mr. S.C.W. Douma

Optimization of Tax Sovereignty and Free Movement

Although, as Community law stands at present, direct taxation does not fall within the purview of the Community, the powers retained by the Member States must nevertheless be exercised consistently with Community law. This proposition very clearly reveals the conflict between two areas of legal competence of which the rules are more or less carved in stone.

On the one hand, it is settled ECJ case law that Community law takes precedence over national law and that it has direct effect if its provisions are clear, precise and unconditional enough to be invoked and relied upon by individuals before national courts. The EC Treaty provisions of free movement of goods, persons, services and capital meet the criteria of direct effect, so that any national tax measure which contravenes a free movement provision is rendered automatically inapplicable (the EC Treaty contains only a few possible exceptions which are almost never applicable to national direct tax rules).
On the other hand, the Member States as a matter of principle retain extensive competences in tax matters. They remain free to determine the organisation and conception of their tax system and to determine the need to allocate between themselves the power of taxation. Apart from these ‘internal’ objectives, the Member States are also at liberty to pursue ‘external’ objectives through tax measures such as the protection of the environment or stimulation of research and development. Indeed, it is hard to conceive of a more sensitive area of domestic Member States’ competence, either legally or politically, than direct taxation.

The ECJ, called upon to interpret and apply the free movement provisions of the EC Treaty in direct taxation cases, has the difficult task to interpret and apply the free movement provisions in relation to national direct tax measures. It seems obvious that a literal interpretation of the free movement provisions – without any further exceptions than the express Treaty derogations – would severely undermine the powers retained by the Member States in the field of direct taxation. In turn, not to apply the fundamental freedoms to direct taxation on the ground that the latter does not fall within the purview of Community law would deny the existence of the obligations to which the Member States have committed themselves when they concluded the EC Treaty with the creation of an internal market as the primary objective. As a consequence, the ECJ has the difficult task to reconcile the consequences of the fiscal sovereignty retained by EU Member States with the obligations flowing from the EC Treaty (an internal market without frontiers). How should sovereign rights be reconciled with the obligations enshrined in the EC Treaty?

The ECJ has been criticised on several points for the way it balances fiscal sovereignty against free movement. It has been accused of going too far in striking down national direct tax rules, thereby effectively failing to appreciate that the Member States have intended to maintain their national tax sovereignty. It would not understand the difficult area of tax law. Also, the ECJ has been blamed for acting as a legislator rather than as a court by positively harmonising national tax law instead of only (negatively) reviewing national tax measures for compatibility with the fundamental freedoms. Other authors have argued that the ECJ is fully competent to positively harmonise national tax laws and that it should use this power. At the same time, especially in the last years, the ECJ has been blamed for giving the Member States to much leeway. Apart from these criticisms on the ECJ’s alleged policy, many writers have argued that the ECJ applies the free movement provisions in the area of direct taxation inconsistently and unclearly. As a result, national legislators nor taxpayers would be able to tell which national tax measures are ‘EC proof’ and which are not.

Traditionally, the literature on this subject attempts to identify mistakes or missed opportunities by the ECJ by taking generally accepted principles of national and international tax law and existing ECJ case law as a starting point. In the author’s view, this ‘internal’ approach cannot lead to a satisfactory answer to the question of whether the ECJ’s case law is correct or incorrect with respect to the reconciliation of national direct tax sovereignty and free movement. It results in a politicized 'tis-'tisn't argument without bringing the discussion at a level where it can be objectively determined whether a fair balance has been struck in a particular case or not. It is submitted that a proper analysis can only be made in the light of an assessment model which is external to and independent of the ECJ’s current case law. For this purpose the present study develops a theoretical assessment model which will provide a framework for optimizing the two conflicting principles of direct tax sovereignty and free movement. It will subsequently be shown that similar models are applied in general public international law, in particular under the principle of good faith and Article 31(3)(c) VCLT. Finally, it will be examined to what extent the case law of the ECJ fits in the model, which serves to answer the question of whether the aforementioned criticisms are justified.

Last Modified: 31-01-2013