1. Introduction

“Should I stay or should I go… ”? The implementation of the EU’s internal market, characterized in the Treaty on the functioningof the European Union ( TFUE) as ”an area without internal frontiers in which the free movement of goods, persons, services and capital is ensured” ^[2], together with the persistence of considerable differences between the factual and normative conditionsfound by companies i n the twenty-sevenMember States of the Union converts the previous question from a well- known songrefrain in to an omnipresent sound bite, echoing i n the minds of CEO’s and CFO’s all across Europe.

Under the European perspective, the transfer of an economic activity is not seen as anegative side effect of the internal market. From the very beginning, treaties recognizedthe need to protect the freedom of establishment, enclosing a ”right to take up and pursue activities as self-employed persons and to set up and manage undertakings, in particular companies or firms” ^[3].

In order to achieve an effective i nternal market, obstacles to this freedom of establishment have to be abolish ed , whichrequires also changes in the field of direct taxation. In this field, exit taxes is ^[4], certainly, one of the most discussed topics . These rules have an obvious impact in the internal marketand all across Europe discussion s are having place on whether th e s e rules are comp atible with EU Law.

This discussion is also taking place in Portugal. In November 2008 the EU Commission has sent a reasoned opinion concerning the exit tax rules on companies (reference no.2007/2365 ). As Portugal hasn’t introduced any chang es or conveniently justified its rules, the case was referred to the Court of Justice of the EU (hereinafter CJEU) – case number 38/10. Several other countries have alsocases pending before the court ^[5].

The purpose of this paper is to examine the compatibility of those Portuguese corporateexit taxes with EU Law. We will depart from a concise description of the rules targeted by the Commission and currently under the Court’s review. Subsequently we will focus in applicability, to companies, of CJEU’s case law on individuals. At a later stage we will focusagain in the Portuguese system, in order to ascertain whether it can be said in line withthe previously described EU law requirements.

2. The Portuguese normative framework

2.1. The adoption of the rules

In the above mentioned pro cedure it is questioned whether the rules of arts. 83 to 85(formerly arts. 76-A, 76-B and 76-C) of thePortuguese Corporate Income Tax Code (hereinafter PCITC) ^[6] can be considered asincompatible with EU Legal order. All these articles are gathered under the same section of the code, entitled “trans fer of a company’s seat abroad and cease of non-resident activities”.

The rules, that establish forms of exit taxation for companies and shareholders, were introduced by the State Budget for 2006 ^[7]. Till then, the transfer of a company’s seat wassimply not recognized as a tax able event ^[8]. There were, however, some previous attempts. State Budget for 2004 ^[9] had already authorized the government to introduce an “exit tax on companies”, but that “legislative authorization” expired before any measure was adopted ^[10]. Therefore, and till the end of 2005, if a company transferred its seat abroadwithout winding up , no corporate income tax would be levied.

It is somehow puzzling to understand the realmotivation behind this set of rules . They were part of a “package”, aimed to implement the Directive 2005/19/ EC ^[11], which modified the original merger directive ’s regime ^[12]. Nevertheless, said diploma did not grant bases for the i ntroduction of any new tax. It only set forth, and regarding the Societas Europaea ^[13] (SE) or the Societas Cooperativa Europaea ^[14] (SCE), that a transfer of residence would not give rai s e to any tax regarding the assets and liabilities that: i) remain ed attached to a PE, located in Portugal and; ii) played a part in generating the profits of such a PE ^[15]. An a contrario interpretation of such regime, extended to the other types of companies, seems to be in the genesis of the regime .

The Portuguese corporate exit tax regime encompasses three sets of rules. The following segments will be devoted to them ^[16].

2.2. Rule 1: Exit taxes on companies

According with art. 83 (1) PITC, ”in the taxable year when the activity ends, by virtue of the transfer of its seat or the place of effective management to another country, shall be considered as positi ve or negative elements [of the taxable income] the difference between the market value and the book value for tax purposes of the assets in the moment of the transfer”.

The rationale is easy to understand and is shared with most of other European exit tax regimes : the need to safeguard a State’s taxing rights over the hidden reserves in value of the company asset’s obtained till the moment of the transfer . This is done because, according with tax treaty law, a ContractingState may only tax the gains of a non-resident if it is sourced in that State. If a company leaves, even if the profits accrued while it was a resident, those profits might no longer be taxed. Moreover when the transfer happens, tax authorities may no longer examine directly its activity.

The Portuguese rule was, however, drafted in a very broad manner. In fact, any entity considered as a tax subject (for the PICTC), including SE’s and SCE’s, transferring its seat or place of effective management to an other country will be covered by this regime.

To trigger the rule it is necessary that both seat and place of effective management(effective seat) are transferred abroad. The maintenance of one of this connection factor sin national territory will be sufficient to deem an entity as resident and, in such a case, the exit tax will not be applicable ^[17].

Despite the prolixity of the formula for the assessment of the liability, its content is easy to explain. To the taxable profit of a company that leaves Portugal should include, in the year it leaves the country (i.e., the year when it transfers its seat and place of effective management abroad) the “hidden” or non-realized gains. This is done subtracting: i) to the market value of a comp any assets; ii) the book value for tax purposes of those assets.In simple terms, the gains obtain ed till the transfer.

2.3. Exception: the remaining PE requirement

If one understands the rationale behind thepreviously mentioned rule, it is not surprising to find an excepti on for the cases where the company leaves a permanent establishment (PE) - art. 83 (2) (3) and (4). Two conditions have, though, to be met: i) the assets have to ”remain effectively connected to a permanent establishme nt of the same entity” locate d in Portugal; ii) those assets have to play a role in the production of the taxable profit of that PE”. Being that the case, and despite the transfer , the exit tax will not be levied .

This exception is only granted because, under international tax law, gains on those assets (both the accrued till the transfer, and thoselatter on obtained ) will still be submitted to Portuguese tax jurisdiction.

For these cases, there is still an additional rule: the PE may deduct to its profits the losses that the transferred company had in the moment of the transfer ^[18]. This promotes the continuity of the activity held in national territory, when it is absorbed by the PE .

This exception also encloses an anti-abuse rule, art. 83 (4). In practice, this works as an “exception of the exception” and is aimed to prevent the application of the ”benefit” toabusive cases. The legislative technique wasrather curious: instead of drafting a particular anti-abuse rule, the legislator has decided to refer this issue to art. 73 (10), implementingthe anti-abuse clause of the merger directive ^[19]. Its wording is copied from the directive ^[20].

It is somehow puzzling to ascertain how this anti-abuse clause might be applied in cases of”remaining PE’s”, as it is clearly addressed toother cases. We believe that t he aim w as to deny the benefits to situations were the allocation of the assets to the PE was driven by tax purposes, is artificial or has no sound connection with its activity.

2.4. Rule 2: Exit taxes on Permanent Establishment

Another situation that trigger s the exit tax is the cease of the activity of a permanent establishment. In fact, art. 84º PCITC extends the exit tax provisions to two types of situations concerning PE’s: a) when it ceases its activity in national territory; b) when ittransfers, by any juridical or material act, to another country, assets c onnected w ith that PE .

This provision is essentially addressed to avoid that the gains on some assets were left untaxed when the PE ceases its activity in national territory. This would be the case when a PE would be left out with a substantial amount of assets following a business restructuring operation with the transfer of the seat of the main company to another Member-State.

2.5. Rules applicable to the shareholders

Under art. 85º, the transfer has a lso e ffects at the level of the transferring company’s shareholders (individuals or not). For them,tax is levied on the difference between the company’s net assets (value d at the time of the transfer at market prices) and the acquisition costs of the participation. The rules for the assessment of the value and for other procedures were simply remitted to the regime in force for companies’ wind-up (which is illustrative of the real aim beneath the regime) ^[21]. There is also a specific set of rules for cases where the transferring company is treated as a transparent one ^[22].

This article includes a ”safeguard clause”, aimed to carve out cases where the transferred company is a SE or a SCE . The wording used is, basically, a copy of current art. 14º of the merger Directive and provides that thetransfer of one of those companies” does not imply, as such, the application ”of the regime(immediate taxation of the shareholders) ^[23]. As no further guidance is given, hermeneutical problems may arise.

3. Exit taxes on individuals and EU Law

It is clear that any tax triggered by the transfer of a person (regardless of its status) from one Member State to another creates ahindrance to the internal market.

The court has already scrutinized tax ruleswith this profile, in de Lasteyrie du Saillantand N (although some of guidance could already been inferred from the decision in Biehl ^[24]).

In the first, it was considered inadmissible to levy a tax on unrealized capital gains, whose taxable event w as the mere transfer of the individuals’ residence to another Member Stateeven when the collection was deferred to the moment of realization, essentially because thedeferral w as conditioned to burdensome guarantees. In N , the court stated that the exit taxation would not become admissible simply by lifting a burdensome guarantee without further measures. Moreover, decreases in value of the assets after the moment of the transfer should nevertheless be taken in consideration ^[25].

This was, in short, the output given by the court in these cases. Notwithstanding, those decisions provide no guidance to a serie s ofconnected questions. The CJEU has only provided that the taxation of unrealized gains at the moment of the transfer had to be considered a restriction ^[26]but that, in some cases, it could be justified , namely by the fight aga inst tax avoidance and evasion or by the need to maintain balanced allocation of taxing rights between Member States, according to the principle of territoriality, connected with a temporal element ^[27].

Therefore, there is no a priori or absolute banto an “exit tax”, as such ^[28], or to the request of certain administrative formalities at themoment of the transfer ^[29]. It might beconsidered admis sible as long as it pursues a valid justification and its proportional to that aim ^[30]. In both previously mentioned cases,the measure s went beyond what was need edt o pursue the alleged goals ^[31].

In conclusion, a M ember State is allowed tolevy a tax on the accrued gains obtained by the taxpayer till the transfer whenever: i) the subsequent decreases in value of the securities are taken in account; ii) the effective taxation is deferred to the moment when the gains are obtained (disposal of the assets); iii) no disproportionate administrative or financial burdens are attached to the deferral. Similar conclusions are reached and discussed in the Commission’s Communication on exit taxes ^[32] and in the Council of the European Union “Resolution on coordinating exit taxation”^[33].

4. Exit taxes and companies

The admissibility of any form of exit taxationon companies is, still, an open discussion ^[34]. Even if the court used consistently the term “taxpayer” in its previous case law, it is not quite clear if those findings can be immediately applied in the field of companies.Two objections can be found: i) the legal personality question, at a civil/ commercial level, and ; ii) the substance over form approach.

Let’s start with the first: unlike individuals, whose legal personality is determined by pre-legal and natural events (such as birth and death) ^[35], companies are created andextinguished by a juridical act ^[36]. Therefore, one has to start by ascertaining if the specific legal order allows a company to maintain its legal personality when it transfer s to another country. This is due to the fact that, in the EU, the question is still not harmonized and Member States are free to create their own rules, which are still modelled following two archetypes (although, in practice, most countries use elements from both): the incorporation theory and the real seat theory ^[37]. Only in the first the transfer is admissible.

Cartesio ^[38] drawn a certain parallel between nationality and incorporation of a company ^[39] and stated that a Member State has still thepower to define the criteria that allow a company to maintain its legal personality ^[40]. If the legal order requires that a company has to maintain its real seat inside the country of incorporation, the unavoidable consequenceof its transfer - accepted by EU Law ^[41]- is the loss of legal personality. In practice, the company is forced to wind-up before moving to another Member State, which: i) forces the disposal or realization of the gains , and ; ii) the attached taxation of such gains. Onlywhen the company is able to transfer abroadwithout losing its legal personality as a consequence of the emigration, we can move further in the legal analysis.

On should note, however, that in the current state of affairs, Member States are able to circumvent the CJEU’s orientation on exit taxation: this is done by simply introducingsome changes in their civil and commercial law in order to disallow a company to maintain its legal personality when transferringabroad ^[42].

When the discussion is taken to the tax dimension, it is still possible to have an objection: to argue that the exit tax is not more than a requalification, for tax purposes, of the transfer. Applying a “substance over form” approach one can sustain that moving abroad is the same as liquidating a company . This requires the application of the normal tax consequence attached to the liquidation, i.e.,the levy of a tax on the (accrued) gains obtained till the moment of the transfer. Notwithstanding , this would lead to a discriminatory and unacceptable treatment as ,in this case, no realization takes place and the shareholders also don’t receive any real flow of income ^[43].

If one overcomes these two discussions, then it is possible to start questioning the compatibility of exit taxes with EU Law. And in the field of direct taxation, the settled position of the court is that a national measure cannot introduce an unjustified and disproportionate infringement of the fundamental freedoms ^[44].

The Court’s case law also suggests that acompany transferring to another EU Member State (or EEA State ^[45]) cannot be submitted to any tax burden higher or anticipated, comparing with the burden that a taxpayer making a similar domestic transfer would face ^[46]. Of course, the domestic and the cross-border cases are not entirely comparable, and some specific rules for cross-border cases may be enacted ^[47].

The analysis has to be focused on the effects of the particular levy. In this sense it seemsirrelevant to ascertain if tax is levied when the gains are realized (taking in consideration only those who accrued while the company was resident) or, instead, if the tax is levied at the time of the transfer, on the accrued gains (and , immediately, a deferral is granted till the realization of those assets) ^[48].

Perhaps even more important than the discussion around the compatibility is the one focused on the coordination between Member States ’ policies in this field . In our opinion, both Member States and the Commission (and neither of these parties should just rely in the other) can take active steps to coordinateMember States’ tax systems in order to avoid any cases of double taxation. However, insofar as these situations flow from overlapping rules, they become simple disparities, remaining outside the scope of this study. We will also not deal with the different alternatives to levy those taxes, as it is currently discussed by some commentators or with the question of whether exit taxation may constitute an infringement to tax treaty law ^[49].

5. Corporate Exit Taxes in Portugal

5.1. Introduction

In terms of corporate taxation, there areessentially two situations in which Portuguesemeasures may rise concerns in terms of itscompatibility with EU law. Those are the taxation on unrealized gains: i) when a company transfers its seat and place of effective management abroad; ii) when a PE is transferred to another member State or transfers abroad some of its assets. Problems may also arise due to the immediate taxation of shareholders of the companies that move abroad. This paper will only deal with these specific forms of exit taxation.

In this segment we will: i) ascertain whether it is possible, according with Portuguese law, to transfer a society to another Member State, and ; ii) verify if the measures currently in force are in line with EU Law. In the lastsection we will examine the regime applicable to shareholders of companies that transfer their residence.

5.1. Changing the seat or the place of effective management of company resident in Portugal

From Cartesio, the question of knowing whether a company maintains its legal personality when it moves abroad becomes a logical precursor of all the analysis. This encompasses t w o sets of issues: i) to ascertain whether the law of the Member State that governs the company allows it to move abroad and to continue its existence as such; ii) to know whether the Host Member State’s law allows that comp any to continue to exist .

For the purposes of this paper, we will only focus on the first part of the discussion. Nonethele ss one must bear in mind that even if we conclude that Portugal allows a company to move abroad, it is still necessary to check if the host Member State law (and this depends on the specific MS) allows that company tocontinue exist as such ^[50]. This two-prongedexam will only not be necessary , as already stated, facing SE ’s and SCE ’s ^[51].

The answer seems to be relatively straightforward: “a company with its seat in Portugal may transfer it to another country, maintaining its legal personality, if it is accepted by the law of the other country” - See art. 3 ( 4 ) of the Commercial Societies Code (CSC) ^[52]. Symmetrically, Portugal accepts the transfer of a company governed by the law of another country, p rovided that this other country’s legal system also accepts that tra nsfer. Nonetheless, said company has to adapt its statutes to domestic law.

Therefore, domestic company law creates nobarriers to the transfer of a Portuguesecompany abroad ^[53]. It is possible to transfer the real seat, the effective seat or both. If that other country’s domestic law also accepts the continuity of such a company (recognizing its legal perso nality) we can move forward ^[54] and ascertain the compatibility with EU law ^[55]. For the purposes of the following segments we will assume that, in the case of the transfer of a Portuguese governed company, the host state continues to recognize its legal personality.

5.2. Compatibility with EU Law of the exit taxes on companies

First of all one should note that despite all similarities, the Portuguese exit tax regime is not an implementation of the merger directive ^[56]. While the latter addresses the benefits that some cross-border businessreorganizations may obtain, exit taxes create a levy with is triggered by the transfer of tax residence of a company.

Second of all, and after detailing all the features of the Portuguese exit tax regime, we are now in a position to accurately assess its compatibility with primary EU Law. The answer seems to be quite straightforward: the Portuguese rules, when applicable, lead to an inacceptable infringement of the freedom of establishment. In other words, companies that decide to leave Portugal or to transfer their assets abroad are subject to an immediate taxation, whereas companies which remain in Portugal or transfer their assets domestically are not taxed.

Prima facie, this transfer seems to be under the protection of the freedom of establishment (art. 49 of the Treaty on the Functioning of the European Union – TFUE and art. 31º of the Agreement on the European Economic Area – AEEA ^[57]). As long as the legal personality issues are overcome, the transfer of the company corresponds directly to the exercise of the freedom of establishment . Moreover,the rules at stake constitute an infringement to that freedom, which can be characterized both as a restriction ^[58] and as a discrimination ^[59]. Decisive is the fact that this diff erence in treatment dissuades companies from exercising some features of their freedom of establishment , as transferring their residence outside Portuguese territory ^[60]. The obiter dicta present in de Lasteyrie du Saillant seem to apply perfectly to these cases ^[61].

Obviously, fundamental freedoms are not absolute and one might wonder if the measurecan still be considered admissible, i.e., if itwas enacted to ensure an acceptable justification and is proportional to that aim. In this situation, justifications could be as diverse as the fight against tax evasion and avoidance, the need for an effective fiscal supervision or the need to ensure a balanced allocation of taxation rights. Nevertheless , and regardless of the justifications invoked, one isalmost immediately lead to the conclusion that the Portuguese regime would be considered disproportional.

In fact, the regime is even harsher than the one scrutinized in de Lasteyrie du Saillant as: i) there is no possibility of deferral; ii) it is not possible to take in consideration eventual decreases in value occurred after the exit. Therefore, the assessment moves upstream: we are not accessing if the declaration or the guarantees required at the moment of the deferral are proportional, but if the immediate taxation, as such, is admissible. And the answer is clearly negative.

All the previous mentioned objectives could be ensured with less restrictive measures, while keeping the taxation at the moment of the realization ^[62] (or, equivalently, allowing the taxation at the mom ent of the transfer and establishing a immediate deferral of the collection to the moment when the realization takes place, without imposing disproportionate administrative burdens). The balanced allocation goal would be achieved as Portugal would still be able to tax the gains accrued while the taxpayer was a resident (i.e. before the transfer) ; the fight against tax avoidance and evasion as well as the fiscal supervision would be guaranteed by the combination of a procedural burden (e.g. some declarations) ^[63] with the mechanisms set in force by the directives on mutual assistance in the exchange of information and on the recovery of (tax) claims .

Therefore, a charge like the Portuguese one, which is collected immediately with no possibility of deferral goes way beyond what is necessary to pursue valid justifications and, as a result, is not in line with EU law.

5.3. Compatibility with EU of the tax levied on shareholders

The problems of compatibility with EU law arise a lso at the level of the shareholders. The reasons that we’ve explored in the previous segment are here, with minor adaptations, fully applicable.

It is not admissible to (indirectly) discriminate shareholders (and apply a less favourable tax treatment) on the grounds that the company in which they have a holding has exercised its freedom of establishment and moved abroad.One should take in consideration that the event that leads to the infringement is the transfer of the society – therefore an exercise of the freedom of establishment. It follows that it is not relevant to know if the holding provides is bearer a definite influence ^[64] in the sub judicio company.

Moreover, and in terms of tax policy, it seems hard to justify such a regime. If the taxpayer continues to be a resident, policy wise, it is irrelevant if the company transfers its assets or not: Portugal would still be entitle d to tax eventual capital gains at the moment of its realization, as it happens for domestic situations ^[65]. The transfer of the residence and the eventual changes in the company’s tax regime are irrelevant at the level of the shareholder; what should really matter is hisreal ability to pay, measured by the gain that he eventually obtains with the disposal of shares.

6. Conclusions

The taxation of unrealized gains of a company’s assets due to the transfer of its seat and place of effective management to another country is very recent, and was only introduced by the Portuguese State Budget for 2006. Those rules are currently present in art. 83º to 85 of the PCITC (previously art. 76º-A, 76º-B and 76º-C). There is an undeniable innuendo that the se rules come as an implementation of the directive 2005/19/CE, of 17 of February, which introduced some changes in the merger directive. The measures follow very closely, in it s wording, the rules present in that instrument (as it is more than evident in the remission to the anti-abuse clause of for business restructuration, derived from the merger directive).

In the sense that this regime embraces clauses, concepts and other ter ms that are clearly taken out from secondary EU law, it is quite clear that national tax authorities and courts will have to interpret those provision salong the lines that are se t forth by the CJEU. T he a contrario interpretation of the directive(in which the regime seems to find ground s of legitimacy) is not to be admissible as: i) the directive only provides for partial harmonization and i s not meant to be taken as a comprehensive instrument of legislation (from which an a contrario reasoning could be inferred); ii) even the non-harmonized part is already governed by the fundamental freedoms and, as the court a s established as settled case law, domestic tax measuresinfringing those freedoms, trigger ed by the sole exercise of them, will most likely be considered incompatible with EU law.

Broadly speaking, what the domestic legislator introduced, in current arts. 83º to 85º of the PCITC, was a new tax. This restriction/discriminatory treatment could beassessed under different rule of reason justifications (as the fight against tax evasion and avoidance, th e need to ensure effective fiscal supervision and the balanced allocation of taxing rights). But, in any case, the absence of a deferral feature converts it in a disproportionate measure to achieve any of those goals.

In conclusion, Portuguese rules requiring that unrealized capital gains in respect of a company’s assets must be included in the taxable base of the year, when a Portuguese company transfers its seat and place of effective management to a not her M ember State or, in case a PE of a non-resident entity ceases its activity in Portugal or transfers its assets located in Portugal to another State, whereas unrealized capital gains from purely domestic transactions are not included in the taxable base - is incompatible with EU law.

Besides all the warnings and proposals (namely of the Commission and the Council, through the mentioned Communication and Resolution) Portugal has still not adopted any changes and maintains rules that are , policy wise, difficult to understand, if not simply inadequate. It would be advisable not only to introduce the a fore mentioned changes but also that the Commission, more than expecting a pro-active coordination among member States ^[66] , took a step forward(following the subsidiarity principle) and proposed a binding legal instrument , in order to deter the unintended cases of double taxation that will inevitable persist while an harmonized system in this field is not adopted.

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