First decision by the European Court of Human Rights on suspicion of reverse discrimination in tax matters

 

 

Dr Samira-Asmaa Allioui, Research fellow, Centre d'études internationales et européennes, Université de Strasbourg

Photo credit : Chabe10, via Wikimedia Commons

The applicants in the European Court of Human Rights judgment in Deforrey and others v France are three French nationals who allege reverse discrimination (ie, treating issues subject to EU law more favourably than issues subject to national law) in tax matters. Relying on Article 14 (right to non-discrimination) taken in conjunction with Article 1 of Protocol No. 1 to the Convention (right to property), the applicants complain about the methods used to calculate their income tax. They denounce reverse discrimination, arguing that they would have benefited from more favorable tax treatment if the capital gains on which they were taxed had been part of transactions falling within the scope of EU Directive 2009/133/EC of 19 October 2009, which concerns the taxation of mergers of companies between different Member States.

With regard to this directive, the Court of Justice of the European Union (CJEU), consulted by the French Conseil d’Etat decided that the relevant articles of this directive must be interpreted as meaning that, in the context of a securities exchange transaction, they require that the same tax treatment be applied to the capital gain relating to the securities exchanged and placed in tax deferral, as well as to the capital gain arising from the sale of the securities received in exchange, with regard to the tax rate and the application of a tax allowance to take into account the length of time the securities were held, as that which would have been applied to the capital gain that would have been realized upon the sale of the securities existing before the exchange transaction, had it not taken place.

But what if the same transaction as regards companies in the same Member State is treated worse for tax purposes? The three applicants denounce the discriminatory nature of the methods used to calculate their income tax base, claiming they are treated less favorably than taxpayers who have carried out a securities exchange transaction governed by European Union law. They maintain that their situation is comparable to that of taxpayers who have carried out a cross-border securities exchange transaction within the European Union internal market and complain of direct discrimination based on the location of the securities exchanged during the restructuring transactions and the national origin of the securities, arguing that this difference in treatment did not pursue a legitimate aim and was devoid of objective and reasonable justification.

In the present case, the Human Rights Court considers that it has been established that the alleged difference in treatment is correlated with an identifiable characteristic, drawn from the nature of the transactions carried out by the taxpayer, and more specifically, whether he carried out a cross-border exchange of securities within the European Union internal market.

The Court recalls that a State is ordinarily granted broad latitude when it comes to defining general measures in economic or social matters. Thanks to their direct knowledge of their society and its needs, national authorities are, in principle, better placed than international courts to determine what is in the public interest in economic or social matters, and the Court generally respects the State's understanding of the imperatives of public interest, unless its judgment proves to be "manifestly lacking a reasonable basis." Similarly, the Court tends to recognize a wide margin of appreciation when the situation is partly the result of individual choice. Conversely, only very compelling considerations can justify a difference in treatment based exclusively on nationality.

In this case, the Court notes, first, that the difference in treatment at issue is not based on the taxpayers' nationality, but on certain characteristics of the transactions they carried out. Second, it notes that the taxed gains result from transactions freely entered into, the taxpayers having chosen to dispose of their securities with full knowledge of the facts. Third, it observes that the difference in treatment at issue falls within the realm of taxation, this area being part of the core prerogatives of public authorities.

Regarding the existence of a “rapport raisonnable de proportionnalité” (reasonable relationship of proportionality) between the means employed and the aim sought to be achieved, the Court has already acknowledged that accession to the European Union and the specific nature of the European Union legal order could justify a difference in treatment between nationals of Member States and other categories of foreign nationals. However, it has never been called upon to rule on a situation of reverse discrimination, in which the rules of a domestic legal order are less favourable than those applicable to situations covered by European Union law. In this regard, the Court reiterates that it is not its task to replace the competent national authorities in determining what is in the public interest in economic or social matters or in assessing whether – and to what extent – ​​differences between situations that are similar in other respects justify differences in treatment. It is solely for it to determine whether any difference in treatment implemented exceeds the margin of appreciation granted to the Contracting States.

In this case, the Court notes, like the French Constitutional Council and the Council of State (Conseil d’Etat), that the domestic legal system also includes rules with similar effect. The tax deferral regimes applicable to capital gains from the exchange of securities are intended to guarantee a degree of tax neutrality for these transactions by preventing the taxpayer from being forced to sell their securities to pay the tax. Only the degree of tax neutrality of the exchange of securities transaction varies, being reinforced for situations falling within the scope of Directive 2009/133.

The Court further notes that the deduction for holding period provided for in Article 150-0 D of the French General Tax Code is intended to apply to all capital gains on securities when the conditions set out in that article are met. This text does not, in principle, exclude capital gains realized in purely domestic situations from its scope. While this allowance does not apply to capital gains carried forward prior to January 1, 2013, this is primarily an effect of the transitional provisions attached to the tax reform implemented by the Finance Acts for 2013 and 2014.

However, the Court has already observed that the implementation of economic or social reforms intended for a broad public requires determining their temporal scope, which implies excluding certain beneficiaries according to criteria that may appear arbitrary to the persons concerned; the resulting differences in treatment are the inevitable consequence of the introduction of new rules. In the Court's view, these transitional provisions do not appear arbitrary.

The Court considers that the difference in treatment at issue was based on an objective justification and was not manifestly lacking a reasonable basis. In view of all these considerations, the Court considers that the respondent State did not exceed the wide margin of appreciation available to it in this matter. Accordingly, there has been no violation of Article 14 of the Convention.

One of the four components of discrimination is that the rule at issue must establish a distinction based on a prohibited criterion. In CJEU case law, criteria are prohibited when they establish a distinction based on a cross-border element, such as the fact that the services are obtained from a provider established in another Member State. This is a preliminary question to be examined before the Court assesses comparability and the existence of a disadvantage. If the rule at issue does not establish a distinction based on a prohibited criterion, there can be no discrimination.

Despite the lack of clear guidelines on how to resolve specific cases, one thing is clear: unlike the CJEU, which consistently demonstrates concern for the functioning of the common market and the promotion of free movement in its tax discrimination cases, this is not the case for the Human Rights Court. The CJEU frequently concludes that tax policies are discriminatory because they "discourage" or "deter" cross-border economic activity. This interpretation makes sense considering that one of the explicit objectives of the EU's creation was to integrate the economies of previously independent states by removing barriers to cross-border economic activity and preventing states from erecting new ones that would prevent taxpayers from operating across borders. The problem with tax discrimination decisions, however, is that they provide little guidance on when tax policies "discourage" or "deter" the type of cross-border economic activity in question.

Tax discrimination cases raise complex questions with no readily available answers. For example, what impact do differential tax rates have on determining whether discrimination exists? These questions attract much commentary, but neither the judicial decisions themselves nor the academic commentaries on them provide answers to these fundamental questions.