13 October 2009

UK tax tribunal rules that restrictions on consortium relief are incompatible with European law

Adam Dolder
Senior associate | UK

There have been a number of past court cases about the compatibility of UK corporation tax with EU law but any relevant questions of EU law have always previously been referred to the European Court for a preliminary ruling. However, a UK tax tribunal has recently issued the first ever UK decision about the compatibility of UK corporation tax with EU laws in which questions of EU compatibility were decide by the tribunal itself, without any questions of EU law first being referred to the European Court for resolution.

The tribunal ruled against the UK tax authorities in a case brought by the Philips group in which they claimed that it was unlawful to prevent a UK branch of a Dutch company surrendering losses to an associated UK company. The tribunal agreed that it was wrong to prevent such a surrender of losses in a case where the relevant relationship was traced through intermediate non-UK companies if a surrender would have been possible in the case of a similar relationship traced through UK companies.

The tribunal also ruled that it was unlawful for the UK to impose a blanket restriction on the use in the UK of any branch losses that could also have been used in another country. Furthermore, in case the tribunal was later held to have been wrong in that respect, it also expressed the view that the UK’s current restriction on use of losses that might also be used abroad was disproportionate to the aim of preventing double use of such losses, since a suitably targeted restriction could have been imposed in more limited terms.   


The UK’s corporation tax system contains rules which, under certain conditions, allows losses to be transferred from one company to a closely related company. A variant of this group relief system, known as consortium relief, also applies to companies which do not meet the conditions required for group relief but which are nonetheless related through a specified shareholding relationship. In broad terms, consortium relief is designed to extend the benefit of the basic group relief regime from groups under single ownership to joint venture arrangements, with relief being restricted to the percentage interest held by a company in the joint venture vehicle.

The relevant relationship may be traced through intermediate relationships between other companies but the UK rules on consortium relief effectively prevented a relationship being traced through companies which had no fiscal connection to the UK. In addition, the rules also purported to prevent a branch loss being surrendered to any other entity if there was any prospect of any part of such a loss also being taken into account under any foreign system of tax law.

A UK-incorporated member of the Philips group of companies sought to reduce its own UK taxable profits by offsetting certain losses sustained by the UK branch of a company based in the Netherlands, that company being related to the UK company by virtue of a joint venture between the Philips group and a South Korean group of companies. The UK tax authorities refused the claim for tax relief on the basis that the only relevant relationship between the UK company and the UK branch was traced through two other companies which were not themselves within the scope of UK corporation and that the losses of the branch could potentially have been deducted from taxable profits in the Netherlands, this being the location of the head office of the company with the loss-making UK branch.

When the dispute came before the tax tribunal, the UK tax authorities supplemented their main arguments by objecting to the taxpayer’s right to raise questions of EU law at all. It was argued that a UK company was not exercising any rights under EU law in respect of its activities in the UK, so that only the Netherlands company with the UK branch had any entitlement to raise questions about EU law when considering the application of UK tax laws to a relationship between a UK and a non-UK company. This was because only the Netherlands company was exercising its right to freedom of establishment under EU law by carrying on business in a country other than its country of incorporation.    
The tribunal rejected this contention and allowed the UK company to raise any relevant arguments of EU law which potentially affected that company’s tax liabilities. Although the UK company was not itself exercising any rights under EU law it had a legitimate interest in ensuring that principles of EU law were respected and properly implemented because its own tax liabilities stood to be increased if EU law was breached in the circumstances of the present case.

Tracing relationships through non-UK companies

The requirement to trace a relevant consortium relationship only though UK taxpaying companies seemed somewhat at odds with other elements of UK tax law, including the basic group relief rules from which consortium relief derived. The group relief rules would apply, for example, as between two UK subsidiaries of a non-UK parent company. In fact, no serious attempt was made to defend this position when the case came to court but it was argued on behalf of the UK tax authorities that the taxpayer’s claim should fail for other reasons.     

Restriction on use of losses otherwise relievable abroad
The UK tax authorities seemed to have thought that it was inappropriate to provide any kind of tax relief in the UK for UK-source losses of a foreign entity which might also be used to reduce foreign tax liabilities (for example, by being set against the foreign profits of a foreign company’s head office). However, general principles of EU law required a UK branch of a foreign company to be treated in the same way as a UK subsidiary of a foreign company to the extent that the UK taxed local companies and local branches of foreign companies in the same way. UK corporation tax did generally apply in the same way to both local companies and branches of foreign companies, and so a departure from equal treatment could only be regarded as lawful if it was objectively justifiable.     

Possible justification

Under general principles of European law, discriminatory national tax rules are only prohibited if the particular form of discrimination cannot be justified by reference to objective factors, such as the need to protect the coherence and integrity of a country’s internal tax system. The European Court made it clear long ago that governmental concern about loss of national tax revenues did not in itself provide a valid justification for the retention of discriminatory tax rules and that any form of discrimination had to have a specific and rational basis.
A recent French case showed that prevention of double utilisation of tax losses was capable of being a justification for discriminatory local tax rules but the particular restriction adopted in the UK’s consortium relief rules appeared arbitrary and irrational. The most obvious difference between the French case and the present case was that the disputed French tax rule was concerned with the prevention of double tax relief in France itself, whereas the UK’s consortium relief rules were designed to prevent double loss relief being claimed in two different jurisdictions, even though the UK would not generally have been able to impose tax on any foreign profits of a foreign company having a UK branch.

Double use of tax losses in different jurisdictions had been considered by the European Court in an earlier case and there were some grounds for regarding it as a factor which might sometimes justify discriminatory tax rules. But this possibility had been considered as part of a wider argument about the need to ensure a balanced allocation of taxing powers between different EU countries and to prevent tax avoidance. The prevention of double use of losses was not an end itself which could automatically be justified without regard to any other relevant factors.

The question of balancing the allocation of taxing powers had to be considered, in the case of cross-border business conducted through a branch structure, against the background of a generally accepted international practice (not itself forming part of EU law but which both EU and non-EU countries tended to respect to an equal degree) whereby the host country had primary taxing rights over a local branch of a foreign company.

This meant that it was the UK’s responsibility to provide the primary form of tax relief for any UK branch of a foreign company if that branch was fully liable to taxation in the UK. Since the UK did generally allow branch losses to be relieved from tax – for example, by being carried backwards or forwards and set against earlier or later profits of the branch itself – there was no compelling reason why the UK should not allow loss relief to take the form of a transfer of branch losses to a related UK company if that form of relief would have been available to a local UK subsidiary of a foreign company under the ordinary group relief regime.  

It was a matter for the Netherlands, as the country of residence of the company which had established a UK branch, to decide whether to enact rules which restricted local tax relief in the Netherlands for losses that had also been taken into account in a UK tax computation. However, since there were as yet no harmonised EU rules for the taxation of business profits, this was a matter which lay solely within the discretion of the Netherlands and any failure on that country’s part to prevent double utilisation of tax losses by one of its resident companies did not justify another country, such as the UK, introducing rules which discriminated arbitrarily against a local branch of a foreign company.     


In case the tribunal was wrong in its view that the UK’s current consortium relief rules imposed an unjustified restriction on the freedom of establishment of a non-UK company seeking to create a UK branch, the tribunal then went on to consider whether, on the assumption that such a restriction could be legally justified, it would also be proportionate to its objective. Since the relevant legislation purported to impose a blanket prohibition on the use in the UK of any tax losses which might also be capable of use elsewhere the tribunal concluded that the restriction would not have been proportionate to its aim even if such a restriction was justified in principle.

The earlier decision of the European Court in the Marks & Spencer case indicated that the way to counter the threat of double utilisation of tax losses was to permit their use in one jurisdiction once there remained no practical possibility of overlapping utilisation in another jurisdiction. And recent authority from the Court of Appeal in England showed that the UK courts were entitled to read suitable limitations into any UK tax legislation which was otherwise incompatible with EU law.

Unless the tribunal’s primary conclusions are later over-ruled by a higher court, this particular conclusion will remain largely academic. But it might potentially be of some importance if parts of the original decision are eventually reversed because a combination of tax limitation rules in the Netherlands and a poor trading history in that country made it unlikely that much use would ever actually be made in the Netherlands of the UK branch losses which UK law had purported to sterilise in case they were used in both jurisdictions.


It appears that the UK’s tax tribunals are now prepared to take robust decisions on behalf of taxpayers who are faced with any local tax legislation that appears to impose unjustified discriminatory restrictions on the seeking of tax relief for cross-border business ventures. When seeking to comply with UK domestic tax laws, it is important to ask whether such laws are actually valid, as a matter of general EU law. Businesses should be prepared to assert, where necessary, that they are not bound by discriminatory local tax laws.

Adam Dolder Senior associate | London

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