Marks & Spencer: EU claims for cross-border loss relief.

• Author: Hare, Jonathan
• Position: European Union

Introduction

The European Court of Justice (ECJ) is charged with hearing cases and deciding whether the domestic law of member states of the European Union is in breach of the fundamental freedoms laid down in the various EU treaties (collectively, the "EC treaty"). Initially, the ECJ was not focused on direct taxation matters and, indeed, there were only three direct taxation cases heard by the ECJ by the mid-1980s--more than two decades after the ECJ was created. Since then, however, the number of direct taxation cases heard by the ECJ has accelerated year on year and, more important, in 95 percent of the direct tax cases heard by the ECJ, the taxpayer is victorious.

There have recently been a number of cases heard by the ECJ where the taxpayer has won which have had, and continue to have, a profound effect on the direct and indirect taxation of EU residents (e.g., Lankhorst-Hohorst concerning the legality of German "thin capitalization" rules, and Bosal concerning the legality of Dutch interest deductibility rules). In these cases, a decision by the ECJ has often led to changes in domestic legislation, not only in the country directly concerned but also in other EU jurisdictions. This is not surprising since (a) the EC treaty and ECJ case law take precedence over domestic law, (b) extrapolation of a decision regarding one jurisdiction's law to other jurisdictions is relatively straightforward in many cases, and (c) ECJ decisions are generally made on broad principles and are not focused on the detailed provisions in question.

Whilst the previous cases have prompted a significant amount of change, along with which comes opportunity and risk, there is one particular case that may have a revolutionary effect on multinational taxpayers operating through multiple entities or business units in the EU. Although judgment has not yet been delivered, the Marks & Spencer (M&S) case has been heard by the ECJ and the Advocate-General has issued an opinion.

Background of the M&S Case

M&S is a household name in the United Kingdom, a high-street retail company that is listed on the U.K. stock exchange. In the early 1990s, M&S decided to expand into continental Europe and to do so set up, among others, a French subsidiary to operate a retail outlet in Paris. Unfortunately, the commercial experiment was not a success and the French and other European subsidiaries incurred significant losses before M&S withdrew from the continental Europe retail market.

In the same period, the U.K. operations of M&S were profitable and a U.K. tax liability was incurred. Under U.K. domestic rules, there was no way to use the losses of the French subsidiary to reduce the profits of the U.K. operations for U.K. tax purposes, since the UK group relief provisions (a statutory scheme that affords an entitlement to certain commonly controlled company groupings to surrender or share losses between group members) restricts loss claim and surrender to U.K. resident companies and foreign resident companies with a U.K. business.

M&S challenged the law, contending that the UK rules were in breach of the fundamental freedom of establishment under the EC Treaty, inasmuch as group relief would have been granted if the two entities or units were resident in the U.K. M&S's litigation objective is to invoke the supremacy of EU law (i.e., the EC treaty) to obtain refunds of UK corporate income tax paid in prior periods by claiming the right to re-compute the U.K. group members' aggregate taxable income, net of operating losses incurred by its European subsidiaries over the same periods.

If M&S is successful in its claim to the ECJ, taxpayers will need to consider their own facts and circumstances in order to determine the impact this may have on their structure. The likely conclusion, however, is that several other European jurisdiction tax consolidation or group relief systems will be deemed equally in breach of the EC Treaty, such that claims could follow across Europe. The exact nature of the illegality, how a claim would be...