Background factsThe case arose out of a joint venture between the Philips Group, led by Koninklijke Philips Electronics NV ("KPE"), registered and resident in the Netherlands, and LG Electronics Inc
Background facts
The case arose out of a joint venture between the Philips Group, led by Koninklijke Philips Electronics NV ("KPE"), registered and resident in the Netherlands, and LG Electronics Inc of Korea. At the head of the joint venture was LG Philips Displays Holding BV, which was tax resident and incorporated in the Netherlands. With three of its subsidiaries, this company formed a fiscal unity for Dutch tax purposes for most of the period in question.
One of these subsidiaries, LG Philips Displays Netherlands BV ("LGPD"), created a UK branch. The UK branch was loss making. LGPD entered into an agreement with Philips Electronics UK Ltd ("Philips"), an indirectly held subsidiary of KPE, under which Philips was to pay to LGPD an amount equal to half of the UK corporation tax saved by using the losses of LGPD's UK branch.
Philips made various claims for consortium relief in relation to the losses arising in the UK branch of LGPD. HMRC denied the claims. Section 403D(1)(c), Income and Corporation Taxes Act 1988 prevents the use of losses of a UK branch of a non-resident company if any part of the losses corresponds to amounts deductible for foreign tax; and, in this case, a significant part of the losses was available to be surrendered in the Netherlands. The issue as to whether s.403D(1)(c) is contrary to the freedom of establishment was referred by the Upper Tribunal to the Court of Justice of the European Union (the "ECJ").
Opinion of the Advocate General
On 19 April 2012, Advocate General Kokott delivered her opinion: s.403D(1)(c) is contrary to EU law.
The right to freedom of establishment required that companies should be able to establish a permanent establishment in a Member State that was subject to the same conditions as a subsidiary resident there. Section 403D(1)(c) applied only to non-UK resident companies (with a UK permanent establishment) and, therefore, led to such companies being treated differently from UK resident companies.
There was no justification for this restriction on the right to freedom of establishment. In Marks and Spencer, the ECJ had referred to three different potential justifications: (i) the balanced allocation of taxing powers between Member States (the "balanced allocation" justification); (ii) the risk of double use of losses; and (iii) prevention of tax avoidance and had applied them conjunctively, but without explaining how the justifications interact. According to the Advocate General (as she had opined previously in Oy AA), preserving the allocation of taxing powers (conjunctively with preventing tax avoidance) was the overriding rationale for all three justifications. Preventing the risk of double use of losses was neither a separate autonomous justification nor a necessary element of the balanced allocation justification.
The balanced allocation justification applies where a Member State that is required to take losses into account does not have a right to tax corresponding profits. In this case, the UK was entitled to tax the profits of the UK branch, and so its taxing powers could not be deemed to be impaired. Moreover, the allocation of taxing power between the UK and the Netherlands was set out in the double tax treaty between them.
The Advocate General went on to say that even if, contrary to her view, preventing double use of losses was an autonomous justification for what would otherwise be a breach of the right to freedom of establishment, s.403D(1)(c) went beyond what was necessary to prevent this. Section 403D(1)(c) did not allow consideration to be given to the circumstances in any particular case. This was particularly because, under s.403D(1)(c), use of all losses was prohibited, even if only part were relieved in another territory.
Decision of the ECJ
On 6 September 2012, the ECJ released its decision. It adopted a similar analysis to that of the Advocate General and held the restriction on the freedom could not be justified by overriding reasons in the public interest either based on the objective of preventing the double use of losses or the objective of preserving a balanced allocation of the power to impose taxes between Member States or by a combination of those two grounds.
The Upper Tribunal had asked the ECJ to advise on what consequences should follow in the event that this was its answer. The ECJ's answer was: "in a situation such as that in the main proceedings, the national court must disapply any provision of the national legislation which is contrary to Article 43 EC."
Consequence of the decision
This is an extremely important case for two reasons. First, changes will be needed to be made to the UK consortium relief rules, because s.403D(1)(c) has been held to be in breach of EU law. Relaxation of the rules will make it more attractive to form multinational consortia with a UK presence.
The second reason is that this decision stands as an important reminder to taxpayers that claims for relief should be made by reference to applicable EU law provisions, rather than just the statutory wording. The UK now must disapply those aspects of the UK consortium relief rules that are contrary to EU law and allow relief to any UK resident company that is claiming consortium relief in circumstances that are similar to those applicable to this case.
The case arose out of a joint venture between the Philips Group, led by Koninklijke Philips Electronics NV ("KPE"), registered and resident in the Netherlands, and LG Electronics Inc of Korea. At the head of the joint venture was LG Philips Displays Holding BV, which was tax resident and incorporated in the Netherlands. With three of its subsidiaries, this company formed a fiscal unity for Dutch tax purposes for most of the period in question.
One of these subsidiaries, LG Philips Displays Netherlands BV ("LGPD"), created a UK branch. The UK branch was loss making. LGPD entered into an agreement with Philips Electronics UK Ltd ("Philips"), an indirectly held subsidiary of KPE, under which Philips was to pay to LGPD an amount equal to half of the UK corporation tax saved by using the losses of LGPD's UK branch.
Philips made various claims for consortium relief in relation to the losses arising in the UK branch of LGPD. HMRC denied the claims. Section 403D(1)(c), Income and Corporation Taxes Act 1988 prevents the use of losses of a UK branch of a non-resident company if any part of the losses corresponds to amounts deductible for foreign tax; and, in this case, a significant part of the losses was available to be surrendered in the Netherlands. The issue as to whether s.403D(1)(c) is contrary to the freedom of establishment was referred by the Upper Tribunal to the Court of Justice of the European Union (the "ECJ").
Opinion of the Advocate General
On 19 April 2012, Advocate General Kokott delivered her opinion: s.403D(1)(c) is contrary to EU law.
The right to freedom of establishment required that companies should be able to establish a permanent establishment in a Member State that was subject to the same conditions as a subsidiary resident there. Section 403D(1)(c) applied only to non-UK resident companies (with a UK permanent establishment) and, therefore, led to such companies being treated differently from UK resident companies.
There was no justification for this restriction on the right to freedom of establishment. In Marks and Spencer, the ECJ had referred to three different potential justifications: (i) the balanced allocation of taxing powers between Member States (the "balanced allocation" justification); (ii) the risk of double use of losses; and (iii) prevention of tax avoidance and had applied them conjunctively, but without explaining how the justifications interact. According to the Advocate General (as she had opined previously in Oy AA), preserving the allocation of taxing powers (conjunctively with preventing tax avoidance) was the overriding rationale for all three justifications. Preventing the risk of double use of losses was neither a separate autonomous justification nor a necessary element of the balanced allocation justification.
The balanced allocation justification applies where a Member State that is required to take losses into account does not have a right to tax corresponding profits. In this case, the UK was entitled to tax the profits of the UK branch, and so its taxing powers could not be deemed to be impaired. Moreover, the allocation of taxing power between the UK and the Netherlands was set out in the double tax treaty between them.
The Advocate General went on to say that even if, contrary to her view, preventing double use of losses was an autonomous justification for what would otherwise be a breach of the right to freedom of establishment, s.403D(1)(c) went beyond what was necessary to prevent this. Section 403D(1)(c) did not allow consideration to be given to the circumstances in any particular case. This was particularly because, under s.403D(1)(c), use of all losses was prohibited, even if only part were relieved in another territory.
Decision of the ECJ
On 6 September 2012, the ECJ released its decision. It adopted a similar analysis to that of the Advocate General and held the restriction on the freedom could not be justified by overriding reasons in the public interest either based on the objective of preventing the double use of losses or the objective of preserving a balanced allocation of the power to impose taxes between Member States or by a combination of those two grounds.
The Upper Tribunal had asked the ECJ to advise on what consequences should follow in the event that this was its answer. The ECJ's answer was: "in a situation such as that in the main proceedings, the national court must disapply any provision of the national legislation which is contrary to Article 43 EC."
Consequence of the decision
This is an extremely important case for two reasons. First, changes will be needed to be made to the UK consortium relief rules, because s.403D(1)(c) has been held to be in breach of EU law. Relaxation of the rules will make it more attractive to form multinational consortia with a UK presence.
The second reason is that this decision stands as an important reminder to taxpayers that claims for relief should be made by reference to applicable EU law provisions, rather than just the statutory wording. The UK now must disapply those aspects of the UK consortium relief rules that are contrary to EU law and allow relief to any UK resident company that is claiming consortium relief in circumstances that are similar to those applicable to this case.