Freedom of Establishment of Companies in the EU: A Legal Analysis, Study notes of Law

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• Judge / Ministry of Justice DG for EU Affairs.

Free Movement of

Companies within the EU

Ulvi ALTINIŞIK*

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ABBREVIATIONS

Art. : Article CMLRev : Common Market Law Review COM : Commission ECJ : European Court of Justice ECR : European Court Reports eds : Editors EEC : European Economic Community ELJ : European Law Journal ELRev : European Law Review EU : European Union ibid : in the very same place IEA : The Institute of European Affairs. n : note Oup : Oxford University Press para : paragraph paras : paragraphs pp : pages TFEU : Treaty on the Functioning of the European Union UK : United Kingdom vol : volume

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I. Introduction

Freedom of establishment constitutes one of the fundamental principles of the European Union. It plays a crucial role in relation to completion of the inter- nal market with the other freedoms. Due to changes and challenges that have taken place in the global and internal market, freedom of establishment has to be exercised in a more flexible manner than it was in the early stages of the European Communities. In this regard as the cross-border mobility of goods, services, labour, capital increased, the freedom of establishment of companies gained more attention in the EU. [1]^ Especially in the last decade, European company law has evolved significantly with the judicial contribution of the European Court of Justice. This essay aims to assess the extent of freedom of establishment of companies under EU law. To this end I will focus on the free movement rights of companies, such as transfer of seat, setting up branches, subsidies, exceptions to free movement, justifications for restrictive measures, equal treatment of companies, and taxation issues. The rights granted to natural persons are excluded from the scope of the study.

II. The Freedom of Establishment

Under Articles 49 and 54 of TFEU

A. GENERAL SCOPE

Article 49 of TFEU provides that restrictions on the freedom of establishment of nationals of a Member State in another host Member State are prohibited. From the legal persons’ perspective the setting-up of agencies, branches or subsidies in the host Member State is also subject to the same prohibition. The second paragraph of the article states that freedom of establishment includes setting up and managing companies and firms within the meaning of Article 54 of TFEU which provides: “Companies or firms formed in accordance with the law of a Member State and having their registered office, central administration or principal place of business within the Community shall, for the purposes of this chapter [the Chapter on freedom of establishment], be treated in the same way as natural persons who are nationals of Member States. ‘Companies or firms’ means companies or firms constituted under civil or commercial law, including cooperative societies, and other legal persons gov- erned by public or private law, save for those which are non-profit-making.” Article 54 aims to maintain the treatment of companies in the same way as

[1] See M Kiikeri, The Freedom of Establishment in the European Union , Report to the Finnish Ministry of Trade and Industry, 2002, general remarks, 10.

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The supplementing Directive [7]^ on the involvement of employees Art 2(c) contains a definition of “subsidiary”: a “‘subsidiary’ of a company means an undertaking over which that company exercises a dominant influence defined in accordance with Article 3(2) to (7) of Directive 94/45/EC”.[8] The company’s registered office is the place where the company’s offices are located according to its official registration and its statutes. The head office of a company is where the management and main administration are actually situated.[9]

B. FREE MOVEMENT OF COMPANIES Companies or firms are entitled to set up primary and secondary establishments in other Member States. In the event that such activities take place, some specific issues are raised in relation to the nationality of the company, the applicable law that governs the establishment, and the activities of the company. Although repealed Article 293 of EC Treaty provided that Member States shall enter into negotiations concerning retention of legal personality when companies transfer their seats from one Member State to another, there was no existing convention on the basis of repealed Article 293.[10] Basically, there are two conflicting theories trying to find a solution to the question of which law is applicable to a company incorporated in one Member State but has commercial ties with another Member State. The incorporation theory suggests that a company is a creature of the system under which it was incorporated. The system is thus in the most appropriate position to govern the validity of the formation of the company and related issues. It is not possible to change the governing law unless the company is dissolved or set up anew in another Member State. The UK, Ireland, the Netherlands and Denmark hold this theory in their national legal order. [11]^ On the other hand real seat theory recognises that the place of a company’s management, control, real seat or principal place of business determines the applicable law to the company. The continental Member States, namely France, Germany, Spain, Portugal Belgium, Luxembourg, and Greece, adopted this theory.[12]

[7] Council Directive 2001/86/EC of 8 October 2001 supplementing the Statute for a European company with regard to the involvement of employees, OJ L 294 p 22-32. [8] Council Directive 94/45/EC of 22 September 1994, OJ L 254, p 64-72. [9] P. Storm, The Societas Europaea: a new opportunity? (Dirk van Gerven and Paul Storm (eds), The European Company (Vol I 2006)) 5 expressed by C H Dickens, Establishment of the SE Company: An Overview over the Provisions Governing the Formation of the European Company, (2007)EBLR, 1423-1464, 1426. [10] P. Dyrberg, Full Free Movement of Companies in the European Community at last?,(2003)28(4) ELRev 528-534, 529. [11] A. Roussos, Realising the Free Movement of Companies, EBLRev(2001)january/february,8. ; E. Wymeersch, ‘The Transfer of the Company’s Seat in European Community Law’(2003) 40 CMLRev,661-695, 666- 667. [12] İbid.

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In comparison, incorporation theory seems to be in favour of the mobility of companies. Companies can move their principal or management offices to other Member States without the question of re-incorporation in the host country.[13]^ In other words, since the company abides by the law of the coun- try where it was incorporated regardless of its central administration, its legal capacities are recognised by the national legal orders of the host states. [14]^ How- ever, it has been criticised that this may lead to ‘mailbox’ companies where the establishment procedures are simpler and cheaper. This situation may put the interests of employees, creditors, or investors in danger in the host country and increase the competition among Member States. [15]^ On the other hand the real seat theory enables Member States’ control over the foreign companies which have their head offices in their territories. Thus, host countries protect their domestic interests. [16]^ The most criticized side of this theory is that it restricts the free movement of companies by requiring reincorporation of the company in the event that it transfers its main office to the host country. [17]^ Otherwise they lack legal capacity and can not conclude legally binding contracts or take legal actions before courts.[18] In relation to the case-law of the ECJ, it is obvious that the Court held the same opinions regarding the freedom of establishment as in its earlier cases. In Factortame [19]^ it stated that under article 52(now Art 49 TFEU) freedom of establishment covered pursuance of an economic activity through a fixed establishment in another Member State. Following this, in some other cases such as Commission v France, [20]^ Segers [21]^ the Court declared the restrictions on the establishment of the agencies, branches, or subsidies unlawful. [22] Daily Mail[23]^ was an important case with regard to the transfer of the primary establishment of a company from one Member State to another. An investment

[13] Dyrberg(n10)529. for analyses of the theories and conflict of law issues see, R. R.Drury, Migrating companies,(1999) ELRev 24(4), 354-372. [14] Hirt(n5) 1195. [15] Ibid; Dyrberg(n10), 529-530. [16] Ibid.; M. Lauterfeld, ‘Centros and the EC Regulation on Insolvency Proceedings: The End of the ‘Real Seat’ Approach towards Pseudo-foreign Companies in German International Company and Insolvency Law? EBLRev(2001) March/April, 79-88, 79. [17] Hirt(n5), 1196; Roussos(n11), 8;Dyrberg(n10)530. [18] For the situation in Germany see N. Rothe, ‘Freedom of establishment of Legal Persons within the European Union: An analysis of the European Court of Justice Decision in the Überseering Case, American University Law Review, (2004)vol 13, 1104-1141. [19] Case C-221/89[1991]ECRI-3903. [20] Case C-270/83[1986]ECR273. [21] Case 79/85 Segers v. Bedriifsvereniging voor Bank- en Verzekeringsweren, Groothandel en Vrije Beroepen [1986] ECR 2375. [22] Roussos (n 5)9. [23] 81/87 R. v. H.M. Treasury et al., ex parte Daily Mail and General Trust PLC [1988] ECR

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fact, both Danish and British laws approved incorporation theory and Danish authorities referred to Centros Ltd as a foreign company governed by British law. However, it was the domestic legislation that required a minimum amount of capital to be paid. Therefore it had been argued that real seat theory was not affected. [27] The situation was not clarified until the Überseering [28]^ judgment where a Dutch company owned a property in Germany and concluded a contract with the construction company NCC for renovation of the building. However, due to some defects, NCC’s performance was not satisfactory for Überseering. In 1994, all shares of the company were obtained by two German nationals and Überseering transferred its head office and place of management to Germany. Its legal actions against NCC were rejected both in the first and second instance on the basis that Überseering did not have legal capacity in Germany. Under German conflicts of law the legal capacity of a company is determined by the law of the place (real seat theory) where the head office is located. The legal capacity of Überseering was thus subject to German law, which stated that foreign incorporated companies should be reincorporated in Germany in order to acquire legal capacity. Überseering appealed the decisions and the German Supreme Court requested a preliminary ruling from the ECJ in relation to interpretation of the Articles 43 (now Art 49 TFEU) and 48 (now Art 54 TFEU) EC Treaty. The Court pointed out that the host Member State’s denial of legal capac- ity of a company incorporated in another Member State imposed illegitimate restriction on the freedom of establishment. Thus, under articles 43(now Art 49 TFEU) and 48 (now Art.54 TFEU), the host Member State was obliged to recognise the legal capacity and capacity to be a party in legal actions of the company which transferred its seat to its territory.[29] Another significant judgment is the Inspire Art[30]^ in terms of formation of companies, registration and branch. Inspire Art Ltd was incorporated in Britain where its registered office was, and also had a branch in Amsterdam. Under Dutch company law, foreign companies should be registered with an indica- tion that it was a ‘formally foreign company’. Inspire Art was asked to comply with this provision and to use the ‘formally foreign company’ indication in its

Centros Case see also, P. Cunha/P. Cabral, ‘Presumed Innocent’:Companies and the Exercise of the Right of Establishment Under Community Law, (2000) ELRev25(2), 157-164; M. Siems, ‘Convergence, competition, Centros and conflicts of law: European company law in the 21st century’(2002)ELRev 27(1), 47- [27] Lauterfeld,(n16)81. [28] Case C-208/00 Überseering BV v Nordic Construction Company Baumanagement GmbH [2002] ECRI -9919. [29] For further analyses see Rothe(n18), 1123;Hirt (n 5), 1200-1201; Dyrberg(n10), 533-535. [30] Case C-167/01 Inspire Art [2003] ECR I- 10155

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business transactions. However it refused to do so and the conflict was referred to the ECJ by the national Court. In fact, Inspire Art was established in Britain in order to circumvent Dutch company law and take the benefit of the Brit- ish law in relation to minimum capital requirement. Under Dutch company law stricter rules were applied to foreign companies with regard to minimum capital and director’s liability. In relation to the first question the Court stated that the formation of a company for the sole purpose of enjoying the benefit of more favourable legislation did not constitute abuse even if that company conducted its activities entirely or mainly in that second State. [31]Thus, it was stated that application of such national rules on minimum capital and director’s liability constituted restrictions on freedom of establishment under articles 43 (now Art 49 TFEU) and 48 (now Art.54 TFEU).[32] In Centros, Überseering and Inspire Art the Court ruled in favour of incor- poration theory and clarified the abuse theory. In this regard, the establishment of companies, branches, or subsidiaries in another Member State with the aim of benefiting from more favourable provisions does not really constitute circumvention of the domestic legislation of the Member State in question or abuse. That is something permitted and guaranteed within the freedom of establishment, by the Treaty. [33]

C. THE EXCEPTIONS TO THE FREE MOVEMENT OF COMPANIES Exceptions to the freedom of establishment of companies are similar to those applied in goods and services. Basically, there are two types of restrictions: one is Treaty based restrictions and the other is created by caselaw. Article 45 of the EC Treaty provides that provisions on freedom of establish- ment shall not be applied in the case of exercise of official authority. Activities which have direct and specific connection with the exercise of official authority are excluded from freedom of establishment rules.[34]^ Thus, the Court held in Commission v. Spain[35]that activities of private security undertakings and their staff did not constitute exercise of official authority. The Court reiterated the same approach in Commission v. Belgium,[36]^ or that the activities of security firms, security systems firms and internal security services are not normally directly and specifically connected with the exercise of official authority.[37] Article 46 is another provision that grants Member States to derogate from

[31] Para 96. [32] Para 104. [33] For the importance of Inspire Art see, E. Vaccaro, Transfer of Seat and Freedom of Establishment (2005) EBLR, 1348-1365, pp 1356- [34] Case 2/74, Reynes v. Belgian State [1974] ECR 631, [1974] 2 CMLR 305. [35] Case C-114/97, Commission v. Spain [1998] ECR I-6717. [36] Case C-355/98 Commission v. Belgium [2000] ECR I- 1221 [37] Ibid para 26.

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formula. Sevic merged with a company that was incorporated in Luxemburg and then it applied for registration in the commercial register of merger of Germany However the application was rejected on the grounds that German national legislation only provided for mergers between two companies established in Germany. The Court replied that cross-border mergers constituted an exercise of freedom of establishment and rejection of registration was contrary to the Articles 43 (now Art 49 TFEU) and 48(now Art.54 TFEU). The Court then searched for justification and ruled that the national rules could be justified on the basis of protecting the interests of creditors, minority shareholders, employees and preservation of the effectiveness of fiscal supervision and the fairness of commercial transactions. Nevertheless, national law was not proportionate.[44] In some cases the Court accepts that national measures are proportionate, such as in Pfeiffer. [45]^ Pfeiffer was a company operating supermarkets in Austria under the name of Plus Kaufpark. There was another German rival company called Löwa, using the same name ‘Plus’ and running business in the same sector in Austria. Relying on national provisions on unfair competition, Pfeiffer issued a court order restraining Löwa using the same name ‘Plus’. Upon reference, the ECJ declared that such an order against a company established in another Member State was contrary to Article 43 (now Art 49 TFEU). However, since there was a risk of confusion of names, the domestic legislation was justified under the general interest pertaining to the protection of industrial and com- mercial property. [46]^ In this case the Court stressed that issuance of a restraining order did not go beyond the objective aimed by the domestic legal order. [47] It has been established by the caselaw that direct discriminations infringe upon Article 49 and can be saved only by expressed derogations in Article

46. On the other hand indirect discriminations violate Article 43(now Art 49 TFEU), unless they are justified under public interest requirement, that is to say Gebhard formula, and express derogations.[48]

D. EUROPEAN COMPANY (SOCIETAS EUROPAEA-SE) AND RESTRICTIONS ON FREEDOM OF ESTABLISHMENT European company is a form of European public limited liability company which may be established within the Union, in order to maintain companies to transfer their registered office without closing the company or creating a new legal person. [49]^ In other words one of the main objectives in creating the

[44] Ibid Para 28,29,30. [45] C- 255/97 Pfeiffer Grosshandel Gmbh v. Löwa Warenhandel Gmbh [1999] ECR I- [46] İbid para21. [47] İbid para23. [48] Barnard (n2)345. [49] Article 8 of Council Regulation (EC) No 2157/2001 of 8 October 2001 on the Statute for a European company (SE), OJL 294, p 1-21.

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European company is cross-border mobility. Since they shall be located in the same place, transfer of the registered office means transfer of the head office as well. Roughly, in Article 8 of the Regulation it is stated that transfer process shall not be completed without a transfer proposal, publication, a justificatory report, a two-month transition period, a general meeting approval, protection of creditors and possibly minority shareholders, and certificate and subsequent registration in the new Member State, followed by publication again. As one can easily predict, although it is created for cross-border mobility of the companies the transfer procedure seems time consuming and cumbersome.[50] Moreover, there are several obstacles which have a potential to violate freedom of establishment, namely the protection of minority shareholders who oppose the transfer, the two-month period where no decision on transfer may be taken, the requirement for a certificate attesting the transfer, and opposition to the transferral on grounds of public interest.[51] There is another significant provision of the Regulation which may con- stitute an obstacle for freedom of establishment. Under Article 7 a company can not transfer its registered office to another Member State while leaving its head office in the first Member State or vice versa. This restricts freedom of establishment in relation to companies that want to benefit from the domestic rules of a Member state by establishing their head office in that Member State without transferring their registered office. [52] Under Article 230 EC (now Art. 263 TFEU), since the Regulation can not be in contradiction with the Treaty provisions on freedom of establishment, it shall be partly annulled by the ECJ. [53]

IV. Equal Treatment, Taxation, And Beyond

A. Equal Treatment Articles 49 and 54 of TFEU foresee that once a company has established itself or a branch in the host Member State then it must enjoy the same terms and conditions, benefits and social advantages available to national companies. In Commission v Italy [54], Italian legislation authorized the State to conclude contracts in some sectors of public activity, such as taxation, health and agri- culture, only with the companies in which all or the majority of the shares were

[50] Dickens(n9)1462. [51] Article 8(5)(6)(8)(14) of the Regulation. [52] Wymeersch(n 11), 692;ibid 1462-1463; for transfer of seat of SE see M. G.Riestra, ‘The Transfer of Seat of the European Company v Free Establishment Case-Law’ (2004) EBLRev.1295-1323, 1306 and onwards. [53] Dickens(n9) 1463. [54] Case C-3/88[1989]ECR4035.

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However, it should be stressed that not all differences of treatment are incom- patible with the freedom of establishment. In taxation there is a distinction based on resident and non resident companies which falls outside the scope of the discrimination provisions. Generally speaking, resident companies are liable to tax on all their worldwide income where as non-resident companies are just liable for the profits saved in the host Member State in question. [61] This approach is also adopted by the Court in Futura Participations[62]. There are several examples concerning tax restrictions imposed by Member States on companies whose registered office is in that state, whereas its subsidies or branches are located in other Member States. For example, in Commission v France[63]^ France granted tax credits to insurance companies whose registered office was in France, but not to those with registered offices in another Member State. The Court decided that traders are at liberty to choose appropriate legal form in which to pursue their activities in another Member State and that freedom of choice must not be limited by discriminatory tax provisions.[64] Therefore domestic legislation breached Article 43(now Art. 49 TFEU) and could not be justified on the facts. The ECJ used the formula based on the removal of hindrances, obstacles or restrictions to the freedom of establishment. One can observe this in Futura Participations. Luxembourg tax law required that if the branch of a company wanted to take tax benefits, it had to keep two accounts: one in Luxembourg and the other one in the Member State where it had its seat. The Court said that the rule constituted restriction to freedom of establishment and was con- trary to Article 43(now Art.49 TFEU). Although the rule was justifiable on the grounds of ensuring effectiveness of fiscal supervision, the Court found that the rule was not proportionate.[65] Marks and Spencer[66]^ was another high-profile case subject to restriction analysis. Under British tax law, resident companies in a group granted the right to offset their profits and losses among themselves. M&S declared that it had ceased trading in continental Europe due to losses of its subsidies there and asked for group relief in the UK. The claims for relief were rejected on the ground that group relief could only be granted for losses recorded in the UK. The Court ruled that any domestic legislation preventing a parent company

[61] N. Travers, ‘Residence Restraints on The Transferability of Corporate Trading Losses And The Right of Establishment in Community Law’, Case Comment(1999)ELRrev24(4),403- 409,44;Barnard(n2) 347. [62] C-250/95 Futura Paticipations SA et al. v. Administation des Contributions[1997] ECR I-2471. [63] Case 270/83 Commission of the European Communities v French Republic.[1986] ECR [64] Para 22. [65] (n51). [66] Case C-446/03 Marks &Spencer Plc v Halsey [2005]ECRI-10837.

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from deducting losses—which were incurred in another Member State by its subsidiary—from its taxable profits which were compatible with the Community law. Nevertheless, if the parent company proved that those losses were not or could not be taken into account in the state of residence of those subsidiaries, it was contrary to the freedom of establishment to preclude a group relief for the parent company. The Court then considered whether the restrictions could be justified, and noted that the facts were justified in terms of public interest. However, restrictive provisions failed in a proportionality test. The Court has established that Member States may treat companies differently in relation to cross border tax issues as far as they can prove it to be justified and proportionate. In this regard, prevention of tax avoidance and preventing companies from enjoying the same tax advantage twice may be accepted as legitimate objectives. However, they are subject to critical observation whether they are necessary and proportionate. [67]

[67] Craig/Burca(n2)812.

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