News Analysis: ECJ Sorts Out Deductibility of University Fees

Volume 58, Number 11 June 14, 2010 News Analysis: ECJ Sorts Out Deductibility of University Fees by Tom O Shea Reprinted from Tax Notes Int l, June 14, 2010, p. 870

Reprinted from Tax Notes Int l, June 14, 2010, p. 870 News Analysis: ECJ Sorts Out Deductibility of University Fees In Emiliano Zanotti v. Agenzia delle Entrate Ufficio Roma 2 (Case C-56/09), the European Court of Justice examined Italian tax deduction rules that denied Italian residents tax deductions (or imposed limits on them) for attending educational courses in EU member states other than Italy. Zanotti complained that such tax treatment breached his right to obtain services in another member state and his EU citizenship right to move to another member state, because the Italian authorities denied him a tax deduction for attending an international tax law course in the Netherlands. The Court determined that the denial of deductions for university courses attended outside Italy was in breach of both the freedom to provide services in article 49 of the EC Treaty and the free movement rights of EU citizens contained in article 18 of the EC Treaty in situations when such tax deductions were granted for courses attended in Italy. Background In 2003, Zanotti, a tax lawyer resident in Rome, attended an international tax law course in the Netherlands. In his tax returns for that year he deducted from his gross tax an amount equal to 19 percent of the university fees. The Italian tax authorities failed to grant this deduction. Consequently, Zanotti challenged his tax assessment and the matter was referred to the ECJ for a preliminary ruling on the EU law issues arising from the case. Admissibility On a preliminary issue, the ECJ ruled that the action was admissible despite the lack of clarity in the order for reference as to whether the tax deduction claimed by Zanotti was disallowed or simply reduced. Which Freedom Is Applicable? The Court noted that since article 18 of the EC Treaty found specific expression in article 49 of the EC Treaty (the freedom to provide services), it did not apply in situations when article 49 of the EC Treaty was COUNTRY DIGEST applicable. The Court observed that the freedom to provide services included the right of recipients to go to another member state to receive such services from a service provider established there. In this case, the ECJ held that courses essentially financed by persons seeking training or professional specialisation must be regarded as constituting services within the meaning of Article 50 EC. 1 The ECJ indicated that it was a matter for the Italian referring court to determine whether the Dutch educational services in this case were in fact services for remuneration. Accordingly, the ECJ determined that article 49 of the EC Treaty was the applicable freedom in situations when the services were for remuneration. Freedom to Provide Services Next, the ECJ investigated whether the Italian tax rules amounted to a restriction of the freedom to provide services. The Court noted that there was a dispute between the parties on whether Zanotti was refused the tax deduction or whether he was granted a reduced deduction in accordance with the rules at issue. The ECJ stated that this was a matter for the Italian referring court to determine. The ECJ went on to point out that when a taxpayer who attended a university course in another member state was refused a tax deduction for fees paid to the foreign university, while at the same time the rules allowed a taxpayer to deduct the costs of attending a university course at an Italian university, such rules would result in a larger tax burden for taxpayers attending universities abroad. 2 The Court explained that such rules infringed on the freedom to provide services in two ways: First, they deterred taxpayers resident in Italy from attending university courses at establishments in other member states; and second, they hindered the offering of education by private educational establishments established in other Member States to 1 Zanotti, para. 33. 2 Id., para. 40. TAX NOTES INTERNATIONAL JUNE 14, 2010 1

COUNTRY DIGEST Reprinted from Tax Notes Int l, June 14, 2010, p. 870 taxpayers resident in Italy. 3 Accordingly, the Italian rules at issue constituted an obstacle to the freedom to provide services guaranteed by Article 49 EC 4 and no justification was put forward by Italy for such rules. Territorial and Quantitative Limits 3 Id., para. 41. 4 Id., para. 42. 5 Id., para. 46. 6 Id., para. 52. 7 Id., para. 53. 8 Id., para. 52. Next, the ECJ investigated a further aspect of the Italian rules, which imposed territorial and maximum deduction limits on the tax deductions for educational courses attended in other member states. The Italian rules limited the amount of university fees deductible from gross tax to the maximum amount laid down for the course fees of some Italian establishments. Thus, deductions for courses attended in other member states were limited to the course fees that would be paid for attending similar courses at the Italian State university nearest to the taxpayer s residence for fiscal purposes. 5 Zanotti argued that those limits were more onerous for Italian residents who chose a university course in another member state than those who chose a course in Italy. The ECJ rejected this argument, pointing out that the maximum limits applied both to private establishments providing educational courses in Italy and to those situated in other member states. Moreover, regarding the territorial limits, the ECJ noted that if an Italian taxpayer attended a course at a private university in Italy, the limit was set by reference to fees charged by the Italian State university in the same city as the private university, or failing that, in the same region, 6 whereas if the taxpayer attended a course in another member state his course fees were deductible up to the amount laid down for the course fees of the Italian university nearest to his residence in Italy that offers similar courses. The ECJ pointed out that these rules did not necessarily treat the crossborder situation less favorably. The Court explained that taxpayers who chose to attend courses in other member states had as their point of reference the extensive range of State universities throughout the national territory 7 since the maximum deduction for fiscal purposes was based on the costs of a similar course offered by the state university nearest to their residence. If the taxpayer attended a course in Italy the maximum deduction was based on the fees charged by the Italian state university in the same city as the private university, or failing that, in the same region. 8 The Court noted that the Italian rules affected taxpayers attending courses in other member states as well as those taxpayers who attended courses at private establishments in Italy. Fees paid at Italian state universities differed, as did regional taxes. Consequently, the Italian rules at issue gave rise to variations that affected the maximum amount that could be deducted for tax purposes based on whether the taxpayer attended a private establishment in Italy or in another member state. Accordingly, the Court held that such variations did not constitute a restriction on the freedom to provide services within the meaning of article 49 of the EC Treaty. The Court observed that the taxpayer, by attending the course in another member state: did not necessarily find himself in a less favourable situation...than he would have been in had he attended a private university in Italy. Depending on the private university chosen in Italy, the amount of deductible costs would have been greater or less than the amount calculated by reference to the costs of attending the Italian State university nearest to his residence for fiscal purposes, that is to say, the point of reference applied for educational courses provided in other Member States. 9 The Court went on to point out that it was not possible to identify any factor which might dissuade taxpayers resident in Italy from attending university courses at establishments situated in another Member State. 10 The Court stressed that in the absence of harmonized rules, it was a matter for the member states to design their tax deduction rules for university fees, provided that such rules complied with EU law and did not dissuade taxpayers resident in Italy from attending university courses offered by establishments situated in other Member States. 11 The Court concluded that the imposition of an upper limit on deductible costs, in accordance with the territorial and quantitative limits, did not constitute an obstacle to article 49 of the EC Treaty. EU Citizenship Rights Next, the ECJ dealt with a possible breach of Zanotti s right of free movement guaranteed by article 18 of the EC Treaty in those situations when article 49 of the EC Treaty did not apply. The Court observed that the taxpayer availed himself of his EU citizenship rights when he attended a university course in another member state. If the national rules at stake denied a deduction for university fees for courses undertaken in other member states, whereas such a deduction was 9 Id., para. 58. 10 Id., para. 63. 11 Id., para. 64. 2 JUNE 14, 2010 TAX NOTES INTERNATIONAL

Reprinted from Tax Notes Int l, June 14, 2010, p. 870 possible for courses attended in Italy, such rules would place taxpayers at a disadvantage solely on the ground that they have availed themselves of their freedom of movement by going to another Member State to attend a university course there. 12 The Court determined that such tax treatment would amount to an obstacle to the freedoms conferred by article 18(1) of the EC Treaty on every EU citizen. Similarly, the Court pointed out that the refusal to deduct the costs of university courses attended in other member states could not be justified solely by the fact that similar courses were not provided by Italian state universities. Such tax treatment was contrary to article 18(1) of the EC Treaty. Regarding the territorial and quantitative limits used when calculating the tax-deductible amounts, the Court applied the same reasoning it applied above and concluded that such limits on the deductions did not constitute obstacles to the free movement rights of EU citizens granted under article 18(1) of the EC Treaty. The ECJ s Conclusions The ECJ concluded that a general refusal to grant the tax deduction for costs of university courses attended in other member states in situations when such deductions were granted in Italy was contrary to articles 49 and 18(1) of the EC Treaty. However, the Court held that articles 49 and 18(1) of the EC Treaty did not preclude Italian rules that imposed upper limits and territorial limits on the amount of costs of university courses attended in other member states, because such limits also applied to university courses attended in Italy. Analysis The ECJ s judgment in Zanotti generates a number of interesting issues worth further analysis. First, the judgment in Zanotti echoes much of the Court s reasoning in Schwarz (C-76/05). 13 Second, the judgment highlights the fact that in the absence of harmonized rules at the EU level regarding direct taxes, the member states retain significant powers to design their tax deduction and relief systems as long as they comply with EU law. Third, Zanotti demonstrates the relationship between the freedom to provide and receive services (contained in article 49 of the EC Treaty) and the free movement rights granted to EU citizens (in article 18 of the EC Treaty). Lastly, Zanotti provides an example of an origin state situation whereby two origin state nationals are treated differently depending on 12 Id., para. 73. 13 For a detailed analysis of the Schwarz judgment, see Tom O Shea, A Failing Grade for Germany s Rules on School Fees, Tax Notes Int l, Oct. 29, 2007, p. 483, Doc 2007-23086, or2007 WTD 214-13. whether they exercise their fundamental freedoms. Regarding the first aspect of the case, the taxpayer s arguments are successful (subject to verification of the rules by the Italian referring court) but for the second aspect of the case, the taxpayer s arguments are rejected. Understanding the difference between the two types of rules at stake in Zanotti is key to understanding why the Court found the former type of rule (which denied deductions cross-border while granting deductions domestically) restrictive of the freedoms but determined that the territorial and maximum limitation rules did not constitute an obstacle to the freedoms in the circumstances of this case. Competence in Direct Taxes The ECJ continually reminds us that competence regarding direct tax matters remains with the member states subject to the requirement that any exercise of that competence must comply with EU law. Regarding the exercise of the fundamental freedoms, when member states are designing their direct tax relief and tax deduction rules concerning university fees, they are obliged to comply with two cardinal rules: First, the member states must not discriminate on grounds of nationality; and second, the member states must not restrict the freedoms unless such rules can be justified by a general interest reason that is proportionate in the circumstances of the case. Thus, in Zanotti, the Court makes it clear that if a taxpayer is refused a tax deduction because the university course was provided in a member state other than Italy but would be granted a tax deduction if he attended a similar course in Italy, such rules restrict the freedom to provide and receive services: They restrict the freedom to receive services because they deter taxpayers resident in Italy from attending courses at establishments situated in other member states, and they restrict the freedom to provide services because they hinder private educational establishments located in other member states from providing their services to taxpayers resident in Italy. By denying the tax deductions, the Italian rules (depending on the findings of the Italian referring court) made the purchase of the educational services outside Italy more expensive and less attractive compared with similar services provided in Italy that benefited from the tax deduction. The Court reiterated that the freedom to provide services precludes the application of any national rules which have the effect of making the provision of services between Member States more difficult than the provision of services purely within a Member State. 14 In other words, the freedom to provide services precluded such protectionist rules. The Court applied the 14 Zanotti, para. 42. COUNTRY DIGEST TAX NOTES INTERNATIONAL JUNE 14, 2010 3

COUNTRY DIGEST Reprinted from Tax Notes Int l, June 14, 2010, p. 870 same reasoning regarding article 18 of the EC Treaty on the free movement of EU citizens. National Treatment The ECJ has made it clear on many occasions that the national treatment principle applies from both the perspective of an origin member state and from the perspective of a host member state. Thus, in de Groot (C-385/00), the Court stated: As far as the exercise of the power of taxation so allocated is concerned, the Member States must comply with the Community rules... and, more particularly, respect the principle of national treatment of nationals of other Member States and of their own nationals who exercise the freedoms guaranteed by the Treaty. 15 [Emphasis added.] The Court s Zanotti judgment concerns the tax rules of an origin state (Italy), which affected one of its own nationals when one or more of the fundamental freedoms was exercised (in this case the freedom to provide services contained in article 49 of the EC Treaty, and, depending on the circumstances, the free movement of EU citizens contained in article 18 of the EC Treaty). Italy s obligation under the national treatment principle is to treat its own nationals who are exercising the freedom to provide or receive services in a similar way to its own nationals who are receiving or providing similar services domestically, unless it can show some objective difference to justify the different tax treatment or unless it can demonstrate some public interest requirement that justifies the different treatment. Under the Zanotti decision, Italy breaches the national treatment principle if it allows deductions for university fees when the university course is provided in Italy but it refuses similar tax deductions for courses provided in other member states. Clearly, in a situation when an Italian taxpayer obtains such services in another member state, that taxpayer is disadvantaged compared with a similar Italian taxpayer who obtains similar educational services in Italy. Both are taxed as Italian residents but only one is granted a tax deduction for university fees. Italy, therefore, breaches the national treatment principle in this instance, in the absence of some acceptable justification or being able to demonstrate an objective difference in some situations (subject to verification of the Italian rules by the national referring court). The same does not hold true for the Italian rules that imposed a limit on the deductions available for cross-border university fees or that imposed territorial limitations on the amount of the tax deductions. Regarding these rules, the Court was satisfied that there was no breach of the fundamental freedoms because the cross-border situation was not necessarily disadvantaged when compared with a similar domestic situation (the so-called migrant/nonmigrant test used by the Court in applying the national treatment principle). Thus, in Zanotti, the Court noted that maximum limits applied both to private establishments in Italy and to those situated in other member states. Similarly, regarding the territorial limits imposed by the Italian rules, the Court pointed out that the taxpayer did not necessarily find himself in a less favourable situation, as regards the tax deduction at issue, than he would have been in had he attended a private university in Italy. 16 The Court concluded that such rules did not dissuade taxpayers resident in Italy from attending university courses at establishments situated in another Member State. 17 In other words, as the Court pointed out, in the absence of harmonized rules in the area of tax deductions for university fees, it is a matter for the member states to design their tax systems subject to their obligation to comply with EU law. The Court stressed that this meant, in particular, that those rules must not dissuade taxpayers resident in Italy from attending university courses offered by establishments situated in other Member States. 18 Difference Between the Italian Rules A general rule denying tax deductions for university courses attended in other member states when tax deductions were granted for attending university courses at Italian private establishments clearly deters taxpayers resident in Italy from obtaining educational services in other member states, and also deters the exercise of the free movement rights of EU citizens. There is a clear difference in the tax treatment between the domestic and the cross-border situation caused by the national rule at issue. Such rules constitute a restriction on the fundamental freedoms. The Italian maximum and territorial limitation rules are different. These rules did not disfavor the crossborder situation compared with a similar domestic situation. They did not amount to a restriction on the fundamental freedoms. Since direct tax matters remain within the competence of the member states subject to compliance with EU law, Italy was entitled to choose a criterion to calculate the maximum amount of fees that could be deducted when the course was attended in Italy or in another member state. The Court, applying the same reasoning regarding EU citizenship situations, found that such territorial and quantitative rules did 15 See de Groot, para. 94. See also Renneberg (C-527/06), para. 51. 16 Zanotti, para. 58. 17 Id., para. 62. 18 Id., para. 64. 4 JUNE 14, 2010 TAX NOTES INTERNATIONAL

Reprinted from Tax Notes Int l, June 14, 2010, p. 870 not constitute obstacles to the freedoms contained in articles 49 and 18 of the EC Treaty. In other words, such rules did not restrict the freedoms because they affected not only the maximum amount of costs that could be deducted by a taxpayer attending a private establishment in another member state but also the maximum amount of costs that could be deducted for courses offered by a private establishment in Italy. Such COUNTRY DIGEST rules, therefore, did not dissuade taxpayers resident in Italy from attending university courses in other member states and did not constitute an obstacle to article 49 or 18 of the EC Treaty. Tom O Shea, Queen Mary University of London, Centre for Commercial Law Studies TAX NOTES INTERNATIONAL JUNE 14, 2010 5