Double dip or Double Dutch

Double Dip Or Double Dutch?
A reaction to an article in the forty-ninth Inland Revenue Tax Bulletin concerning international corporate groups with branch losses; from Thom Rasser and Ronald Hein.
The Inland Revenue recently issued the forty-ninth Tax Bulletin, and one of the articles in that publication provided guidance on the new United Kingdom group relief regulations. These regulations were introduced with the Finance Act 2000. They are to be found in sections 403D and 403E, Taxes Act 1988, and have effect for accounting periods ending on or after 1 April 2000.
An important feature of the new rules is the possibility to offset losses from a United Kingdom branch against other United Kingdom income that is generated within the same group. However, the applicability of this form of group relief is subject to the important condition that the branch loss is not deductible or allowable, in any period, against non-United Kingdom profits. The article in the Tax Bulletin aimed to demonstrate the branch taxation regulations of selected overseas jurisdictions against this condition.
In attempting to define a number of foreign tax systems, the Revenue seemed to realise that it was treading on thin ice, given the following remark in the introductory paragraph: 'These examples should not be taken as definitive statements on the foreign law'. It is clear from the beginning of the Tax Bulletin article that this caution is to be taken very seriously indeed. In this article, we take a closer look at the situation in which a Netherlands company has a permanent establishment in the United Kingdom.
What the Bulletin said
First it may be helpful to restate what the Revenue said in relation to the Netherlands tax system:
'Although the Netherlands operates an exemption system, losses of overseas permanent establishments are nevertheless available for set-off against domestic income of the company after being set first against non-taxable foreign source income. If the loss in the United Kingdom branch is entirely set against such non-taxable income in the Netherlands, group relief will be available in the United Kingdom. However, if the loss in the United Kingdom branch is available against domestic income (i.e. it exceeds profits in other foreign branches) group relief is not due.'
Branch losses in the Netherlands
The Tax Bulletin article correctly defines the Dutch way of dealing with overseas branch losses as an exemption system. It also rightly states, that such losses are nevertheless available for set-off against domestic income. However, contrary to the subsequent suggestion, there is no need to net the loss of a permanent establishment against any positive income deriving from other overseas branches. The Revenue's (incorrect) understanding can be illustrated as follows:
Example 1
Year t
Dutch domestic income 50
United Kingdom branch income (40)
United States branch income 30
Worldwide income 40
Tax 35 per cent 14
In year t the sum of the income from foreign branches amounts to an overall loss of 10. The Revenue's view is that this is the basis for the relief of double taxation in the Netherlands. Since the outcome is negative, no relief is obtained.
The current approach
It is true that such a system of providing relief, generally known as the 'overall' method, once prevailed in the Netherlands, but it was traded in for a 'per country' approach well over five years ago. Nowadays, the loss of one branch is fully deductible without limiting the relief given in respect of the profits of another. In terms of our earlier example: irrespective of the United Kingdom branch's loss, relief is given for the profit of the United States branch. The relief amounts to 30 @ 35 per cent = 10.5 and reduces the company's Dutch tax liability to 3.5.
As a result of this mix-up, the Revenue's conclusion concerning the Netherlands is wrong as well: in reality, domestic relief is nearly always available for overseas branch losses of a Dutch corporate taxpayer. As a general rule, therefore, the United Kingdom branch of a Dutch company will not have access to United Kingdom group relief.
Why should they not qualify?
Once the Revenue's understanding of the Dutch relief legislation has improved, it will undoubtedly deny most United Kingdom branches of Netherlands companies access to the new United Kingdom grouping regulations. But why is that? The purpose of the rule is, according to the Revenue, to prevent relief being obtained twice once for United Kingdom tax and once for overseas tax. In itself, the explanation is sensible enough but, generally speaking, it does not apply to the relief system under consideration.
Example 2
Year 1 Year 2
Dutch domestic income 50 10
United Kingdom branch income (40) 55
United States branch income 30 15
Worldwide income 40 80
Tax @ 35 per cent 14 28
Relief 30 @ 35 per cent 10.5
Relief (55 + 15 - 40) @ 35 per cent 10.5
Tax liability 3.5 17.5
In the Netherlands, as Example 2 demonstrates, branch loss deduction is a temporary affair. Future profits deriving from the same branch operation that generated the deductible loss will not qualify for relief of double taxation in the Netherlands, until such point as the entire loss has been recouped. Thus, the initial benefit of the branch loss deduction is neutralised. This claim from the Dutch authorities is extended to any subsidiary that should take over the branch's activities. Although the Revenue recognises this point, it simply states that 'that will not make the losses available for United Kingdom group relief'. This is a peculiar outcome, given that, in the Dutch context, relief is generally not being obtained twice.
Unjustified discrimination
According to the press release of 26 February 1999, in which the new group relief rules were announced, the main objective of the introduction of sections 403D and 403E, Taxes Act 1988 is to deal with the European Court of Justice's ruling on Imperial Chemical Industries plc v Colmer (Case C-264/96). In other words: the new regulations are directed against unjustified discrimination. Example 2 clearly illustrates that it is in this very respect that the Revenue's reasoning is flawed. Bearing in mind Imperial Chemical Industries plc v Colmer, as well as the comparable rulings in Compagnie de Saint Gobain v Finanzamt Aachen (Case C-307/97) and Error! Hyperlink reference not valid., it is questionable whether the Revenue will be able to uphold its views where United Kingdom branches of Dutch companies are concerned.
Thom Rasser and Ronald Hein are both based in the Netherlands.

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