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18.03.2015
German Tax and Legal News

CJEU gives EU member states latitude to significantly restrict cross-border loss relief

The CJEU rejected the European Commission’s claim that the UK legislation on cross-border group relief is incompatible with the freedom of establishment because the rules make it virtually impossible in practice and concluded that the UK rules, as introduced in 2006, are compatible with EU law.

In a decision issued on 3 February 2015, the Court of Justice of the European Union (CJEU) generally followed its previous jurisprudence on the treatment of cross-border loss relief, but it also granted EU member states some latitude to significantly restrict such relief. The CJEU rejected the European Commission’s (EC’s) claim that the UK legislation on cross-border group relief is incompatible with the freedom of establishment because the rules make it virtually impossible in practice to obtain cross-border loss relief and concluded that the UK rules, as introduced in 2006, are compatible with EU law.

In 2005, the CJEU ruled in the landmark Marks & Spencer (C-446/03) case that the fundamental freedoms under the Treaty on the Functioning of the European Union (TFEU) require an EU parent company’s country of residence to permit group loss relief if a foreign subsidiary has exhausted all possibilities available in its state of residence for itself or a third party to take into account such losses in the past, the present or the future (i.e. the losses are “final losses”). Retailer Marks & Spencer had tried to use the UK’s group relief rules that existed at the time to offset losses made by its Belgian and German subsidiaries against UK profits. Those rules restricted group relief to losses of UK resident companies and losses of UK branches of nonresident companies. The CJEU held that if an EU member state allowed a resident parent company to transfer losses to a group member established within that same member state, the same option must be offered for losses incurred by a subsidiary established in another member state where all other possibilities for relief had been exhausted. Several cases subsequently were brought before the CJEU due to uncertainties regarding the application and definition of the “M&S exception” (i.e. the obligation to grant cross-border loss relief where there is no possibility that the losses could be taken into account). The CJEU ruled in these cases that the M&S exception is applicable by analogy to nonresident permanent establishments, that the rules for calculating the amount of such relief are based solely on the domestic legislation of the parent`s state of residence, and that legal restrictions regarding loss carryforwards in the subsidiary´s state of residence do not necessarily mean that the losses should be characterized as final losses.

The present case involves a challenge by the EC to the cross-border loss relief provisions under the UK´s group tax regime that were introduced in 2006 to bring the UK legislation in line with EU law following the Marks & Spencer decision. According to the EC, although the UK legislation provides for a possibility of cross-border loss relief, the actual requirements make it impossible, in practice, to effectively set off such losses.

Under this revised UK group tax regime, it is possible to set off losses of one entity against current income of another entity within a tax group by filing an application within two years from the date after the end of the financial year in which the losses are incurred. Two additional conditions must be fulfilled to use this group tax relief regime in a cross-border context: (1) the losses must be “final” (as defined under CJEU jurisprudence); and (2) the finality of the losses must be proven immediately after the end of the financial year in which the losses were incurred. As a result, the period of time in which the loss relief application can be filed effectively is reduced to a point in time shortly after the financial year in which the losses are incurred. Due to this very limited period of time, the EC is of the opinion that the offsetting of final foreign losses under UK law is possible only where: (1) the other state does not provide for the carryforward of losses under its domestic law, or (2) it is already known during the ongoing financial year that the company will cease to exist, i.e. that it will be liquidated. The EC also took the position that the relevant provisions of UK law only take into account losses incurred after 1 April 2006 and that no cross-border group relief could be claimed for losses incurred before that date. According to the Commission, the applicable provisions of UK law are incompatible with the fundamental freedoms under the TFEU (article 49) and under the Agreement on the European Economic Area (AEEA, article 31).

In its decision, the CJEU agrees with the EC that the current UK legislation constitutes a restriction of the freedom of establishment under the TFEU and AEEA. However, the CJEU states that, according to settled case law, the restriction can be justified by three overriding reasons in the public interest: the need to preserve the balanced allocation of powers of taxation between the member states, the need to prevent the double use of losses and the need to combat tax avoidance. The court, therefore, had to determine whether the UK´s legislation is proportional to achieving its aim and does not go beyond what is necessary to do so. In this regard, the court needed to consider that the present case constituted an infringement procedure and, consequently, that the burden of proof lay with the EC as the applicant.

The EC claimed that the provisions of the UK legislation are not proportional to the aim achieved, since cross-border loss relief is possible only where either the other state generally does not allow for the carryforward of losses or the nonresident company is going to be liquidated. With regard to the first situation, the CJEU pointed out that legal restrictions regarding loss carryforwards do not necessarily create final losses and, therefore, this reason could not be considered within the scope of the EC’s complaint. With regard to the second situation, the CJEU stated that the relevant provision of UK law does not state that a liquidation procedure needs to be initiated. According to the CJEU, the EC did not substantially prove that the only case where cross-border loss relief may apply is where a liquidation procedure is initiated, so the court dismissed this complaint.

With regard to the EC’s second complaint that the current UK legislation does not allow relief for losses that arose before 1 April 2006, the UK defended its legislation by stating that losses that were incurred before that date are taken into account in the scope of the former legislation, which is interpreted in light of the M&S decision. As the EC did not provide evidence to the contrary, the CJEU also dismissed the second complaint.

With this decision, the CJEU generally followed its previous jurisprudence with regard to cross-border loss relief. Despite the advocate generals` request to abandon the M&S exception due to contradictions with other case law and the legal uncertainty this creates, the CJEU continued to rely on the exception and the concept of final losses. The CJEU decision, however, does not provide any substantial clarification with regard to the definition of final losses and, in itself, has no direct effect on the application of legislation or case law on cross-border loss relief in other EU member states. However, the decision would seem to grant member states some latitude to significantly restrict cross-border loss relief. As the CJEU found legislation that theoretically allows for cross-border loss relief but makes it impossible, in practice, to take such losses into account to be in line with EU law, it remains to be seen whether other EU member states will make use of this opportunity to tighten their restrictions on cross-border loss relief. Entities should monitor legal and regulatory developments in the EU member states in which they operate, and should consider acting to utilize current cross-border loss relief provisions before the windows of opportunity potentially are closed.

Contact

Dr. Alexander Linn
Director

allinn@deloitte.de
Tel.: 089 29036-8558

Contact

Dr. Alexander Linn
Director

allinn@deloitte.de
Tel.: 089 29036-8558

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