Advocate General’s opinion: UK loss relief rules for branches breach EU law


At all material times, UK legislation prohibited a group (or consortium) relief claim being made in respect of a loss of the UK permanent establishment of a foreign company where (per section 403D(1)(c) ICTA 1988) that loss:  

“corresponds to, or is represented in, any amount which, for the purposes of any foreign tax, is (in any period) deductible from or otherwise allowable against non-UK profits of the company or any other person”

Philips Electronics (UK) Ltd (“Philips UK”) made consortium relief claims in respect of losses of the UK permanent establishment of a Netherlands company, LG.Philips Displays Netherlands BV (“LG.Philips Netherlands”). Not unusually, Philips UK agreed to pay LG.Philips Netherlands in respect of the surrender of its UK losses.  

At the time Philips UK first made such claims for consortium relief, LG.Philips Netherlands, though loss making, had not entered bankruptcy in the Netherlands. (Philips UK’s claims were later “refreshed” after LG.Philips Netherlands entered bankruptcy.)  

HMRC challenged Philips UK’s claim for consortium relief on the grounds that two provisions prevented it. One of the two provisions was section 403D(1)(c). HMRC argued that this prohibited consortium relief where there was a possibility – however unlikely – that the losses (or some fraction of them) might be used in the Netherlands.  

Philips UK contended that those provisions infringed EU law, and the parties agreed to refer the question to the First‑tier Tribunal.  

The First-tier Tribunal (Tribunal Judges Roger Berner and John Avery Jones CBE) found in favour of Philips UK, holding that both provisions infringed EU law. HMRC appealed the Tribunal’s decision in relation to section 403D(1)(c) to the Upper Tribunal. They conceded Philips’ position on the other provision, section 406(2), and Finance (No.3) Act 2010 amended the relevant legislation, although HMRC have continued to rely on section 406(2) in litigation with other taxpayers.

The Upper Tribunal (Mrs Justice Proudman and Judge Howard Nowlan) referred the issue of section 403D’s applicability to the CJEU for a preliminary ruling, asking (in effect) whether:  

  1. section 403D(1)(c) constituted a restriction of the freedom of establishment (by treating the branches of companies established in other Member States less favourably than UK companies) (“Question 1”);
  2. if it was a restriction, it could be justified on the basis of (i) the need to prevent the double use of losses; or (ii) the need to preserve the balanced allocation of taxing powers between Member States; or (iii) both (“Question 2”);
  3. if it was justified, whether the restriction was proportionate (“Question 3”); and
  4. EU law required the UK to provide Philips UK with a remedy (despite the fact that it was LG.Philips Netherlands that had exercised its freedom of establishment) (“Question 4”).  

After an oral hearing in February 2012, the AG delivered her opinion.  

Question 1

A restriction exists when comparable situations are treated differently (with the cross-border situation at a disadvantage to the domestic situation).  

The AG found that section 403D(1)(c) resulted in companies established in other Member States suffering at least two disadvantages in relation to their UK permanent establishments as compared with UK companies.  

Firstly, those foreign companies would find it more difficult to form consortia with UK companies since UK companies would tend to form consortia with other UK companies (whose losses could be surrendered freely, without any restriction of the sort imposed by section 403D(1)(c)). Secondly, those foreign companies might be unable to receive a payment for surrender of losses since their losses might not be capable of surrender.  

The UK had accepted that there was a difference in treatment between UK resident companies and companies resident in other Member States with UK permanent establishments, but had sought to argue that this treatment was not discriminatory since the UK and foreign companies were not objectively comparable. In this respect, the UK’s core argument was that UK companies were subject to taxation on their worldwide profits, whereas foreign companies were subject to limited taxation (on profits attributable to UK permanent establishments) only.  

The AG rejected that distinction. Since the UK subjected UK permanent establishments to taxation on UK profits attributable to them, in exactly the same way as it taxed a UK-resident company on such profits, demonstrably there was no objective difference for these purposes between UK permanent establishments (on the one hand) and UK companies (on the other). She also clarified that the CJEU considers comparability of branches differently in an in-bound situation (such as this) compared to an outbound situation (such as X Holding).  

Question 2

The key issue in relation to Question 2 was the interpretation of the CJEU’s decision in M&S in relation to when a restrictive domestic measure could be justified.

The AG acknowledged that there had been some “confusion” following that decision. In M&S, the CJEU had identified three elements relevant to whether the domestic provisions in that case could be justified – namely: (i) the need to protect the balanced allocation of taxing rights; (ii) the need to prevent the double use of losses; and (iii) the need to prevent loss trafficking. HMRC had argued (on the basis of their interpretation of subsequent case law of the CJEU, including Oy AA, Lidl Belgium, and X Holding) that the elements identified in M&S were each justifications in their own right.  

The AG disagreed with HMRC’s analysis of M&S: her view was that the only justification recognised in that case was the need to preserve the balanced allocation of the power to impose taxes. In the AG’s opinion, the other “elements” identified by the CJEU simply went to whether the allocation of the power to impose taxes had been interfered with. Further, she found that there was no reason of principle for “preventing the double use of losses” to be recognised as a justification.  

The AG also explained that the allocation of the power to impose taxes was a matter for the Member States involved. In the present case, the Member States had agreed (by double tax convention) that the UK should have the power to tax the profits of a UK permanent establishment of a Netherlands company. Accepting arguments relating to symmetry, she concluded that it would not interfere with that balanced allocation for the UK to be required to allow relief for corresponding losses. Therefore the allocation of the power to impose taxes as between the UK and Netherlands was not jeopardised by losses of a UK branch being surrendered for use in the UK.  

Even if the need to prevent the double use of losses were an autonomous justification (which the AG had rejected), the AG held that it would not be in point in the present case. She considered various provisions of UK law, and identified that the UK did allow relief for permanent establishment losses in some circumstances. Relying on non-tax cases, she concluded that these other provisions prevented the UK from arguing that section 403D(1)(c) was justified as preventing double use of losses, as that objective was not pursued in a “consistent and systematic manner”. If upheld by the Court, this conclusion could significantly undermine Member States’ defence of restrictive provisions, as piecemeal development means that tax systems often fail to pursue their goals in such a manner.  

Question 3

HMRC had sought to argue that the prohibition in section 403D(1)(c) conformed with the “no possibilities test” in M&S and therefore was proportionate.  

The AG rejected HMRC’s contention. She found that proportionality has to be assessed by reference to the objective pursued by the provision in issue. The objective in M&S was to safeguard the balanced allocation of the power to impose taxes. The AG had already made clear that that objective could not be relevant in the present case. Therefore the M&S test of proportionality could not be relevant. This was a point HMRC had fought hard, and the First-tier Tribunal had accepted their arguments.  

The AG considered the position if the objective of preventing the double use of losses (i) could be an autonomous justification; and (ii) applied in the present case. Even then, the AG considered that section 403D would be disproportionate. She gave indicators of specific features of the legislation which could not be applied: to (i) deny an entire loss where only a fraction might possibly be used; (ii) permanently deny the use of loss if a corresponding loss is only temporarily used abroad; and (iii) deny the use of losses on the basis that they might be used “in any period” in the future whatever the facts at the relevant time. She did not express a view on whether these features would require section 403D(1)(c) to be completely disapplied. This seems entirely possible given the Court of Appeal decision in Vodafone.  

Question 4

The AG’s opinion was that the freedom of establishment of one person (“Party A”) can be relied upon by another person (“Party B”) where this would be the only way of ensuring that Party A can have a fully effective freedom.  

In the present case, LG.Philips Netherlands could only fully enjoy its freedom (including by receiving payment for the use of its UK branch losses) if Philips UK could rely on LG.Philips Netherlands’ EU law rights. This required section 403D(1)(c) to be disapplied, thereby allowing the claim for consortium relief.  

The AG firmly rejected HMRC’s suggestion that there was no need to allow Philips UK to rely on the infringement on the basis that LG.Philips Netherlands could pursue a Francovich claim for damages against the UK Government instead. The AG’s view was that the effort associated in bringing such a claim would itself constitute a further restriction on LG.Philips Netherlands’ freedom of establishment. Further, the prospect of obtaining damages would not eliminate the disadvantage resulting from the fact that UK companies would tend to form consortia with other UK companies rather than foreign companies.