On 13 December 2005, the European Court of Justice ("ECJ") ruled that Marks and Spencer plc ("M&S") could claim group tax relief from UK tax authorities in relation to the losses incurred by its European subsidiaries.

M&S claimed relief from UK tax authorities on the basis that, just as UK resident companies in a group may set off their profits and losses among themselves, so it should be able to set off the losses it had incurred through foreign subsidiaries which had ceased trading in Belgium, Germany and France.  M&S had incurred losses in these subsidiaries between 1998 and 2001 which could not be set off against tax liabilities in these jurisdictions.

The claim was rejected in the UK because UK domestic tax provisions do not allow losses to be set off where they have been incurred by subsidiaries which have no establishment in the UK and do not trade there.  M&S therefore brought proceedings in the Chancery Division of the High Court of Justice ("High Court").  The High Court asked the ECJ whether the UK provisions were compatible with the provisions of the EC Treaty on freedom of establishment.

The ECJ found that whilst, in principle, the relevant UK tax provisions pursued legitimate objectives, they had gone beyond what was necessary to achieve those objectives and so constituted a restriction on freedom of establishment.  A parent company should be able to set off losses incurred by its foreign subsidiary or subsidiaries against tax liabilities in the parent's state of residence provided it could demonstrate to the tax authorities of its state of residence that:

  • a non-resident subsidiary could not, under the domestic tax law of its own state of residence, claim tax relief in that state for the relevant accounting period and any previous accounting periods; and
  • there was no possibility that the subsidiary's losses could be utilised in that state in future periods, whether by the subsidiary or by a third party, in particular where the subsidiary had been sold to that third party.

Since M&S was able to demonstrate this to the UK tax authorities, the ECJ found that it was contrary to the principle of "freedom of establishment" for UK tax authorities to preclude M&S from applying to have the losses which had been incurred by its non-resident subsidiaries deducted from its taxable profits.

Had the ECJ found conclusively against UK tax authorities in this case, the door may have been opened for numerous similar cases, possibly costing the Treasury billions of pounds in tax rebates.  Given the conditions attached to the ECJ's opinion, the Treasury commented that it is likely that there will only be "a very small number" of successful claims.  It has been suggested that the final cost to the Treasury of successful claims will most likely amount to hundreds of millions of pounds.  With one significant group litigation involving Heinz, BNP Paribas and BT on its way back to the High Court for decision, and at least one other reportedly about to commence, the actual cost of this judgment for the UK tax authorities will soon become clearer.

In the meantime, the Treasury is consulting with business on what amendments will need to be made to UK tax legislation to bring it in line with the ruling of the ECJ.  The judgment may also have implications for tax regimes in certain other European states.  In Belgium, for example, there is no such thing as group tax relief, so no direct change will be required.  However, states such as Ireland and Sweden, whose tax regimes are similar to that in the UK, will doubtless have to arrange for amendments to be made.

Case referred to: Marks & Spencer plc v David Halsey (Her Majesty's Inspector of Taxes) C-446/03

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