RSS feedsWhen in 1973 Edward Heath signed Britain up to the European Economic Community, the chances are that the implications his decision would have for the UK’s tax-making powers were very far from his mind.
By entering the Common Market Heath paved the way for previously unimaginable levels of external influence over our country’s tax regime. What is perhaps more surprising is where that influence came from and how central a role tax lawyers would play in the process.
Because Chancellor Gordon Brown is adamant that the UK won’t bow down to legal challenges to the public purse, Britain is experiencing something of a Mexican stand-off between the authorities and the tax advisers and their clients. The latter are unwavering in their belief that they are owed money because the UK’s tax legislation falls foul of European law.
Billions of pounds of shareholders money is at stake, so companies are well within their rights – nay, it is their duty – to pursue refunds for what they see as wrongly paid tax.
As Chris Morgan, head of EU tax at KPMG says, an individual would have no hesitation in putting in a claim for overpaid tax, so why should a company?
Back-door tax harmonisation
But because the government refuses to accept that the UK tax regime falls short of EU law we have found ourselves in a situation experts describe as tax harmonisation by the back door.
“I have a lot of sympathy with the comments,” says Peter Cussons, international corporate tax partner at PricewaterhouseCoopers. “The backdrop of course is the continuing requirements for unanimity for fiscal measures in the European Council of Finance Ministers which, with 25 finance members, must be very difficult to achieve.
“The greater part of the action on the EU tax stage has been courtesy of the European Court of Justice whose output on direct tax cases is steadily increasing and, moreover, they are not anorak-type cases. They are all big picture issues.”
Cussons lists a host of cases currently at various stages at the ECJ (see below) with Marks & Spencer the one most commonly referred to. UK tax legislation covering cross border loss relief, controlled foreign companies, thin capitalisation rules, advance corporation tax and franked investment income are all being challenged in one form or another.
“I have a lot of sympathy with the dictum that the ECJ is setting the pace and the output of the ECJ is at some level, slowly but steadily, bringing about harmonisation by the back door,” says Cussons
France and Germany Join forces
Sensing this, France and Germany have decided to take the bull by the horns. Together the two countries have sponsored a plan for harmonisation of European company taxation.
The EU’s tax commissioner, Laszlo Kovacs, is working on the details to create a uniform system across Europe for calculating a company’s tax base. “At the moment there are 25 different ways to calculate the corporate tax base,” Kovacs told the Financial Times in May. “If we manage to have only one EU-wide set of rules that will increase competitiveness.”
The EU is at pains to point out that the establishment of a uniform system to calculate corporate taxation will not mean that individual member states will lose their tax sovereignty. They will, Kovacs stresses, be free to set their own tax rates, something which the UK is extremely sceptical of.
“They are afraid that it is a Trojan horse to implement the harmonisation of tax rates at a later stage,” Kovacs continues. “We have no ambition and I have no personal ambition to do that.”
The French and the Germans do, however. They see it as the perfect foil to an avoidance industry that can take advantage of countries with low corporate tax rates.
While this is a battle that Gordon Brown is well attuned with, he is loathe to lose any control he has over the country’s tax system and hence fiscal policy which is not an unreasonable position.
But this leaves the UK caught between two unstoppable forces: the European Union mantra of a single market and the powers of the ECJ backed by fired-up tax barristers.
One recent case involving Vodafone highlights how powerful a force the ECJ has become. Asked by HM Revenue & Customs to produce information in relation to a particular controlled foreign company (CFC) issue that the tax body felt needed further investigation, the company refused.
Vodafone argued in front of the Special Commissioners that it would not offer the documents in question because HMRC was asking for information in relation to a provision which could be contrary to the EC Treaty. The commissioners sided with Vodafone and referred HMRC’s request for information straight to the ECJ – bypassing the whole of the UK judiciary – saying that until there is clarity on whether or not the CFC regime is legal, it is up to the ECJ whether Vodafone is required to provide that information.
“The Vodafone point is of very broad application because Vodafone has said that HMRC cannot force it to provide information in relation to a provision which is suspected of being contrary to the EC Treaty,” says Cussons. “Commissioners have sympathised with that approach and that principle can be applied to any area of tax law where the taxpayer has reasonable grounds to assert that a particular facet of taxes are potentially contrary to the EC Treaty.”
It leads Cussons to offer a straightforward appraisal of where the power of tax policy lies. “My views are that the reins of tax policy in Europe are largely held by the ECJ,” he says. Simon Whitehead, a partner at law firm Dorsey & Whitney who acts as lead solicitor to the vast majority of the group litigation orders currently underway, says that Vodafone’s decision not to comply is a first.
“I would have to say that it is a farreaching position, it’s not a position our clients have taken before,” he says. “It’s simply saying we are not going to comply. It shows a very aggressive attitude among some taxpayers.”
From its 2005 annual report, it soon becomes clear why Vodafone is taking such an aggressive stance. “The company has taken provisions, which at 31 March 2005 amounted to £1,757 million, for the potential UK corporation tax liability and related interest expense that may arise if the Company is not successful in its challenge of the CFC regime,” it states.
Whitehead goes on to explain that it is the ECJ’s role to protect the European single market which the 25 member states signed up to with the EC Treaty. Because tariffs and taxes are how countries have traditionally protected their fiscal borders, it is also up to the ECJ to address these.
“If you are going to have a single market then tax and tariff barriers are a logical area for conflict,” says Whitehead. “It’s the court’s job to maintain a single market so it’s the court’s job to do something about differential tax effects.”
M&S judgment critical
The hundreds of companies involved in tax litigation are well within their rights to use the courts, and every time a company joins a litigation, the power of the ECJ grows and the power of the government diminishes.
As Roger Taylor, chief financial officer of Carphone Warehouse says: “You have an opportunity, so you either put down your claim or you lose your opportunity to do so.”
It will become clearer how powerful the ECJ has become in the next few weeks as the M&S judgment is finally delivered. Should the court side with M& S and rule that the UK should be offering relief on losses that the retailer incurred in Europe, vast swathes of tax legislation would have to be rewritten. HMRC has even threatened to abolish group relief within the UK in order to avoid the massive refunds. It is a move that would cost UK plc a staggering £11bn and highlights the desperate position the government is now in.
TAX AND THE EURO
EU member states seem certain to lose even more control over their tax laws as a
result of adopting the euro.
Derek Scott, economic consultant to KPMG and a former economic adviser to Tony Blair, says that tax “will be part of that agenda” although he conceded that it may not initially be the main focus.
Writing in the Financial Times in August, Jean Pisani-Ferry, director of the Brussels think tank Bruegel, argued that growth in a weak and underperforming eurozone “can only be expected from structural reforms” of which tax is sure to be one.
GLOS: THE ORDER OF THE DAY
Tax payers have succeeded at the European Court of Justice on several
occasions, which has encouraged tax lawyers and accountants to work together to
establish six group litigation orders (GLOs) on behalf of their clients.
The GLOs challenge a wide variety of corporate tax legislation, all of which
they believe is in contravention of the EC Treaty and the directives emanating
from Brussels. It is one of the treaty’s four key fundamental freedoms – the
freedom of establishment – that is most often seen as being breached by the
British tax regime.
From a British perspective the most oft-cited challenge at the ECJ is Marks
& Spencer’s £30m loss-relief claim. A ruling from the ECJ
is expected any day now, and would set the scene for a substantial GLO sitting
in its slipstream.
The loss-relief GLO – whose test claimants include Autologic, BT and Heinz – is still in the UK courts after HMRC tried to block the claim on a technicality. Should M&S win, the GLO will almost certainly be referred to Europe.
Perhaps the biggest GLO, however, is based on the potential illegality of the UK’s advance corporation tax regime.
There are four separate classes in the overall GLO, with Class 1 having already been won by the taxpayer Deutsche Morgan Grenfell. Class 4 has been referred to the ECJ while Classes 2 and 3 are at various stages in the UK courts.
The UK’s thin capitalisation rules have also been challenged by Volvo, IBM and Pepsi.
The GLO was referred to the ECJ in November 2004 and a trial is likely to be heard mid-2006.
A fourth GLO challenging the UK’s controlled foreign company legislation was also referred to Europe in January this year, with Cadbury Schweppes at the helm. Although more questions will be heard this month the trial is expected next July.
Two further GLOs have been established.
A franked investment income challenge from companies including British American Tobacco and Aegis is with the ECJ and should be heard early next year.
Finally, a foreign income dividend GLO spearheaded by the BT Pension Scheme was given permission by the High Court in July 2004 – a case management conference has been scheduled at the High Court for 4 October.
Any decision from the ECJ in favour of the taxpayer would lead to the Treasury having to rewrite sections of its tax legislation.
