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Mixed result
Marks & Spencer plc had subsidiaries in Germany, Belgium and France. From the middle of the 1990s, those subsidiaries recorded losses, and in 2001 Marks & Spencer ceased trading on mainland Europe. It then sought group relief in respect of losses incurred by its subsidiaries from 1998 to 2001, but these claims were rejected by the Inspector of Taxes on the ground that group relief does not apply to subsidiaries which are neither resident nor economically active in the UK.
On appeal to the High Court, the judge asked the European Court of Justice whether the UK provisions were compatible with EC law, in particular with the principle of freedom of establishment.
The Advocate General has said that the refusal of a tax advantage might be regarded as restricting the treaty, if it was principally associated with the exercise of the right to establishment. Group relief constituted a tax advantage for a group of companies, but a group whose UK-resident parent company wished to establish subsidiaries in other Member States was deprived of that advantage. This constituted an exit restriction discouraging UK companies from establishing subsidiaries in other Member States, thus the freedom of establishment was restricted.
Could that restriction be justified as a measure pursuing a legitimate objective justified on general-interest grounds? The Advocate General rejected the German Government's argument that to allow such loss relief could lead to a reduction in tax revenue. With regard to the territorial principle, the Advocate General said that it was important to find out if the granting of that advantage would damage sovereignty in tax matters by all the Member States. There was nothing to prevent the UK from extending the relief to parent companies with non-resident subsidiaries, thus the principle of territoriality could not justify the restriction.
Finally, he said that, with regard to preserving the coherence of a tax system, there had to be a direct connection between the grant of a fiscal advantage and the offsetting of that advantage by a specific charge to tax. The aim of group relief was to ensure the fiscal neutrality of the effects of the creation of a group of companies. Losses could be transferred, but the surrendering company was not allowed to use those same losses for tax purposes. The Advocate General said that this was excessive. While it was appropriate for the Member State concerned to take account of the treatment of losses of subsidiaries in the countries in which they were respectively resident, justification based on cohesion of the system of relief was only acceptable if the foreign losses could receive equivalent treatment in the country in which those losses arose.
Thus, the Advocate General said that granting the relief should be subject to the condition that the losses of foreign subsidiaries did not receive advantageous tax treatment in the country in which they were resident. If the foreign subsidiaries were able to assign their losses elsewhere, the Member State was entitled to oppose a claim for the cross-border transfer of those losses. Relief would then have to be obtained in the country in which the subsidiary was established. Companies should not be able to choose the place where they use their losses, as this could otherwise develop into trafficking in losses at EC level.
Andrew Shilling, director of international tax at Chiltern plc said that the Advocate General's ruling had effectively provided the 'UK Government with a get out of jail free card'. The Advocate General said that the UK was entitled to oppose a claim for the transnational transfer of losses, where the foreign subsidiary could pass those losses on to another person or carry them forward to other financial years. As, according to Chiltern, most other EU countries allow the carry forward of tax losses, all the Revenue has to do is 'some minor tweaking to tax legislation to retain a group relief system that will comply with EU law, but will not permit relief for the vast majority of foreign losses'. This, said Andrew, would avoid 'the nightmare scenario of the abolition of group relief', an otherwise not wholly unlikely event. He reckoned this was 'good news for UK corporates' as it gave them certainty in the management of their tax affairs.
With regard to existing similar claims, Andrew said claimants were still likely to receive tax refunds, and that new claims should be submitted as soon as possible since the Revenue 'may take action to time-bar any new claims'.
It should be noted that the Advocate General's opinion is just that, and the European Court of Justice may reach a different conclusion, although that would be unlikely.
(European Court of Justice press release 29/05 dated 7 April 2005.)
Not the wild west
Advocate General Poiares Maduro has published his opinion in the cases of Halifax plc, Leeds Permanent Development Services Ltd, County Wide Property Investments Ltd v CCE (Case C-255/02); BUPA Hospitals Ltd, Goldsborough Developments Ltd v CCE (Case C-419/02); and University of Huddersfield Higher Education Corporation v CCE (Case C-223/03).
All three cases concerned transactions that had been entered into with the purpose of gaining a tax advantage by recovering more input tax than would otherwise be the case.
In Halifax, the construction of call centres was routed through subsidiary companies to avoid the restriction on input tax that would have arisen by virtue of most of the supplies of Halifax being exempt financial services. In BUPA Hospitals Ltd, the companies made substantial payments in advance for drugs, etc. to enable the input tax to be reclaimed before such supplies were removed from the zero-rating regime; and in Huddersfield, buildings were leased through a trust to enable input VAT on refurbishment work to be recovered as this would not have been possible if carried out by the university itself, which made exempt supplies of education.
The Advocate General rejected the contention of Customs that as the transactions were carried out for the sole purpose of avoiding or deferring VAT they were not economic activities and could thus not be supplies under the VAT legislation.
The Advocate General considered that even if the transactions were for tax avoidance, they were intrinsically lawful and therefore within the scope of the Sixth Directive. 'The tax avoidance purpose is therefore an external circumstance that does not change the inherent and objective nature of each of those transactions.' The idea promulgated by the UK Customs that the intention of the parties to a transaction was of central importance, was 'counter to the objective character of the notion of “economic activity”, which constitutes a fundamental feature of the VAT system'. The Advocate General also foresaw serious problems with the UK's suggestion that transactions for tax avoidance should be left out of the VAT system as this could mean that transactions where VAT was in fact otherwise payable would also be left out of account. Customs' argument presupposed that there was always one 'normal' way of carrying on a transaction and innocent parties in a series of transactions could be adversely affected.
The view of the Advocate General was, instead, that 'the terms “economic activity” and “supply” ... should be interpreted as meaning that each of the transactions at issue must be considered objectively and per se ... the fact that a supply is made with the sole intention of obtaining a tax advantage is immaterial'.
However, he did consider that the notion of 'abuse' was well-established and Community law could not be relied on for abusive or fraudulent ends. However, this must be carefully interpreted and restricted to cases where there is 'an improper advantage, manifestly contrary to the objective of that provision'.
This had to be contrasted to cases where there was 'no abuse but merely a legitimate exercise of the right'. In the view of the Advocate General, the test is objective: 'What matters is not the actual state of mind ... but the fact that the activity, objectively speaking, has no other explanation but to secure a tax advantage'.
The Advocate General stressed that whilst it was important that there should be legal certainty so that taxpayers were aware of potential financial burdens resulting from transactions: 'tax law should not become a sort of legal “wild-west” in which virtually every sort of opportunistic behaviour has to be tolerated so long as it conforms with a strict formalistic interpretation of the relevant tax provisions'.
The Advocate General's advice to the national courts, in response to questions put to the ECJ were that the terms 'economic activity' and 'supply' made by a 'taxable person acting as such' should be considered objectively; and tax advantage was immaterial; but that abuse would exist where two objective elements are found. 'First, that the aims and results pursued by the legal provisions formally giving rise to the tax advantage invoked would be frustrated if that right were conferred. Second, that the right invoked derives from economic activities for which there is objectively no other explanation than the creation of the right claimed.'
With regard to the BUPA case, the Advocate General also considered that the rules regarding payments on account would not apply where a payment was made for unspecified goods, which the buyer could choose at a later date and even recover the balance of any unused payment. Such an agreement would be outside of Article 10(2) of the Sixth Directive and VAT would not therefore be chargeable on receipt of the payment. The BUPA scheme would therefore fail on that basis.
(http://europa.eu.int/cj/en/)
