Decline of Controlled Foreign Company Rules and Rise of Intellectual Property Boxes: How the European Court of Justice Affects Tax Competition and Economic Distortions in Europe

Abstract

The European Court of Justice (ECJ) has become an influential player in the field of direct taxation in the European Union (EU) in the past 20 years. However, it is unclear whether or not the ECJ's decisions and the corresponding reactions by the member states actually contribute to tax neutrality in economic terms and, therefore, to the achievement of the internal market. In 2006, the ECJ limited the applicability of specific tax rules in the EU that are intended to prohibit the excessive use of low‐tax countries by multinationals. Our counterfactual analysis shows that the court's restriction of so‐called controlled foreign company rules and the related second‐round reactions by some member states – i.e. the introduction of low‐tax regimes for income from acquired intellectual properties (IP boxes for acquired IP) – cast doubt on the seemingly positive effects the ECJ has on reducing tax distortions. In addition, we demonstrate that the restricted applicability of IP boxes as endorsed by the OECD and the European Commission would strengthen tax neutrality in Europe.

Breaking Borders? The European Court of Justice and Internal Market

“…Hence, Estonia is only considered where suitable in the following subsections, as most of the ECJ's case law under consideration in this study would not have any impact. 52 See Bräutigam et al (2017), pp. 722, 732 who further refer to Devereux/Pearson (1995) and Elschner et al (2011).…”

“…For a detailed description and discussion of the case, see, for instance Meussen (2007). 91 See, for instance, references to Ruf/Weichenrieder (2012) and Ruf/Weichenrieder (2013) in Bräutigam et al (2017), pp. 721 f. 92 See Bräutigam et al (2017), p. 722. corporation situated in one Member State invests into a subsidiary located in any other Member State.…”

“…91 See, for instance, references to Ruf/Weichenrieder (2012) and Ruf/Weichenrieder (2013) in Bräutigam et al (2017), pp. 721 f. 92 See Bräutigam et al (2017), p. 722. corporation situated in one Member State invests into a subsidiary located in any other Member State. In terms of a comprehensive analysis, we assume a weighted investment across all five kinds of assets instead of the mere acquisition of a patent.…”

“…9 On the other hand, legal literature analyses the development of European judicature in different fields of tax law. 10 In contrast, evidence on the economic impact of case law on, for example, investment conditions or Member States' location attractiveness is comparatively scarce: 11 For instance, Bräutigam et al (2017) analyse the implications of the ECJ's decision in the Cadbury 1 See Panayi (2010), p. 267. See European Commission (2018) for a list of cases in the field of direct taxation.…”

Corporate Taxes, Patent Shifting, and Anti-avoidance Rules: Empirical Evidence

“…The ECJ decided that, unless such a case can be proven to exist, taxation based on controlled foreign company (CFC) legislation is an infringement to the freedom of establishment. While this ECJ decision was perceived as a substantial weakening of CFC laws in Europe (Bräutigam, Spengel, and Streif 2017), evidence suggests that CFC legislation has still been effective in limiting income-shifting behavior after the ECJ decision (see Clifford 2019). 10.…”