The European Court of Justice has ruled that EU states are allowed to restrict companies transferring income from one state to another in order to pay lower taxes.
The ruling could have implications for companies which establish operations in Ireland to take advantage of the 12.5% corporate tax rate, which is much lower than other EU countries.
In a ruling on a Finnish case, the European Court of Justice in Luxembourg decided that states can refuse to accept as tax-deductible expenses the transfer of income from a subsidiary in one state to a parent company in another state.
The court ruled that allowing companies total freedom to decide where profits would be taxed would undermine the system of the allocation of the power to tax between member states.
The court said such freedom would force states to renounce their power to tax company profits in favour of another state.
Such a situation would encourage what it called 'purely artificial arrangements' in which groups of companies would set up head offices in states that apply the lowest tax rates.
On this basis the court ruled that the Finnish government was entitled to introduce a law that gave Finnish-based subsidiaries of foreign companies less favourable tax treatment than Finnish-based subsidiaries of Finnish-based parent companies.
The German government has long complained that German companies are establishing treasury operations in the IFSC in Dublin in order to pay lower taxes.
The British government recently took an unsuccessful case against Cadbury-Schweppes for running its treasury operations through an IFSC company.
The European Commission aims to introduce draft legislation next year on the establishment of a common corporate tax base.
This would give companies doing business in several EU states the possiblilty of using a single method of calculating taxable income across their companies.
But states would retain the power to decide at what rate such income is taxed. The commission proposal also contains plans to apportion income liable for tax to the states where the economic activity takes place, rather than the state where the group is headquartered.
