The UK corporation tax system permits companies that are members of a group for tax purposes to surrender losses to other companies that are in the same group, so that the claimant may deduct those losses from its taxable profits (group relief). In order to qualify, the surrendering company and the claimant company must be either resident in the UK or carrying on a trade in the UK through a permanent establishment.

M&S had suffered losses in its French, German and Belgian subsidiaries and sought to surrender those losses, by way of group relief, against the profits that had been made by companies in its UK group. HM Revenue & Customs (HMRC) rejected these claims on the basis that the group relief rules do not permit surrenders by companies not resident in the UK.

M&S appealed, arguing that the UK group relief rules were incompatible with EC law, in particular, the right to freedom of establishment in Articles 43 and 48 of the EC Treaty. The Special Commissioners rejected M&S’s appeal (see News brief “Non-discrimination: UK tax rules under pressure?” www.practicallaw.com/3-102-2580). The High Court referred the question of whether the UK group relief rules were compatible with EC law to the European Court of Justice (ECJ).

On 13 December 2005, the ECJ decided that the UK group relief rules were contrary to Articles 43 and 48 of the EC Treaty insofar as they restricted loss surrenders by non-UK resident companies in circumstances where there was no possibility of relief (whether in current, past or future accounting periods) for the losses in question in the state in which they were suffered (www.practicallaw.com/7-201-9056). The case was remitted to the High Court.

M&S argued that the proper reading of the ECJ’s decision was that the blanket restriction in the UK group relief rules on claiming losses of a group company resident elsewhere in the EU was contrary to EC law and unenforceable. Therefore, intra-EU group relief should be permitted in all circumstances, even in relation to losses for which relief was available where the losses had been suffered (that is, losses in respect of which the ECJ had considered that a restriction would be justified).

Park J declined to strike down the restriction in its entirety. He agreed with HMRC that the restriction was generally valid and enforceable but that if, on the facts of an individual case, it could be shown that the losses had not been and could not be used in the EU member state in which they were suffered, the UK rule had to be disapplied in that particular case. He therefore:

An M&S spokesperson commented that M&S had sought leave to appeal to the Court of Appeal, but the company had not made a final decision about whether to pursue this. The total amount at stake in relation to the three subsidiaries is an amount equal to the tax on around £100 million (about half of which relates to the French subsidiary) so, as Park J says in his judgment, it is a “big money case”.

“The High Court decision is not surprising,” says Dominic Stuttaford, a tax partner at Norton Rose. Andy Collins, a tax partner at Denton Wilde Sapte agrees: “Park J’s approach is much as expected after the ECJ decision and offers useful guidance on its application in practice.”

However, the decision is interesting in the context of a wider series of challenges to the UK tax system at EU level (see, for example, “Franked investment income”, Bulletin, Taxation, this issue). The majority of these challenges have been successful and some (such as the decision in Lankhorst-Hohorst, which indirectly resulted in the extension of the UK transfer pricing regime to domestic transactions (Case C-324/00)) have prompted significant changes in tax law in the UK and other member states, and sparked concerns about EU tax harmonisation through the back door (www.practicallaw.com/3-102-2580).

A feature of these cases has been reluctance on the ECJ’s part to accept the argument that treating resident and non-resident companies differently is necessary for the cohesion of national tax systems. However, in the M&S case, the ECJ apparently accepted arguments broadly similar to the cohesion argument in concluding that the UK group relief rules were contrary to EC law only in certain specific and narrow circumstances. In particular, it recognised that treating residents of other member states differently for tax purposes might in some cases be justified by the need “to protect a balanced allocation between states of the power to impose taxes”. Perhaps the tide is turning.

The High Court chose to interpret the ECJ decision in such a way as to do as little damage as possible to the existing UK legislation and corporation tax regime and, unsurprisingly, the government is making the minimum changes it considers necessary to reflect the ECJ decision in UK law (see “Budget in brief: Group relief”, Bulletin, Taxation, this issue).