible with arts. 43 EC and 48 EC a measure which only attributed the chargeable profits of a CFC to the UK-resident controlling person(s) if the situation was abusive in that it disclosed wholly artificial arrangements. The scheme of the CFC legislation and the European Court thus approach the problem presented by the specific type of tax avoidance concerned by opposite routes. The CFC legislation sets an inclusive rule, subject to exceptions to leave the rule applicable in abusive situations, while the European Court's reasoning requires that the rule should exclusively apply to abusive situations.

We do not regard this difference of approach as affecting the fundamental convergence of the scheme of the CFC legislation and the proportionate justification recognized by the European Court in Cadbury Schweppes at the point of attributing the chargeable profits of a CFC to UK-resident controlling person(s) only in abusive situations. That, in our view, is the scheme of the CFC legislation and "the grain" of the CFC legislation. The scheme and "grain" of the motive test has to be ascertained in this context.

The motive test in terms prevents an apportionment where the two stated conditions requiring the absence of a tax avoidance purpose are present (see: s.748(3) ICTA). The European Court has stated that the CFC legislation can be regarded as compatible with arts. 43 EC and 48 EC only if the motive test, as defined by the CFC legislation, lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements (Cadbury Schweppes paragraph 72).

Wholly artificial arrangements for these purposes are such arrangements where, "in addition to a subjective element consisting of the intention to obtain a tax advantage, objective circumstances showing that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment as set out in paragraphs 54 and 55 of Cadbury Schweppes has not been achieved" (see: ibid. at paragraph 64).

Clearly the motive test in terms effectively restricts the application of the CFC legislation to cases where there is a subjective element consisting of the intention to obtain a tax advantage. The exceptions under s.748(1) ICTA broadly exclude the application of the CFC legislation in a series of other circumstances which are objectively defined. The exclusion of the application of the CFC legislation in cases where, although there is a subjective intention to obtain a tax advantage, there is objective evidence that the arrangements are not wholly artificial would, we consider, be consistent with the purpose of the CFC legislation (it would "go with the grain") and would also achieve the objective pursued by freedom of establishment.

We have to address the question which the European Court posed at paragraph 72 of Cadbury Schweppes, that is, whether "the motive test as defined by the legislation on CFCs, lends itself to an interpretation" enabling the taxation provided for by the CFC legislation to be restricted to wholly artificial arrangements. We bear in mind that the European Court said earlier in the judgment (at paragraph 51) that a national measure restricting freedom of establishment could be justified "where it specifically relates to wholly artificial arrangements".

Unfortunately the Special Commissioners have been unable to agree as to what the right answer to this question is.

Mr. Walters considers that it would be consistent with the scheme and the "grain" of the motive test, which ought to be considered, not in isolation but in its proper context as part of the CFC legislation, to interpret s.748(3) ICTA, pursuant to our obligation under s.2(4) ECA 1972, as if it provided, in addition, a second, alternative, condition (paragraphs (a) and (b) of section 748(3) ICTA providing the first condition) for there to be no apportionment under s.747(3) ICTA. (Section 748(3) ICTA contains the motive test as defined by the CFC legislation and is therefore the subject of the conforming interpretation.) This second condition would be that there will be no such apportionment (despite the presence of an intention to obtain a tax advantage) if there are also objective circumstances showing that the objective pursued by freedom of establishment in Community law has been achieved and the establishment of the CFC reflects economic reality (cf. the judgment in Cadbury Schweppes, at paragraph 55). This second, alternative, condition would specifically relate to wholly artificial arrangements (or to the absence of them) and would, in effect, ensure that the motive test, as defined by the CFC legislation, would be applied without prejudice to the directly enforceable Community rights of companies established in the Community – compare Lord Nolan's comments in Colmer, cited above at [51] on the effect of interpreting s.258 ICTA 1970 in accordance with s.2 ECA 1972.

Mr. Walters therefore, concludes that we are able to, and should, interpret the motive test so that it can apply in the case of a CFC established in another Member State only where such application relates only to wholly artificial arrangements intended to escape the United Kingdom tax normally payable, in the sense that that expression is used by the European Court in the dispositif in Cadbury Schweppes. Accordingly the CFC legislation cannot be applied, in such a case, where it is proven by the UK-resident controlling person(s), on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives the CFC concerned is actually established in the host Member State (in this case, Luxembourg) and carries on genuine activities there.

Mr. Walters considers that this interpretation is a reasonable (in Litster terms) and a possible (in Marleasing and Webb terms) construction.

He respectfully adopts the approach of Arden LJ in IDT – see ibid. [114] – and does not "attempt to splice precise words into the language used by Parliament in [the motive test] as if [we] were [ourselves] the parliamentary drafter". He notes that extensive legislation is contained in the Finance Bill 2007 to amend the CFC legislation following Cadbury Schweppes. Although Mr. Whiteman made much play of the extensive nature of the amendments which the Government has evidently thought it necessary to propose to Parliament, as an indication that the conforming interpretation which we propose would be unreasonable or impossible, Mr. Walters does not accept that submission.

Mr. Wallace, however, notes that paragraph 72 of the European Court's judgment in Cadbury Schweppes is directed to the motive test as defined by the legislation and that, therefore, the question posed by the European Court is directed to the terms of the legislation. He considers that whatever restrictive wording falls to be read into the motive test under the principle of conforming interpretation cannot on any normal use of language be described as being "defined by the legislation". He considers that it is important that the European Court was considering the compatibility of the national legislation with rights expressly contained in the Treaty. In these circumstances, it is not surprising that the European Court required the CFC legislation to relate specifically to wholly artificial arrangements and required the national court to consider the interpretation of the motive test "as defined by the legislation on CFCs".

Mr. Wallace notes that Mr. Plender had said that all that is needed is to read "chargeable profits" in s.747(3) ICTA as meaning "profits arising from wholly artificial arrangements", or to add to the end of s.747(3) ICTA the words "to the extent that such apportionment does not infringe rights sustained under Community law". Mr. Plender had said that he was not wedded to any particular form of wording.

Mr. Wallace considers that whereas reading in such words would ensure that the CFC legislation would be limited to wholly artificial arrangements, it would not be a normal use of language to describe the legislation as "specifically [related] to wholly artificial arrangements" (see paragraph 51) unless "specifically" encompasses reading in a restriction not present in the legislation.

He notes that in any event Mr. Plender's suggested wording to be read into s.747(3) ICTA would not affect the motive test as defined by the CFC legislation.

Mr. Wallace comments that the obligation of domestic courts to interpret domestic legislation consistently with Community law is fundamental to Community law. If the European Court considered that such obligation was potentially relevant in Cadbury Schweppes, so as to require a restriction to wholly artificial arrangements to be read into the legislation, the wording of the question posed at paragraph 72 of the judgment was to say the least surprising. If the European Court considered that a general conforming interpretation was appropriate in that case, there is no apparent reason why it should have focused on the motive test.

He notes that Mr. Plender had submitted that the focus in Cadbury Schweppes was on the motive test, because of the submissions by the United Kingdom in that case, but comments that the European Court was concerned with the compatibility of the CFC legislation with Community law and that could not vary according to the submissions in a particular case.

Mr. Wallace comments that it might have been argued that the question of interpreting national legislation was a matter for the national court and not the European Court, however he notes that there was no suggestion by Mr. Plender that the European Court was not entitled to pose the question in paragraph 72 in the way in which it did. Nor was there any suggestion that paragraph 72 was no more than guidance which was not binding.

Mr. Wallace summarises his conclusions as follows. He is in agreement with the Decision up to paragraph 67 but he parts company at that point. He has no difficulty in accepting that the limitation of the CFC legislation to wholly artificial transactions goes with the grain of the legislation. However he notes that Mr. Plender was not able to put forward any way in which the motive test as defined by the CFC legislation could be interpreted as restricted to wholly artificial arrangements. He does not see how the approach of Arden LJ in IDT at [114] can be adopted so as to avoid the need to address the question on the interpretation of the motive test posed in paragraph 72 of Cadbury Schweppes. He concludes that the motive test is not amenable to a conforming interpretation such as would confine its application to wholly artificial arrangements. This is because the criteria on which the motive test is based mean that, where none of the exceptions laid down by the CFC legislation applies and the intention to obtain a reduction in United Kingdom tax is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, even where there is no objective evidence such as to indicate the existence of a wholly artificial arrangement (cf. paragraph 72 of the European Court's judgment in Cadbury Schweppes). A specific restriction would accord with the principle of certainty.

The difference between us is, put shortly, as follows.

Mr. Walters considers that a restriction in the application of the motive test as defined in the CFC legislation to its application only to wholly artificial arrangements can be "read down" into s.748(3) ICTA as a matter of conforming interpretation, and the result would not be inconsistent with the scheme or "grain" of the motive test as defined by the CFC legislation. In particular, he regards the scheme or "grain" of the motive test as so defined to be to serve as part of the legislative mechanism in place to ensure that the CFC legislation is not applicable in situations which are not abusive (or, put positively, to ensure that the CFC legislation is only applicable in abusive situations).

Mr. Wallace, on the other hand, takes the view that, although a provision restricting the CFC legislation to wholly artificial arrangements would not be inconsistent with the basic purpose of the CFC legislation, the European Court in Cadbury Schweppes did not envisage reading into the motive test a restriction which is wholly absent from that test as defined in the legislation.

Whether or not we should withdraw the reference from the European Court

We go on to consider whether or not, in the light of the conclusions above, we should withdraw the reference from the European Court. Mr. Wallace comments that if he had reached the conclusion that the motive test could be interpreted compatibly with the right of establishment, he would not have considered that the questions in our reference, which were not addressed in Cadbury Schweppes, would need to be maintained in the light of the judgment in that case and that, in particular, in the context of anti-avoidance legislation which penalizes only wholly artificial arrangements, criticisms of the complexities of such legislation carry little weight. In this part of this Decision, therefore, we approach the issues on the basis that, as Mr. Walters considers, the motive test as defined in the CFC legislation lends itself to an interpretation such that it can apply in the case of a CFC established in another Member State only where such application relates to wholly artificial arrangements intended to escape the United Kingdom tax normally payable, in the sense that that expression is used by the European Court in the dispositif in Cadbury Schweppes.

In our Decision at the previous stage of this application we noted (at [62]) that the issue of the compatibility of the CFC legislation needed to be determined to enable us to give judgment on the application for a closure notice.

The European Court in Cadbury Schweppes has undoubtedly provided a general answer to the question raised by that issue, namely that the CFC legislation constitutes a restriction on freedom of establishment within the meaning of articles 43 EC and 48 EC (ibid. at paragraph 46), but that such a restriction can be justified if the CFC legislation makes it possible to thwart practices arising out of wholly artificial arrangements, which have no purpose other than to escape the tax normally due on the profits generated by activities carried on in the national territory (ibid. at paragraph 59) and that it is a matter for the national court to decide whether the motive test can be interpreted to ascertain whether the CFC legislation applies in the case of a CFC established in a Member State only in a case where there are wholly artificial arrangements.

Nevertheless the reference we made in this case raised various issues which were not raised in the reference in Cadbury Schweppes and which are certainly still "live" in the sense that Mr. Whiteman continues to rely on them. He relies on them particularly, as we understand it, to show that the CFC legislation imposes burdens (especially but not exclusively compliance burdens), which are disproportionate to the justification (which the European Court in Cadbury Schweppes has accepted exists) of the restriction on freedom of establishment effected by the CFC legislation. Mr. Whiteman cited FKP Scorpio Konzertproduktionen GmbH v Finanzamt Hamburg-Eimsbüttel (Case C-290/04) in this connection.

Mr. Plender's submission was that all the questions have effectively been answered by the European Court in Cadbury Schweppes. At paragraphs 136 and 142 of his Opinion in Cadbury Schweppes, the Advocate-General (Léger) made comments to the effect that the CFC legislation does not impose an unreasonable burden on the companies to which it applies. Mr. Plender pointed out that in the dispositif in Cadbury Schweppes, the European Court had been content to place on the UK-resident company a burden of proving, on the basis of objective factors which are ascertainable by third parties, that, despite the existence of tax motives, the controlled company is actually established in the host Member State and carries on genuine economic activities there. He submitted, and we accept, that that burden is clearly envisaged as placed on the resident company seeking to benefit from the exception from the CFC legislation for arrangements which are not wholly artificial, which exception the European Court in Cadbury Schweppes required.

We turn to the questions we referred:

The opening part of the first question was intentionally modelled on the question referred in Cadbury Schweppes and has been answered by the European Court.

The first sub-part of the first question (paragraph 22.1.1 of the reference) asks whether the fact that the resident company must establish that an exemption from the CFC legislation applies is incompatible with the Treaty. The European Court in Cadbury Schweppes has answered this question by its requirement that the resident company be given an opportunity to produce evidence that the CFC is actually established and that its activities are genuine (paragraph 70).

The second sub-part of the first question (paragraph 22.1.2 of the reference) asks whether the fact that the CFC legislation provides for exemptions which give scope for uncertainty as to the availability in practice of an exemption on the establishment of a CFC or thereafter makes the CFC legislation incompatible with the Treaty. The uncertainties arose from ambiguities or obscurity in the wording of the legislation, changes in the terms of the exemption from time to time, changes of practice of the Revenue from time to time in applying the exemption, and the subjective nature of the terms of the exemption (see: [85] of our Decision at the previous stage of this application). In the light of the European Court's judgment in Cadbury Schweppes, these points appear to us to have been dealt with by the approach adopted by the European Court, particularly its insistence that the CFC legislation must not be applied where it is proven on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives, the CFC is actually established in the host Member State and carries on genuine economic activities there.

The third sub-part of the first question (paragraph 22.1.3 of the reference) raises the point that the CFC legislation imposes certain compliance requirements where the resident company does not seek or is not able to claim any exemption, and pays tax in respect of the profits of the CFC. This point has, in our view been effectively disposed of by the European Court's approach, and by the absence of any disagreement with the Advocate-General's view that the CFC legislation does not impose an unreasonable burden on the companies to which it applies (see: paragraph 65 above).

The fourth sub-part of the first question (paragraph 22.1.4 of the reference) raises a similar point on the burden of compliance requirements where the resident company seeks to obtain exemption from the CFC legislation. Again, we consider that the Advocate-General's views, not disapproved by the European Court, dispose of this point.

The fifth sub-part of the first question (paragraph 22.1.5 of the reference) raises generally the administrative and cost burdens on the resident company. Again, we consider that this point is disposed of by the same aspects of the Cadbury Schweppes judgment.

The second question asks if the answers to the first question would be different if: (1) the CFC carried out only minimal activities in the host Member State, or (2) only a minimal part of the profits of the CFC are subject to tax in the host Member State, or (3) the CFC was established as part of an artificial scheme to avoid tax. We consider all these points have been addressed by the European Court in Cadbury Schweppes as part of its reasoning supporting the application of the CFC legislation to wholly artificial arrangements.

The third question raises points on the abuse of the freedoms established under the Treaty. This question was inserted at the request of the Revenue and Mr. Plender said that the Revenue was content that it should come out of any reference which was maintained, because it has been answered in Cadbury Schweppes.

The fourth question concerned the possible incompatibility of the CFC legislation on the ground that the CFC legislation had been amended in 2000 with the result of denying the resident company the availability of a pre-existing exemption, which ought in accordance with Declaration no. 7 of the Maastricht Treaty have been maintained. However this point was based on the Applicant's submission that art. 58(1)(a) EC precluded the amendment, and the European Court in Cadbury Schweppes at paragraph 32 have decided that the relevant freedom is freedom of establishment, not freedom of movement of capital. This question has therefore been effectively answered.

The fifth question concerned the possibility that the Treaty freedoms precluded the CFC legislation on the basis that the CFC legislation applies to a CFC capitalized with equity and not to a CFC capitalized with debt. The European Court in Cadbury Schweppes has drawn no distinction between CFCs capitalized with debt and CFCs capitalized with equity, but, as Mr. Plender submits, we consider that this factor is highly unlikely to raise any additional point of Community law on which we required the European Court's guidance. It is instead an aspect of the factual question which must be inquired into by the national court at some stage, namely, whether the arrangements in question are wholly artificial arrangements which do not reflect economic reality.

The sixth and final question raised the point of whether the Treaty freedoms precluded the CFC legislation on the basis that one or more exemptions are available if the CFC's income in the host Member State comprised sources in that Member State (but not if it comprised sources in another Member State) or if it comprised dividend income instead of interest income from the same company. We consider, in agreement with Mr. Plender's submissions, that this question also raises aspects of the factual question, namely whether the arrangements are wholly artificial arrangements which do not reflect economic reality.

Conclusion

We ought, pursuant to art. 234 EC only to maintain the reference if we are of the view that a further ruling of the European Court is necessary to enable us to give judgment on this application. We reject Mr. Whiteman's submission that the criterion for maintaining a reference in the circumstances of this stage of this case is different from the criterion for making a reference under art. 234 EC.

For the reasons given in the foregoing paragraphs (which incorporate differences, given that Mr. Walters concludes that the motive test can be interpreted so that it conforms with Community law and Mr. Wallace concludes that it cannot be so interpreted), we both initially formed the view that in the light of the European Court's judgment in Cadbury Schweppes it was not necessary for us to maintain the reference. Mr. Wallace, however, has concluded that our difference as to the effect of paragraph 72 of the judgment in Cadbury Schweppes is a reason for maintaining the reference. Mr. Walters's view is that the issue of interpretation raised in that paragraph is a matter of domestic law and that therefore it does not give rise to a reason for maintaining the reference.

The issue remaining for decision in the application is whether the Revenue have reasonable grounds for not giving a closure notice "immediately", or within a specified time. Mr. Walters's conclusion, that, in the light of Cadbury Schweppes, the CFC legislation can validly be applied in the circumstances of this case (a CFC established in Luxembourg), subject to the restriction of such application only to a case where there are wholly artificial arrangements intended to escape the United Kingdom tax normally payable, would require us to consider at a further hearing the question of fact, whether the circumstances of this case show such wholly artificial arrangements. Mr. Wallace's conclusion that the decision in Cadbury Schweppes indicates that the CFC legislation cannot be validly applied in the circumstances of this case would indicate that we can and should reach a conclusion on the closure notice without maintaining the reference and that such conclusion should be that we should direct the issue of a closure notice at an early date.

As a postscript, we mention that we were informed since the hearing that Rimer J was invited on 3 April 2007 by the Registrar of the European Court to indicate whether the High Court wished to maintain its reference in Case C–201/05 The Test Claimants in the CFC and Dividend Group Litigation. That reference covers much of the same ground as our reference, but also concerns matters which do not arise in this application. Rimer J responded to the Registrar on 12 June 2007 in terms agreed by the parties to the case before him, as follows:

"In reply to your letter of 3 April, this Court does wish to maintain its preliminary reference in this matter. The parties are agreed that there are matters in the circumstances of these claims which differ from those to which the previous judgments to which you refer [Cadbury Schweppes, Case C–374/04 Test Claimants in the FII Group Litigation, and Case C–524/04 Test Cases in the Thin Cap Group Litigation] were directed and on which guidance is still required although they are not agreed as to the extent of the questions which remain to be answered. In the circumstances the most prudent course seems to me to maintain the reference unaltered."

We have considered whether this development should in any event cause us to maintain the reference in this application.

We have decided that it should not, for the following reasons.

First, the reference in Case C–201/05 asked questions covering issues going beyond those arising in this application. Secondly, the parties in Case C–201/05 were in agreement that that reference should be maintained: there is no such agreement between the parties to this application. Thirdly, Rimer J's response to the Registrar of the European Court indicates that he had not considered it necessary to address (and had not addressed) the issues raised by art. 234 EC as to the maintenance of the reference in that case. We have considered those issues in relation to the reference in this application (see paragraphs [101] and [102] above) and neither of us sees any reason to revise his respective view in the light of Rimer J's decision to maintain the reference in Case C–201/05.

The decision of the Special Commissioners is (by reason of Mr. Walters's casting vote – see: reg. 18(2) Special Commissioners (Jurisdiction and Procedure) Regulations 1994, SI 1994 No.1811) that we shall not maintain the reference and that the CFC legislation is compatible with arts. 43 EC and 48 EC, on the basis that the motive test as defined in the CFC legislation lends itself to the conforming interpretation indicated above.

We propose to invite the parties' submissions on the directions that are appropriate.

We apprehend that the Applicant may wish to appeal against our Decision. Having regard to the undoubted avoidable inconvenience if we were to withdraw the reference, only to have to reinstate it following a decision of a higher court, we will delay communicating to the Registrar of the European Court our decision to withdraw the reference until the later of the expiration of the time limit for appealing against our Decision and the final disposal of any appeal that may be made.

JOHN WALTERS QC

THEODORE WALLACE

SPECIAL COMMISSIONERS

RELEASE DATE: 26 July 2007

APPENDIX

JUDGMENT OF THE COURT (Grand Chamber)

12 September 2006 (*)

(Freedom of establishment – Law on controlled foreign companies – Inclusion of the profits of controlled foreign companies in the tax base of the parent company)

In Case C-196/04,

REFERENCE for a preliminary ruling under Article 234 EC by the Special Commissioners of Income Tax, London (United Kingdom), made by decision of 29 April 2004, received at the Court on 3 May 2004, in the proceedings

Cadbury Schweppes plc,

Cadbury Schweppes Overseas Ltd

v

Commissioners of Inland Revenue,

THE COURT (Grand Chamber),

composed of V. Skouris, President, P. Jann and A. Rosas, Presidents of Chambers, J.N. Cunha Rodrigues, R. Silva de Lapuerta, K. Lenaerts (Rapporteur), E. Juhász, G. Arestis and A. Borg Barthet, Judges,

Advocate General: P. Léger,

Registrar: C. Strömholm, Administrator,

having regard to the written procedure and further to the hearing on 13 December 2005,

after considering the observations submitted on behalf of:

– Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd, by J. Ghosh, Barrister, and J. Henderson, adviser,

– the United Kingdom Government, by R. Caudwell, acting as Agent, and D. Anderson QC, M. Lester and D. Ewart, Barristers,

– the Belgian Government, by E. Dominkovits, acting as Agent,

– the Danish Government, by J. Molde, acting as Agent,

– the German Government, by A. Tiemann and U. Forsthoff, acting as Agents,

– the Spanish Government, by L. Fraguas Gadea and M. Muñoz Pérez, acting as Agents,

– the French Government, by G. de Bergues and C. Mercier, acting as Agents,

– Ireland, by D. O'Hagan, acting as Agent, and R.L. Nesbitt, A. Collins SC and P. McGarry BL,

– the Italian Government, by I.M. Braguglia, acting as Agent, assisted by A. Cingolo, avvocato dello Stato,

– the Cypriot Government, by A. Pantazi, acting as Agent,

– the Portuguese Government, by L. Fernandes and J. de Menezes Leitão, acting as Agents,

– the Finnish Government, by A. Guimaraes-Purokoski, acting as Agent,

– the Swedish Government, by A. Kruse and I. Willfors, acting as Agents,

– the Commission of the European Communities, by R. Lyal, acting as Agent,

after hearing the Opinion of the Advocate General at the sitting on 2 May 2006,

gives the following

Judgment

The reference for a preliminary ruling concerns the interpretation of Articles 43 EC, 49 EC and 56 EC.

The reference was made in proceedings between Cadbury Schweppes plc ('CS') and Cadbury Schweppes Overseas Ltd ('CSO') on the one hand and the Commissioners of Inland Revenue on the other hand concerning the taxation of CSO in respect of the profits made in 1996 by Cadbury Schweppes Treasury International ('CSTI'), a subsidiary of the Cadbury Schweppes group established in the International Financial Services Center in Dublin (Ireland) ('the IFSC').

National legislation

The tax legislation of the United Kingdom of Great Britain and Northern Ireland provides that a company resident in that Member State within the meaning of that legislation ('the resident company') is subject in that State to corporation tax on its worldwide profits. Those profits include the profits made by branches or agencies through which the resident company carries on its activities outside the United Kingdom.

On the other hand, the resident company is not generally taxed on the profits of its subsidiaries as they arise. Nor is it taxed on dividends distributed by a subsidiary established in the United Kingdom. Dividends distributed to a resident company by a subsidiary established abroad are taxed in the hands of that company. In order to prevent double taxation, the United Kingdom tax legislation provides, however, for the grant of a tax credit to the resident company up to the amount of the tax which was paid by the foreign subsidiary as the profits arose.

The United Kingdom legislation on controlled foreign companies ('CFCs') provides for an exception to the general rule that a resident company is not taxed on the profits of a subsidiary as they arise.

That legislation, which is contained in sections 747 to 756 and Schedules 24 to 26 of the Income and Corporation Taxes Act 1988, provides that the profits of a CFC – namely, under the version of that legislation applicable at the time of the facts in the main proceedings ('the legislation on CFCs'), a foreign company in which the resident company owns a holding of more than 50% – are attributed to the resident company and taxed in its hands, by means of a tax credit for the tax paid by the CFC in the State in which it is established. If those same profits are then distributed in the form of dividends to the resident company, the tax paid by the latter in the United Kingdom on the profits of the CFC is treated as additional tax paid by the latter abroad and gives rise to a tax credit payable in respect of the tax owed by the resident company on those dividends.

The legislation on CFCs is designed to apply when the CFC is subject, in the State in which it is established, to a 'lower level of taxation', which is the case, under that legislation, in respect of any accounting period in which the tax paid by the CFC is less than three quarters of the amount of tax which would have been paid in the United Kingdom on the taxable profits as they would have been calculated for the purposes of taxation in that Member State.

The taxation which is attributable to the application of the legislation on CFCs is accompanied by a number of exceptions. According to the version of that legislation in force at the time of the facts in the main proceedings, that taxation does not apply in any of the following cases:

– the CFC adopts an 'acceptable distribution policy', which means that a specified percentage (90% in 1996) of its profits are distributed within 18 months of their arising and taxed in the hands of a resident company;

– the CFC is engaged in 'exempt activities' within the meaning of that legislation, such as certain trading activities carried out from a business establishment;

– the CFC satisfies the 'public quotation condition', which means that 35% of the voting rights are held by the public, the subsidiary is quoted and its securities are dealt in on a recognised stock exchange, and

– the CFC's chargeable profits do not exceed an amount set at UK £50 000 (de minimis exception).

The taxation provided for by the legislation on CFCs is also excluded when 'the motive test' is satisfied. The latter involves two cumulative conditions.

First, where the transactions which gave rise to the profits of the CFC for the accounting period in question produce a reduction in United Kingdom tax compared to that which would have been paid in the absence of those transactions and where the amount of that reduction exceeds a certain threshold, the resident company must show that such a reduction was not the main purpose, or one of the main purposes, of those transactions.

Secondly, the resident company must show that it was not the main reason, or one of the main reasons, for the SEC's existence in the accounting period concerned to achieve a reduction in United Kingdom tax by means of the diversion of profits. According to that legislation, there is a diversion of profits if it is reasonable to suppose that, had the SEC or any related company established outside the United Kingdom not existed, the receipts would have been received by, and been taxable in the hands of, a United Kingdom resident.

The decision making the reference also states that in 1996 the United Kingdom tax authorities published a list of States within which, subject to specified conditions, a CFC could be established and carry on its activities and be regarded as meeting the requirements for exemption from the taxation provided for by the legislation on CFCs.

The facts in the main proceedings and the question referred for a preliminary ruling

CS, a resident company, is the parent company of the Cadbury Schweppes group which consists of companies established in the United Kingdom, in other Member States and in third States. That group includes, inter alia, two subsidiaries in Ireland, Cadbury Schweppes Treasury Services ('CSTS') and CSTI, which CS owns indirectly through a chain of subsidiaries at the head of which is CSO.

CSTS and CSTI, which are established in the IFSC, were subject to a tax rate of 10% at the time of the facts in the main proceedings.

The business of CSTS and CSTI is to raise finance and to provide that finance to subsidiaries in the Cadbury Schweppes group.

According to the decision making the reference, CSTS replaced a similar structure which included a company established in Jersey. It was established for three purposes: first, to remedy a tax problem encountered by Canadian taxpayers holding CS preference shares, secondly, to avoid the need to obtain consent from the United Kingdom authorities for overseas lending transactions and, thirdly, to reduce the withholding tax on dividends paid within the group under the scheme of Council Directive 90/435/EEC of 23 July 1990 on the common system of taxation applicable in the case of parent companies and subsidiaries of different Member States (OJ 1990 L 225, p. 6). According to that decision, those three objectives could have been achieved if CSTS had been incorporated in accordance with United Kingdom legislation and established in the United Kingdom.

CSTI is a subsidiary of CSTS. In the view of the national court, it was incorporated in Ireland in order not to fall within the application of certain United Kingdom tax provisions on exchange transactions.

According to the decision making the reference, it is common ground that CSTS and CSTI were established in Dublin solely in order that the profits related to the internal financing activities of the Cadbury Schweppes group could benefit from the tax regime of the IFSC.

Given the rate of tax applicable to companies established in the IFSC, the profits of CSTS and CSTI were subject to 'a lower level of taxation' within the meaning of the legislation on CFCs. The United Kingdom tax authorities took the view that, for the 1996 financial year, none of the conditions for exemption from taxation provided for by that legislation applied to those subsidiaries.

By decision of 18 August 2000, the Commissioners of Inland Revenue therefore claimed, under the CFC legislation, corporation tax from CSO in the sum of UK £8 638 633.54 on the profits made by CSTI in the financial year ending 28 December 1996. The tax notice related only to the profits made by CSTI because, in that financial year, CSTS made a loss.

On 21 August 2000, CS and CSO appealed against that tax notice to the Special Commissioners of Income Tax, London. Before that body, they maintained that the legislation on CFCs was contrary to Articles 43 EC, 49 EC and 56 EC.

The national court states that it is faced with a series of uncertainties as to the application of Community law to the case before it.

First, it asks whether, in establishing and capitalising companies in another Member State solely to take advantage of a tax regime more favourable than that applicable in the United Kingdom, CS is abusing the freedoms introduced by the EC Treaty.

Secondly it asks whether, if CS is merely exercising those freedoms in a genuine manner, the correct approach in the circumstances of this case is to consider whether the legislation on CFCs may be viewed as a restriction on the exercise of those freedoms, or discrimination.

Should that legislation be viewed as involving a restriction on the freedoms enshrined by the Treaty, the national court asks, thirdly, whether the fact that CS may pay no more tax than what CSTS and CSTI would have paid if they had been established in the United Kingdom means that there is no such restriction. It also asks whether it is relevant that on the one hand there are differences in some respects between the rules for calculating the tax liability in respect of the income of CSTS and CSTI and the ordinary rules applicable to United Kingdom subsidiaries of CS and on the other the fact that losses of a CFC cannot be deducted from the profits of another CFC or from the profits of CS and its United Kingdom subsidiaries, whereas such a deduction would have been available if CSTS and CSTI had been established in the United Kingdom.

Should the legislation on CFCs be viewed as involving discrimination, it asks, fourthly, whether a parallel should be drawn between the facts in the main proceedings and the incorporation by CS of subsidiaries in the United Kingdom or the establishment by CS of subsidiaries in a Member State which does not charge a lower rate of tax as provided for in that legislation.

Should the legislation on CFCs be viewed as involving discrimination or a restriction on the freedom of establishment, it asks, fifthly, whether that legislation can be justified on grounds of prevention of tax avoidance, given its objective to prevent the reduction or diversion of profits liable to United Kingdom tax; and, if so, whether the legislation may be considered to be proportionate having regard to its purpose and the exemptions which may be obtained by companies which, unlike CS, succeed in proving under the motive test that their purpose does not relate to tax avoidance.

In the light of those questions, the Special Commissioners of Income Tax, London, decided to stay the proceedings and refer the following question to the Court for a preliminary ruling:

'Do Articles 43 EC, 49 EC and 56 EC preclude national tax legislation such as that in issue in the main proceedings, which provides in specified circumstances for the imposition of a charge upon a company resident in that Member State in respect of the profits of a subsidiary company resident in another Member State and subject to a lower level of taxation?'

The question referred for a preliminary ruling

By that question, the national court asks, essentially, whether Articles 43 EC, 49 EC and 56 EC preclude national tax legislation such as that in issue in the main proceedings, which provides under certain conditions for the imposition of a charge upon the parent company on the profits made by a CFC.

That question must be understood as referring also to Article 48 EC, under which companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community are to be treated in the same way as natural persons who are nationals of Member States, referred to in Article 43 EC, for the purposes of the provisions of the Treaty on freedom of establishment.

In accordance with settled case-law, national provisions which apply to holdings by nationals of the Member State concerned in the capital of a company established in another Member State, giving them definite influence on the company's decisions and allowing them to determine its activities come within the substantive scope of the provisions of the Treaty on freedom of establishment (see, to that effect, Case C-251/98 Baars [2000] ECR I-2787, paragraph 22, and Case C-436/00 X and Y [2002] ECR I-10829, paragraph 37).

In this case, the legislation on CFCs concerns the taxation, under certain conditions, of the profits of subsidiaries established outside the United Kingdom in which a resident company has a controlling holding. It must therefore be examined in the light of Articles 43 EC and 48 EC.

If, as submitted by the applicants in the main proceedings and Ireland, that legislation has restrictive effects on the free movement of services and the free movement of capital, such effects are an unavoidable consequence of any restriction on freedom of establishment and do not justify, in any event, an independent examination of that legislation in the light of Articles 49 EC and 56 EC (see, to that effect, Case C-36/02 Omega [2004] ECR I-9609, paragraph 27).

Before examining the legislation on CFCs in the light of Articles 43 EC and 48 EC, it is important to answer the national court's initial question seeking to ascertain whether the fact that a company established in a Member State establishes and capitalises companies in another Member State solely because of the more favourable tax regime applicable in that Member State constitutes an abuse of freedom of establishment.

It is true that nationals of a Member State cannot attempt, under cover of the rights created by the Treaty, improperly to circumvent their national legislation. They must not improperly or fraudulently take advantage of provisions of Community law (Case 115/78 Knoors [1979] ECR 399, paragraph 25; Case C-61/89 Bouchoucha [1990] ECR I-3551, paragraph 14; and Case C-212/97 Centros [1999] ECR I-1459, paragraph 24).

However, the fact that a Community national, whether a natural or a legal person, sought to profit from tax advantages in force in a Member State other than his State of residence cannot in itself deprive him of the right to rely on the provisions of the Treaty (see, to that effect, Case C-364/01 Barbier [2003] ECR I-15013, paragraph 71).

As to freedom of establishment, the Court has already held that the fact that the company was established in a Member State for the purpose of benefiting from more favourable legislation does not in itself suffice to constitute abuse of that freedom (see, to that effect, Centros, paragraph 27, and Case C-167/01 Inspire Art [2003] ECR I-10155, paragraph 96).

As noted by the applicants in the main proceedings and the Belgian Government, and by the Cypriot Government at the hearing, it follows that the fact that in this case CS decided to establish CSTS and CSTI in the IFSC for the avowed purpose of benefiting from the favourable tax regime which that establishment enjoys does not in itself constitute abuse. That fact does not therefore preclude reliance by CS on Articles 43 EC and 48 EC (see, to that effect, Centros, paragraph 18, and Inspire Art, paragraph 98).

It must therefore be examined whether Articles 43 EC and 48 EC preclude the application of legislation such as that on CFCs.

According to settled case-law, although direct taxation falls within their competence, Member States must none the less exercise that competence consistently with Community law (Case C-311/97 Royal Bank of Scotland [1999] ECR I-2651, paragraph 19; Case C-319/02 Manninen [2004] ECR I-7477, paragraph 19; and Case C-446/03 Marks & Spencer [2005] ECR I-10837, paragraph 29).

Freedom of establishment, which Article 43 EC grants to Community nationals and which includes the right to take up and pursue activities as self-employed persons and to set up and manage undertakings, under the conditions laid down for its own nationals by the law of the Member State where such establishment is effected, entails, in accordance with Article 48 EC, for companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community, the right to exercise their activity in the Member State concerned through a subsidiary, a branch or an agency (see, in particular, Case C-307/97 Saint Gobain ZN [1999] ECR I-6161, paragraph 35; Marks & Spencer, paragraph 30; and Case C-471/04 Keller Holding [2006] ECR I-0000, paragraph 29).

Even though, according to their wording, the provisions of the Treaty concerning freedom of establishment are directed to ensuring that foreign nationals and companies are treated in the host Member State in the same way as nationals of that State, they also prohibit the Member State of origin from hindering the establishment in another Member State of one of its nationals or of a company incorporated under its legislation (see, in particular, Case C-264/96 ICI [1998] ECR I-4695, paragraph 21, and Marks & Spencer, paragraph 31).

In this case, it is common ground that the legislation on CFCs involves a difference in the treatment of resident companies on the basis of the level of taxation imposed on the company in which they have a controlling holding.

Where the resident company has incorporated a CFC in a Member State in which it is subject to a lower level of taxation within the meaning of the legislation on CFCs, the profits made by such a controlled company are, pursuant to that legislation, attributed to the resident company, which is taxed on those profits. Where, on the other hand, the controlled company has been incorporated and taxed in the United Kingdom or in a State in which it is not subject to a lower level of taxation within the meaning of that legislation, the latter is not applicable and, under the United Kingdom legislation on corporation tax, the resident company is not, in such circumstances, taxed on the profits of the controlled company.

That difference in treatment creates a tax disadvantage for the resident company to which the legislation on CFCs is applicable. Even taking into account, as suggested by the United Kingdom, Danish, German, French, Portuguese, Finnish, and Swedish Governments, the fact referred to by the national court that such a resident company does not pay, on the profits of a CFC within the scope of application of that legislation, more tax than that which would have been payable on those profits if they had been made by a subsidiary established in the United Kingdom, the fact remains that under such legislation the resident company is taxed on profits of another legal person. That is not the case for a resident company with a subsidiary taxed in the United Kingdom or a subsidiary established outside that Member State which is not subject to a lower level of taxation.

As submitted by the applicants in the main proceedings and by Ireland and the Commission of the European Communities, the separate tax treatment under the legislation on CFCs and the resulting disadvantage for resident companies which have a subsidiary subject, in another Member State, to a lower level of taxation are such as to hinder the exercise of freedom of establishment by such companies, dissuading them from establishing, acquiring or maintaining a subsidiary in a Member State in which the latter is subject to such a level of taxation. They therefore constitute a restriction on freedom of establishment within the meaning of Articles 43 EC and 48 EC.

Such a restriction is permissible only if it is justified by overriding reasons of public interest. It is further necessary, in such a case, that its application be appropriate to ensuring the attainment of the objective thus pursued and not go beyond what is necessary to attain it (Case C-250/95 Futura Participations and Singer [1997] ECR I-2471, paragraph 26; Case C-9/02 De Lasteyrie du Saillant [2004] ECR I-2409, paragraph 49; and Marks & Spencer, paragraph 35).

The United Kingdom Government, supported by the Danish, German, French, Portuguese, Finnish and Swedish Governments, submits that the legislation on CFCs is intended to counter a specific type of tax avoidance involving the artificial transfer by a resident company of profits from the Member State in which they were made to a low-tax State by means of the establishment of a subsidiary in that State and the effecting of transactions intended primarily to make such a transfer to that subsidiary.

In that respect, it is settled case-law that any advantage resulting from the low taxation to which a subsidiary established in a Member State other than the one in which the parent company was incorporated is subject cannot by itself authorise that Member State to offset that advantage by less favourable tax treatment of the parent company (see, to that effect, Case 270/83 Commission v France [1986] ECR 273, paragraph 21; see also, by analogy, Case C-294/97 Eurowings Luftverkehr [1999] ECR I-7447, paragraph 44, and Case C-422/01 Skandia and Ramstedt [2003] ECR I-6817, paragraph 52). The need to prevent the reduction of tax revenue is not one of the grounds listed in Article 46(1) EC or a matter of overriding general interest which would justify a restriction on a freedom introduced by the Treaty (see, to that effect, Case C-136/00 Danner [2002] ECR I-8147, paragraph 56, and Skandia and Ramstedt, paragraph 53).

It is also apparent from case-law that the mere fact that a resident company establishes a secondary establishment, such as a subsidiary, in another Member State cannot set up a general presumption of tax evasion and justify a measure which compromises the exercise of a fundamental freedom guaranteed by the Treaty (see, to that effect, ICI, paragraph 26; Case C-478/98 Commission v Belgium [2000] ECR I-7587, paragraph 45; X and Y, paragraph 62; and Case C-334/02 Commission v France [2004] ECR I-2229, paragraph 27).

On the other hand, a national measure restricting freedom of establishment may be justified where it specifically relates to wholly artificial arrangements aimed at circumventing the application of the legislation of the Member State concerned (see to that effect ICI, paragraph 26; Case C-324/00 Lankhorst-Hohorst [2002] ECR I-11779, paragraph 37; De Lasteyrie du Saillant, paragraph 50; and Marks & Spencer, paragraph 57).

It is necessary, in assessing the conduct of the taxable person, to take particular account of the objective pursued by the freedom of establishment (see, to that effect, Centros, paragraph 25, and X and Y, paragraph 42).

That objective is to allow a national of a Member State to set up a secondary establishment in another Member State to carry on his activities there and thus assist economic and social interpenetration within the Community in the sphere of activities as self-employed persons (see Case 2/74 Reyners [1974] ECR 631, paragraph 21). To that end, freedom of establishment is intended to allow a Community national to participate, on a stable and continuing basis, in the economic life of a Member State other than his State of origin and to profit therefrom (Case C-55/94 Gebhard [1995] ECR I-4165, paragraph 25).

Having regard to that objective of integration in the host Member State, the concept of establishment within the meaning of the Treaty provisions on freedom of establishment involves the actual pursuit of an economic activity through a fixed establishment in that State for an indefinite period (see Case C-221/89 Factortame and Others [1991] ECR I-3905, paragraph 20, and Case C-246/89 Commission v United Kingdom [1991] ECR I-4585, paragraph 21). Consequently, it presupposes actual establishment of the company concerned in the host Member State and the pursuit of genuine economic activity there.

It follows that, in order for a restriction on the freedom of establishment to be justified on the ground of prevention of abusive practices, the specific objective of such a restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality, with a view to escaping the tax normally due on the profits generated by activities carried out on national territory.

Like the practices referred to in paragraph 49 of Marks & Spencer, which involve arranging transfers of losses, within a group of companies, to companies established in the Member States which apply the highest rates of taxation and in which the tax value of those losses is therefore the highest, the type of conduct described in the preceding paragraph is such as to undermine the right of the Member States to exercise their tax jurisdiction in relation to the activities carried out in their territory and thus to jeopardise a balanced allocation between Member States of the power to impose taxes (see Marks & Spencer, paragraph 46).

In the light of those considerations, it must be determined whether the restriction on freedom of establishment arising from the legislation on CFCs may be justified on the ground of prevention of wholly artificial arrangements and, if so, whether it is proportionate in relation to that objective.

That legislation covers situations in which a resident company has created a CFC which is subject, in the Member State in which it is established, to a level of taxation which is less than three quarters of the amount of tax which would have been paid in the United Kingdom if the profits of that CFC had been taxed in that Member State.

By providing for the inclusion of the profits of a CFC subject to very favourable tax regime in the tax base of the resident company, the legislation on CFCs makes it possible to thwart practices which have no purpose other than to escape the tax normally due on the profits generated by activities carried on in national territory. As the French, Finnish and Swedish Governments stated, such legislation is therefore suitable to achieve the objective for which it was adopted.

It must further be determined whether that legislation goes beyond what is necessary to achieve that purpose.

The legislation on CFCs contains a number of exceptions where taxation of the resident company on the profits of CFCs does not apply. Some of those exceptions exempt the resident company in situations in which the existence of a wholly artificial arrangement solely for tax purposes appears to be excluded. Thus, the distribution by a CFC of almost the whole of its profits to a resident company reflects the absence of an intention by the latter to escape United Kingdom income tax. The performance by the CFC of trading activities excludes, for its part, the existence of an artificial arrangement which has no real economic link with the host Member State.

If none of those exceptions applies, the taxation provided for by the CFC legislation may not apply if the establishment and the activities of the CFC satisfy the motive test. That requires, essentially, that the resident company show, first, that the considerable reduction in United Kingdom tax resulting from the transactions routed between that company and the CFC was not the main purpose or one of the main purposes of those transactions and, secondly, that the achievement of a reduction in that tax by a diversion of profits within the meaning of that legislation was not the main reason, or one of the main reasons, for incorporating the CFC.

As stated by the applicants in the main proceedings and by the Belgian Government and the Commission, the fact that none of the exceptions provided for by the legislation on CFCs applies and that the intention to obtain tax relief prompted the incorporation of the CFC and the conclusion of the transactions between the latter and the resident company does not suffice to conclude that there is a wholly artificial arrangement intended solely to escape that tax.

In order to find that there is such an arrangement there must be, in addition to a subjective element consisting in the intention to obtain a tax advantage, objective circumstances showing that, despite formal observance of the conditions laid down by Community law, the objective pursued by freedom of establishment, as set out in paragraphs 54 and 55 of this judgment, has not been achieved (see, to that effect, Case C-110/99 Emsland-Stärke [2000] ECR I-11569, paragraphs 52 and 53, and Case C-255/02 Halifax and Others [2006] ECR I-0000, paragraphs 74 and 75).

In those circumstances, in order for the legislation on CFCs to comply with Community law, the taxation provided for by that legislation must be excluded where, despite the existence of tax motives, the incorporation of a CFC reflects economic reality.

That incorporation must correspond with an actual establishment intended to carry on genuine economic activities in the host Member State, as is apparent from the case-law recalled in paragraphs 52 to 54 of this judgment.

As suggested by the United Kingdom Government and the Commission at the hearing, that finding must be based on objective factors which are ascertainable by third parties with regard, in particular, to the extent to which the CFC physically exists in terms of premises, staff and equipment.

If checking those factors leads to the finding that the CFC is a fictitious establishment not carrying out any genuine economic activity in the territory of the host Member State, the creation of that CFC must be regarded as having the characteristics of a wholly artificial arrangement. That could be so in particular in the case of a 'letterbox' or 'front' subsidiary (see Case C-341/04 Eurofood IFSC [2006] ECR I-0000, paragraphs 34 and 35).

On the other hand, as pointed out by the Advocate General in point 103 of his Opinion, the fact that the activities which correspond to the profits of the CFC could just as well have been carried out by a company established in the territory of the Member State in which the resident company is established does not warrant the conclusion that there is a wholly artificial arrangement.

The resident company, which is best placed for that purpose, must be given an opportunity to produce evidence that the CFC is actually established and that its activities are genuine.

In the light of the evidence furnished by the resident company, the competent national authorities have the opportunity, for the purposes of obtaining the necessary information on the CFC's real situation, of resorting to the procedures for collaboration and exchange of information between national tax administrations introduced by legal instruments such as those referred to by Ireland in its written observations, namely Council Directive 77/799/EEC of 19 December 1977 concerning mutual assistance by the competent authorities of the Member States in the field of direct taxation (OJ 1977 L 336, p. 15) and, in this case, the Convention between the Government of the United Kingdom of Great Britain and Northern Ireland and the Government of the Republic of Ireland for the avoidance of double taxation and the prevention of fiscal evasion with respect to taxes on income and capital gains of 2 June 1976.

In this case, it is for the national court to determine whether, as maintained by the United Kingdom Government, the motive test, as defined by the legislation on CFCs, lends itself to an interpretation which enables the taxation provided for by that legislation to be restricted to wholly artificial arrangements or whether, on the contrary, the criteria on which that test is based mean that, where none of the exceptions laid down by that legislation applies and the intention to obtain a reduction in United Kingdom tax is central to the reasons for incorporating the CFC, the resident parent company comes within the scope of application of that legislation, despite the absence of objective evidence such as to indicate the existence of an arrangement of that nature.

In the first case, the legislation on CFCs should be regarded as being compatible with Articles 43 EC and 48 EC.

In the second case, on the other hand, the view should be taken, as submitted by the applicants in the main proceedings, the Commission and, at the hearing, the Cypriot Government, that that legislation is contrary to Articles 43 EC and 48 EC.

In the light of the preceding considerations, the answer to the question referred must be that Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a CFC in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that CFC is actually established in the host Member State and carries on genuine economic activities there.

Costs

Since these proceedings are, for the parties to the main proceedings, a step in the action pending before the national court, the decision on costs is a matter for that court. Costs incurred in submitting observations to the Court, other than the costs of those parties, are not recoverable.

On those grounds, the Court (Grand Chamber) hereby rules:

Articles 43 EC and 48 EC must be interpreted as precluding the inclusion in the tax base of a resident company established in a Member State of profits made by a controlled foreign company in another Member State, where those profits are subject in that State to a lower level of taxation than that applicable in the first State, unless such inclusion relates only to wholly artificial arrangements intended to escape the national tax normally payable. Accordingly, such a tax measure must not be applied where it is proven, on the basis of objective factors which are ascertainable by third parties, that despite the existence of tax motives that controlled company is actually established in the host Member State and carries on genuine economic activities there.