European Court limits impact Marks & Spencer case
Marks & Spencer, a company registered in the UK, had subsidiaries in the United Kingdom and in a number of Member States. In 2001 it ceased trading abroad owing to the losses recorded from the mid-1990s. Marks & Spencer claimed group relief from the UK tax authorities for losses incurred by its Belgian, German and French subsidiaries. Under the UK tax provisions, such deduction is not allowed where the losses are incurred by foreign subsidiaries. Following the refusal of its claim, Marks & Spencer brought legal proceedings.
In its decision of 13 December 2005, the European Court of Justice decided that the UK provisions constitute a restriction on freedom of establishment. In effect, the United Kingdom rules apply different treatment for tax purposes to losses incurred by a resident subsidiary and losses incurred by a non-resident subsidiary. They therefore discourage undertakings from setting up subsidiaries in other Member States.
Such a restriction is permissible only where it pursues a legitimate objective and is justified by overriding reasons in the public interest. It is further necessary that the restriction be apt to ensure the attainment of the objective in question and that it does not go beyond what is necessary to attain that objective.
The Court considers that the UK provisions pursue legitimate objectives which are compatible with the EC Treaty because it aims to protect a balanced allocation of the taxation rights between the various Member States. A further justification is found in the fact that the provisions avoid the risk of the double use of losses which would exist if the losses could be taken into account in the Member State of the parent company and in the Member States of the subsidiaries. A third justification is the objective to avoid the risk of tax avoidance which would exist if companies would be allowed to organise themselves in such way that losses are transferred to the companies established in the high tax countries and in which the tax value of the losses is therefore the highest,
After throwing out this lifeline the UK Revenue does not pass the last hurdle: the principle of proportionality. The Court considers that the United Kingdom provisions go beyond what is necessary to attain the objectives pursued. The proportionality is not observed where:
- the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account in its State of residence for the accounting period concerned by the claim for relief and also for previous accounting periods, and
- there is no possibility for the foreign subsidiary’s losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.
If the parent company demonstrates to the tax authorities that the above conditions are fulfilled, the freedom of establishment dictates that the parent company should be able to deduct the losses incurred by its foreign subsidiary from its taxable profits.
