GT Alert

December 13, 2005: EC Court of Justice Judges in Marks & Spencer Case: Cross-border Loss Relief Between EU Resident Companies Under Strict Conditions Possible

December 2005

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Marks & Spencer, a UK-based company, wanted to deduct from its taxable profits the losses incurred by its Belgian, French and German resident subsidiaries. Based on the decision of the European Court of Justice (“ECJ”), Marks & Spencer should be allowed to deduct these losses, since these subsidiaries have exhausted the possibilities for loss relief in their respective countries.

In almost all EU Member States, loss carry forward provisions are included in the tax laws. Therefore, even if group relief provisions are available in a particular EU Member State, only in limited situations is it possible to effectively transfer losses to another EU parent company.

The decision of the ECJ may have a retroactive effect. Consequently, companies with loss-making non-resident subsidiaries in the current or past years should investigate whether a cross-border loss relief claim can be made. In addition, tax restructuring may be developed to avoid situations in which EU losses cannot be used at all.

The Marks & Spencer case:

Marks & Spencer (“M&S”) is a UK-based company with – amongst others – EU resident subsidiaries. In 2001, M&S sold its French subsidiary to a third party, and closed down its Belgian and German subsidiaries. As a consequence, the losses of those subsidiaries could not be used in those countries as a loss carry forward to future years. Therefore, M&S claimed group relief from the UK tax authorities for losses incurred by its Belgian, German and French subsidiaries. Under UK tax laws, the UK resident companies in a group may offset their profits and losses within this group. However, losses of subsidiaries that do not have a presence in – and do not have trade in – the UK may not be offset with the profits of the UK group.

In 2003, the UK High Court of Justice asked the ECJ whether the UK laws were compatible with the provisions of the EC Treaty on freedom of establishment.

Judgement of the ECJ:

1. In principle, the EC Treaty does not preclude the provisions of a Member State’s tax system which prevent a resident parent company from deducting from its taxable profits the losses incurred in a Member State by a subsidiary resident of that Member State, even if such provisions allow the parent company to deduct the losses of a resident subsidiary.

2. However, such provisions conflict with the EC Treaty if such provisions prevent deduction of the losses of an EU resident subsidiary in the event that this subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account in its state of residence for the accounting period concerned and for previous accounting periods, and if this subsidiary has no possibility in its state of residence of offsetting these losses with future profits, either of the subsidiary itself or of a third party, especially in the event that the subsidiary has been sold to that third party.

3. Consequently, where in one Member State the resident parent company can demonstrate that those conditions are fulfilled, it is contrary to the freedom of establishment to preclude the possibility for the parent company to deduct such losses from its taxable profits in that Member State.

In addition:

The ECJ argued that the abovementioned restriction in the UK tax provisions for loss compensation is permissible only where it pursues a legitimate objective compatible with the Treaty and is justified by overriding reasons in the public interest. It is further necessary, in such a situation, that the restriction be apt to ensure the attainment of the objective in question and that it does not go beyond what is necessary to attain that objective. In the light of the three justifications relied on by the Member States, namely:

• to protect a balanced allocation of the power to impose taxation between the various Member States concerned, so that profits and losses are treated symmetrically in the same tax system;

• to avoid the risk of the double use of losses, which would occur if the losses were taken into account in the Member State of the parent company and in the Member States of the subsidiaries; and

• to avoid the risk of tax avoidance, which would occur if the losses were not taken into account in the subsidiaries’ Member States. Within a group of companies, losses might be transferred to the companies established in the Member States which apply the highest rates of taxation and in which the tax value of the losses is therefore the highest,

the ECJ considered that the UK provisions pursue legitimate objectives which are compatible with the EC Treaty, but that the UK provisions do not observe the principle of proportionality – that is to say, they go beyond what is necessary to attain the objectives pursued.

This Alert was written by Richard Smeding and Gerwin de Wilde in the Amsterdam office. Please contact Mr. Smeding at +31 20 30 17 375 or Mr. de Wilde at +31 20 30 17 419 or your Greenberg Traurig liaison, if you have any questions regarding the subject matter of this Alert.

© 2005 Greenberg Traurig

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