Pose 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
• 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
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
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
One situation, such as a distressed subsidiary, would also be exempt from
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
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.
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
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
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
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.