It is not often that a judgment in a tax case is headline news for the major UK national newspapers and on television, but Marks & Spencer v Halsey (HM Inspector of Taxes) was one such case when the decision of the European Court of Justice was released on 13 December 2005. Some of the more sensationalist headlines focused on the significant revenue loss to the UK Treasury as a result of claims by other companies that would follow the judgment.
In truth, the decision offers as much comfort to revenue authorities as to taxpayers. Marks & Spencer effectively won its claim but largely on the facts of its particular case. Whether other companies can take advantage of the judgment will very much depend upon how it is applied by the UK courts and on how UK law is amended to bring it into line with judgment.
The case concerned the UK’s “group relief” rules which allow a loss-making company to “surrender” its losses to another group company to be set against its profits. Such surrenders, however, are only allowed under the UK’s corporation tax code where the respective companies are either UK resident or have a permanent establishment in the UK. Marks & Spencer, the prominent UK retailer, established operations in France, Germany and Belgium in the 1970s. These operated through subsidiary companies which had no presence in the UK. After incurring increasing losses during the late 1990s, the German and Belgian operations were shut down, and the French subsidiary was sold.
Marks & Spencer sought to surrender losses of the subsidiaries for use against the profits of the UK parent, citing the rights to freedom of establishment and freedom of movement of capital enshrined in the European Union Treaty. It fell to the European Court of Justice to determine whether restriction of group relief to companies with a UK presence contravened these fundamental freedoms.
The court’s approach closely follows that of the Advocate General’s opinion in April 2005 (see On the Subject 15 April 2005).
The court reaffirmed its settled view that the competence of Member States in legislating direct tax law was constrained by a requirement to do so in a way consistent with fundamental treaty freedoms. Group relief, as currently structured, deterred parent companies from establishing subsidiaries in other Member States because, in effect, it conferred a cash advantage to purely domestic groups by allowing immediate relief for losses.
However, the court accepted as legitimate the concerns of Member States that allowing cross-border loss relief would “jeopardise a balanced allocation of the power to impose taxes between member states” and risked allowing companies both the opportunity of “double dipping”—obtaining relief for the same loss in two jurisdictions—and “loss trafficking”—transferring losses to companies established in Member States with the highest rates of taxation. A blanket restriction on cross-border loss relief went beyond what was necessary, but it would be acceptable to allow it in situations where the non-resident subsidiary had exhausted only the possibilities for use in its state of residence.
Effect on UK Law
The case now returns to the UK courts for a determination of what Marks & Spencer can recover. There remains a considerable amount of doubt as to how the judgment will be applied. Whilst the UK courts will clearly be obliged to strike out the restriction of group relief to UK-resident or established companies, it is less clear whether they will be able to read into the legislation a restriction that losses can only be used to the extent that they are not available elsewhere.
In the specific case, this will determine whether Marks & Spencer can recover tax in respect of the German and Belgian losses only, or whether it can also recover in respect of the French losses even if these could have been used by the purchaser of the French subsidiary.
More broadly, the approach the UK courts take will determine whether significant numbers of other multinational companies will be able to make claims of this nature. If there is a risk of a flood of claims, the UK Government might seek to legislate acceptable limitations on group relief with retrospective effect to staunch the flow.
In a press statement issued shortly after the judgment, the Government indicated that it was minded to retain group relief and that, going forward, only relatively minor amendments would be necessary to bring it into line with the judgment. In practical terms, it is not clear precisely how this will be achieved. Group relief is available in respect of current year profits only. If a foreign subsidiary is obliged to exhaust all possibility of carry forward relief in the country of origin before turning to group relief in the UK as a remedy, it may well find that it is time barred from making a group relief claim, as these normally need to be made within two years of the end of the relevant accounting period.
Who can claim?
The most obvious potential beneficiaries of the judgment are groups similar to Marks & Spencer: UK-parented groups with EU subsidiaries. However, as non-discrimination on grounds of nationality is fundamental to EU law, the principle should extend to groups and sub-groups parented by a company resident elsewhere in the EU to enable surrender from parent to subsidiary or between sister companies: provided in both cases that the surrendering company is resident in the EU and the claiming company resident in the UK.
The position is less clear where the potential surrendering company is resident outside the EU or where the surrendering and claimant companies are held directly by a non-EU parent without an EU holding company. Whether such groups will be able to claim successfully will depend on how broadly the UK courts apply the European Court’s decision. Some non-EU parented groups are additionally arguing that the non-discrimination clause in the treaty between the UK and the country of residence of the parent company obliges the UK to grant relief under this principle.
Multinational groups should be alive to the opportunity to make claims on the basis of this judgment if they accrued taxable profits in the UK at any time over the last six years and losses in any other EU jurisdiction in the same year. Where the group is US-parented, there is arguably almost an obligation to do so—failure to do so might be regarded by the Internal Revenue Service (IRS) as the payment of “non-compulsory” foreign tax, resulting in the denial of an equivalent amount of foreign tax credit in the US.
A number of multinationals have issued court proceedings against the revenue authorities for recovery of damages in respect of group relief, and these claims have been consolidated by the High Court under a group litigation order, effectively resulting in a “class action”. It is open to potential claimants to join the order, and the number of claimants means that costs are kept relatively low. However, if they are still in time to do so, the relevant group companies should also file a group relief claim and surrender with the relevant local tax inspector: the courts have indicated that, where possible, statutory procedures should be followed and exhausted before the courts can consider a claim.