European Union Tax Law

Sources and Limits of EU Tax Competence

The European Union possesses no general competence to legislate in direct taxation. Under the principle of conferral, direct taxation remains within the fiscal sovereignty of the member states. The EU’s role in direct taxation arises indirectly through the fundamental freedoms enshrined in the Treaty on the Functioning of the European Union (TFEU) — the free movement of goods, persons, services, and capital — and through the prohibition of state aid under Article 107 TFEU. National tax measures that discriminate against cross-border activity or restrict the exercise of Treaty freedoms are prohibited unless justified by overriding reasons in the public interest and proportionate. In indirect taxation, the EU possesses direct legislative competence under Articles 110–113 TFEU to harmonise VAT, excise duties, and other turnover taxes. The Court of Justice of the European Union (CJEU) has developed an extensive body of tax jurisprudence, applying the fundamental freedoms to national tax rules and elaborating the justifications for restrictive measures, including the coherence of the tax system (Bachmann, C-204/90), the balanced allocation of taxing rights (Marks & Spencer, C-446/03), and effective fiscal supervision.

Fundamental Freedoms and Direct Taxation

The CJEU’s jurisprudence on direct taxation is extensive. In Avoir Fiscal (C-270/83), the Court held that a member state may not grant tax advantages to resident companies while denying them to branches of non-resident companies, establishing the principle of non-discrimination in corporate taxation. The freedom of establishment (Article 49 TFEU) has been applied to discriminatory exit taxes (Commission v Portugal, C-503/14), dividend withholding taxes on outgoing dividends (Denkavit, C-170/05), and cross-border loss relief (Lidl Belgium, C-414/06). The free movement of capital (Article 63 TFEU) governs inheritance taxes and third-country situations. The CJEU permits restrictions justified by overriding reasons in the public interest, provided they are proportionate and do not constitute arbitrary discrimination. The proportionality requirement is rigorous: less restrictive means must be exhausted before a restrictive measure may stand.

ATAD and ATAD 2

The Anti-Tax Avoidance Directive (ATAD, Directive 2016/1164) and ATAD 2 (Directive 2017/952) represent the most significant EU legislative intervention in direct taxation. ATAD establishes five mandatory anti-avoidance rules applicable to all member states, implementing the OECD BEPS recommendations. The interest limitation rule (Article 4) limits deductible interest to 30% of EBITDA. The exit taxation rule (Article 5) requires the taxation of unrealised gains on assets transferred to third countries, payable in instalments over five years. The general anti-abuse rule (GAAR, Article 6) disregards non-genuine arrangements whose essential purpose is tax avoidance. The controlled foreign company (CFC) rule (Articles 7–8) attributes passive or low-taxed income of controlled foreign entities to the parent company. ATAD 2 addresses hybrid mismatch arrangements (including dual-residence, dual-source, and deduction/non-inclusion mismatches) involving third countries, neutralising tax outcomes where a deduction is allowed in one jurisdiction without corresponding inclusion in another.

Directive on Administrative Cooperation (DAC)

The Directive on Administrative Cooperation (DAC, Directive 2011/16/EU, as amended through DAC 6) establishes the framework for tax information exchange. DAC 1 (2011) replaced the Savings Directive, requiring automatic exchange of certain categories of income. DAC 2 (2014) implemented the Common Reporting Standard (CRS), requiring financial institutions to report account information on tax residents of other member states. DAC 3 (2015) requires automatic exchange of advance cross-border tax rulings. DAC 4 (2016) requires country-by-country reporting by multinational enterprise groups with consolidated revenue above €750 million. DAC 5 (2018) grants tax authorities access to beneficial ownership information held under anti-money laundering rules. DAC 6 (2018) imposes mandatory disclosure of cross-border arrangements meeting specified hallmarks of aggressive tax planning, including the use of loss companies, ring-fenced profits, and standardised tax avoidance structures. Intermediaries (advisers, banks, lawyers) must report hallmarked arrangements within 30 days; failure to report carries significant penalties.

State Aid and Taxation

Article 107 TFEU prohibits state aid that selectively favours certain undertakings, including through tax measures. The European Commission has investigated member state tax rulings conferring selective advantages, most notably in the Apple Ireland case (2016), Starbucks Netherlands (2016), and Fiat Finance Luxembourg (2016). The Commission’s approach requires that tax rulings respect the arm’s length principle and do not deviate from the general tax system without objective justification. Recovery orders require member states to recover illegal state aid plus interest from the beneficiary. The CJEU has refined the state aid analysis in taxation, requiring the Commission to demonstrate selective treatment by reference to a correct application of the national tax system.

VAT Harmonisation

The common system of VAT is governed by the VAT Directive (Directive 2006/112/EC), which requires a standard rate of at least 15%, permits one or two reduced rates of at least 5%, and lists exempt supplies. The place of supply rules were reformed in 2010 for services and in 2022 through the VAT e-commerce package. The definitive VAT regime, proposed as a long-term reform, would apply the destination principle through the One-Stop Shop mechanism, replacing the transitional regime in cross-border business-to-business supplies. The VAT gap — the difference between expected and collected VAT — is a continuing concern, with the Commission pursuing digital reporting and real-time transaction data through ViDA (VAT in the Digital Age) proposals.

Tax Good Governance and External Policy

The EU maintains a list of non-cooperative jurisdictions for tax purposes (the “EU blacklist”), assessed against criteria including tax transparency, fair taxation, and implementation of BEPS minimum standards. The list is updated biannually. The proposed Business in Europe: Framework for Income Taxation (BEFIT) would establish a common corporate tax base with formula apportionment, replacing the separate accounting approach. The proposed Digital Services Tax, pending international consensus through the OECD Inclusive Framework, would impose a 3% levy on revenues from online advertising, digital intermediation, and data transmission.