ECJ landmark ruling on the Marks & Spencer case

The European Court of Justice (ECJ) released on 13 December a landmark ruling on the famous Marks & Spencer case.

Basically, the ECJ ruled in favour of Marks & Spencer which had argued that, in calculating its UK tax payable, it should allowed to take into account losses in its “failed” businesses in other EU member states, such as France, Germany and Belgium. According to the ECJ Marks & Spencer can claim tax relief on losses incurred outside the UK, but only when all possibilities of relief in the countries where its subsidiaries traded have been exhausted. This limitation (i.e. all possibilities of relief have been exhausted) is viewed as a considerable limitation on the effects of the ruling since only in restricted cases the country of the parent company is then obliged to recognize foreign losses realized by subsidiaries (e.g. liquidation losses) .

Notwithstanding such limitations this decision has to be viewed as a landmark ruling, since it forces most of the EU member states group taxation regimes to be reassessed in light of the conditions for cross-border relief laid down by the ECJ. It should be noted that currently only, France, Denmark, Italy and more recently Austria provide for some sort of cross-border relief of losses.

With regards to the exact implications of the ruling, it must be said that the case will now be referred back to the UK courts that will decide whether Marks & Spencer group will actually be entitled to cross-border group relief (i.e. if all possibilities of relief in France, Germany and Belgium where exhausted).

From a tax policy perspective, although the ruling is addressed primarily to the UK, it can be said that the principles of the judgment can be extracted by other group relief schemes in place in Europe and it is therefore expected slight adjustments to their application in cross-border situations. On this point even the ECJ made its own remark by pointing out in par. 58 that although in practice it may be possible to identify less restrictive measures in other countries (such as the Austrian system), such measures in any event require harmonisation rules adopted by the Community legislature. This for me means that Member States should only adjust their systems (to comply with the ruling) and any more extensive change should be made through the EC institutions (i.e. subject to the unanimity principle).

From a legal standpoint, I found the legal reasoning of the court a bit disappointing. In short, the ECJ held that, as EC Law currently stands, freedom of establishment does not preclude group taxation schemes that restrict cross-border loss relief within the European Union (1st Principle). In summary, the ECJ started by observing that UK group relief provisions constitute a restriction on freedom of establishment, as they differentiate (for tax purposes) between losses incurred by resident subsidiaries and losses incurred by non-resident subsidiaries.

Nevertheless, after reaching this conclusion the ECJ considered that taking into account, as a whole, three justifications (balanced allocation of the taxing powers, dual use of losses and tax avoidance) submitted by the United Kingdom and other EU Member States, the UK group relief provisions should be viewed as pursuing legitimate objectives compatible with the EC Treaty. In addition, in the ECJ's view, these justifications constitute overriding reasons in the public interest, making such group taxation schemes in principle, compatible with EC law. Despite these conclusions, the ECJ held (on the basis of the proportionality test) that group relief provisions that prevent a EU parent company from setting off losses incurred by foreign subsidiaries are incompatible with EC law if these subsidiaries have exhausted the possibilities to offset the loss in their state of residence (2nd principle).

Under the first principle, European group taxation schemes that restrict cross-border loss relief will suffice provided they comply with the second principle. In order to restrict the effects of the ruling to the situations covered by the second principle the court made some innovative considerations on three factors (balanced allocation of the taxing powers, dual use of losses and tax avoidance) that taken as a whole make such group taxation schemes compatible with the EC Treaty (on the basis of legitimate objectives and overriding reasons in the public interest).

In my view, this “bundling approach”, where three factors equal one justification seems to me a bit revolutionary and it may open the floodgates for other member states to start justifying their restrictive tax provisions on the same basis. This “bundling approach” is even more disappointing if one looks at the considerations of the ECJ on each one of the so called factors/justifications. Taken independently, the balanced allocation of the taxing powers, the risk of dual use of losses and the risk of tax avoidance, would perhaps never constitute a justification but aggregated they do!

It seams to me that this “bundling approach” simply boils down to say that, although a reduction in tax revenue (which would result of allowing full relief of foreign losses) cannot be regarded as an overriding reason in the public interest that justifies a restrictive measure, nonetheless if you aggregate more factors into the ball game the ECJ is perhaps ready to accept such justification (see points 41 to 51).

In the end, one can speculate that this “inflection" is a result of the peer pressure of EU governments on the ever-increasing impact of ECJ judgments on their tax revenues or a change in priorities of the ECJ due to some recent political failures in Europe (such as the NO to the EU Constitution). Only the next big cases, to be dealt by the ECJ (see the IRAP case), will tell if this inflection is a true change in orientation or not.