Part1、A landmark ruling—the Manninen Case

　　1．Background

　　In 1990 Finland introduced an imputation tax credit system in relation to dividends distributed by companies resident in Finland. This means that a Finnish resident shareholder who receives dividends from a Finnish company has received an imputation tax credit equal to the tax paid by the relevant company on the income it has distributed. The imputation tax credit is offset against the tax payable by the shareholder on the dividend.

　　And this means that the dividend is effectively tax-free. But the tax credit has not been available to non-resident shareholders in almost all cases. It has also been unavailable to Finnish shareholders on dividends arising from non-residents, although it should be noted that the Finnish Parliament has now decided to abolish the system from the beginning

　　2． Facts

　　Mr. Manninen, a Finnish national who is tax resident in Finland, owned 2,000 shares in a quoted Swedish company. He applied for a binding advance ruling from the Central Board of taxation asking if his dividends from these shares should be taxed in Finland when Articles 56 and 58 of the EC treaty are taken into account. When the central board of taxation ruled that Mr. Manninen was not entitled to the imputation credit, he appealed to the Supreme Administrative Court (Korkein Hallintooikeus, KHO), which referred the case to the ECJ for a preliminary ruling. The profits of the distributing had already borne corporation tax in Sweden (tax rate 28% in 2001). The dividends distributed to Mr. Manninen were also subjected to withholding tax in Sweden at the rate of 15%, in accordance with Article 10 of the Nordic Multilateral Tax Convention. Dividends distributed by foreign publicly-listed companies to a Finnish recipient do not benefit from imputation credit in Finland and are subject, as capital income, to income tax at the flat rate of 29%. Dividends received from non-listed companies are currently dividend for tax purposes between capital income and earned income. (Earned income is taxed at a progressive rate, up to 60%).

　　3．The Treaty provisions

　　Article 56(1) EC provides that all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited. But art. 58(1) (a) EC is derogation from that fundamental principle. It says that the provisions of art. 56 EC shall be without prejudice to the right of member states to:

　　(a) apply the provisions of their tax law which distinguish between taxpayers who are not in the same situation with regard to their place of residence, or with regard to the place where the capital is invested; and

　　(b) to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation.

　　However, art. 58(3) EC limits that derogation considerably by requiring a strict interpretation. This means art. 58(1) EC cannot be seen by taxing authorities as a convenient device to make tax legislation (that distinguishes between taxpayers by reference to the place where they invest their capital) automatically complies with the Treaty.

　　4．The judgment

　　（1）、The ECJ ruled in favor of Mr. Mannien, stating that Finnish tax legislation constitutes a restriction on the free movement of capital, which is, in principle, prohibited by Article 56 EC. Profits distributed by Finnish companies were subject to corporation tax and the shareholders also should pay individual income tax when receiving the dividend, but to avoid double taxation the shareholders were granted a tax credit in the same amount as their income tax liability, which was set off against it, with the net result that the only tax paid was the company's corporation tax.

　　Dividends received by the shareholders from companies outside Finland were also subject to income tax, with no equivalent tax credit. The claimant, who thus had to pay income tax on dividends received by a Swedish company in which he had shares, complained that the difference in treatment infringed arts 56 and 58 EC, and the matter was referred to the Court of Justice for a preliminary ruling. In other words, Finnish tax law is effectively deterring fully taxable persons in Finland from investing their capital in companies established in another member state. The law is also unfair to companies established in other member states, making it harder for them to raise capital in Finland.

　　The court stated that the calculation of a tax credit granted to a shareholder fully taxable in Finland must take account of the tax actually paid by the Sweden company, as calculated under Sweden tax legislation applying the Sweden corporate income tax rate. Possible difficulties in determining the tax actually paid cannot, in any event, justify an obstacle to the free movement of capital. Nor could discrimination be justified on the grounds of maintaining the cohesion of the national tax system.

　　The court said that the imputation system Finland adopted was apt to deter Finnish investors from investing in other countries, and companies in other member states from seeking to raise capital in Finland, and the relevant legislation was therefore in principle contrary to art 56. Art 58(1)(a) was to be interpreted restrictively, and, regard also being had to art 58(3), did not mean that all legislation that made distinctions by reference to the place of investment of capital was compatible with art 56. It could do so if it dealt with situations that were not comparable, but in the present case the situations of shareholders receiving dividends from Finnish and non-Finnish companies, respectively, were comparable, as in both cases the dividends were at risk of double taxation. Further, the unequal treatment could not be justified by the need to maintain the cohesion of the tax system, as even if there was the necessary link between a tax advantage and a countervailing tax deduction, it was disproportionate as the granting to the claimant of a tax credit to offset the corporation tax payable in Sweden would be less restrictive of the free movement of capital.

　　（2）、The case was seen from an early stage as being of wider importance than simply a question of Finnish domestic tax law. This is clear from the fact that in addition to Mr. Manninen himself, and understandably the Finnish Government, both the governments of Britain and France made representations in the proceedings.

　　One of the first points to be noted by the ECJ was that although direct taxation is within the competency of member states, they must exercise that competency consistently with Community law The ECJ also noted that although the relevant Finnish tax rules were designed to prevent double taxation of company profits, the tax convention agreed between the States of the Nordic Council is not capable of eliminating unfavorable tax treatment. In the light of this, the ECJ found that fully taxable persons in Finland were deterred from investing their capital in companies established in other member states.

　　They went on to find that companies established in other member countries were faced with an obstacle in the form of the relevant Finnish legislation, that affected their ability and willingness to raise capital in Finland because their shares would be less attractive to Finnish investors than the shares of companies established in Finland.

　　The ECJ then went on to consider these findings in the light of the two articles, and concluded that the Finnish law did contravene art. 56 EC in principle. But, as we have seen, it was required to see if the restriction could be justified under art. 58(1)(a) EC.

　　The Finnish, British, and French Governments argued that art. 58(1)(a) EC:

　　‘clearly shows that Member States are entitled to reserve the benefit of the tax credit for dividends paid by companies established in their territory’.

　　The question here was the distinction between unequal treatments allowed under art. 58(1)(a) EC and ‘arbitrary discrimination’illegal under art. 58(3) EC. The three governments claimed that the dividends paid by Finnish companies were fundamentally different in character from those paid by non-Finnish companies because the profits distributed in the form of dividends paid to fully taxable persons in Finland by Finnish companies were subject to Finnish CT and the consequential tax credit, whereas the companies established in other member states were not. In addition, the French Government claimed that Finnish tax laws conformed to the principle of ‘territoriality’。

　　The Finnish, British and French Governments also claimed that the relevant legislation was objectively justified to maintain the cohesion of the Finnish tax system。The Finnish and British Governments claimed various practical obstacles such as the impossibility of granting tax credits in one member state to taxpayers resident in another member state.

　　However, these assertions were rejected by the ECJ. It said that the answer to the question referred to it must be that art. 56 EC and art 58 EC:

　　‘preclude legislation whereby the entitlement of a person fully taxable in one Member State to a tax credit in relation to dividends paid to him by limited companies is excluded where those companies are not established in that State’.

　　Thus, the ECJ found for the taxpayer, showing that it was willing to reject again the coherence defense (successfully used by the Belgian Government in the early nineties) in Bachmann. It also rejected the assertions of territoriality made by France and the practical difficulties put forward by Finland and Britain.

　　Part2、The future of the imputation system seen from the case

　　The imputation system is a way to relieve the economical double taxation when dealing with portfolios investment. It allows corporate tax entities, which pay corporate tax, to pass on to their shareholders a credit for income tax paid on profits, when distributing those profits. Under imputation credit system, although shareholders are taxed on the full amount of the profit represented by their dividend distribution, they are allowed credit for the tax already paid by the corporate entity. This prevents double taxation, that is, the taxation of company profits when earned by a company, and again when a shareholder receives a dividend. There are two kinds of imputation system: full imputation credit system and partial imputation credit system. Full imputation credit system means all the mount the companies pay in the form of company tax can all be credited when distributing dividends. Respectively, partial imputation credit system means only part of the company tax that are collected can be credited, the uncredited part is called mainstream tax.

　　Many countries have some form of imputation tax system that credits some proportion of company tax against personal tax liabilities. There are only a handful of OECD countries still applying the classical tax system, with the USA the most noteworthy. However, the USA is known to be considering introducing some form of crediting system.

　　Under the imputation tax system, the much of the money collected as "company tax" is really a withholding of personal tax. If shareholders could access all company tax payments as imputation credits and all such credits could be redeemed as pre-payment of personal tax liabilities, then there would be no company tax. The only tax liability would be the personal tax liability. In practice, this extreme case of zero company tax is not achieved. Not all company tax payments are distributed as credits and of those credits that are distributed, not all can be utilized by the recipients. Companies rarely have a policy of 100% payout of earnings so some credits are not accessible by shareholders.

　　The imputation system, we should say, is a very clever invention by France. There are three points for this. Firstly, it can really relieve the economical double taxation. The companies pay CIT (company income tax) at a higher rate first, but part of them is paid for the shareholders when they distribute dividends as they can be credited by the shareholders from the government. Secondly, what the shareholders really care is that how much dividends they can earn from the companies after paying the IIT (individual income tax). Under the Imputation system, the shareholders pay little IIT for the dividends they received though the companies pay higher CIT-----that is not their matter. Thus the investors have more incentive to invest and the companies’ stocks have more charming because the companies sacrifice their own interest for their investors psychologically and practically. Thirdly, there are some taxation competitions among country authorities. The Imputation system provides more chances and room for the cooperation among countries as the tax credit is generally only enjoyed by the dweller taxpayers. When countries engage in discussion in concluding tax conventions, they often put their eyes on the Imputation rate the other country can offer. If the country adapts another credit system other than Imputation credit system, it surely has nothing to offer. Thus the country will be in an inferior status in the negotiation. That is why Germany changes from its precious split-rate system to split-rate+Imputation system in 2000.

　　However, the Imputation system also faces many challenges. The first challenge is discrimination. Because Imputation credit is generally used on its dweller taxpayers while the foreign shareholders cannot enjoy benefits from it. As a result, as we see in the Manninen case, it is complained to defer the free movement of capital under EC law. Thus many countries have already abandoned the Imputation system under the pressure of EC law. Another complaint it receives is that the government may rob the profits of the companies since the Imputation credit can only be enjoyed only the companies distribute dividends. But in practice, nearly no companies distribute 100% of their income, so the additional interest is occupied by the government. Thirdly, the judicial double taxation issue may be reproduced because of the Imputation system. Countries often adapt tax exemption method or tax credit method to relieve judicial double taxation. Assume that one company wants to distribute profits more than the total income it earned domestically, it has to use the income it earned from foreign branches or subsidiaries. Then the government has to collect CIT on the foreign income, otherwise it won’t pay because it did not collect the tax from the foreign income. Then the judicial double taxation is reproduced. In a word, the Imputation system may be too perfect to be applied in the real practice.

　　Especially, as mentioned in Manninen case, the ECJ are akin to hold negative opinion on the Imputation system from the free movement of the capital and its final aim---- establishment of the united European market. The future of the Imputation system may be not very bright.