This long running Court of Justice of the European Union (CJEU) case examined the lawfulness of the UK’s cross-border group relief provisions introduced by Finance Act 2006 (following the landmark decision in the Marks & Spencer v Halsey (M&S) case C-446-03) and specifically the “no possibilities test”.

The Court did not follow the Advocate General’s Opinion. That opinion of last October recommended that the “no possibilities test” be abandoned on the basis that ascertaining whether losses might be available for surrender in future periods created too many procedural difficulties. Accordingly, the Advocate General’s view was that the UK’s amendments to its rules on group relief went beyond that required by EU law, as they allowed for the possibility of cross-border relief in certain cases.

Had the CJEU followed the Advocate General’s non-binding opinion, this would have reversed the ECJ’s original decision. However the CJEU did dismiss the EC’s current action. The decision takes a very narrow view of the “no possibilities test” (meaning that relief must only be given if a loss cannot be carried forward). The decision concluded that the UK legislation which requires the determination to be decided at the end of the accounting period in which the loss was made as complying with this requirement.

Interestingly, an unexpected implication of this judgment is that cross-border group reliefs meeting the necessary conditions of the legislation would appear to be more widely available than previously thought to be, for periods prior to the introduction of these rules (pre 1 April 2006).

The UK Supreme Court’s 2013 judgment in the M&S case looked at periods prior to 2006, and decided that the no possibilities test should be assessed at the date the claim is made by the taxpayer, rather than the end of the period in which the losses arose. This opens up the possibility of making claims which were previously thought to be out of time.

Key facts and arguments

On 19 July 2007, the European Commission (the Commission) sent a letter of formal notice to the United Kingdom (UK) drawing its attention to the possibility that the tax rules adopted by the UK in the wake of the judgment in Marks & Spencer (C-446/03) (M&S) were incompatible with the freedom of establishment. The Commission argued that the rules were based on a particularly restrictive interpretation of the condition relating to the exhaustion of all possibility of the non-resident subsidiary’s losses being taken into account in its state of residence.

In addition, according to the Commission, those rules applied only from the date on which the new legislation entered into force, that is to say, from 1 April 2006.

The UK responded asserting that its legislation on cross-border group relief was consistent with the principles laid down by the Court in the M&S judgment.

In September 2008, the Commission sent the UK a reasoned opinion re-stating its position. The UK reaffirmed its own position. That was followed by the Commission sending the UK a supplementary reasoned opinion following the adoption of the Corporation Tax Act (CTA) 2010. The UK further responded to this in January 2011.

Not convinced by the line of argument put forward by the UK, the Commission brought the present action. Infringement of Article 49 of the Treaty on the Functioning of the European Union (TFEU) and Article 31 of the European Economic Area (EEA) Agreement were both cited, on the basis that section 119(4) of the CTA 2010 makes it virtually impossible for a resident parent company to obtain cross-border group relief.

In its arguments, the Commission submitted that section 119(4) of the CTA 2010 does not meet the requirements contained in paragraphs 55 and 56 of the judgment in M&S. This is on the basis that it is impossible to establish if losses sustained by a subsidiary established in an EU/EEA Member State can be taken into account in the future because this assessment must be made ‘as at the time immediately after the end’ of the accounting period in which the losses are sustained.

As a result of section 119(4) of the CTA 2010, cross-border group relief may be granted in only two very specific situations. The first situation arises where no provision is made under the legislation of the non-resident subsidiary’s state of residence for losses to be carried forward. Secondly, if the non-resident subsidiary enters into liquidation before the end of the tax year in which the losses are sustained, cross-border group relief may be possible.

The crux of the Commission’s argument was that cross-border group relief is therefore not possible and is precluded in the normal commercial situation. One example cited of such a commercial situation is, where, after the end of a tax year in which losses have been occurred, a decision is subsequently taken to cease trading and the non-resident subsidiary is placed in liquidation. In addition, the Commission argued that relief is limited to losses sustained in a single tax period.

The Commission also argued that compliance with the conditions in the M&S judgment required that the possibility of obtaining tax relief in the state of residence should be assessed at the time when the claim for group relief is made in the UK. It should also be assessed on the basis of the actual facts of the case, and not on the basis of some theoretical possibility (of subsequently taking into account losses sustained by the non-resident subsidiary) which exists only because the foreign subsidiary has not yet been placed in liquidation.

The UK argued that the M&S judgment (which deals with the condition that there must be no possibility of the losses being taken into account for future periods) makes clear that the related assessment must be made at the end of the accounting period in which the losses arise.

Responding to the Commission’s argument that it is virtually impossible to obtain cross-border group relief, the UK contended that a company will normally have the possibility of carrying losses forward to a subsequent tax period in circumstances in which it continues to trade. It further argued that the condition in section 119(4) of the CTA 2010 is capable of being satisfied in circumstances wider than those set out by the Commission. The relevant provisions do not make cross-border relief conditional on the non-resident subsidiary entering liquidation before the end of the accounting period in which the losses were occur.

Evidence of an intention to wind up a loss-making subsidiary and initiation of the liquidation process soon after the end of the accounting period would be factors to be taken into account. In determining whether the “no possibilities test” in section 119(4) CTA 2010 is met, the intention to wind up the subsidiary is taken into account, together with all other relevant facts at the end of the accounting period in which the losses occur.

A number of intervening parties to the case (Germany, Spain, the Netherlands and Finland) further submitted that the UK is not under any obligation to allow losses sustained by non-resident subsidiaries to be taken into account in all cases in which those losses may not be taken into account elsewhere. Furthermore, it was that argued treating liquidation of the non-resident subsidiary as being de facto a condition for loss relief would not be disproportionate.

Decision

The CTA 2010 establishes group relief arrangements under which losses sustained by a company may be offset against the profits of other companies belonging to the same group. Unlike losses sustained by resident companies, those sustained by non-resident companies may be taken into account for the purposes of group relief only if the conditions laid down in sections 118 and 119 of the CTA 2010 are met.

Group relief under the CTA 2010 constitutes a tax advantage for the companies concerned. By speeding up relief for loss-making companies and allowing them to be set off immediately against the profits of other group companies, that system confers a cash-flow advantage on the group.

The difference in treatment in group relief between losses sustained by resident subsidiaries and non-resident subsidiaries hinders the exercise by the group parent company of its freedom of establishment for the purposes of Article 49 TFEU. This acts as a deterrent from setting up subsidiaries in other Member States.

According to case-law of the Court, such a difference in treatment may be justified by three overriding reasons in the public interest; by the need to preserve the balanced allocation of powers of taxation between the Member States, the need to prevent the double use of losses and the need to combat tax avoidance.

It remains to be considered whether the conditions laid down by the CTA 2010 for cross-border relief are consistent with the principle of proportionality in that, whilst being appropriate for achieving the objectives they do not go beyond what is necessary to achieve them.

The judgment in M&S held that the difference in treatment between the losses sustained by a resident subsidiary and those sustained by a non-resident subsidiary goes beyond what is necessary to attain the objectives pursued in two situations.

Firstly; where the non-resident subsidiary has exhausted the possibilities available in its state of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring those losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods.

And, secondly, there is no possibility for the foreign subsidiary’s losses to be taken into account in its state of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party.

According to paragraph 56 of the judgment, where, in one Member State, the resident parent company demonstrates to the tax authorities that a non-resident subsidiary has sustained definitive losses, it is contrary to Articles 49 TFEU to preclude the possibility for the parent company to deduct from its taxable profits in that Member State the losses incurred by its non-resident subsidiary.

However, sections 118 and 119(1) to (3) of the CTA 2010 allow losses sustained by a non-resident subsidiary to be taken into account by the resident parent company in the situations contemplated in paragraph 55 of the judgment in Marks & Spencer.

Furthermore, the Commission itself acknowledges in its application that, in principle, the CTA 2010 allows the resident parent company to take into account definitive losses sustained by a non-resident subsidiary.

According to the Commission, section 119(4) of the CTA 2010 is contrary to Article 49 TFEU because it makes it virtually impossible in practice for a resident parent company to obtain cross-border group relief.

Section 119(4) of the CTA 2010 sets the date by reference to which it must be decided whether losses sustained by a non-resident subsidiary are definitive, as described in the judgment. That assessment is to be made ‘as at the time immediately after the end’ of the accounting period in which the losses were sustained.

According to the Commission, that requirement makes it virtually impossible for group relief to be obtained for losses sustained by a non-resident subsidiary, since in practice it allows the resident parent company to take such losses into account in only two situations: (i) where the legislation of the Member State of residence of the subsidiary concerned makes no provision for losses to be carried forward and (ii) where the subsidiary is put into liquidation before the end of the accounting period in which the loss was sustained.

However, the first of those situations referred to by the Commission is irrelevant for the purposes of assessing the proportionality of section 119(4) of the CTA 2010. It is settled law that losses sustained by a non-resident subsidiary cannot be characterised as definitive because the Member State in which the subsidiary is resident precludes all possibility of losses being carried forward. In such a situation, the Member State in which the parent company is resident may not allow cross-border group relief without thereby infringing Article 49 TFEU.

As regards the second situation referred to, the Commission has not established that section 119(4) of the CTA 2010 requires the non-resident subsidiary to be put into liquidation before the end of the accounting period in which the losses are sustained in order for its resident parent company to be able to obtain cross-border group relief.

Under section 119(4) of the CTA 2010, the assessment as to whether the losses sustained by a non-resident subsidiary may be characterised as definitive must be made by reference to the situation obtaining ‘immediately after the end’ of the accounting period in which the losses were sustained.

It is clear from the wording of this that it does not impose any requirement for the subsidiary concerned to be wound up before the end of the accounting period in which the losses are sustained.

Secondly, the losses sustained by a non-resident subsidiary may be characterised as definitive only if that subsidiary no longer has any income in its Member State of residence. So long as that subsidiary continues to be in receipt of even minimal income, there is a possibility that the losses sustained may yet be offset by future profits made in the Member State in which it is resident.

Referring to a specific example of a resident parent company which obtained cross-border group relief, the UK confirmed that it is possible to show that losses sustained by a non-resident subsidiary may be characterised as definitive, where, immediately after the end of the accounting period in which the losses have been sustained, that subsidiary ceased trading and sold or disposed of all its income producing assets.

The CJEU also examined the second complaint: infringement of Article 49 TFEU and Article 31 of the EEA Agreement, in that the UK legislation precludes cross-border group relief for losses sustained before 1 April 2006.

The Commission submits that losses sustained before 1 April 2006 are excluded from cross-border group relief, contrary to Article 49 TFEU and Article 31 of the EEA Agreement, because the provisions laid down in the CTA 2010 concerning that relief apply only to losses sustained after 1 April 2006, the date on which the Finance Act 2006 entered into force.

In response to the Commission’s argument, the UK contends that cross-border group relief is also available for periods before 1 April 2006, but that it is governed by the legislation applicable to those earlier periods, construed in accordance with EU law following the judgment in M&S, as was the intention of the Supreme Court in its judgment of 22 May 2013.

Irrespective of whether or not this satisfies the need for legal certainty as regards the possibility of obtaining cross-border group relief for losses sustained before that date, the Court found that the Commission has not established the existence of situations in which cross-border group relief for losses sustained before 1 April 2006 was not granted.

The action was dismissed in its entirety.

The full judgement of the case is available from http://curia.europa.eu