The Court of Justice of the European Union ("CJEU") has confirmed that UK loss relief rules for branches breach EU law (Case C-18/11).
On 6 September 2012 the CJEU delivered a clear ruling in favour of Philips (represented by Herbert Smith), confirming that the UK provisions which prevent losses of UK branches of non-UK resident companies from being surrendered for group relief (section 107 CTA 2010 condition C, formerly section 403D(1)(c) ICTA 1988) constitute an unjustified restriction of the freedom of establishment under EU law. Accordingly, those provisions must be disapplied.
The CJEU's decision delivers (substantively) the same conclusions as the Advocate General's opinion in the case (released on 19 April) albeit in the CJEU's usual, compressed style. (To read our earlier briefing on the Advocate General's opinion, including analysis of her reasoning – click here).
All taxpayers who are members of groups or consortia which include non-UK resident companies with UK branches should consider whether any losses of those UK branches can be claimed by way of group or consortium relief to reduce UK corporation tax on profits of companies owned by those groups or consortia. Where the non-UK resident company with a UK branch is established in the EU, any claim for loss relief will be on firmer ground than where the relevant company is established outside the EU. However, arguments as to the availability of relief in the latter scenario can still be marshalled.
The CJEU's decision on the fourth question before it (see below) is understood to be of significant assistance to certain taxpayers claiming relief for non-UK losses incurred by group companies other than their subsidiaries, but a recent Advocate General's opinion (discussed below) threatens the validity of those claims in a different way.
Analysis of the decision
A UK resident company ("Philips UK") made consortium relief claims in respect of losses of the UK branch of a Netherlands company ("LG.Philips Netherlands"). Those claims were denied by HMRC on the basis that – among other things – there was a possibility that the losses might be used in the Netherlands (and, in consequence, section 403D(1)(c) prevented the claims).
Philips UK contended that section 403D(1)(c) infringed EU law, and the parties agreed to refer the question to the First-tier Tribunal (Tax). The First-tier Tribunal found in favour of Philips UK. HMRC appealed that decision to the Upper Tribunal, who referred four questions to the CJEU for a preliminary ruling. In summary:
- Question 1: did section 403D(1)(c) constitute a restriction of the freedom of establishment?
- Question 2: if it did constitute a restriction, was it justified?
- Question 3: if it was justified, was it proportionate?
- Question 4: did EU law require 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)?
CJEU decision on Question 1: Restriction?
Without difficulty, the CJEU found that section 403D(1)(c) constituted a restriction of the freedom of establishment:
- UK resident companies were subject to tax in the UK on their worldwide profits. Similarly, UK branches of non-UK resident companies were subject to tax in the UK on the worldwide profits attributable to them. Accordingly, the applicable UK tax regime rendered the two (UK companies and UK branches) comparable.
- However, whereas UK branches of non-resident companies were prohibited from surrendering losses which could be used outside the UK, UK resident companies were not subject to any such restriction – meaning cross-border situations were treated less favourably than domestic situations.
CJEU decision on Question 2: Justified?
The UK Government had sought to justify the above difference in treatment on the basis that (by the UK/Netherlands double tax convention) the power to tax the profits of UK branches had been allocated to it, and that by allowing the UK branch to choose between using its losses in the UK or using its losses in the Netherlands (which choice the UK Government said might otherwise be open to the UK branch), that power would be undermined, and the UK tax base might be artificially reduced.
That contention was dismissed by the CJEU. The CJEU appears to have held that although EU law recognises that the preservation of the balanced allocation of powers of taxation can be a justifiable objective for an otherwise restriction provision, it is only actually a justification for provisions which aim to protect the relevant Member State's right to impose taxes – including by safeguarding symmetry between the right to tax profits and the obligation to allow losses. In the instant case, the CJEU held that the right of the UK to tax profits was not jeopardised by allowing the use of losses attributable to a UK branch. Logically, this was because the safeguarding of symmetry (and hence the preservation of the allocation of taxing rights) was ensured only if the UK did allow a deduction for UK branch losses. In other words, the UK Government had correctly identified the justification but had misapplied it.
This was in conformity with the earlier opinion of the Advocate General.
In addition, the UK Government sought to argue that if the UK were to give group relief for the losses of a UK branch of a non-UK resident company, there was a risk that those losses might also be used abroad by the non-UK resident company itself – giving rise to the double use of losses. The objective of section 403D(1)(c), said the UK Government, was to prevent any such double use of losses arising.
Although the CJEU stopped short of adopting the AG's view that the objective of preventing double use of losses is not recognised by EU law as a standalone justification for a restrictive provision in any circumstance, it did agree that it was not a valid justification in the present case. That finding was predicated on the analysis that (for reasons of fiscal symmetry) the UK was obliged to allow a deduction for branch losses, and so the only party who could be aggrieved by any use of losses in the Netherlands (in addition to the use of those losses in the UK) was the Dutch Government. Philips UK had formulated its case to the CJEU in terms that the UK Government was not required (nor should it seek) to act as a "cross-border Policeman" of the use of losses, and the CJEU seems to have agreed with that.
CJEU decision on Question 3: Proportionate?
Since the CJEU held that the provisions in issue were not justifiable, it did not go on to consider whether they were proportionate.
However, it is worth noting that the approach taken by the UK Government to the question of proportionality at the hearing before the CJEU (which approach was rejected by the Advocate General in her opinion) – namely, to invoke the so-called "Marks & Spencer test" – has been seriously called into question by a subsequent opinion of the Advocate General in the Finnish case A Oy (Case C-123/11, released on 19 July 2012). (The "Marks & Spencer test" asks whether a measure which restricts the availability of losses in the general case nonetheless allows the use of losses where – in summary – there is no possibility of those losses being used abroad: if it does, it is proportionate; if it does not, it isn't.)
In that opinion, the Advocate General states that the "Marks & Spencer test" no longer represents good law, since – having regard to the principle of symmetry now recognised as being at the heart of the need to preserve the balanced allocation of powers of taxation – losses should either be allowed in all circumstances (in cases where a corresponding power to tax profits has been allocated to the Member State in question) or they should not be allowed at all (in cases where no such power has been allocated). There is no grey area of the sort catered for by the "Marks & Spencer test".
If the Advocate General's opinion is confirmed by the CJEU in A Oy, this would have life threatening consequences for cases involving group relief claims for non-UK losses as in the Marks & Spencer group relief case (the most recent appeal in which case is due to be heard by the Supreme Court in June 2013).
CJEU decision on Question 4: Remedy?
The final issue addressed by the CJEU was whether only LG.Philips Netherlands could rely on an infringement of the freedom of establishment in order to secure disapplication of section 403D(1)(c) (since it was LG.Philips Netherlands that had sought to exercise that freedom) or whether it could be relied upon by Philips UK also.
The Advocate General had opined that Philips UK could rely on the infringement (and secure disapplication) since – on the facts – this was the only way in which full effect could be given to LG.Philips Netherlands' freedom. The CJEU substantively agreed, but on the more fundamental basis that whenever a Member State Court hears a case within its jurisdiction, it is that Court's duty (under EU law) to disapply any provisions of national law which contravene EU law (by, for example, restricting a fundamental freedom) irrespective of who the parties to those proceedings are – ie, irrespective of whether the party complaining of the infringement is the party whose rights have been infringed or not.
This is an important confirmation for cases involving group relief claims, since it will often be the surrendering company whose freedom has been infringed but the claimant company who brings any appeal against a denial of relief.