Prevention of hybrid mismatches as a justification

Prevention of Hybrid Mismatches as a Justification?
I. Introduction
In the current scenario of international tax law, characterized by the accelerated
pace of intersections among..different tax systems, cross-border tax arbitrage re-
presents a central challenge for the European Union and other countries around
the world, due to the fact that the inherent differences in the tax rules of several
jurisdictions created unique opportunities for taxpayers to engag.e in tax planning
strategies. The potential opportunities for tax arbitrage, in which a taxpayer relies
on differences between two tax systems to structure a cross-border transaction,
has sharply increased in recent years due to the expansion of international trade
and the promotion ofinternational investments.!
An active source of cross-border tax arbitrage involves the use of hybrid mis-
match arrangements, which can be defined as tax structures designed to exploit
asymmetries in the tax treatment ofhybrid financiaI instruments, hybrid entities,
and hybrid transfers in different jurisdictions, with the goal of obtaining double
deductions, deduction with non-inclusion or foreign tax credits.2 Recently, hy-
brid mismatch arrangements have become an extremely sensitive political issue,3
especially in the light ofthe initiatives ofthe OECD4 and the European Union5 to
tackle harmful tax practices and aggressive tax avoidance. In this respect, the
BEPS project represents a substantial attempt towards the elimination of double
non-taxation stemming from base erosion and profit shifting, which reflects the
current view that international standards may not have kept pace with changes in
the global corporative business environment.6
In the context of the European Union, on 20 June 2014, the European Union's
Economic and FinanciaI Affairs Council (ECOFIN) reached political agreement
on a proposed amendment to the Parent-Subsidiary Directive, which aims at pre-
venting double non-taxation derived from deduction and non-inclusion schemes
obtained through the use of hybrid mismatch arrangements.7 In particular, the
legislative amendment focuses on cross-border tax arbitrage that exploits differ-
ences in the characterization of income derived from hybrid financiaI instru-
ments in two Member States, in which the remuneration paid qualifies as a tax-
H. D. Rosenbloom, The David R. Tillinghast Leeture International TfL'< Arbitrage and The Interna-
tionaI Tax Regime, Tax LalV RevielV 2000, pp. 142-143.
2 R. de Boer/M. Nouwen, The European Unioll'S Struggle lVith Mismatches and Agressive Tax Planning
(The Hague: EIeven International Publishing, 2013) p. 6.
3 A. de Graaf, International Tax Poliey Needed to CounterbaIanee the Exeessive Behaviour ofMultina-
tionals, EC Tax RevielV 2013, p. 108.
4 üECD, Hybrid Mismatch Arrangements: Tax Po/icy and Comp/iance Issues (Paris: üECD, 2012).
üECD, Neutra/ising the Effects ofHybrid Mismatch Arrangements (Paris: üECD, 2014).
5 European Comission, Action Plan to Strengthen the Fight Against Tax Fraud and Tax Evasion (Brus-
seIs: European Comission, 2012).
6 üECD, Addressing Base Erosioll and Profit Shifting (Paris: üECD, 2013) p. 47.
7 A. P. Dourado, The Base Erosion and Pro/h Shifting (BEPS) Initiative under Analysis, Illtertax 2015, p. 4.
Tomazela Santos
- b 'd' nd as a tax-exemptd ductible interest expense at the levei of the su SI Iary a 8 Th
e fit distribution at the leveI of the parent company in the oth~r .count~. . e
~:: provision was inserted into Article 4.1 (a) ofthe Parent-Subsldlary DlrectlVe,
and reads as followS:9
bl" h t b irtue ofthe association of
Where a parent eompany or its pe:n:anent es~a I~. m~~, ~v fit the Member State
the parent eompany with its subsldlary, reeelves Istn ute pro I sbl" h t hali ex-
of the parent eompany and the Member. State of its permanent esta IS men s ,
ee t when the subsidiary is liquidated, elther: .
p . f m taxin sueh rofits to the extent that such profits are not deduct~ble by
a) ~~~r~:~s~~iary, anJ tax sJch profits to the extent that such profits are deductlble by
the subsidiary; or d h nent estab-
h rofits while authorising the parent eompany an t e perma .
b) ~~~~:nt fo deduet from the amount of tax due that fraction of the e?rporabtl?d~ tax
d 'd b th subsidiary and any lower-tler su SI lary,
related to those pr?~ts an pai y. e d' 1 wer-tier subsidiary fali
subjeet to the condltlon that at eaeh tler a company an ItS o. .d d
within the definitions laid down in Article 2 and meet the req~lrements proVI e
for in Article 3, up to the limit ofthe amount ofthe correspondmg tax due.
In eneral terms, the Parent-Subsidiary Directive deaIs wit~ th.e ta~ treatment of
pn~fitdistributions between parent and subsidiary compa~les I~.dl~f~~e~fd~~~~
ber States with the objective of eliminating both economlC an )un lCa f d' .
taxation. It seeks to abolish tax obstacles to th~ cross-borde.r p~ymeFtho . ~Vl~
dends within groups of companies, thus improv~~g the.functl~nmg o tem .er
I ket Upon the fulfilment of certain condltlOns, It provldes an exemptlOn
na mar . f h b 'diary on out-from the withholding income tax levied in the country o t e su SI
b d d' .dends 10 as well as the obligation for the state ofthe parent company to
e~~~nat~V~ouble'taxation.n Member States are free to decide b~tween the exemp~
tion method and the credit method, depending on the tax pohcy adopted. In or
der to avoid double taxation, Article 4(1) provides that the Men:be~ ~tate of/he
arent company must: (i) refrain from taxing the dividends recelve exemp lOn
~ethod)' or (ii) tax the dividend received, allowing the parent company tOfjoffset,
against i~s corporate income t~x, ~he tax gaid by the subsidiary on the pro ItS out
of which the dividends were dlstnbuted.
After the 2014 amendment, the Member State ofthe parent company must only
refrain from taxing distributed profits to the extent that such profits are n~t
deductible by the subsidiary. On the other hand, the Member State must tax t e
8 L. de Broe, At Last, Some üutput on the Fight against Double Non-Taxation, EC Tax RevielV 2014,
pp.310-311. N b 2011 (reeast) amended by: Council Direetive 2013/9 Council Direetive 2011/96/EU of 30 ovem er ,
13/EU of 13 May 2013 and Council Direetive 2014/86/EU of8 July 2014.
10 Artide 5 of Couneil Direetive 2011/96/EU of 30 November 2011 «reeast».
'1' . 2011/96/EU of 30 November 2011 reeast.
11 Artide 4 of CounCl DlreelIve L 6' d'l' n (Alphen aan den Rijn: Kluwer Law Interna-
12 B. J. M. Terra/P. J. Wattel, European Tax aIV, e 110
tional, 2012) p. 312.
164 Dziurdí/Marehgraber (Eds), Non-Diserimination in European and Tax Treaty law . ., . . European and Tax Treaty lawDziurdí/Marehgraber (Eds), Non-Dlscnmlnatlon In 165

Tomazela Santos
Against this background, many EU countries, such as Denmark 16 17
Italy, Austria18 and the United Kingdom 19 have alread' I 'd Germany,
I b E, , ylmp emente anti-hybrid
:~ ~s ev~n e
h
ore th~ ~me~dment ofthe Parent-Subsidiary Directive, for purposes
ded~~~;~ t ~ par~I~I~atlOn exemption where the correspondent payment was
so t t
Y2~ e su sldlary company from the corporate income tax levied in the
urce s a e.
Original ProposaI by Approved text
the Commission
"refrain from taxing such profits to the "refrain from taxing such profits to the
extent that such profits are not deduct-
ible by the subsidiary of the parent
extent that such profits are not deduct-
ible by the subsidiary of the parent
company".
company, and tax such profits to the
extent that such profits are deducti-
ble by the subsidiary",
dividends received to the extent that the corre d' -
from the corporate income tax paid by the sPbo~d,mg p;hmenl
t
was deducted
amendment is tackl' d d ' SU SI lary. e cear goal of the
br'd fi ' . mg e uctlOn and non-inclusion schemes derived from h
le~el ~~~ncIaI msttruments, whose ~emuneration is classified as dividend at t~~
e paren company and as mterest at the leveI of the subsidiary.13
~t is.imp~rtant to cla~i~that the final version ofthe text approved by the ECOFIN
eVlates rom ~he ongmal proposal of the Commission, in which Member
were not effectlvely required to tax the dividend 'd h States, 1 s recelVe ,as t e text of the o .
~a p{oposal for amending the Parent-Subsidiary Directive did not oblige ~~-
. em er State to exercise its right to tax under the domestic law 14 Th fi 1 e
s~o~ of t~e ne.w anti-hybrid rule embedded in Article 4(l)(a) of'the P:r~~:_Sver
shldladrybDlreCtlVe now clearly establishes the obligation to tax apparently en/
b
-
t e e ate as to whether the M b S h " mg
lity to tax 15 The d'fE, ,emher tate~ ave an obhgation or a mere possibi-
d
. b1 erence m t e wordmg of the original proposaI and the
approve text can e seen below:
13
14
15
16
17
18
19
20
L. de Broe, EC Tax Review 2014, p. 311, FN 8.
C. Marchgraber, Tackling Deduclion and Non-Inclusion Sch
Commission, European Taxation, p. 136. emes - The ProposaI of lhe European
~:~::~~;~ ~~:~~ ~~~h~rI~~~~ ~axCI, AasCalm(Eendked by Law No. 344, of 18 April2007,
c d"" 111 ommensteuergesetz - EsIG) Th h' ..
lor IVldends in § 8b(I) of lhe Corporale Income Tax A I (K" h ft . e malc mg pnnclpIe
Seclion 10 (7) oflhe Auslrian Corporale Income Tax AccI orpersc a sleuergeselz - KSIG).
Seclions 931B(c) and 93ID(c) oflhe Corporale Taxation Acl (CTA)
OECD, Hybrid Mismatch Arrangements: Tax Policy and Complianc~ Issue 18s, p. .
11. Hybrid Arrangements in the Internai Market
In order to understand the reasons why the European Union decided to tackle
hybrid mismatches arrangements and to examine possible justifications, it is
necessary first to analyze in detail how these tax planning structures may hamper
the achievement of the objectives of the single market.
First, hybrid mismatch arrangements may result in a significant loss of tax reve-
nue, caused by the reduction of the overall tax liability.21 As a consequence of
their impact on tax revenue, the Member State concerned may be required to ei-
ther reduce public spending or shift to other revenue sources.22
This may increase
the volatility ofincome tax revenue and affect state budgets, in particular because
aggressive tax planning strategies make it difficult for governments to predict the
tax receipts. In the current economic crisis in Europe, the impact of hybrid mis-
matches can be even more significant, forcing governments not only to cut public
expenses, but also to increase the statutory corporate income tax rates. However,
an increase of tax rates, in the current economic climate, is undesirable on the
path towards recovery from the economic and financiaI crisis, This reduction in
tax revenue may also contravene the intention ofdomestic law and lead to a gen-
eral increase in taxes levied on wages, salaries, and consumption in an effort to
pass on the costs to domestic taxpayers. The problem is that the high Mpendency
on tax revenue derived from immobile factors, such as labor and local consump-
tion, is aIso questionable from a tax policy perspective, because it may cause neg-
ative consequences in terms of economic activity (increase labor costs and
prices).23 Thus, the alternative of combating the loss of tax revenues through the
crackdown on hybrid mismatches was probably the only feasible option available
to the European Union,
Second, hybrid mismatches may distort competition on the single internaI mar-
ket, as particular types of companies may have a competitive advantage through
the use of hybrid financiaI instruments.24 In particular, it distorts competition
between companies with different opportunities to avoid taxes, which is against
the goal ofensuring a leveI playing field for market participants. Furthermore, the
increase of the profit margin through aggressive tax planning may hide the real
economic performance of the company, not only allowing it to maintain ineffi-
cient business or operational practices, but aIso discouraging improvements in
21 OECD, Hybrid A'fismatch Arrangements: Tax Policy and Compliance Issues, pp. 11-12.
22 S. Barsch, Taxation ofHybrid Financiai Instrwllents and the Rel1HlIleration Derived Therefrom in an
Intemational and Cross-border - Issues and Optionsfor Reform (Berlin/Heidelberg: Springer VerIag,
2012) p. 52.
23 A. Sleichen, Tax Compelilion in Europe or The Taming ofLevialhan, In: W. Schon (Ed.), Tax Com-
petition in Europe (Amslerdam: IBFD, 2003), pp. 53-58.
24 R. de Boer, Preliminary Observations on lhe European Comission's Slralegy for Tackling Hybrid
Mismalch Arrangemenls, in: R. de Boer/M. Nouwen (eds.), The European Union's Struggle wi/h Mis-
matches and Agressive Tax Planning (The Hague: EIeven Inlernational Publishing, 2013) p. 51.
166 Dziurdz/Marchgraber (Eds), Non-Discrimination in European d T
an ax Treaty law Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty law 167

pn)(lllcti,on capacity or technological innovation. The tax savings obtained by the
exploitation of cross-border tax arbitrage may also be used to eliminate competi_
tors and other market players, which contrasts strongly with the essential idea
that the internaI market should ensure a fair competition environment in which
companies are able to compete on an equal footing.
Third, cross-border tax arbitrage may interfere with the principIe of tax neutral_
ity, as an investment carried out abroad becomes more attractive than a domestic
equivalent investment because of its tax consequences.25 IdealIy, tax rules should
neither create economic distortions nor affect economic judgments of rational
taxpayers. Thus, the tax rules should aim to achieve the highest degree ofneutral-
ity possible, without affecting the allocation of production factors at the leveI of
the economy.26 The problem is that the objective of creating hybrid mismatches
in cross-border transactions may interfere with the capital structure of the com-
pany, especially in relation to the choice among different modes of corporate
finance (retained earnings, new equity issues, or debt capital). In addition, in an
international context, the concept of tax neutrality implies that the decision on
where to invest should not be distorted by taxes. Instead, the choice of the juris-
diction in which to invest should be determined by other economic factors, such
as geographical benefits, pre-tax interest rate, labor costs, degree of economic
deveIopment, and political stability. The non-taxation obtained through the use
of hybrid arrangements leads to an inefficient incentive to invest in pure cross-
border transactions with specific jurisdictions, rather than equivalent domestic
transactions. The taxpayer will have a stimulus to use the same formula several
times to create the hybrid mismatch, generally using the same financiaI instru-
ment and the same foreign jurisdiction.
Fourth, hybrid mismatch opportunities are more readily available for taxpayers
with income from capital, rather than labor.27 In fact, the main objectives sought
by taxpayers with international tax planning structures are usually exploited
through income arising from capital. In brief, the main tax planning goals pur-
sued by taxpayers are: (i) avoidance ofthe taxable event ("escape"); (ii) deferral of
taxes to a later date, taking advantage of the cost of money over time ("di./fer");
(iii) transference ofthe tax liability to another legal entity ("shift"); or (iv) reclassi-
fication of the income to another category, which is subject to a more favorable
tax treatment ("convert").28 These aspects affect the fairness of the tax system,
which requires the taxpayers to contribute to the public expenses based on their
25 S. Barsch, Taxatíon ofHybrid Financiai lnstruments and the Remuneration Derived Therefrom in an
lnternational and Cross-border, pp. 44-52.
26 S, Barsch, Taxation ofHybrid Financiai lnstruments and the Remlmeration Derived Therefrom in an
lnternational and Cross-border, pp, 44-52,
27 R. de Boer in: R. de Boer/M. Nouwen (eds.), The European Union's Struggle with Mismatehes and
Agressive Tax Plamling, p. 51.
28 E. J. Mccaffery, lncome Tax Law (New York: Oxford University Press, 2011), p. 27.
Tomazela Santos
--, 'd ' f double non-taxa-. . From a tax policy perspective, the avOl ance o . . .
ab1h~y to P~~~l for the achievement ofequality in the determinatlOn o~each~nd{d
tion 1S esse 's tax burden. In order to promote tax fairness, law~a ers s .ou.
vidnal t~xpahe~les exploited by taxpayers through cross-border arbltr~ge,~~1ch 1S
remove oop . d b ditional market forces. The promotlOn o mter-
nnlikely to b~ c~nstrame ~ ~:: overnance supports the EU initiatives against
national tax Justlce a~d gooh g tt . based on the idea that multinational
ressive tax planmng, w ose mo o 1S
agg . should pay their fair share of taxes.29
compames .
Even though it is possible to r~~s~ d:~b~~o~th~~;et~;l~~~~~rd~f:~etr~:~J :~~
siderations discussed above, ~e:tt::~emb:r States, together with the European
matches arrangements promp . der to tackle their negative effects for the
Commission, to adopt tax measures m o~. considerations will have to be taken
single m~rket. ~or .thishreaso1n, tt:~:fpo~~~ble grounds ofjustification to the dis-
. to cons1deratlOn m t e eva ua 1
~~iminatory tax measures adopted by the Member States.
111. Restrictions of Fundamental Freedoms and
Discriminatory Measures
h . . I of conferral 30 Member States still have sovereignty in the
Based on t e pnnClp e . I' b when the European Union was cre-
area of direct taxation, in partlCu ar ecause, .d ed to be a relevant goal to
ated, the harmonization ~~di~ect tax~~ w~~ ~:~~~~1S::tes were (and still are) re-
be achieved through pos1tlve mtegr~ lOn. direct taxes In the absence of far-
luctant to renounce national sovere1gn? over. ' la~ provisions for direct
reaching harmonization, the ~ost re e~aFt ~~::rywhich establish limits and
taxes ended up being the fun amenta . r~e . ' .. ') 32
boundaries for exercising national tax junsd1ctlOn (negat1ve mtegratlOn. .
. I for alI Members States m the
In this context, the introductlOn .of com~on ru es h the creation of secondary
field of direct taxes has been mamly reahzed throug . b ni-
EU law.
33
AccforlIdiMngemtobAe;t~~:t:sl~s~~:~ir:~~i~:Sr~~et~ ~:{~nor;~ecit:~~~on,mous vote o a ,
, I 'n A ainst Aggressive Tax Planning and Harmful
29 M. Nouwen, lnternationaI and Supranatlona ~c~~ Sta~e of Play of Recent Work of the OECD and
Tax Competitlon IS Gammg Momentum Fast. ;he European Union's Strugg/e with Mismatehes and
the EU, in: Reinout de Boer/MartlJ~ ~ouweI~ternational Publishing, 2013) pp. 13-15.
Agressive Tax P/anmng (The Hague. even
30 B.). M. Terra/P.). Wattel, European Tax taw
, P'f4'D'rect Taxation in' Michael Lang/Pasquale Pis-
31 L. Adamczyk, The Sources of EU L(a; R)~e~a~uc~~on I
to Eur~pean Tax' Law 011 Direet Taxation, 3rd
tone/josef Schuch/Claus Starmger e s. n ro
edition (Vienna: Linde, 2013) p. 25. I p' /j f Schuch/Claus Staringer (eds.) lntroduetíon to
32 L Adamczyk in: Michael Lang/Pasqua e Istone ose
E;lropean Tax Law on Direet Taxation, rpp2;-25i)osefSchuch/Claus Staringer (eds.) lntroduetíon to
33 L. Adamczyk, in: Michael Lang/Pasqua e IS one
European Tax Law on Direct TaxattOn, p. 25.
168 DziurdZlMarchgraber (Eds), Non-Discrimination in European and Tax Treaty law . . . E ropean and Tax Treaty lawDziurdz/Marchgraber (Eds), Non-Discrimmatlon m u 169

44
40
41
42
43
with the objective of approximating national tax mIes which directly affect the
functioning of the interhal market. Thus, a directive is the only binding legal
instmment available for harmonization ofdirect taxes.34
Member States are obliged to implement the directives into nationallaw within a
given timeframe. If a Member State fails to do so, the provisions of the directive
may become directly applicable and enforceable.35 The actual wording ofdomestic
laws lies within the competence of Member States, which have a certain degree of
discretion in the process of the transposition of the directives in the national tax
system. In fact, although the general provisions contained in a directive have to be
transposed into effective tax mIes, the implementation procedure leaves a certain
leeway for the Member States concerning the definition of the procedure to be fol-
lowed for its application in concrete cases. For this reason, it is possible to identify
three different leveIs of outcomes for the process of transposition of EU directives
into domestic law: conformable, partially conformable and non-conformable.36
Therefore, the first type ofissue that may arise involves a potential conflict between
the national anti-hybrid mIe and secondary EU law, due to their partial conformity
or non-conformity with the Parent-Subsidiary Directive. The actual application of
the domestic anti-hybrid mIes may violate the Parent-Subsidiary Directive,
depending on the transposition procedure adopted by the Member State.
However, even if domestic law is in accordance with the amended version of the
Parent-Subsidiary Directive, the question that arises is whether the rules intro-
duced are compatible with the fundamental freedoms. The EC] already decided
that the Member States are allowed to make use ofthe options provided for by the
directives, to the extent that the implementation ofsuch mIes into domestic law is
in line with the fundamental freedoms.37 This confirms that it is not sufficient to
implement anti-hybrid mIes in accordance with the provision ofthe Parent-Sub-
sidiary Directive. Rather, it is aIso necessary to comply with primary EU law.
Thus, the second question involves a potential conflict between the national anti-
hybrid mIes and the fundamental freedoms.
In fact, national anti-hybrid mIes, even when based on the Parent-Subsidiary Di-
rective, may exceptionally be in conflict with the fundamental freedoms. The di-
rectives do not grant immunity to domestic tax measures, which could also con-
stitute a breach of the key principIe of non-discrimination.38 This implies that,
34 B. J. M. Terra/P. J. Wattel, European Tax Law, pp. 16-17.
35 M. Helminen, The International Tax Law Concept ofDividend (Alphen aan den Rijn: Kluwer Law In-
ternational, 2010) pp. 34-35.
36 T. Kõnig/L. Mãder, Non-conformable, partial and conformable transposition: A competing risk
analysis ofthe transposition process of directives in the EUI5, European Union Politics 2013, p. 46.
37 Judgments in Bosal Holding, C-168/01, EU:C:2003:479; Keller Holding, C-471104, EU:C:2006:143.
38 N. Strelnikova, Assessment of'Anti-Hybrid' Approach to the Problem ofAggressive Tax Planning in
the light ofthe European Comission's proposal to amend Article 4(l)(a) ofthe Parent-Subsidiary Di-
rective, Master Thesis - Master's Programme in European and International Tax Law (Sweden: Lund
University, 2014) p. 22.
Tomazela Santos
- d~bY~~~ffh' the European Union framework, tax measures a op 1 'th
wit m. order to counteract hybrid mismatches arrangements must comp y Wl
States III f' l'd'ty
f damental freedoms, under the penalty o lllva 1 1 .
~W . .
f this a er it is assumed as a starting point that natlOnal antl-
For the purposes ~ h P P '. f the fundamental freedoms, hindering cross-
b .d ules restnct t e exerClse o . d
~~r~~r:CtiV~ti~:~~~~~lth::u~~f~~nf~rn~o;~;~:~t~~~:h:r~:~::::'~nd:d:c~~~~
tlC contex~~ ~~~ subSidi: a~d as dividend for the parent compa~y,as .the ;pph-
eXb~;::x~mIes on the cl?:sification of financiaI instrumentshare l~e~t~al.·t J~~
ca tance of this premise is necessary because the focus of t e tOplC 1S lml e
accep d f' 'fi f 40
the investigation of possible groun s o Justl lca lOn.
IV. Justifications in the area of direct taxation
A. Rule of Reason . .
in challen e faced by the EC] in the area ofdirect taxation conslsts III rec-
The. ~a . g i n in the exercise of taxing powers and the fundamen-
o~~llmânatl~ln;~:o~~th~sá"eveloped the doctrine ofjustification (:ule ofre~so~)
ta ree oms. h 1"t the fundamental freedoms and justify dlrect and mdl-
fO:t~~:~~:~~a~~~a;a~~~ularlyin the tax area.. In t~e Cassis de D,ijon c.a~e,42 th~
~ec] developed, for the first time, u~writ~enjustlficat~ong;o~n~~~~:~:::~grr::-ns of public interest) for restrictlOns m the exerClse o te. f
;oms 43 Thereafter EeJ case law has gradually developed over tlme a s,rstem o
{~~~~'~~t~~~r:~~~nt:~a~les~~:~t:~:~a~~:i:~~~:~i~~eU~;;~~:~~t~:wc~om:e~~
ther restrict the fundamental freedoms nor to discriminate agalllst economlC
players without adequate justification.
44
From the different types of unwritten justification g:ounds th~t have.alrlea.fY~b~:
ted or re'ected by the EC] in concrete cases, thlS paper wl11 partlcu aI y o
~~c:~ebalanc~d allocation oftaxing rights, the cohesion oft~e~ationalta~d~~~
and the prevention of tax abuse, which are those most cose y connec e
----,.- /A L' "The New German DCL and Dividend Matching Rules and EU Law", Intertax39 O. Thommes . mn, ,
2014, p. 33. . . J' D' Maria in this volume.
On the comparablhty test, see eSSlca I d h B I d Allocation of Ta;,: Jurisdiction, Intertax
M. POllIsen, Freedom of Estabhshment an t e a ance
2012, pp, 200-201. G C-120/78 EU:C:1979:42, para. 8.
JlIdgment ltl Rewe-Zentral A, d' .'D' k Ehlers (ed.) European Fundamelltal Rights alld Free-
A. Epiney, Free Movement ofGoo s 1lI. h1rft Veria s 2007) p. 249.
doms. (Berlin: De Gruyter Rechtswls~et:c ~ Te: Ince;ti~eswithin the Single Market in: 1. Richelle/
E. Traversa/B. Vintras, The Terllntor~a 1 j,o p~lVers withill the Europeall Ullion (Berlin/Heidelberg:
W. Schõn/E. Traversa (eds.) A ocatmg ax
Springer Verlag, 2013) p. 175.
170 Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law Dziurdz/Marchgraber (Eds), Non-Diserimination in European and Tax Treaty Law 171

----::...:.~.:....:...::....:.:.:..:..:.:.::..::.:::..:..:.::...=::..:~~~~------
hybrid arrangements:
45
Then, it will address the need to counteract hybrid ar-
rangements as a posslble new ground ofjustification.
It is worth mentioning that the grounds ofjustifications analyzed henceforth m
be invoked jointly by the Member State concerned.46 The EC] took this appro ai:
for the first time in the Marks & Spencer case,47 where it stated that the th .ac
'fi' d ree JUs-
tI lcatIOns nee to be examined together in order to constitute overriding reaso
i~ the public interest compatible with the EU law.48 Since then, the EC] has esta~~
~lsh~d a new method for assessing whether a discriminatory national tax law is
Just~fiable und:r the E.u law, based on a careful analysis ofthe situation and a col-
lectIve evaluatIOn ofdlfferent grounds ofjustifications.49
B. The Balanced Allocation of Taxing Powers
A possible justificati?n already accepted by the EC] consists in the preservation of
the balance~ al~ocatIOn b~tw~en Member States of their powers to impose taxes,
the und~rlymgldea ofwhICh lS that, based on its tax sovereignty, a Member State
has th~ nght to effectively exercise its taxation power over an element (tax subject,
tax ~bJect or ~oth) that.has a genuine link with its tax jurisdiction.50 This justifies
the mtroductIOn of natIOnal tax rules to protect its tax claims against several fac-
tors that may affect the allocation of taxing rights in a cross-border context and
hence the exercise of its tax jurisdiction.51 In certain circumstances, the need to
p.rotect the bal~nced allocation of taxing rights seems to overlap with the cohe-
SIOn of the natIOnal tax system, as well as with the principIe of territoriality.52
~onetheless, in the X Holding case (C-337/08),53 the EC] accepted for the first
tIn:e the need t~ s~feg.uard.the balanced allocation of the power to impose taxes
by Itself as a vahd JuStIficatIOn for discriminatory rules,54 regardless of its combi-
45
46
47
48
49
50
51
52
53
54
J. Bundgaard, Hybrid Financiai Instruments and Primary EU Law - Part 2, European Taxation 2013
pp.587-594. '
M. Lang, The Marks & Spencer Case - The Open Issues Following the ECT's Final Word European
TaxatlOn 2006, p. 59. '
Judgment in Marks & Spencer, C-446/03, EU:C:2005:763.
D. Pezzella, Final Losses under EU Tax Law: Proposal for a Better Approach, European Taxation
2014,p.72.
M. Hilling, Justifications and Proportionality: An Analysis ofthe ECJ's Assessment ofNational Rules
for the Prevention ofTax Avoidance, Intertax 2013, p. 296.
J. M~nsenego, Taxation ofForeign Business Income Within the European Internai Market (Amster-
damo IBFD, 2012) pp. 33-38; R. S. J. Martha, The Jurisdiction to Tax in International Law: Theoryand
Practlce ofLeglslatlve Fiscal Jurisdiction (Deventer: Kluwer Law International and Taxation Publish-
ers, 1989), p. 19.
M. Hilling, Intertax 2013, p. 298, FN 49.
B. J. M. Terra/P. J. Wattel, European Tax Law, p. 24.
Judgment in X Holding, C-337/08, EU:C:201O:89.
V. E. Engl~air, The Relevance of lhe Fundamental Freedoms for Direct Taxation in: Michael Lang/
Pasqu~le Plstone/Josef Schuch/Claus Stannger (eds.) Introduction to European Tax Law on Direct
TaxatlOn, 3rd edIllOn (Vienna: Linde, 2013) p. 78.
Tomazela Santos
--nation with other reasons. It was also accepted as a separate ground o~ justifica-
. l'n the National Grid Indus case (C-371/l0) 55 The balanced allocatIOn of tax-tlon ' . .
ing rights is to some extent connected with the preservation of tax base mtegnty
in a cross-border context,56 mainly in order to prevent the transfer of tax bases
between Member States.
57
At a first sight, it would seem that hybrid arrangements may be considered to be
tax planning strategies adopted to disconnect the taxation of income d~rived
from cross-border transactions, thereby jeopardizing the balanced allocatl~n.of
taxing rights between Member States. However, it should be noted that the Jomt
initiative of the OECD and the European Union against hybrid mismatches is ad-
dressing a problem caused fundamentally by the lack of coordination ?f tax sys-
tems between Member States,58 which is an inherent feature ofEU law m the area
of direct taxation. The absence of tax neutrality between the treatment applicable
to equity and debt in different Member States is precise~y the re~s~n why numer-
ous tax planning schemes can be successfully created wlth hybnd mstruments.
It follows that, although the national tax authorities tend to invoke almost automat-
ically the balanced allocation of taxing rights as a justification for re.strictiv~ tax
measures in striving to maintain tax revenues, it is doubtful whether thlS ,ffectIvely
plays a role on the issue ofhybrid mismatches. Anti-hybrid rules patterned on the
Parent-Subsidiary Directive are applicable by the residence state of the parent com-
pany, which has the obligation either to tax or to exempt the amount recei~ed, de-
pending on whether the payment was deducted or not from the corporate l.n~on:e
tax due at the level of the subsidiary situated in another Member State. ThlS mdl-
cates that anti-hybrid rules do not exactly preserve the tax jurisdiction or the alloca-
tion of taxing rights from the perspective of the residence state, but rather changes
the way by which taxing rights are exercised in a cross-border cont~xt, merely t.o
avoid the loss of tax revenues from one Member State to another. It IS also practI-
cally impossible to define what balanced allocation oftaxing rig~ts a~ti-hybrid rules
are willing to ensure, which is a particularly criticaI and challengmg Issue, as EU law
does not set out objective criteria for the distribution of taxing rights between
Member States.59 The crucial point of the balanced allocation of taxing rights, as a
ground of justification, relies on the protection of the right granted to Member
States to exercise their taxing rights on elements (tax subject or tax object) that have
a sufficient economic link with its tax jurisdiction, in accordance with international
customary law. Thus, it aims to ensure that an item ofincome that should be taxed
in a specific Member State, in accordance with the ability-to-pay or the benefits
55 Judgment in National Grid Indus, C-371/10, EU:C:2011:785.
56 B. J. M. Terra/P. J. Wattel, European Tax Law, p. 462.
57 M. Hilling, Intertax 2013, p. 298, FN 49.
58 R. S. Avi-Yonah, Advanced Introduction to International Tax Law (Cheltenham: Edward EIgar Pub-
lishing, 2015) pp. 90-105.
172 DziurdílMarchgraber (Eds), Non-Discrimination in European and Tax Treaty Law Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 173

principle,60 w~ not be intentionally transferred to another Member Stat ft
~ufl~ses.~n ~lmple terms, taxpayers should not be free to transfer tax ba:es
o
; ta)(
ne e~ er tate to another, choosing where their income will be rOI1l
a.s mentlOned before, anti-hybrid mIes are not desi ned to rotect taxed. ~o,:ever,
tlOn of a single Member State or its ability t t g ~ , ~.e tax Junsdic_
'th" , 61 o ax economlC actIV1tIes cond t d
Wl m 1tS te:ntory. Indeed, irrespective of the fact that the onus of uc, e
double taxatlOn or double non-taxation falls on th'd preventmg, e reSl ence state of the p
compa~y, 1t appears that the cornerstone of anti-hybrid mIes is th 'arent
tax aVOldance within the European Union as a whole 'th t d' e preventlOn of
~oY~~~db~ncedallocabtion oftaxing rights in a single Me':be~~t:te.l~~~r~~::r~e~~~~
. r es cannot e regarded as a protection for a Member State ,1-
nght to tax activities carried out within its territo 62 'd to ensure the
Rewe Zentralfinanz case (C-347/04).63 ry, as reqUlre by the ECJ in the
F,u~t?ermore, the decisive characteristics for the tax classification ofhybrid fi
Cla ms~mments are part of important considerations in formulatin man-
tax 'pohcy.. There is no clear policy path on the distinction betwe g corporate
;~~:~~:r.~~;,c;;~~t~f:::;;s:~~,~~::'~;~::~~~:;:~:Yd~;:e::,~~::n{!~~~,at~~
pra~ tax systems ofMembers States, it is highly doubtful whether the EC~e.C~l
~~~:ra~oEa~cl:~~~e bala;teddallocation oftaxing rights as a valid jUstificatio~.l~~
petences and the e:, n~ ar owfn dany general criteria for the attribution ofcom-
, . e 1mmatlOn o ouble non-taxation amon Memb S
:~l~~~t:~:::~~~~;:;d~~:~~~~~~:~i~~;~:~d~r~~b:~ea~~~~c:!:~~c~~~~?}~:~~
a Member State to tax activities carried out in its territory is~ot ha~per:l16~ t of
C. The Cohesion of the National Tax 5ystem
The h' f hr co es~on, o t, e n.ational tax system was accepted for the first time as a
g ound ofJustIficatlOn m the Bachmann case (C-204/90) 66 ' h' h h
held
d
the existence of a connection between the deduc;ibi;7;o~cc t : iC~.up-
ma e by employees and the right to tax the amounts payable b th ~n n u lOns
der pension and life assurance contracts.67 The cohesion ofth t
Y
e msurers un-e ax system presup-
60
61
62
63
64
65
66
67
M
R. SH'~11~i-YOnah, Advaneed Introduetion to Interrzational Tax Law pp 3-7
, I mg, Intertax 2013, p, 298, FN 49, ' . ,
J, Bundgaa,rd, European Taxation 2013, p, 589, FN 45.
Judgment m Rewe Zentralfinanz, C-347/04, EU:C:2007:194, para 42
P. Harns, Corporate Tax Law - Strueture P [' d P . . .
Press, 2013), pp. 9-11. ' o /ey an raet/ee (Cambridge: Cambridge University
O. Thõmmes/A, Linn, Intertax 2014, p. 30, FN 39.
Judgment in Baehmann, C-204/90, EU:C:1992:35, para. 21.
M. Lang, Chapter 2 - The Binding Effeet of the EC Fund
Gassner/M. Lang/E. Leehner (eds.) Tax Treaties and EC~men(t~1 F~edoms on Tax Treaties, in: W.
1997), pp. 27-28. aw on on: Kluwer Law International,
Tomazela Santos
poses that the deduction of contributions made to pension schemes or life assur-
ance plans should be offset by the taxation of pensions, annuities or capital sums
payable by the insurers.68 For this reason, the ECJ held that the discriminatory
Be1gian tax mIe that only allowed the deduction of contributions made to Belgian
insurance companies was justified based on the cohesion of the national tax sys-
tem, due to the absence of a proper mechanism to guarantee and enforce
Be1gium's right to tax the amounts pay by foreign insurers,69
Although the ECJ has since addressed the fiscal cohesion on several occasions,7°
it is still difficult to extract from case law a well-defined concept that specifies
the parameters for its application in concrete cases and shapes the contours and
boundaries of its definition.71
At the core of this diffuse concepf
2
seems to be
the idea of preserving the symmetry between the right to tax an item of income
or profit and the right to deduct the corresponding expense or loss, at least ini-
tially in relation to the same taxpayer and the same tax.73
Indeed, in the Bosal
case (C-168/0l), the ECJ held that fiscal cohesion requires, within the scope of
the same taxpayer, a direct link between the tax advantage and its further offset-
ting by a fiscallevy, both of which related to the same tax.
74
This decision re-
duced the relevance that fiscal cohesion could have achieved in tax matters.
75
However, it should be remembered that, in the Manninen case (C-319/P2), AG
Kokott argued in her Opinion76 that a single taxpayer is not always a p;econdi-
tion for the application of fiscal cohesion, as its essential concept may also be
fulfilled where the tax is imposed on the same item of income or the same eco-
nomic process, even if it is not charged on the same taxpayer.
77
As noted earlier, hybrid mismatch arrangements exploit differences in the tax
treatment offinancial instmments, entities, and transfers between two or more ju-
risdictions, with the ultimate goal of reducing the overall tax burden. A fundamen-
tal characteristic ofthese tax planning stmctures is that they may well comply with
both the letter and the spirit of the domestic law of each Member State concerned,
68 M. Jannm, "Chapter 3 - How Does the EC Law Affeet Benefits Available to Non-Resident Taxpayers
under Tax Treaties" in: W. Gassner/M. Lang/E. Leehner (eds.) Tax Treaties and EC Law (London:
Kluwer Law International, 1997), p. 64.
69 M. Lang in: W. Gassner/M. Lang/E. Leehner (eds.) Tax Treaties and EC Law, p. 28.
70 Judgments in Wieloekx, Case C-80/94, EU:C:1995:27I, para. 31: Asseher, C-I07/94, EU:C:1996:251,
para. 51.
71 M. Lang in: W. Gassner/M. Lang/E. Leehner (eds.) Tax Treaties and EC Law, p. 30.
72 Opinion of Advoeate General Kokott in Manninen, C-319/02, EU:C:2004:164, point 51.
73 M. Dahlberg, Direet Taxation in Relation to the Freedom of Establishment and Free Movement of
Capital (The Hague: Kluwer Law International, 2005), p. 256.
74 Judgment in Judgment in Bosal Holding, C-168/01, EU:C:2003:479, para. 29.
75 L. Hintsanen, Non-Discrimination under EC Law, in Raffaele Russo (ed.) The Attribution ofProfits to
Permanent Establishments: The Taxation ofintra-company dealings (Amsterdam: IBFD, 2005), p. 469.
76 Opinion of Advoeate General Kokott in Manninen, C-319/02, EU:C:2004:164, point 61.
77 M. Dahlberg, Direet Taxation in ReIation to the Freedom of Establisllment and Free Movement of
Capital, p. 321.
174 DziurdílMarehgraber (Eds), Non-Diserimination in Europe d Tan an ax Treaty Law Dziurdz/Marehgraber (Eds), Non-Diserimination in European and Tax Treaty Law 175

- Tomaze/a Santos
while still resulting in low or non-taxation in a cross-border context,78 In additio
hybrid mismatches resúlt from differences between tax systems and the lack ofc~
ordinati~n ~it~in the EU. In~eed, as the framework of EU law does not require
harmollIzatlOn m the area.ofdlrect taxation, the Member States have sovereignty .
d ·· th· . In
eSlg?mg elr own tax system. Thus, it is not surprising that, from the perspective
~f a smgle Member State, the tax treatment applicable to the financiaI instrument
IS completely symmetrical, without affecting the fairness or cohesion of the tax sys-
tem.
79
This implies that unilateral countermeasures adopted by a Member Stat
against hybrid mismatch arrangements may lead to an untenable contradictio e
with the structure and principIes ofits tax system. To sum up, the fiscal cohesion o~
a single tax system is not distorted through the use ofhybrid financiaI instruments.
It is true that, from the perspective offiscal cohesion, it is possible to establish a di-
rect link between the deduction ofinterest expenses by the subsidiary and the sub-
sequent taxation ofthe dividends by the parent company, as long as possible differ-
ences in :ax rates ~re neglected. However, the most problematic issue is the require-
ment, lmd down m EC] case law, that the correlation between the tax deduction
and the taxation must be verified in relation to the same taxpayer and the same tax
within the same Member State.80 Indeed, from the standpoint of a single Membe:
State, the use ofa debt instrument already creates the possibility oftax base reduc-
tion, because the interest paid to the lender - foreign or national- is usually dassi-
fied as a tax-deductible expense. The treatment of the remuneration derived from
the same financiaI instrument as dividends in the other Member State is a mere
consequence of the underlying tax policies adopted, without any dear relation to
the preservation of the cohesion of the national tax system of the former Member
State. Therefore, Members States cannot rely on the cohesion of the national tax
system as a justification for tackling hybrid mismatch arrangements, because it
~rongfully ignores the basic parameters of EU law, such as fiscal sovereignty, the
nght to use tax planning, and the disparities in the area ofdirect taxation.
Despite this, it seems reasonable to analyze the cohesion of the tax system from a
broader perspective, which would cover the European Union as a whole. In the
Danner case (C-136/00)81, the EC] examined fiscal coherence not from the micro
leveI of the nationallegislation ofa Member State, but from the larger macro leveI
oftwo Member States that signed a tax treaty.82 On this basis, it might be possible
78
79
80
81
82
R. de Boer, in R. de Boer/M. Nouwen (eds.), The European Union's Struggle with Mismatehes and
Agressive Tax Planning, p. 50.
H. D. Rosenbloom, Tax Law Review 2000, p. 143, FN 1.
N. Bammens, The Principie ofNon-Diserimination in International and European Tax Law (Amster-
dam: IBFD, 2012) p. 1000: Dennis Weber, An Analysis ofthe Past, Current and Future ofthe Coher-
ence of the Tax System as a Justification, EC Tax Review 2015, p. 54.
Judgment in Danner, Case C-136/00, EU:C:2002:558.
M. Dahlberg, Direet Taxation in Relation to the Freedom ofEstablishment and the Free Movement of
Capital, p. 132.
to establish a direct link between, on the one hand, the deductibility ~f the remu-
neration derived from the hybrid instrument at the level ofthe Subsldlary, and, on
the other hand, the taxation of the corresponding amount at th~ leveI of the ~ar
ent company. The preservation of a direct link between deductlOn and taxatlOn,
in a broader cross-country context, may be accepted by the EC] as valid ground of
justification to guarantee the coherence among the different tax system.s, as the ~U
Treaties constitute the legal basis for analyzing the subject from an mter-natlOn
erspective, whereby co-equal sovereign nations endeavor to receive their fair
~ortions of a shared tax base.83 In this perspective, it should be kept in min~ that,
. the Manninen case (C-319/02), AG Kokott already attempted to estabhsh an
In dh . I ..'mmediate link between the coherence of the tax system an t e smg e tax pnnCl-
~le, by observing that it "generally means no more than avoidi.ng .double taxation
ar ensuring that income is actually taxed, but only once (the princIpie ofonly-once
taxation)".84 The extension of the same reasoning to a cross-country context
would allow the justification of restrictive domestic rules designed to prevent tax
arbitrage with hybrid instruments, as provided for in Artide 4.1 (a) of the Parent-
Subsidiary Directive.
In this sense, it is worth remembering that, over the years, the EC] has already
turned aside the requirement that the fiscal coherence must be assesse4 in rela-
tion to a single taxpayer.85 It would be necessary to once again shift the angle for
measuring the fiscal coherence from the national leveI to an intra-Community
leveI, in which case national anti-hybrid rules may be justified.
D. The Prevention of Tax Abuse
According to EC] case law, the need to counteract tax abuse may be put for~ard
by the Member States as a justification for discriminatory measures, provlded
that the domestic rule affects only wholly artificial arrangements.86 In the Cadbury
Schweppes case (C-196/04), the EC] held that the prevention of tax abuse may
serve as a justification for national tax measures affecting the fundamental free-
doms that reach exdusively wholly artificial arrangements87 which aim at circum-
venting the application of a Member State's tax law.88
It follows that, in order to a restriction on the freedom of establishment to be justified
on the ground of prevention of abusive practices, the specific objecti:e ?f such a restnc-
tion must be to prevent conduct involving the creation of wholly artifiCIal arrangements
whieh do not ref/eet economie reality (...).
83 On inter-nation equity, see: A. C. lnfanti, lnternation equity and human development, in: Y. Braunerl
M. Stewart (Eds.), Tax, Law and Development (Cheltenham: Edward EIga, 2013) pp. 212-213.
84 Opinion of Advocate General Kokott in Manninen, C-319/02, EU:C:2004:164, point 51.
85 )udgment in Danner, C-136/00, EU:C:2002:558, para. 41.
86 )udgment in Test Claimants in the Thin Cap Group Litigalion, C-524/04, EU:C:2007:161, paras. 72-73.
88 )udgment in Cadbury Sehweppes, C-196/04, EU:C:2006:544, para. 51.
176 DziurdZ!Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law DziurdZ/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 177

-Prevention of Hybrid Mismatches as a Justification?
while still resulting in low or non-taxation in a cross-border context.78 In additi
hybrid mismatches result ftom differences between tax systems and the lack of on,
ordination within the EU. Indeed, as the framework of EU law does not requ~O-
h ' . . h fd' IrearmomzatlOn m t e area o 1rect taxation, the Member States have sovereignty .
d ·· th· 1ll
eS1g~mg e1r own tax system. Thus, it is not surprising that, from the perspective
?f a smgle Member State, the tax treatment applicable to the financial instrument
1S completely symmetrical, without affecting the fairness or cohesion ofthe tax sy _
tem.
79
This implies that unilateral countermeasures adopted by a Member Sta:
against hybrid mismatch arrangements may lead to an untenable contradictio e
with the structure and principIes ofits tax system. To sum up, the fiscal cohesion ~~
a single tax system is not distorted through the use ofhybrid financiaI instruments.
It is true that, from the perspective offiscal cohesion, it is possible to establish a di-
rect link between the deduction ofinterest expenses by the subsidiary and the sub-
seque~t taxation ofthe dividends by the parent company, as long as possible differ-
ences m ~ax rates ~re neglected. However, the most problematic issue is the require-
ment, la1d down m ECJ case law, that the correlation between the tax deduction
and the taxation must be verified in relation to the same taxpayer and the same tax
within the same Member State.80 Indeed, from the standpoint of a single Membe:
State, the use ofa debt instrument already creates the possibility of tax base reduc-
tion, because the in~erest paid to the lender - foreign or national- is usually dassi-
fied as a tax-deductlble expense. The treatment of the remuneration derived from
the same financiaI instrument as dividends in the other Member State is a mere
consequence of the underlying tax policies adopted, without any dear relation to
the preservation of the cohesion of the national tax system of the former Member
State. Therefore, Members States cannot rely on the cohesion of the national tax
system as a justification for tackling hybrid mismatch arrangements, because it
v:rongfully ignores t~e basic parameters of EU law, such as fiscal sovereignty, the
nght to use tax plannmg, and the disparities in the area ofdirect taxation.
Despite this, it seems reasonable to analyze the cohesion of the tax system from a
broader perspective, which would cover the European Union as a whole. In the
Danner case (C-136/00)81, the ECJ examined fiscal coherence not from the micro
leveI ofthe nationallegislation ofa Member State, but from the larger macro leveI
oftwo Member States that signed a tax treaty.82 On this basis, it might be possible
78
79
80
81
82
R. de Boer, in R. de Boer/M. Nouwen (eds.), The European Union's Slruggle with Mismatches and
Agressive Tax Plalllling, p. 50.
H. D. Rosenbloom, Tax Law Review 2000, p. 143, FN 1.
N. Bammens, The Principie ofNon-Discrimination in International and European Tax Law (Amster-
dam: IBFD, 2012) p.l000; Dennis Weber, An Analysis ofthe Past, Current and Future ofthe Coher-
ence of the Tax System as a Justification, EC Tax Review 2015, p. 54.
Judgment in Danner, Case C-136/00, EU:C:2002:558.
M. Dahlberg, Direct Taxation in Relation to the Freedom ofEstablishment and the Free Movement of
Capital, p. 132.
Tomaze/a Santos
--to establish a direct link between, on the one hand, the deduetibility?f the remu-
neration derived from the hybrid instrument at the leveI ofthe Subs1dIary, and, on
h other hand, the taxation of the corresponding amount at the leveI of the par-
~n~ company. The preservation of a direct link between deduction and taxation,
in a broader cross-country context, may be accepted.by the ECJ as valid ground of
justification to guarantee the co~erence amo~g the differ:nt tax system.s, as the ~U
Treaties constitute the legal bas1s for analyzmg the sub)ect from ano lnter-~atlo.n
rspective, whereby co-equal sovereign nations endeavor to rece1ve theIr fa1r
~~rtions of a shared tax base.83 In this perspective, it should be kept in min~ that,
. the Manninen case (C-319/02), AG Kokott already attempted to estabhsh an
~:mediatelink between the coherence of the tax system and the single tax princi-
le by observing that it "generally means no more than avoiding double taxation
~r ;nsuring that income is actually taxed, but only once (the principIe ofonly-once
taxation)".84 The extension of the same reasoning to a cross-country context
would allow the justification of restrictive domestic rules designed to prevent tax
arbitrage with hybrid instruments, as provided for in Artide 4.1 (a) ofthe Parent-
Subsidiary Directive.
In this sense, it is worth remembering that, over the years, the ECJ has already
turned aside the requirement that the fiscal coherence must be assessed ip rela-
tion to a single taxpayer.85 It would be necessary to once again shift the angle for
measuring the fiscal coherence from the national leveI to an intra-Community
leveI, in which case national anti-hybrid rules may be justified.
D. The Prevention of Tax Abuse
According to ECJ case law, the need to counteract tax abuse may be put forv:ard
by the Member States as a justification for discriminatory measures, prov1ded
that the domestic rule affects only wholly artificial arrangements.86 In the Cadbury
Schweppes case (C-196/04), the ECJ held that the prevention of tax abuse may
serve as a justification for national tax measures affecting the fundamental free-
doms that reach exdusively wholly artificial arrangements87 which aim at circum-
venting the application of a Member State's tax law.88
It follows that, in order to a restriction on the freedom of establishment to be justifi~d
on the ground of prevention ofabusive practices, the specific objective ofsueh a restnc-
tion must be to prevent conduct involving the creation of wholly artificial arrangements
which do not reflect economic reality (...).
83 On inter-nation equity, see: A. C. 1nfanti, Internation equity and human development, in: Y. Brauner/
M. Stewart (Eds.), Tax, Law and Development (Cheltenham: Edward EIga, 2013) pp. 212-213.
84 Opinion of Advocate General Kokott in Manninen, C-319/02, EU:C:2004:164, point 51.
85 Judgment in Danner, C-136/00, EU:C:2002:558, para. 41.
86 Judgment in Test Claimants in the Thin Cap Group Litigation, C-524/04, EU:C:2007:161, paras. 72-73.
88 Judgment in Cadbury Schweppes, C-196/04, EU:C:2006:544, para. 51.
176 Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 177

b h ' an arrangement is artificial, the objective
y t e apphcab~e fundamental freedom needs to be taken into account, asl-'lw.lrSllPrl
the partIcular Clrcumstances ofthe concrete case Essentially th h . ell as
of ~ tr~ns~ction.as a wholly artificial arrangem~nt depend~ o: ~~~~~~~Z~tion
subJectIve. llltentIOn to achieve a tax advantage (subjective element) and fa.r
s
. the
comply wIth the purpose ofthe fundamental freedom under discussio I.ure. to
elem~nt).8~It follows that the national Iegislation cannot be applied e~~~~~~tIve
any sltuatIOn, base~ on an absolute legal presumption (''juris et d:jure') 90 ~to
needs to focus speClfically on abusive transactions through a case by c ' ut
t 91 Th M b - - ase assess
men . ~s, em er States have to analyze every single case on the basi . -
facts a?d Clrcumsta~ces.92In the Rimbaud case, the ECJ held that a ener:t
f
ItS
sumptIOn of tax aVOIdance is insufficient to justify a tax measure th~t . f' pre-
fundamental freedoms.93 III nnges
As can be se~n from c~se Iaw: the ECJ applies a very strict concept of tax avoid-
ance, acc?rdmg to whlch natIOnal anti-avoidance rules must be specificall t
geted agamst wholly artifici~larrangements which do not reflect economic r~aI~r
and the sole purpose of WhICh is to circumvent tax Iaw 94 In add't' . . ty
t l' . I IOn, restnctIve
ax measures app led by Member States to prevent abusive tax ractices m
comply with the principle ofproportionality.95 p ust
~aseJ on t~e fot~going,it seems that the ECJ is not willing to accept a justification
ase. o~ t .e c alm th~t the use of certain types of financiaI instruments can be
~buslve III Itself. In thls respect, cross-border transactions with hybrid financ' 1
I~struments cannot be considered per se illegaI or wholly artificial.96 This is ::_
cIsely the re~son why g.eneraI anti-avoidance rules (GAARs) do not provilfe a
comprehenslve mechamsm to counter the use of hybrl'd m' t h
d 1 Isma c es arrange-
ments an to so ve st~u~turaI problems ofa tax system,97 which Ied the üECD and
~heI~~ro~eanCommlssIOn to propose specific changes in domestic Iaws in order
o III t e tax treatment of financiaI instrument, in one jurisdiction t~ the tax
89
90
91
92
93
94
95
96
97
M. Hilling, Intertax 2013, p. 297, FN 49.
A. P. Dourado, "Aggressive Tax Planning in EU Law in the Light ofBEPS' Th EC R d .
on Aggresslve Tax Planning and BEPS Actions 2 and 6", Intertax 2015, '45 e ecommen atlOn
Judgment m Lankhorst-Hohorst GmbH, C-324/00, EU:C:2002:749, ara
P
":'7 .
M. Lenz, SWltch-Over Rules and EU Law in' C Mass / p. '" ,
tional Group Financingand Taxes (Vienna: LÍnd~, 2012)r;r2~5,StorcklB. Sturzhnger (eds.) Interna-
~CJ;/f October 2010, Case C-72/09, Rimbaud [201OJ, para. 34. See T. O'Shea "EC}'s R' b d R I
mg o sters Mut~al Assistance View", Ta.x Notes International201O, pp. 648-652 Im au u -
i·07::~~;~~.EroslOn and Profit Shifting and Interest Expenditure, Sul/etin for Int~rnationalTaxation
Ebru Tiyar, Tax Treatment of Intra-Group Interest in th EU' .
zlinger (eds.) International Group Financing and Taxes (Vi:nna: ~~~~~:~~ner~~6Storck/B. Stür-
J. Bundgaard, European Taxation 2013 p.593 FN 45' L d B EC i: '.p. .
V. R. Almendral, Tax Avoidance th' , , : e roe, ax Revlew, p. 311, FN 8.
Standard, in: I. Richelle/W. S'chó~/E~alanced AllocatlOn ofTaxing Powers and the Arm's Lenght
Union (Berlin/Heidelberg: Springer Verl:~:r;~I~~~1~ocatmgTaxmg Powers within the European
Tomazela Santos
tre:atn1erllin another jurisdiction (linking rules). Unquestionably, a GAAR may be
used to recharacterize a financiaI instrument based on a teleologicaI interpretation
of its economic substance, regardless of its legal formo However, it does not pro-
vide a comprehensive response to cases of double non-taxation arising from
cross-border tax arbitrage,98 whose legal gaps should be covered by the Iegislator.
99
In contrast, one may argue that anti-hybrid rules target only artificial hybrid ar-
rangements, whose purpose is exploiting mismatches in the characterization of fi-
nanciaI instruments in different jurisdictions in order to obtain double non-taxa-
tion. This is because anti-hybrid rules only tax the dividends received by the parent
company to the extent that the remuneration derived from the hybrid financiaI in-
strument is deductible at the leveI of the subsidiary. Consequent1y, it would Iead to
the conclusion that the domestic tax measures only adversely affect cross-border
transactions that intentionally pursued and achieved double non-taxation through
deduction and non-inclusion schemes. This argument is not convincing, because
the mismatch in tax outcome does not constitute an abusive tax practice if the hy-
brid financiaI instrument provides an arm's Iength remuneration and satisfies a
genuine financiaI need of the borrower.lOO
Clear evidence to support the statement
above stems from the fact that, even after the 2014 amendment of the Parent-Sub-
sidiary Directive, the hybrid financiaI instrument is not re-characterized for tax
purposes. Instead, oniy the tax treatment of the amount received by tHe parent
company is adjusted with respect to the portion of the mismatch in the tax out-
come.101 Another important point to be mentioned is that, when the parent com-
pany decides to finance the subsidiary through hybrid financiaI instruments, it nei-
ther takes an improper advantage ofthe fundamental freedoms nor deliberately cir-
cumvents domestic Iaw. In addition, it should be kept in mind that taxpayers may
choose financiaI instruments with hybrid features for a variety of non-tax rea-
sons.102 From the corporate financing standpoint, the combination of equity and
debt characteristics in a financiaI instrument may be driven by severaI economic,
financiaI, commercial, and legal reasons,103 which bear no relation to tax reduction
strategies. In general, it can be affirmed that the development of hybrid financing
has been motivated primarily by the opportunity to combine the qualities of both
equity and debt instrument, rather than for exploiting cross-border tax arbitrage.104
98 C. Marchgraber, European Taxation 2014, p. 133, FN 14.
99 A. P. Dourado, Intertax 2015, p. 48, FN 90.
100 L. de Broe, Some observations on the 2007 communication from the Commission: The application of
anti-abuse measures in the area ofdirect taxation within the EU and in relation to third countries, EC
Tax Review 2008, p. 146.
101 R. de Boer/O. Marres, BEPS Action 2: Neutralizing the Effects on Hybrid Mismatch Arrangements,
Intertax 2015, p. 24.
102 E. Eberhartinger/M. Six, Taxation ofCross-Border Hybrid Finance: A Legal Analysis, Intertax 2009, p. 4.
103 E. F. Brigham/M. C. Ehrhardt, Financiai Management: Tlteory & Practice. 12th Edition (Mason,
Thomson/Souther-Western, 2008), pp. 742-766.
104 M. Helminen, The International Tax Lmv Concept ofDividend, pp. 164-164.
178 Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 179

Tomazela Santos
--------------------------------
In view of the existence of non-tax reasons for the use ofhybrid financiaI instru-
ments, domestic laws should at least allow taxpayers the opportunity to Rrove that
tax avoidance was not the primary or dominant reason for the structured
adopted. Indeed, as the ECJ already held that protection of tax revenues cannot
serve as a possible ground of justification for limiting fundamental rights under
the EU law,I08 it seems necessary to assess, based on the facts and circumstances of
each case, whether the use of the hybrid financiaI instruments can be considered
an artificial tax-driven transaction.
Following ECJ case law, it is possible to state that anti-abuse tax measures must be
based on an objective criterion verifiable by a third party109 and grant to the tax-
payer the opportunity to provide evidence of any business ar economic justifica-
tion for the transaction carried out, without being subject to undue administra-
tive constraints.110 This implies that the taxpayer must have the right to demon-
strate that, in the particular case, the use of the hybrid instrument is not wholly
artificial, reflecting the economic reality.lll
To summarize, the prevention of tax abuse does not constitute a general ground
ofjustification for national anti-hybrid rules for the following reasons:
Redeemable Preferred shares usually • priority in the receipt of fixed or
Preferred have priority in receipt of cumulative dividends
Shares dividends, whether fixed • priority on the return ofcapital
or minimum, and prior- • no dilution in corporate control
ity in the right to claim • reduction of debt : equity ratio
the repayment of capital • absence ofvoting rights
upon liquidation.
Convertible A convertible bond (or a • delayed dilution of common
bonds or convertible debenture) is stock and earnings per share
debentures a specific type of bond • lower coupon rate in comparison
that grants to the holder with straight bonds
the right to receive cou- • limited interest payment until
pon payments and to the conversion
convert the bond into
shares of common stock
in a future date.
. may be chosen to achieve an optimal uuan<:i;1]
structure, by V1rtue of the following advantages: ability to raise capital fundo .
co t [fi' t d" mg m as -e IClen manner, accommo atmg to mvestors' needs'1OS facility to bal h
. I d" , a n c e t e
c.aplta structure an achleve a hlgher efficiency with respect to equity and d bt
tIOS; potential to improvethe company's liquidity and its financialleverage e t.
ra
-
. b . ra lOS'
~apaclty .to o t~m ~ better classification in the companies' balance sheet anel
lmprove ItS credIt ratmg, preventing the increase ofthe risk ofdefault among th
106 Th th ' o er
ones: us:.e parent company may have genuine business reasons to opt for a
speclfic hybnd mstru~ent, which implies that the mere existence of a binary di-
chotomy between eqUlty and debt in corporate law and private civillaw107 is not
enough to assess whether or not the mismatch in tax outcome derives from an t'
fi . I b' 1 I ar 1-
ICla or a uSlve ega transaction. In the table below, it is possible to find non-tax
reasons for the use ofthe most common financial instruments:
PossibIe non-tax reasons for using hybrid financiaI instruments
FinanciaI Ins- Definition PossibIe non-tax reasons
trument
PerpetuaI Perpetualloans consist of • interest rates are low for longer-
Loans loans that either lack a term debt
definitive maturity date • investors may have a steady and
or specify that maturity predictable source ofincome
will not occur for a pro-
• it may offer periodic interest rate
longed time (typically increases (e.g. 1 % at the end of
longer than 50 years). each 10 years)
Profit Partici- A loan whose interest • the remuneration is contingent
pating payments are dependent upon the results ofthe debtor
Loans on the profits ofthe • participation in losses is contrac-
debtor. tually excluded
• simple and cost-efficient struc-
ture (it does not require analyses
and prospectuses);
• high degree of financial flexibility
(it may include conversion right,
subordination, super maturity)
105 E. GaBo, Drawing the BorderIine .between Debt and Equity in Tax Treaty Law (Hybrid Finance) in:
C: Massoner/A. Storck!B. Sturzlmger (eds.) International Group Financing and Taxes (Vienna'
Lmde, 2012), pp. 467-468. .
106 E. GaBo in: C. Massoner/A. Storck!B. Stürzlinger (eds.) International Group Financing and Taxes
pp.467-468. '
107 W. Schéin et ~l., Debt and Equity in Domestic and 1nternational Tax Law _ A Comparative Policy
Ana!ysls, Brztlsh Tax Review 2014, p. 148.
108 Judgment in Verkooijen, C-35/98, EU:C:2000:294.
109 Judgments in Test Claimants in the Thill Cap Group Litigation, C-524/04, EU:C:2007:161; SIAT,
C-318110, EU:C:2012:415.
110 A. P. Dourado, Intertax 2015, p. 45, FN 90.
111 Dennis Weber, "European Union - Abuse of Law in European Tax Law: An Overview and Some Re-
cent Trends in the Direct and lndirect Tax Case Law ofthe EC] - Part 2", European Taxation2013, p.
316; M. HiIling, Intertax 2013, p. 297, FN 49.
180 Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law
DziurdílMarchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 181

. [fi' are on an objective criterion but h'
msu ICIent. i~adequateto determine whether the transacti~n in w Ich
represents, eIther I~ whole or in part, a purely artificial arran
not .reflect economlC reality. gement does
(2) NatIOnal anti-hybrid mIes do not grant t th t
~rovid~ evidenc~ ofthe underlying econom~cr:as~~Pt~~r'~~~fi~~p~rtunityto
tIOn, wIthout bemg sub)'ect to undue admI'n' t t' ) . t e transac-
(3) N' 1 . IS ra Ive constramts
atI~na antI~hy.bridmIes do not target only abusive situation~, as th
hybnd financIaI mstmments cannot be considered artificial in itself. e Use of
In conclusion, nationallegislation which is not s ecificall .
purely ~rtificiaItax planning may not be regardelas jUstif~:~~~~:do~~a;dress
preventmg tax avoidance. As a result the need t . )ec Ive of
d d
. . , oprevent tax aVOldance can t b
regar e as a)ustIfication for countering hybrid mI's t h no e
'th d' ma C es arrangements i rWI stan mg ECJ case Iaw since the ant' h b'd 1 n me, 1- Y n m es are not s 11 l' d
wholly artificial arrangements. However in exce t' l' o e y app Ie to
'd ' P lOna CIrcumstances the ECJ
may conSI er the prevention oftax abuse to be a valid r . . ' . .
concrete case, provided that the facts and' t g ound of)ustIficatIon m a
artificiality in the transaction performed b~I~~~~;~:;.attest to the existence of
V. The Need to Counteract Hybrid Arrangements:
a New Ground of Justification?
~~:,r~;~ot~;~:~~ou.t ~his paper, natio~alr~Ies that are applicable to every situa-
the subjective inte~i~:°o;~~~Ut~~;~;~~~~~:~~~~~~~i~e~:dt~~oco~~::~~~~:et~~
purposes of combatmg tax avoidance strategies 112 Altho h th ~ b
Ph;i:eCI~phle rigf~t.to comba~ .artificiaI tax planning'stmcture~~mai~y~:e~ro~~~;
e o laIr cOmpetItIOn and co t 'bT
provision that is applicable t rpora ebresponsI 1 Ity, a specific anti-abuse
fi o every cross- order transaction invol' h b .d
manciaI instmments that generate deducfbI vmg y n
general to justify restrictions on the funda~en~a~xfr:~dsoesseems to be excessively
ms.
The question that arises is whether the combating of hybrid' h
such, be regarded as a valid overriding reason in the comm:Is~atc es can, as
?ur?ose .of justifying a restriction to the fundamental freedom~I~e:t, for thhe
)uStIficatIOn based on the need t . . ' s own, t e
has not been yet put forward by aO~~~~:~a~t~~:~~~~r~~me EatCchJeFs arrtha~gements
the aim h . t 'd" . or IS reason
ECJ and ber~ IS o ~rovI e I~SI~ht into the possible challenges to be faced by th~
Y omestIc courts m ItS future judgments on the subject.
112 Judgment in Centros Lld, C-212/97, EU:C:1999:126.
Tomazela Santos
first glance, it may seem that double non-taxation in itself is not contrary to
the fundamental freedoms, because it does not represent an insurmountable ob-
stacle to the free movement of goods, services, persons, and capital irrespective of
natIOnal borders. It might well be argued that double non-taxation does not im-
properly affect economic decisions of undertakings or investors, nor prevent the
development ofeconomic activities within the internaI market, as it does not con-
stitute a serious impediment for working, investing, establishing, or selling
abroad.113 Therefore, this would lead to the conclusion that double non-taxation
is not contrary to the fundamental freedoms, but rather a political issue that
should be countered by the harmonization of Member States' tax systems. Conse-
quently, Member States could not justify discriminatory or restrictive tax meas-
ures on grounds of tackling hybrid mismatches arrangements.
However, a broader analysis of the potential impact of double non-taxation re-
veals its capacity to distort conditions of competition on the single market.1l4
It
aIso stimulates economic agents to invest abroad, rather than in their home coun-
tries, thus improperly affecting economic decisions and the optimal allocation of
resources within Europe as a whole.115 In this scenario, the preservation ofa direct
link between deduction and taxation, in a broader cross-country context,unay be
accepted as result of the singIe tax principIe, according to which income from
international transactions should be subject to tax once (not more, but also not
Iess than once).116 From a theoreticaI perspective, the singIe tax principIe may be
justified based on efficiency, neutrality, fairness, inter-nation equity, and preven-
tion of revenue Ioss.
Strictly speaking, efficient tax mIes are neutral from an economic standpoint, be-
cause they neither create economic distortions nor affect the economic judgment
of rational decision-makers. Tax mIes should not distort decisions on the alloca-
tion ofproduction factors, unless it is strictly necessary for correcting other forms
of inefficiencies, inequalities or externalities that affect the free market.ll7
Extend-
ing the efficiency and neutrality to an international context implies that cross-
border activities and the decision where to invest should not be distorted by dif-
ferences on tax mIes ofvarious countries.118 In order to achieve this goal, income
derived from cross-border transactions should not be taxed more heavily than
domestic income, as the extra tax burden creates an inefficient incentive to invest
113 B.). M. Terra/P. J. Wattel, European Tax Law, p. 130.
114 See section 2 above.
115 W. Schon, "Tax Competition in Eurape - General Report", In: W. Schon (Ed.), Tax Competition in
Europe (Amsterdam: IBFD, 2003), pp. 5-8.
116 R. S. Avi-Yonah, Intemational Tax as lntemational Law - An Analysis ofthe Intemational Tax Re-
gime (Cambridge Tax Law Series, 2007), pp. 8-10.
117 S. Barsch, Taxation ofHybrid Financiai Instrwnents and the Remuneration Derived Therefrom in an
Intemational and Cross-border, pp. 44-45.
118 S. Barsch, Taxation ofHybrid Financiai Instruments and lhe Remuneration Derived Therefrom in an
lntemalional and Cross-border, pp. 46.
182 Dziurdz/Marchgraber (Eds), Non-Discrimination in Europ d T
ean an ax Treaty Law Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 183

124 R. S. Avi-Yonah, Commentary (Response to artic1e by H. David Rosenbloom), Michigan Tax Law
Review 2000, pp. 168-171.
125 Judgments in Mark Kercklwert and Bernadette Morres, C-513/04, EU:C:2006:713; Jacques Dam-
seaux, C-128/08, EU:C:2009:47I.
126 K. Daxkobler/E. Huisman, Levy & Sebbag: The EC) Has Once Again Been Asked To Deliver Its
Opinion on Juridical Double Taxation in the InternaI Market, European Taxation 2013, p. 400.
127 See the following excerpt from the CIBA case: "European Union iaw, in the current state of its devel-
opment (...), does not lay down any general criteria for the attribution ofareas ofcompetence between
the Member States in relation to the elimination of double taxation within the European Union".
Oudgment in CIBA, C-96/08, EU:C:2010:185, paras. 27 et seq).
128 D. Gutmann, How to avoid Double Taxation in the European Union, in: I. Richelle/W. Schõn/E.
Traversa (Eds.), Allocating Taxing Powers within the European Union (Berlin/Heidelberg: Springer
Verlag, 2013), pp. 63-72.
seen from the fact that withholding taxes are reduced in the source state based on
the assumption that the corresponding income is subject to tax in the residence
state. The preservation ofthe matchingprinciple is aIso the primary reason for not
entering into tax treaties with tax havens, in which the income is not properly
taxed.124 Based on the single tax principIe and on the good functioning of the
internaI market, it would be possible to extend the matching principIe beyond the
tax treaty context in order to establish a direct link between, on the one hand, the
deductibility of the remuneration derived from the hybrid instrument at the leveI
of the subsidiary, and, on the other hand, the taxation of the corresponding
amount at the leveI of the parent company.
Thus, the preservation of a direct link between deduction and taxation, in a
broader cross-country context, may be accepted as result of the single tax princi-
pIe. However, if this is the foundation for tackling international tax arbitrage
through the use of anti-hybrid rules, it is necessary to recognize, for the sake of
consistency, that countries should aIso offer proper solutions for all cases of dou-
ble taxation, even outside a tax treaty contexto It implies that double taxation
should no longer be considered to be the simple result of the parallel exercise of
taxing rights by sovereign countries, but rather as a violation of the single tax
principIe. This interpretation of EU law is highly controversial, becaus~ the EC]
has consistently held that the fundamental freedoms do not offer any remedy
against the problem of double taxation,125 which is a consequence of the parallel
exercise of taxing rights and of the Member States' fiscal sovereignty.126
Indeed, in the examination ofdifferent cases, the ECJ has always reached the con-
clusion that the fundamental freedoms do not prevent double taxation, for which
reason Member States should, as far as is necessary, negotiate double tax treaties
to avoid double taxation in the internaI market.127 The approach adopted by the
EC] is very open to criticism, in view ofthe fact that double taxation is an obvious
obstacle to the functioning of the internaI market, which makes it difficult to
accept that its negative effects for the development of international trade are in
line with EU law.128 Despite this, for the sake of consistency, if the EC] decides
Tomazela Santos
----,----------------------_.-:-=..:..:.:..:.:.:::..=.:..:::-=.::..:..:..:..::.::.
domestically. Conver~ely, income arising from cross-border transactions sh::
no: be taxed less heavily, as the tax saving obtained creates an inefficient incent'
to m:,est abroad rather than at home.119 The deadweight loss associated with lVe
taxatI~n or under-taxati0I1of cross-border income contradicts the idea of se~~~
up a smgle market in the European Community. g
Fr?m another ~n~le, the under-taxation ofcross-border income caused by hybrid
mls~atches wlthm the Europ~an Union violates both horizontal and vertical
eqUlty when compared to the hlgher tax burden imposed on domestic-source .
c.ome.
12Ü
Thus, the av~idanceofdouble taxation and double non-taxation is ess~~~
tIal for t.he preservatlOn of fairness and equality in the tax system, since the tax
bu~~en lmposed. o~ each :axpayer has to be determined in accordance with the
ablltttto-pay pr~nclple,121 lrrespective of the origin of the corresponding income
(forelgn-source mcome or domestic-source income).
Deviation~ from th~ sin~le tax principIe caused by hybrid mismatches also distort
t~e allocatlOn oftaxl~g nghts between jurisdictions and affect inter-nation equit ,
glven t~e fact that nelther the residence state nor the source state will impose t~
~n the m~ome g~nerated.by :he hybrid financiaI instrumento The development of
l~ter-natlo~ equlty can slgmficantly contribute to achieving fairness in interna-
tlOnal taxatlOn, but its usefulness as a tax policy goal has been largely underval-
ued, perh~ps ~ecause ~olicy-makers and tax scholars believe it depends greatly on
the coordmatlOn of dlrect tax systems within the EU 122 As J: • t .. . . lar as In er-natlOn
equlty IS conc.erned, taxing rights and tax base have to be equitably allocated
~mong the resld~nce state. and the source state.123 However, by means offinanciaI
m~trumen:s WhlCh combme debt and equity features, it is possible to avoid the
falr a.llocatlOn oftaxes between the countries concerned, regardless ofthe benefits
p:ovlded by e~ch country for the generation of the income (public goods and ser-
VICes, economlC and legal framework).
In lig~t o~ the foregoing, :he anti-hybrid rules introduced in the Parent-Subsidi-
~ry Dl~eCtIve n:ay be consldered a mechanism to achieve the principle 01matching
~n the mternatlO~al tax field beyond the scope of tax treaties. It is well know that
mcome tax treatIes are generally based on the matching principle, which can be
119 R: S. Avi-Yonah, International Tax as International Law - An Analysis oifthe International Tax Re-
gIme, p. 9.
120 R. S. Avi-Yonah, International Tax as International Law - An Analysis oifthe International Tax Re-
glme,p.IO.
121 IS,tBãrScth, Talxatdio'CIofHybrid Financiai Instruments and the Remuneration Derived ThereFrom in an
n erna zona an ross-border, p. 56. :I'
122 K. Brooks, Chapter 15 - Inter-Nation Equity: The Development ofan Important but Undera re'
ated InternatlOnaI Tax Policy Objective, in: J. G. Head/R. Krever (Eds.), Tax Reform in the 21~rCe~::
tury )- A Volume /ti Memory ofRichard Musgrave (Alphen aan den Rijn' Kluwer Lan Inte t' I
2009 , pp. 489-493. . rna lOna,
123 S. Bãrsch, Taxation ofHybrid financiai Instruments and the Remlmeration Derived Th ,r; .
Internatzonal and Cross-border, pp. 57-61. ereJrom /ti an
184 Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law DziurdUMarchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 185

tax principIe and the inter-nation equity are able to justify l1<tlIOn:l1
ruI~s agains.t dou~Ie non-taxation, then it is necessary to folIow the
same approac~ m cas~s mvolvmg double taxation. It is true that, from a practicaI
stand,r0mt, thIS soIutIOn seems to be very difficult to implement, due to the fact
that, m the absence of tax.harmonization, EU Iaw does not provide any criter'
d . h li IOn
to etermme t e a ocation of taxing rights among Member States, which .
essentiaI to verify, in a cross-border context, which Member State did not com IIS
wi.th EU Iaw in a case that ended up in double taxation.129 As double taxat~~
anses from the cumulative exercise of taxing rights by two different Memb
States, it is not possible to blame a single country for this outcome.I3O Howev er
. . e~
Just as It was necessary to amend the Parent-Subsidiary Directive, there is aIso a
need to further develop rules to tackle double taxation at the EU leveI.13l More
specificalIy, it is necessary, at the very Ieast, to create rules to prevent double taxa-
tion derived from hybrid financiaI instruments,which may occur if a cross-bor-
der payment is classified as dividend at the leveI of the subsidiary and as interest
at the leveI of the parent company.132
Furthermore, the ECJ has consistent1y held that Member States are not required
to take into account possible negative effects derived from peculiarities of the
domestic law of another Member State, for the purposes of applying their own
tax legislation.
133
More precisely, in the Krankenheim Ruhesitz am Wannsee case
(~-157/ü7), the ECJ held that Member States are not obliged to design their na-
tIOnal tax Iaw based on the rules in force in other Member States, only to ensure
that, in alI circumstances, any disparities arising from the interaction between
~he two juridical s~stems are eliminated.134
Based on a similar line of reasoning,
m the Keller Holdzng case (C-4711ü4),135 the ECJ decided that a Member State
could not apply a discriminatory tax treatment on dividends received by the
parent company, merely because the profits earned by a foreign subsidiary, out
of which the dividends were distributed, were not taxed in that other Member
State.
136
This implies that a discriminatory tax measure cannot be justified based
on the tax treatment applicable in another Member State, which makes it diffi-
cult to accept as justification the need to safeguard the symmetry between
deduction and taxation in a cross-border context.
129 F. A. García Prats, Revisiting "Schumacker": Source, Residence, Citizenship in the EC) Case Law on
Direct Taxation, in: I. Richelle/W. Schon/E. Traversa (Eds.), A/locating Taxing Powers within the Eu-
ropean Union (Berlin/Heidelberg: Springer Verlag, 2013) pp. 22-25.
130 M. Lang, Chapter 2 -. Double Taxation and EC Law, in: R. S. Avi-Yonah, J. R. Hines Jr.lM. Lang
(Eds.), COI~paratlve Fiscal Federalzsm (Alphen aan den Rijn: Kluwer Law International, 2007), p.17.
131 F. A. Gar~laPrats, In: Isabelle RIChelle/Wolfgang Schon/Edoardo Traversa (Eds.), A/locating Taxing
Powers wlth/ll the European Union, pp. 22-25.
133 O. Thommes/A. Linn, Intertax 2014, pp. 31, FN 39.
134 Judgment in Krankenheim Ruhesitz am Wannsee, C-157/07, EU:C:2008:588, paras. 49-50.
135 Judgment in Keller Holding, C-471/04, EU:C:2006:143, para. 43.
136 O. Thommes/A. Linn, Intertax 2014, pp. 31.
Tomazela Santos
.the EU treaty framework, the functioning of the internaI market is ~is-
d When the taxpayer suffers double taxation or enjoys double non-taxatlOn
torte . . . . . . h
due to disparities or mconslstencres caused by dlvergmg tax systems, glv~n t e
r t that competitive conditions and overalI tax burden are affected dependmg on
IaC . . d ) 137 A' th'the character of the transactIOn (domestIc or cross-bor er . gamst IS argu-
t one may say that the fundamental freedoms only prevent Member Statesmen, . , .
f imposing a worse tax treatment on cross-border transactIOns m companson
ror:rely domestic transactions, without impeding the concession of a favorable
to p I' . h h' . M bt treatment to a cross-border transaction. In me Wlt t IS reasomng, em er
~~tesshould not restrict the funda~entalfreedom~by hi~deringeconomi~play-
in entering other Member States market or leavmg thelr Member States mar-
ers . d' h fuk t because these obstacles against cross-border transactIOns Istort t e nc-
ti~~ing of the internaI market.138
It foliow~that double non-taxa:ion obtained in
eross-border transactions would not constltute an obstacle to the mternal market.
However, the author disagrees with this idea, because if taxpayers earn h~gher
fter-tax returns investing abroad than on domestic investments earning a hlgher
a . . h I tt 139 Abefore-tax return, they WllI prefer the former mvestment over t e a er. s a
result, investments wilI be allocated away from their most productive use, thus
harming the single market. This incentive may aIso result in an over-~u~ply of
capital for cross-border investments and an under-supply for domestI~ mvest-
ments.140
Notwithstanding the arguments above, one may argue that focusing on double-
taxation or double non-taxation diverts attention away from the real problem,
which is the relative tax burden at various relevant margins, regardless of the
number of different times that the same income is taxed under the tax system of
different countries. It is possible to claim that what realIy matters in a cross-bor-
der context is the final tax burden charged at a certain margin, irrespective of the
number of taxes that are effectively charged, since any taxpayer wiU probably pre-
fer to be taxed twice at a 10 % rate each time than once at a 35 % rate. Thus, the
ideal solution would be to focus on the overalI effective tax burden at the margin,
rather than on the number of times that the cross-border income is taxed.141
Whilst the importance of the effective tax burden at the margin has to be
acknowledged, the truth is that the prevention of double non-taxation generated
by deduction and non-inclusion schemes focuses on a concrete problem that cov-
ers the former, because if neither the residence state nor the source state taxes the
137 S. Barsch, Taxation ofHybrid Financiai Instruments and the Renwneration Derived Therefrom in an
Intemational and Cross-border, p. 65. .
138 S. Barsch, Taxation ofHybrid Financiai Instruments and the Remuneration Derived Therefrom /Il an
Intemational and Cross-border, p. 64.
139 R. S. Avi-Yonah, Michigan Tax Law Review 2000, p. 171, FN 124.
140 R. S. Avi-Yonah, Michigan Tax Law Review 2000, p. 171, FN 124. . .
141 D. Shaviro, Fixing U.S. Intemational Taxation (New York: Oxford Umvensty Press, 2014), pp. 4-7.
186 Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty law Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty law 187

143
144
145
income deríved from thehybríd financiaI instrument, then the margínal rate of
tax on that íncome is zero, which is necessarily lower than the rate of tax on th
residence state, thus creating an íncentíve to ínvest in the source country ín orde;
to take advantage of the hybrid mísmatch.142
On the assumption that double non-taxation obtaíned through hybríd ínstru-
ments should be combatted by EU law due to íts negative effects for the ínternal
market, the íssue that aríses is that antí-hybríd rules are not entírely successful in
tackling hybrid mísmatches arrangements because of their límíted scope. Indeed,
the national tax measures adopted by Member States, based on the amendment of
Parent-Subsídiary Dírective, do not cover alI opportunítíes for hybrid mis-
matches, because the oblígation to tax is only applícable wíthin íts materíal and
territorial scope, which compríse profits dístributed by an EU subsídiary to íts EU
parent company. In addítion, outsíde the scope of the Parent-Subsídíary Dírec-
tíve, recalcítrant companies may stíll structure transactions with hybríd financiaI
instruments between an EU and a non-EU company,143 ín order benefit from
exemptíons granted by domestic law or tax treaties, mainly by Member States that
desire to attract foreign investors.
Another type ofhybrid mismatch not covered by the Parent-Subsídiary Directive
involves the notional interest deductíon províded for by the domestic law of cer-
tain countríes, especialIy Belgium.144 Strictly speaking, Article 4.1 (a) of the Par-
ent-Subsídiary Dírectíve does not cover the notional interest deduction, because
the dividend dístributed is not deductible at the leveI of the subsídíary. However,
from an economic perspective, the notional ínterest deduction ensures a similar
effect, as it alIows the subsidiary to deduct the amount corresponding to its risk
capital from the tax base of the corporate íncome taxo Although ít does not pro-
duce a mismatch ín tax outcomes in the sense contemplated by the Parent-Sub-
s~diary Dírective and Action 2 of BEPS Action Plan, the same reasoníng that jus-
tifies tax measures against hybrid financiaI instruments also requires a compre-
hensive approach to the matter, ín order to prevent injustices. Otherwise, not
only taxpayers may exploít new loopholes in tax legíslation, but Member States as
welI may attempt to provide an attractive alternative to foreígn investors.145
Moreover, the Parent-Subsídiary Directíve does not provide for a proper solution
for the cases in which Member States rely on the indirect credit method to avoid
double taxation. A fulI tax credit of the corporate income tax paid by the subsidi-
ary, along with the deduction of the amount distributed to the parent company,
142 R. S. Avi-Yonah, "No Country is an Island: Is a Radical Rethinking of International Taxation
Needed?", Univeristy ofMichigan Public Law Research Paper No. 380 (2014), p. 6.
Article 205 of the Belgian Income Tax Code.
It is not objective of this paper to analyze whether the notional interest deduction may constitute a
form ofState aid.
Tomazela Santos
would aIso lead to double non-taxation.146 As regards the credit method, Article
4(1)(b) of the Parent-Subsidiary Directive states that the parent. company mu~t
deduct from the amount of tax due the fraction of the corporate mcome tax paId
by its subsidiary and any lower-tier subsidiary on the pro~ts distributed. The
wording of the provísíon does not clarify whether the deductlOn of the rem~ner
ation derived from the hybrid instrument reduces the amount of the tax credIto In
order to avoid increasing disparities between the exemption and the credit
method, which are not fulIy equivalent remedies,147 the European Commission
should have explícitly addressed the issue.
In addition, ít ís commonly stated in the líterature that, from an economic per-
spective, ít may be very difficult to dístinguish.between non-taxation .and t~xatí~n
at a very low rate.148 Consequently, anti-hybnd rules may create a dlstortive blas
towards investments that benefit from mismatches in tax rates, as a substantial
difference between the tax rates may lead to an economic result similar to double
non-taxation.149 Strictly speakíng, the anti-hybrid rules only apply where the pay-
ment is deducted at the leveI of the subsidiary, which means, on the other hand,
that the parent company should refrain from taxing the profit distribution where
the payment is not deductible at the leveI of the subsidiary, even if the leveI of tax
actualIy paid ís signíficantly low. In the author's opínion, since the Parent-%Subsid-
iary Directive alIows both the exemption method and the indirect credit method,
the nationallaws of the Member States can provide for a switch-over to the indi-
rect credit method when the leveI of taxation ín the subsidiary state is excessively
low. In this case, the country of the parent company will comply with the provi-
sion of Article 4 of the Parent-Subsidiary Directive, thereby achieving the goal of
preventing double taxation.
Another problem is that the anti-hybrid rule based on the Parent-Subsídiary
Directive may affect legal transactions that were not originalIy íntended to be cov-
ered. As already mentioned, Article 4.1 (a) of the Parent-Subsidiary Directive
states that the Member State of the parent company must "refrain fram taxing
such prafits ta the extent that such prafits are nat deductible by the subsidiary".150
Thus, this legal provision may be rendered applícable where the country of the
subsidiary denies, based on its national thin capitalizatíon rules, the deduction of
a payment characterized as interest under íts domestic law. In this situatíon, there
are two possible outcomes, without any reasonable justification for the unequal
147 B. j. M. Terra/P. j. Wallel, European Tax Law, pp. 312-313.
148 R. de Boer in: R. de Boer/M. Nouwen (eds.), The European Union's Struggle with Mismatches and
Agressive Tax Plmming, p. 68.
149 R. de Boer in: R. de Boer/M. Nouwen (eds.), The European Union's Struggle with Mismatches and
Agressive Tax Planning, p. 68.
150 Council Directive 2011196/EU of30 November 2011 (recast), amended by: Council Directive 2013/
13/EU of 13 May 2013 and Council Directive 2014/86/EU of8 july 2014.
188 Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law Dziurdí/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 189

154
155
156
157
158
159
Prevention of Hybrid Mismatches as a Justification?~~:":":':::":":":-::":":":'::L.:.::..~~~~"::':":':::'::"":::'::"":::",:":::,::,,::,:,,:,::::::,,:::,,:::,:,,,:,:,- _
tax treatment. On the one hand, if the country of the parent company character_
izes the payment as interest, the amount may be taxed based on its domestic law,
under the Interest and Royalty Directive. On the other hand, if the country of the
parent company characterizes the payment as profit distribution, within the con-
text of the Parent-Subsidiary Directive, the corresponding amount must not be
taxed to the extent that the corresponding payment was not deducted at the leveI
of the subsidiary. Therefore, the European Commission did not properIy address
this type of mismatch, stemming from the classification of the income for the
purposes of applying both directives. If it were acknowledged that the neutraliza_
tion of hybrid mismatches arrangements and their effects (double non-taxation
or double taxation) is a goal to be pursued by the European Union, it would be
consistent to adopt a more comprehensive approach, instead of just focusing on
particular types of tax planning strategies.
Finally, it is worth mentioning that, in order to circumvent the application of
anti-hybrid rules, tax planning structures may be adopted to avoid either the sub-
stantial participation of 10 % or other requirements for the application ofthe Par-
ent-Subsidiary Directive, especially when domestic law or tax treaties grant any
kind of relief to portfolio dividends. To this end, dividend washing or dividend
stripping transactions, which entail a temporary transfer of the title to the shares
just before the distribution of dividends,I51 may now be used in the opposite
direction to get around domestic anti-hybrid rules. This may open room for the
use of investment funds, collective investment vehicles, usufruct agreements, to-
tal return swap, among other tax planning strategies, for the purpose of falling
outside the scope of the Parent-Subsidiary Directive and of the anti-hybrid rule.
VI. Proportionality test
The principIe of proportionality initially appeared within the EU framework as a
general principIe of law, but has been assimilated by the ECJ in the course of in-
terpretation and application ofCommunity law.152 The analysis ofthe principIe of
proportionality is of fundamental importance because restrictive tax measures
are often rejected by the ECJ not on the absence of a legitimate ground ofjustifi-
cation, but on the disproportionality of their restrictive effects.153 According to
ECJ case law, national tax measures which are liable to make less attractive the ex-
ercise of fundamental freedoms guaranteed by EU law may nevertheless be
allowed in special circumstances, provided that: (i) they pursue an objective in the
public interest; (ii) they are appropriate to attaining that objective; (iii) they do
151 K. Daxkobler/E. Pamperl, Chapter 12 - Austria, in: G. Maisto (ed.), Taxation oflntercompany Divi-
dends under Tax Treaties and EU LalV (Amsterdam: IBFD, 2012), p. 307.
152 A. Zalasinski, Proportionality of Anti-Avoidance and Anti-Abuse Measures in the ECrs Direct Tax
Case Law, Intertax 2007, p. 310.
153 B. J. M. Terra/P. J. Wattel, European Tax LalV, p. 45.
Santos
beyond what is necessary to attain the objective pursued.
154
Thus, on the
no
t
~ption that a restriction to fundamental freedoms may be justifie~ based o~
ass
U
ounds examined above, the question arises as to whether the natlO~alantl-
th~g.rd rules are in accordance with the principIe of proportionality. In thls paper,
~~sr:mpossibleto reach a definitive conclusion on the fulfillm~ntof the pr~por
I. nality test, since it depends on the analysis ofthe actual wordmg ~fthe ~ntl-ht
tl~d I introduced by each Member State.155 For this reason, thls sectlOn wI11
bn ruoeme controversial aspects of anti-hybrid rules which may eventually be
cover s . l'ty
taken into consideration by the ECJ in its analysis of proportlOna I .
ro riate: The national tax measure must be adequate, app:opriate,. capable,
App 't Pble cor the production of the effects intended by the natlOnalleglslator. It
or SUl a l' b" dope
st clearIy contribute for the attainment of the purpose, o !ectlve, an s~
:~iredb the Member State with the text of the law.156 On .thls matter: an~l-hy
brid rule: introduced by Member States will probably ac.hle~e the obJectl:e ~f
avoiding double non-taxation generated by hybrid finanCIaI mstruments .wlth.m
the scope ofthe Parent-Subsidia1J' Dir~ct~ve, although other f~rms ofhybnd mls-
matches are technically still posslble wIthm the European Umon.
Necessary: From a theoretical perspective, the national tax measure should be the
least restrictive among available alternatives to the fund~m~ntalfreedoms or to the
affected rights granted by EU law.157 Apart from contnbutmg to the gddual pro-
motion of its purpose, the domestic tax rule introduced by the Member State m~st
be the least restrictive among all other tax measures available and equally effectlve
to attain the objective pursued by the legislator.158 However, the ECJ does not ~l
wa s recognize that the Member State has the obligation to choose the least restnc-
tiv; means,159 as can be inferred from the Alpine Investments ~ase (C-384/93),
where it held that "the fact that one Member Stat~ impose less ~tnct rule.s than an-
other Member State does not mean that the latter s rules are dlsproportlOn.ate ~n.d
hence incompatible with Community law".16ü From a theore.tical per.spectlve, It IS
only possible to agree with the ECJ decision if the two optlOn~ avaI1able a.re not
equally effective to attain the objective pursued, even ,tho~g~ thls may be dlffic~t
to evaluate in some circumstances. Thus, in the author s opmlOn, am.o~g aHlequa y
effective tax measures, Member States should choose the least restnc~l:e m~ans
of preventing double non-taxation obtained under the Pare~t-Subsl?la~Dlrec-
tive. This criterion, which is usually disregarded by the ECJ m practlce, would
B. J. M. Terra/P. J. Wattel, European Tax LalV, pp. 44-45.
N. Strelnikova, Master Thesis, p. 32, FN 38.
A. Zalasinski, Intertax 2007, p. 312, FN 152.
A. Zalasinski, Intertax 2007, p. 312, FN 152.
B J M Terra/P J Wattel, European Tax LalV, p. 44. . ( I
c'. HJI 'Pana~i, D~uble Taxation, Tax Treatíes, Treaty Shopping and the European Conllmmlty A-
phen aan den Rijn: Kluwer Law International, 2007), p. 206.
160 Jud ment in Alpine Investments, C-384/93, EU:C:1995:126, para. 51. .
161 U. ~chreiber, Intemational Company Taxatíon (Berlin/Heidelberg: Spnnger Verlag, 2013), p. 103.
162 A. Zalasinski, Intertax 2007, p. 312, FN 152.
190 Dziurdz/Marchgraber (Eds), Non-Discrimination in European and Tax Treaty Law DziurdUMarchgraber (Eds), Non-Discrimination in European and Tax Treaty Law 191

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