Progressive turnover taxes are not contrary to the freedom of establishment or the right of equal treatment.
Recent cases involving “turnover” taxes have sparked a debate in the literature and on the conference circuit not only because they raise novel issues but also because of their implications for other taxes which are being mooted by European governments. As Advocate-General Kokott put it in the opening sentence of her opinion of 13 June 2019 on Hungarian turnover taxes, “in these proceedings the Court is concerned with questions relating to tax law and the rules on State aid which at the same time have particular importance for the turnover-based digital services tax currently being proposed by the European Commission.” [The Commission proposed in March 2018 a directive on “the common system of a digital services tax on revenues resulting from the provision of certain digital services”].
However, in its judgment of 3 March 2020, in case C 75/18, Vodafone Magyarország Mobil Távközlési v Nemzeti Adó- és Vámhivatal Fellebbviteli Igazgatósága [Resources Directorate of the National Tax and Customs Administration, Hungary], the Court of Justice did not make any mention of digital taxes.1 But sooner or later it will be confronted with it.
The present case arose from a request for a preliminary ruling by a Hungarian court which was asked to adjudicate in a dispute between Vodafone’s Hungarian subsidiary and the Hungarian tax authorities.
The dispute concerned issues that went beyond the scope of State aid and centred on the interpretation of Articles 49 TFEU [freedom of establishment] & 54 TFEU [equal treatment] and of Article 401 of Directive 2006/112 [VAT directive]. At the core of the dispute was the payment of a special tax on turnover in the telecoms sector.
According to the documents before the Court, the intention of the Hungarian legislature was to raise revenue, not to penalise telecommunications activities. As quoted in the judgment, “(4) in the context of the correction of budgetary balance, the Parliament enacts this law on the establishment of a special tax imposed on taxpayers whose ability to contribute to the costs of public expenditure exceeds the general obligation to pay tax.”
The taxable amount was the “net turnover” of the taxable person resulting from telecom activities. According to the 2000 Accounting Act of Hungary, the net turnover is the net trading income or the net sales revenue. This is the gross revenue from sales minus refunds, discounts and other adjustments such as for returned items.
The applicable tax bands and rates were as follows:
HUF 0 – 500 million: 0%
HUF 500 million – 5 billion: 4.5%
Over HUF 5 billion: 6.5%
Vodafone’s view was that the special tax constituted prohibited State aid for those paying a lower rate of tax and was also contrary to Article 401 of the VAT Directive.
Is a tax illegal because an exemption from or reduction of the tax may be State aid?
Often undertakings refuse to pay a tax on the grounds that an exemption from the tax involves State aid for other undertakings. This argument is successful only when the tax is hypothecated to an aid measure. Hypothecation means that all the tax revenue goes to finance the aid and all of the budget of the aid measure is financed by the tax revenue. In the case of the Hungarian telecoms tax, of course, there was no hypothecation because even if the lower rates could be considered to be State aid, they were not “financed” by the higher rates.
Not surprisingly, both the Hungarian government and the Commission pointed out that “(18) those liable to pay a tax cannot rely on the argument that the exemption enjoyed by other persons constitutes unlawful State aid in order to avoid payment of that tax”. Then they asked the Court of Justice to declare as inadmissible a question from the referring Hungarian court whether higher tax rates implied prohibited State aid for those subject to lower tax rates.
First, the Court of Justice recalled that “(19) Article 108(3) TFEU establishes a prior control of plans to grant new aid. The aim of that system of prior control is therefore that only compatible aid may be implemented. In order to achieve that aim, the implementation of planned aid is to be deferred until doubt as to its compatibility is resolved by the Commission’s final decision”.
“(21) Whilst an assessment of the compatibility of aid measures with the internal market falls within the exclusive competence of the Commission, […], it is for the national courts to ensure the safeguarding, until the final decision of the Commission, of the rights of individuals faced with a possible breach by State authorities of the prohibition laid down by Article 108(3) TFEU”.
“(23) National courts must offer to individuals the certainty that all appropriate action will be taken, in accordance with their national law, to address the consequences of an infringement of the last sentence of Article 108(3) TFEU, as regards both the validity of measures giving effect to the aid and the recovery of financial support granted in disregard of that provision and possible interim measures”.
“(24) The Court has, however, also held that if, having regard to the rules of EU law in relation to State aid, an exemption from a tax is unlawful, that is not capable of affecting the lawfulness of the actual charging of that tax, so that a person liable to pay that tax cannot rely on the argument that the exemption enjoyed by other persons constitutes State aid in order to avoid payment of that tax”.
“(25) The position is however different where the dispute in the main proceedings concerns not an application to be exempted from the contested tax, but the legality of the rules relating to that tax as a matter of EU law”.
“(26) Further, the Court has consistently held that taxes do not fall within the scope of the provisions of the FEU Treaty concerning State aid, unless they constitute the means of financing an aid measure, so that they form an integral part of that measure. Where the method of financing aid by means of a tax forms an integral part of the aid measure, the consequences of a failure by national authorities to comply with the last sentence of Article 108(3) TFEU must also apply to that aspect of the aid, so that the national authorities are required, in principle, to repay taxes levied in breach of EU law”.
“(27) In that regard, it must be recalled that, for a tax to be regarded as forming an integral part of an aid measure, it must be hypothecated to the aid measure under the relevant national rules, in the sense that the revenue from the tax is necessarily allocated for the financing of the aid and has a direct impact on the amount of that aid”.
“(28) Accordingly, if a tax is not hypothecated to an aid measure, the possible unlawfulness of the aid measure contested under EU law is not capable of affecting the lawfulness of the tax itself, and consequently the undertakings who are liable to pay that tax cannot rely on the argument that the tax measure for which other persons qualify constitutes State aid in order to avoid payment of that tax or to obtain a repayment of tax paid”.
In this case, the Court of Justice found that “(30) even if the de facto exemption from the special tax for which some taxable persons qualify may be classified as State aid, within the meaning of Article 107(1) TFEU, that tax is not hypothecated to the exemption measure at issue in the main proceedings.”
“(31) It follows that any illegality under EU law of the de facto exemption from the special tax for which some taxable persons qualify is not capable of affecting the legality of that tax itself, so that Vodafone cannot rely, before the national courts, on the unlawfulness of that exemption in order to avoid payment of that tax or to obtain repayment of tax paid.” “(32) It follows from all the foregoing that the second question is inadmissible.”
The Court then went on to examine the applicability of Articles 49 and 54 TFEU and did not analyse further the applicability of Article 107 and 108 TFEU.
Freedom of establishment and the right of equal treatment
The referring court asked whether Article 49 TFEU on freedom of establishment and Article 54 TFEU on equal treatment precluded turnover taxes which were steeply progressive and, as a result, undertakings from other Member States bore most of the burden of the tax.
The Court of Justice, first, recalled the relevant principles from the case law. Freedom of establishment means that any discrimination on the basis of where companies are headquartered or registered is prohibited. This prohibition covers both overt and covert discrimination.
Then the Court observed that the special tax on telecoms made no distinction between undertakings according to the location of their registered office.
However, Vodafone and the Commission claimed that the progressivity of the special tax, which had three bands with the corresponding rates of 0%, 4.5% and 6.5%, favoured Hungarian companies and disadvantaged foreign companies. Indeed according to actual data, all the companies that fell under the 0% rate in the first band were Hungarian while those under the two higher rates in the other two bands were mostly foreign, which resulted in a much higher share of the tax revenue paid by foreign companies.
The response of the Court of Justice was that “(49) Member States are free, …, to establish the system of taxation that they deem the most appropriate, and consequently the application of progressive taxation falls within the discretion of each Member State”.
“(50) In that context, and contrary to what is maintained by the Commission, progressive taxation may be based on turnover, since, on the one hand, the amount of turnover constitutes a criterion of differentiation that is neutral and, on the other, turnover constitutes a relevant indicator of a taxable person’s ability to pay.” [Emphasis added]
“(51) In this case, it is apparent …, that, by means of the application of a progressive scale based on turnover, the aim of that law is to impose a tax on taxable persons who have an ability to pay ‘that exceeds the general obligation to pay tax’.” [Emphasis added]
It is not clear what “the general obligation to pay tax” may mean, what benchmark of comparison it implies and whether it refers to the first tax band with its tax rate of 0%.
The Court further explained that “(52) the fact that the greater part of such a special tax is borne by taxable persons [from] other Member States cannot be such as to merit, by itself, categorisation as discrimination. … Accordingly, that situation is an indicator that is fortuitous, if not a matter of chance”. [Emphasis added]
“(53) It must be observed, moreover, that the basic band of tax charged at 0% does not exclusively affect taxable persons owned by Hungarian natural persons or legal persons, since, as in any system of progressive taxation, any undertaking operating on the market concerned has the benefit of the reduction for the proportion of its turnover that does not exceed the maximum amount of that band.”
The Court of Justice ended its analysis with the finding that “(56) Articles 49 and 54 TFEU must be interpreted as not precluding the legislation of a Member State that establishes a progressive tax on turnover, the actual burden of which is mainly borne by undertakings controlled directly or indirectly by nationals of other Member States or by companies that have their registered office in another Member State, due to the fact that those undertakings achieve the highest turnover in the market concerned.”
In the rest of the judgment the Court considered whether the Hungarian turnover tax was contrary to Article 401 of the VAT Directive and concluded that it was not. A turnover tax is not a value-added tax primarily because it is not levied at all the stages of a production and input tax is not deducted from output tax.
Two other related judgments
On the same day, the Court of Justice rendered its judgment in another but similar case: C 323/18, Tesco-Global Áruházak v Nemzeti Adó- és Vámhivatal Fellebbviteli Igazgatósága.2
Tesco, a UK supermarket with shops in Hungary, challenged a progressive turnover tax, this time in the retail sector. The tax was structured as follows:
HUF 0 – 500 million: 0%
HUF 500 million – HUF 30 billion: 0.1%
HUF 30 billion – HUF 100 billion: 0.4%
Over HUF 100 billion: 2.5%
Again the tax was mostly borne by foreign companies. Nonetheless, the Court of Justice, using identical language to its ruling on Vodafone concluded that the turnover tax with fourth bands and with rates ranging from 0% to 2.5% levied on retail companies was not contrary to Articles 49 and 54 TFEU. “(69) Member States are free, […], to establish the system of taxation that they deem the most appropriate, and consequently the application of progressive taxation falls within the discretion of each Member State”. “(70) Progressive taxation may be based on turnover, since, on the one hand, the amount of turnover constitutes a criterion of differentiation that is neutral and, on the other, turnover constitutes a relevant indicator of a taxable person’s ability to pay.” “(71) In this case, it is apparent […], that, by means of the application of a steeply progressive scale based on turnover, the aim of that law is to impose a tax on taxable persons who have an ability to pay ‘that exceeds the general obligation to pay tax’.”
C 482/18, Google Ireland v Nemzeti Adó- és Vámhivatal Kiemelt Adó- és Vámigazgatósága.3 In this case which concerned a turnover tax on advertising, Google’s Irish subsidiary was fined by the Hungarian authorities a total amount of EUR 3.1 million for not registering with the tax authorities and for failing to declare advertising income it had generated in Hungary. The fine of EUR 3.1 million was the sum of five different fines that were imposed by the Hungarian authorities on five consecutive days.
The Court of Justice found that Hungary had the right to require registration of non-local advertisers and impose fines but the imposition of steeply increasing fines without giving sufficient time to Google to respond or comply was a breach of Article 56 TFEU on freedom to provide services. The fines were disproportional to the seriousness of the failure to comply.
Are turnover taxes here to stay?
We now have three new judgments on three different turnover taxes: telecoms, retail and advertising. In May and June 2019 the General Court annulled two decisions of the Commission which had found that a Polish retail tax and a Hungarian advertising tax constituted incompatible State aid [Poland v Commission, joined cases T-836/16 and T-624/17; and Hungary v Commission, T-20/17; respectively]. The 2019 judgments together with the present cases have cemented, what I think is a false notion that progressive turnover taxes are linked to ability to pay. Nonetheless, there is still a chance that the Court of Justice may change tack because the appeals of the Commission are still pending [cases C-562/19 P and C-596/19 P, respectively].
It may be true as a general statement, that, because of economies of scale, larger companies make more profit per unit of output than smaller companies and, therefore, they have more disposable resources to support the common good. But it does not follow that every large company makes more profit than every small company.
More seriously, EU courts have reached the false conclusion that larger turnover is linked to greater ability to pay because they compare small and large companies. If they compare companies of equal size in terms of turnover, then there can be no presumption at all that they all have the same ability to pay in terms of disposable resources. Some companies have higher costs than others, perhaps because their business model emphasises quality over price. Also when companies undertake investments that are financed through debt, their disposable resources decline. Therefore, a turnover tax discriminates against companies of equal size with higher costs and with higher investment expenditure. By contrast, a profit tax is neutral.
It is very revealing and very relevant that the Court of Justice used the words “fortuitous” and “chance” to explain that the turnover tax did not inherently discriminate against foreign companies. Since, however, a turnover tax is inherently discriminatory against companies with higher costs and companies that undertake investments, its impact is neither fortuitous, nor a matter of chance. The Court of Justice said in the landmark Gibraltar case [C-106/09 P, Commission v Gibraltar] that the favourable treatment of offshore companies by the tax system of Gibraltar was selective because it was not a random outcome but the inevitable consequence of its design. Similarly, the impact of turnover taxes is different from the normal functioning of the tax system where those who incur higher costs can deduct them from their taxable income, the tax deduction is strictly proportional to the amount of costs and it is impossible to predict which firms will benefit. Turnover taxes inherently discriminate against companies with higher costs for the same amount of turnover.
Not only is this predictable consequence of turnover taxes selective in nature, their progressive element also constitutes a barrier to entry that in practice discriminates against foreign companies. It is far more likely that when a foreign company enters the retail market of another Member State it is a large company through large investments [see, for example, the recent cross-border expansion of Aldi, Lidl, Carrefour, Tesco]. When a domestic company enters the domestic retail market it is much more likely to be small. Small companies, however, are not harmed by the turnover tax because the starting rate is zero.
A turnover tax cannot be justified by the internal logic or economy of the tax system because there is a mismatch between the objective of the tax which is “imposed on taxpayers whose ability to contribute to the costs of public expenditure exceeds the general obligation to pay tax” and the application of the tax itself.
The only justification for turnover taxes is that they target a harmful activity whose negative effect on society or individuals is directly proportional to the volume of the activity. I hasten to add that the various proposals for digital taxes may also be justified on the grounds that there is no other way to tax companies which are not resident in the country that levies the tax. But this is an issue of how to prevent tax avoidance and aggressive tax planning rather than whether in principle turnover taxes are linked to ability to pay.
Two conclusions may be drawn. First, the turnover taxes that have been the subject of court cases so far contradict their declared objectives of collecting revenue according to taxpayers ability to pay. Second, the impact of turnover taxes is not neutral or fortuitous. They systematically discriminate against companies that undertake investments and market entrants.
http://curia.europa.eu/juris/document/document.jsf?text=&docid=223985&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=175683.  The full text of the judgment can be accessed at:
http://curia.europa.eu/juris/document/document.jsf?text=&docid=223984&pageIndex=0&doclang=EN&mode=lst&dir=&occ=first&part=1&cid=194022.  The full text of the judgment can be accessed at:
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