By Ambroise Bricet and Marie Pierre Hôo
This material has been prepared by professionals in Taj, French tax and legal firm, member of Deloitte Touche Tohmatsu

On 3 April 2008, the European Court of Justice (ECJ) issued its long-awaited decision in the Derouin case, which concerns two French levies charged on U.K.-source income received by a French tax resident partner in a U.K. partnership. The practical effect of the decision is that the French resident partner is not subject to these levies on his U.K.-source income.

In addition to France’s compulsory insurance scheme, which confers on taxpayers the right to social security benefits (in the event of sickness and on retirement), the French social security authorities collect two compulsory levies that do not confer such a right: the CSG and CRDS. Whether these levies are fiscal taxes or social security contributions has been long debated in France, both the authorities and the courts holding diverging opinions on the issue. The French Supreme Tax Court considers the CSG and CRDS to be taxes, the French tax authorities treat them as falling within the scope of all tax treaties concluded by France, the social security authorities take the position that the CSG and CRDS are social security contributions and, according to the Civil Court, the CSG and SRDS qualify as social security contributions within the scope of France’s social security agreements.

Facts

Mr. Derouin is a partner in a U.K. law firm organized as a partnership. The firm maintains offices globally, including in Paris, where Mr. Derouin carries out his professional activities. He performs all his work as a lawyer in the Paris office and is remunerated by receiving a share of the profits made by the partnership through the U.K. and other offices of the law firm.

Mr. Derouin was taxed as a French resident for personal income tax purposes and, therefore was taxed in France and in each country where the partnership is established on his share of the partnership profits. He was covered by a compulsory sickness insurance scheme (social security) in France and was registered with the French social security authorities as a self-employed person.

Mr. Derouin paid French social security contributions on all his French- and foreign-source occupational income. Arguing that CSG/CRDS contributions are taxes rather than social security contributions, he challenged the payment of contributions calculated on his U.K.-source income on the grounds that only income taxable in France, under France’s tax treaty with the U.K., can be subject to CSG/CRDS. According to Mr. Derouin, since his U.K.-source partnership income is taxable only in the U.K. and is not taxable in France under the terms of the France-U.K. tax treaty, that income should not be subject in France to taxes such as CSG/CRDS.

The French social security authorities, however, took the position that since the CSG and CRDS are social security contributions and not taxes, they fall within the scope of the EC Regulation 1408/71. As a result, all of the income earned should be subject to French CSG/CRDS, regardless of source.

EC Regulation 1408/71 provides for a system to coordinate the national social security schemes of EU Member States and includes provisions to determine which national social security legislation should apply in a particular case. The system for resolving conflicts of social security laws seeks, in particular, to prevent the payment of double contributions.

The social security authorities referred the case to the ECJ to determine whether EC Regulation 1408/01 prevents a double tax treaty from excluding a French resident’s foreign-source income from the application of the CSG and CRDS regime.

Under the French Constitution, treaties (and EU laws) override domestic rules. The French social security authorities anticipated that the ECJ would conclude the EC Regulation grants France the right to charge CSG/CRDS, and obliges France to include all the French and U.K. income in the chargeable base.

Decision of the Court

According to the ECJ, under EC Regulation 1408/71, Mr. Derouin qualifies as a resident of France carrying on a self-employed activity in both France and the U.K., thus falling within scope of the Regulation. Therefore, the taxpayer is only subject to the French social security legislation. The ECJ also confirmed that the CSG/CRDS fall within the scope of EC Regulation 1408/71 (without settling the question as to whether the CSG/CRDS are taxes or social security contributions).

Moving on to the key issue, the ECJ stated that EC Regulation 1408/71 is a means of coordination rather than harmonization, i.e. to ensure that workers from various EU Member States are able effectively to exercise their freedom of movement, the Regulation provides a method for determining which legislation will apply in the case of a conflict of applicable social security laws. However, Member States are still permitted to determine the taxable base for contributions, such as CSG/CRDS; in other words, Member States are free to determine the income to be taken into account when calculating such contributions, provided the exercise of this power does not impede the ability of EU persons to move freely throughout the EU.

For these reasons, when a Member State is granted the right to charge social contributions on income received by one of its residents under EC Regulation 1408/71, it can unilaterally decide not to include foreign-source income in the taxable base. The Member State can make this choice either under its domestic rules or under the provisions of an applicable tax treaty, provided the exclusion does not affect the worker’s right to receive all benefits provided by the domestic legislation. As a result, the ECJ concluded that the Regulation does not prevent a Member State whose social security legislation is solely applicable to one of its self-employed residents from excluding from the chargeable base for contributions (such as CSG/CRDS), income earned in another Member State by virtue of a tax treaty.

Conclusion

This decision should resolve the pending litigation in respect of CSG/CRDS in favor of the partners involved. However, whether, under the terms of the proposed France-U.K. tax treaty, U.K.-source income received still can be regarded as exempt (rather than as taxable, the double taxation being eliminated by a tax credit) remains an open question. In summary, although it is to be welcomed, the decision leaves a number of issues unresolved.

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