RSS feedsPose the question ‘what’s going on with the group litigation orders’ and you’re likely to get one initial answer: ‘How much time have you got?’ The GLOs – the massive tax cases brought by hundreds of multinationals alleging that UK tax law is incompatible with the EC Treaty – were complex when they were brought. But their passage through the courts (and 2006 was a particularly busy year) is also spawning new challenges and issues.
There are six central actions that have been launched, covering the following
areas:
• group loss relief (GLR)
• controlled foreign companies (CFC)
• franked investment income (FII)
• thin capitalisation issues
• advanced corporation tax (ACT)
• foreign income dividends (FID)
The group loss relief GLO is the best known, relating to the ability of companies to claim losses incurred elsewhere in the EU against their UK profits. Brought by around 70 companies, the company that is trailblazing ahead (though confusingly in a separate case) is Marks & Spencer.
The European Court of Justice gave its verdict on M&S in December 2005, saying that the losses incurred in France or Germany, as in M&S’s case, could be offset against UK profits.
But they could only be used if there was no possibility of them being used elsewhere. That, in itself, is the subject of further action. M&S has dropped its French claim, apparently because the losses could have been used by Galerie Lafayette, and is pursuing its German and Belgian claims.
The actual GLO that awaits the claim will be heard when M&S has been resolved. It, itself, has various permutations that mean it, like the M&S case, will probably have to go to the ECJ.
The controlled foreign companies challenge is similar, in that one company, Cadbury Schweppes, is pursuing the arguments. Cadbury had set up an Irish treasury function that was taxed at the 10% Irish tax rate.
Controlled foreign companies rules dictate that any company that is set up in a foreign jurisdiction, just to obtain a lower tax rate, is treated as forming part of the UK’s group profits, and taxed as such.
Principle of the matter
Cadbury and others are arguing that the rules themselves contradict EC rules on
freedom of establishment. The court ruled in September 2006 that CFC rules were
sound in principle, as long as they were only used to rule out ‘artificial
arrangements’.
Cadbury and HM Revenue & Customs are now set to return to the Special Commissioners in the UK so that they can argue over whether its arrangements were ‘artificial’.
The GLO case relating to Cadbury is also thus waiting for a hearing, but it would probably not be inaccurate to say that like M&S it may have to return to the ECJ once it is worked through.
The franked investment income case came before the ECJ early in 2006, with the advocate general opining in April. FII rules apply an effective tax credit when a subsidiary pays a dividend up to a group, with the credit not available, or available to a lesser extent, to foreign parents.
The advocate general, Leendert Geelhoed, has said that the UK rules were clearly contrary to EU law.
But in an abrupt about-turn, the court itself limited the impact of the case in December 2006, suggesting that ‘parity’ would be okay if not precisely equivalent treatment. Advisers are even now mulling the many impacts of the case, which wil now return to the UK courts.
The thin capitalisation GLO has also come before the ECJ. Thin capitalisation rules limit the movement of debt around European groups. Essentially, they stop corporates moving debt to the UK to offset against profits, whilst running much larger profits in low tax jurisdictions.
The advocate general said the rules were fine, subject to two points. Broad rules of thumb such as those used in the UK (where levels of indebtedness were crudely compared between a group and a subsidiary) were not appropriate. The new test would be that any lending would be at ‘arm’s length’ in that it could be obtained commercially.
One situation, such as a distressed subsidiary, would also be exempt from that rule.
Class ACT
The advanced corporation tax challenge splits into four parts. The case in essence is about whether foreign parents receiving UK dividends should get the same tax credits as UK parents.
The ECJ ruled a long time ago that they should, leading to various disputes over which circumstances apply. The Deutsche Morgan Grenfell case establishes how far back claims can go.
The Sempra Metals case determines how they should be calculated (both Class 1). The Class 2 case determines the situation where other countries gave some tax credits. The Class 3 case is about parents not resident in the EU, and the Class 4 case concerns whether foreign parents could receive partial or whole credits according to what was available to them in their and other jurisdictions.
The ACT case is in various respects paying out, with the only issues, then, being who can properly claim and how much. The Deutsche case on time limits is especially important for all the cases in that respect, in that it could dramatically increase the amount of money corporates can claim across the board.
The foreign income dividends GLO is, further to that, waiting on the other GLOs. Brought by pension funds, it essentially claims discrimination on the basis of discriminatory provisions relating to the GLOs as a whole. It is still at a largely administrative stage, discussing how claims ought to be made and whether or not they will be time-barred.
Who’s won?
Such is the ongoing complexity of the cases, that a company musing over their
status could be forgiven for wondering whether the lawyers were doing better out
of the claims than they were.
That would be unfair. The cases have, subject to final decisions and further argument, scored some notable victories, on the franked investment income case, on advanced corporation tax (though not in all respects), and on CFCs (even if the government denies it). The thin cap and loss relief claims look like score-draws, whilst it is too early to say what will happen on the pension funds GLO.
Peter Cussons, international tax expert at PricewaterhouseCoopers, says that though the M&S case looked like a turn in the tide for the government, “the Cadbury case was a traditional old style judgment in favour of the taxpayer.” Likewise the FII case, it could be added. Lawyers say the cases will necessarily take a long time to work out.
Most worryingly for the Treasury, the Deutsche time-limits case looks like opening the government up to unimaginable losses. Though the government feels it has put in rules to prevent claims going back to 1973, those are themselves subject to what looks like a credible challenge.
Paul Gray, acting chairman ofHM Revenue & Customs, recently said that those who thought the Deutsche case could be worth £10bn were letting their imaginations run away with themselves.
But successful cases are striking out British tax law across the board, and encouraging claims that, if they do not reach or exceed early estimates of £10bn to £20bn, will come pretty close.
Not worth the candle…
The government has not exactly embraced the cases multinationals have brought
against it. In fact, such is the unpredictability of its response that finance
directors would be well advised to keep a close eye on the detail of its
reactions.
The Treasury has only responded formally to two cases: the M&S case and the Cadbury case. On M&S it issued an interpretation of the ECJ judgment that restricted further its impact.
The court had said losses incurred abroad could be offset against UK profits, if the reliefs could not have been used elsewhere, to which the government added: “or in any other country”.
More recently, the government gave its view of the court’s ruling on controlled foreign companies. Where the court said that companies could set up subsidiaries in low tax jurisdictions to avoid tax, except where it was abusing the system, the government said that abuse related to profits deriving from ‘capital’.
Profits deriving from ‘labour’ would be OK, an old-fashioned distinction that is certain to be challenged. It has left some wondering whether offshore treasury functions are under threat.
Perhaps more importantly than all of those, the government is also pushing a discreet consultation on the EU challenge. The proposal on the table is to drop the taxation of dividends and restrict interest relief.
The restriction of interest relief, already being discussed by many commentators, could be the major and enduring impact of these cases, and would cause havoc in the private equity and multinational world.
