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Tax relief on cross-border losses - crunch time in Europe Back  
The draft judgement from the Marks & Spencer case before the European Court of Justice leaves open the possibility of retrospective claims for tax relief on cross border losses. The draft judgement places a limit on the possibility of such claims. The limit is debateable both as regards its meaning and its validity, writes Pat McDaid in this month's KPMG Tax Monitor.
The Issue
The issue in the Marks & Spencer case was whether a UK holding company was entitled to tax relief in the UK in respect of trading losses incurred in a French resident subsidiary. Had the French resident subsidiary been instead resident in the UK the holding company would have been entitled to group relief for the losses, but the subsidiary would equally have been within a charge to UK corporation tax had it taxable profits.
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The EU treaties grant a freedom of establishment and for that purpose prohibit measures rendering less attractive the exercise of the freedom. The treaties also prohibit discrimination on grounds of nationality.

The Marks & Spencer group were free to make a commercial decision as to whether to conduct their French business through a UK resident subsidiary or through a French resident subsidiary. They chose to do so through a French resident subsidiary. In consequence the rules relating to UK group relief (whereby the trading losses of one group member might be relieved against the taxable profits of another group member) did not apply to the French resident subsidiary, as it was outside the UK corporation tax net. Since the French subsidiary made losses, it was less attractive for the Marks & Spencer Group to have used a French subsidiary rather than a UK subsidiary, since the choice cost it the benefits of group relief.

The issue, notwithstanding the learned arguments of many counsel, was actually quite clear. The answer, that the group relief rules confining the relief to companies within the charge to corporation tax in the UK, represented a restriction on freedom of establishment, was the obvious outcome to the case.

That outcome was to be found in the opinion of the Advocate General. This is a draft judgement which has to be confirmed by the court. The court usually adopts the draft judgements of the Advocate General but is not bound to do so and doesn’t always do so.

Controversial limit
The controversial aspect of the draft judgement was contained in a few lines near the end, where the Advocate General suggested that the UK measure would not amount to interference with freedom of establishment if its denial of relief for losses of foreign subsidiaries was confined to cases where those foreign losses were capable of relief outside the UK. The Advocate General gave very little analysis to support this conclusion, in contrast to his lengthy analysis leading to the conclusion that the group relief restriction complained of was indeed a restriction on the freedom of establishment.

This sting in the tail of the Advocate General’s opinion is of considerable significance. All EU States provide some form of relief for losses, whether through a form of group relief within their own territory, or by offset of trading losses against other income in the same period, or by relief of trading losses against the income of prior periods, or of subsequent periods. Therefore a statement that the denial of group relief to a subsidiary resident elsewhere in the EU represented a restriction on freedom of establishment, but not where the losses could be relieved abroad, on the face of it, amounted to saying that the UK restriction was in fact quite lawful in EU terms, and similar restrictions in other EU Member States, including Ireland, could be similarly upheld.

That would not be a fair interpretation of what the Advocate General said. By way of background, it would appear that the French subsidiary of Marks & Spencer made substantial losses and eventually ceased business. As far as is known, it did not receive relief in France for those losses, because no income or profits arose against which the losses could be utilised. There was of course a theoretical right to obtain relief for such losses, but no effective relief was obtained due to lack of income. Against that factual background it seems likely that what the Advocate General meant was that if, whether due to legal restrictions, or due to lack of income, no relief could be obtained abroad, then relief had to be provided in the UK. That left open therefore the possibility of obtaining relief for foreign losses in circumstances where lack of income made a foreign relief impossible.

That interpretation can be applied reasonably clearly where a company goes into liquidation with unrelieved losses. The possibility of future relief is clearly ended by the liquidation. But if a company has accumulated losses over a long period of years and is continuing to trade, but at a level of profit that means that tax relief will not be obtained for the past losses for a very long time, if ever, does the Advocate General’s opinion mean in such circumstances relief has to be granted in the parent company’s jurisdiction for the foreign losses, on the grounds that effective relief, as opposed to theoretical relief, is unlikely? The Advocate General’s view on this is not clear. It does not explore the distinction between theoretical possibilities of relief, and the probability of effective relief.

In any event, the Advocate General’s opinion is not only poorly explained in this regard but open to objection. It ignores the issue of the timing of relief. If the Marks & Spencer subsidiary operating its French business had been UK resident, relief would have been obtained for its losses in the same period as that in which they arose. Because it was French resident, relief was potentially available only in some future uncertain time period, when profits might eventually have arisen. Even if it had seemed probable that profits would arise several years down the road, against which the losses might be relieved, the contrast in the value of such relief in the future, compared to immediate relief had the company been UK resident, is such to amount to an effective restriction on the freedom of establishment. The contrast would make it very much more favourable for Marks & Spencer to locate its subsidiary in the UK, rather than in France.

What now?
It remains to be seen if the European Court of Justice, in considering the Advocate General’s draft judgement, will explore this issue or indeed whether they will at all accept the Advocate General’s proposed restriction on the obligation to provide cross border group relief.

Since the issue first emerged, companies in Ireland have had to consider whether subsidiaries or fellow subsidiaries in EU States have losses in respect of which the Irish company should make a protective claim in respect of Irish tax. In so far as Irish companies had incurred losses, their fellow group members in other EU States would also have been considering claims in those other States for the Irish losses. The limited freedom opened by the Advocate General’s opinion may slow down the making of such claims and there must be a real possibility that the opinion will not be adopted unchanged. Perhaps the strongest argument in favour of it being adopted unchanged is that the consequences of requiring unrestricted cross border group relief for losses be either the withdrawal of group relief entirely, or an increase in pressure for harmonisation of corporation tax across the community. The Advocate General’s compromise might seem preferable to either of these.

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