Group relief across the EU?

Rajesh Sharma reviews the recent important decision on group relief involving
Marks & Spencer

Europe referred to the European Court of Justice (ECJ) was successful. The Inland Revenue has recently confirmed that it will not be appealing against the decision in the High Court of England and Wales although it will defend its position at the ECJ. This case raises important corporate tax issues and, if successful, could give rise to other claims worth billions of pounds.

Background

Marks & Spencer suffered extensive losses from its French, German and Belgian subsidiaries, whilst its UK side of the business generated sizeable profits. This resulted in unrelieved losses in the overseas subsidiaries. Marks & Spencer submitted group relief claims for the years 1998, 1999, 2000, and 2001 to claim the losses sustained by the overseas subsidiaries of approximately £100m against its UK profits.

The company claimed group relief for the losses of the European subsidiaries despite the fact that none of the overseas companies were resident in the UK under section 413(5), ICTA 1988, and following the Finance Act 2000 in respect of companies resident in the UK, or carrying on a trade in the UK through a branch or agency. It should be noted that had Marks & Spencer operated in the overseas territories through a branch, a claim for relief for losses sustained by the branches would have been available to offset the losses against the profits in the UK. Similarly, any profits generated through branches would have been subject to UK tax with credit relief for overseas taxes suffered by the branches.

Marks & Spencer conceded that none of the subsidiaries satisfied the requirements under section 402, ICTA 1988, for the purposes of surrendering the losses.

The claim by Marks & Spencer was that the UK legislation infringed Article 43 of the EC Treaty, such that no restrictions should be imposed on member states with respect to the setting up of agencies, branches or subsidiaries within the EU.

Marks & Spencer claimed that the UK group relief legislation made it less attractive to establish subsidiaries in other member states.

Based on the decision in ICI v Colmer [1998] STC 874, the ECJ has previously established that it was only necessary to show that a tax provision had discouraged a company in one member state from setting up a subsidiary in another member state for it to be considered discriminatory.

Special commissioners

The special commissioners rejected the claim by Marks & Spencer that the UK group relief rules restricted its freedom under Article 43 to choose whether to establish its operations in France, Belgium and Germany through a branch or a subsidiary. In the opinion of the commissioners, the issue for consideration was whether the UK group relief rules treated the company less favourably when it established its operations in France, Belgium or Germany (irrespective of whether through a branch or a subsidiary), as contrasted with the establishment in the UK in a comparable situation.

The commissioners considered that the foreign subsidiaries were nationals of France, Belgium and Germany rather than UK nationals. The EU Treaty barred discriminatory rules vis-à-vis nationals of other member states that establish business in a host state. For example, if a UK company sets up activities in France, the EU Treaty would ensure that the UK company enjoyed the same rights as nationals of France. France cannot apply discriminatory taxation rates to the branch activities of its UK subsidiary.

Further, the precedent in the European courts is that the discriminatory rules applied to a national of the origin state. Accordingly, these rights were conferred on the foreign subsidiaries rather from Marks & Spencer itself.

High Court

Whilst a formal report of the decision has not been published, it is understood that Mr Justice Park made it clear that the main question to be answered was whether or not to refer the case to the European Court of Justice. As the Inland Revenue opposed a reference on the grounds that the law was clearly in its favour, the hearing continued over three days before a decision for referral was made.

The fundamental question asked in the High Court was whether it was possible to compare Marks & Spencer Plc, which operates profitable stores in the UK and also has a French resident subsidiary which operated a loss-making store in Paris, with a hypothetical competitor X Plc, which operates profitable stores throughout the UK and also has a UK resident subsidiary that operated a loss-making store in Paris.

Although the Revenue's main argument was that the French losses could be used twice, Marks & Spencer stated that it was questionable if and how relevant this was and only increased reasons why the case should be referred.

At the end of the hearing on 3 May 2003, the judge said he would refer the case to the ECJ due to importance of the case, not only to the parties involved but also to companies and governments throughout Europe.

What's next?

We now await the decision of the ECJ.

As far as the UK Revenue is concerned, it is expected that proposals will be announced in the consultation document on the reform of corporate taxation. It is the intention of the Revenue to protect its tax system against legal challenges under European law. Accordingly, the consultation document is also expected to deal with any potential impact of the decision in the German case of Langhorst Hohorst on the UK thin capitalisation legislation.

In the meantime, taxpayers may consider making protective claims to claim group relief for losses sustained by their EU subsidiaries.

Rajesh Sharma is a director at Smith & Williamson, the professional and financial services group. Tel 020 7637 5377. E-mail: Rajesh.Sharma@smith.williamson.co.uk.