Decline of Controlled Foreign Company Rules and Rise of Intellectual Property Boxes: How the European Court of Justice Affects Tax Competition and Economic Distortions in Europe

The European Court of Justice (ECJ) has become an influential player in the field of direct taxation in the European Union (EU) in the past 20 years. However, it is unclear whether or not the ECJ's decisions and the corresponding reactions by the member states actually contribute to tax neutrality in economic terms and, therefore, to the achievement of the internal market. In 2006, the ECJ limited the applicability of specific tax rules in the EU that are intended to prohibit the excessive use of low‐tax countries by multinationals. Our counterfactual analysis shows that the court's restriction of so‐called controlled foreign company rules and the related second‐round reactions by some member states – i.e. the introduction of low‐tax regimes for income from acquired intellectual properties (IP boxes for acquired IP) – cast doubt on the seemingly positive effects the ECJ has on reducing tax distortions. In addition, we demonstrate that the restricted applicability of IP boxes as endorsed by the OECD and the European Commission would strengthen tax neutrality in Europe.