Fourteen years ago the first decision of the European Court of Justice (ECJ) against the UK on the transfer of losses within a consortium under the group relief tax scheme, in ICI v Kenneth Hall Colmer (Case C-264/96), was delivered.
And nine years ago the decision was made in one of the most debated cases in the whole history of the court on the inclusion of foreign subsidiaries' losses in the taxable basis of the parent company, in Marks & Spencer plc v David Halsey (C-446/03).
Now articles 43 and 48 of the treaty establishing the European Community (TEC) seem to have put the UK, once again, in a difficult position after the release of the opinion of Advocate General (AG) Kokott in the Philips Electronics UK Ltd case (Philips UK) (C-18/11) regarding the surrender of losses incurred by a non-UK resident through its UK branch to a UK resident.
The case involves a consortium of UK and Dutch companies with LG.PD Netherlands (LG NL) being the parent company of Philips UK and performing its activities through a UK branch (qualifying as a permanent establishment under the relevant tax treaty). Philips UK submitted a consortium claim, including in its taxable basis the losses suffered by the UK branch of LG NL.
The UK tax authorities refused the group relief based on the same provision of UK tax law which has been previously disputed and accordingly amended because of the result of Colmer and Marks & Spencer. They claimed that the losses may be deducted from the taxable basis of LG NL in the Netherlands, one of the carve-outs of UK law on group relief. The Upper Tribunal in London referred the case to the ECJ for a ruling on whether the specific provision overrules the freedom of establishment.
The freedom of establishment requires the member states to ensure equal treatment between their own and foreign nationals in a twofold mandate: when they act either as home (Marks & Spencer) or host (Philips UK) state, with regard to their establishment in the EU without discriminating on the basis of the chosen legal form.
Firstly, the AG found the UK to be in direct breach of its obligation since the different treatment of non-resident companies is sourced in the wording of the law as having a direct negative impact for foreign companies. The old-fashioned argument of the non-comparability of a resident and a non-resident taxpayer cannot be upheld since the ECJ has already expressed its opinion, in Commission v France (C-270/83), (through the acceptance of the so-called "principle of territoriality". Besides, the UK invalidates its own argument by treating both residents and non-residents as eligible to carry forward and backward losses while accepting that the losses of LG NL are attributable to the UK branch.
What makes this case different in an interesting way is the basis of the rejection of the justifications that the UK tax authorities put forward to defend the different treatment.
Though it is settled case-law that a restriction on the fundamental freedoms of the EU law may be based only on the so-called rule of reason which was established by the ECJ case-law and accepting restrictions that, again from Commission v France, pursue a legitimate objective compatible with the Treaty and are justified by imperative reasons in the public interest, it has to be admitted that the ECJ has not been proven to be fully consistent when applying this rule to testify whether challenged restrictions are compatible with the EU law. The ECJ has applied so far three different reasons, that is:
- the balanced allocation of taxing rights between the member states;
- the danger of double use of losses; and
- the potential tax avoidance - either separately or conjunctively - leading to a considerable confusion regarding their correct application.
In Marks & Spencer, the ECJ applied these three justifications conjunctively but without explaining the way they interact. The AG in the Philips UK case expresses the opinion that the only crucial objective which justifies the restriction is the balanced allocation of taxing rights between the member states after the examples of recently decided cases about the acceptable justifications of discriminatory provisions. In National Grid Indus (C-371/10), for instance, the ECJ used only the balanced allocation of taxing rights to testify the extent to which the restriction was justified.
Defining this objective as a "safeguard of the exercise of their taxing powers in relation to activities carried on in their territory", the AG concludes that balanced allocation means the symmetry between the right to tax the profits and the right to deduct the losses and therefore this justification is valid only to the extent that the losses have been incurred abroad.
In connection to this, the AG contends that in this case the double use of losses cannot be upheld as a justified objective since it is the necessary complement of the inclusion of the profits in the taxable bases of two different states and, as such, an element which conceptually not only does not affect but also secures the balanced allocation of taxing rights.
The AG finds the provision, even if capable, not proportionate since it disallows the whole amount of losses even if they may be partially taken into account in the other state and disregards the procedural argument of the UK that the party which is treated differently is not the claimant in the proceedings due to the direct effect of the freedom of establishment. This lack of proportionality of the restriction, in fact, was the ultimate result of Marks & Spencer.
Given that the opinion of the AG is usually followed by the court, the decision should give clarity on cross-border transfer of losses in a cross-border context.
Henri Prijot is a partner and Nicolas Devergne is a manager in the tax practice of Deloitte Luxembourg
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