& Spencer: A Case for Pro-European Tax Harmonization
Alexis Downs, Roxanne Gooch, and Carl Pitchford
JANUARY 2008 - On
February 20, 2007, the U.K. Court of Appeals entered its judgment
in the closely watched Marks & Spencer (M&S) case [Halsey
(HM Inspector of Taxes) v. Marks & Spencer Plc; 2007 EWCA
Civ 117; see www.bailii.org/ew/cases/EWCA/Civ/2007/117.html]
Beginning in 2001, M&S sought to reduce its taxable U.K. income
by deducting losses from foreign operations located in European
Union (EU) member states. The judgment is the most recent in a series
of court decisions, including decisions by the U.K. High Court and
the European Court of Justice, and the case will now go back to
Her Majesty’s Revenue and Customs (HMRC) Special Commissioners.
is ultimately successful, the case will set a precedent for many
other EU firms with cross-border losses. Furthermore, U.S. firms
with U.K. or EU subsidiaries may become entitled to group relief
for losses of affiliated companies. The M&S case
provides an opportunity from which to explore European integration
and international tax policies.
Spencer is a retailer of clothes, gifts, home furnishings, and
foods in the United Kingdom, Europe, the Americas, and the Far
East. Founded in 1884, Marks & Spencer has two basic formats:
general merchandise, and food only. At one time, the company owned
stores in Belgium, Canada, France, Germany, Hong Kong, Ireland,
Spain, and the Netherlands. During the late 1990s, European sales
were below expectations, particularly in France and Germany due
to weak visibility in Continental Europe, poor management, and
a veritable revolving door for CEOs.
29, 2001, the retailer announced its decision to sell or close
stores in France, Germany, and Belgium. As a result of this announcement,
the company’s March 31, 2001, consolidated profit-and-loss
statement included exceptional charges of £224 million as
a provision for losses on discontinued operations. Because the
store in France was sold and the stores in Germany and Belgium
were closed, M&S had no opportunity for tax relief in those
countries. This meant that M&S could not deduct the losses
on discontinued operations against other revenues from France,
Germany, and Belgium. Resident in the United Kingdom, M&S
appealed for “group relief” available under U.K. tax
laws, meaning that it asked to deduct the foreign losses against
U.K. revenue. In notes to its financial statements, M&S explained
that, if successful, the company would receive a tax refund, before
interest, of at least £30 million.
Inspector of Taxes rejected the initial M&S claim. Although
section 402 of the Income and Corporation Taxes Act of 1988 permits
deduction of losses for companies resident in the United Kingdom
or permanently established in the United Kingdom, deduction of
losses of foreign subsidiaries is not allowable. An M&S appeal
to the HMRC Special Commissioners was rejected in 2002. In 2003,
the U.K. High Court of Justice referred the case to the European
Court of Justice (ECJ). The M&S case (C-446/03) was based
upon articles of the Treaty of Nice, which amended the founding
treaties of the EU, the Maastricht Treaty, and the Treaty of Rome
M&S lawyers argued that differences in the tax treatment of
U.K. and foreign subsidiaries violated the “freedom of establishment”
provisions of Articles 43 and 48 of the treaty. These provisions
prohibit countries from hindering an EU member in one country
from establishing a business in another EU country.
13, 2005, the European Court of Justice ruled that M&S could
claim U.K. tax relief on losses incurred in other EU countries.
According to the ECJ, the U.K. group relief provisions constituted
a violation of the “freedom of establishment” in that
the U.K. law applied different treatment to losses sustained by
a resident subsidiary and losses sustained by a nonresident subsidiary.
However, the ECJ added that a nonresident subsidiary must exhaust
its tax benefits in its resident state before those benefits are
available in a nonresident state.
its decision, the ECJ referred the case back to the High Court
for resolution, specifically on the interpretation of whether
and when a nonresident subsidiary has exhausted its possible tax
benefits in its resident state. In April 2006, the High Court
ruled that possible benefits are not “likelihoods”
and that the “relevant time” for determining if conditions
exist for cross-border group relief is the time when the group
relief claim is made, not when the losses arose. On Note 25 of
its April 1, 2006 consolidated balance sheet, M&S did not
recognize an asset for refund of taxes due to “continuing
Inspector of Taxes and M&S brought the case to the U.K. Court
of Appeal after the High Court’s interpretation of the ECJ’s
ruling. In its February 2007 ruling, the Court of Appeal generally
agreed with the High Court. In effect, the decision extends the
period for filing group relief claims. The M&S case
now returns to the Special Commissioners to review the facts under
this new guidance.
M&S’s lengthy run through the British and European
courts is not over, the United Kingdom has already revised its
group relief laws in response. The new tax rules, effective in
the United Kingdom on April 1, 2006, allow qualifying losses from
a European Economic Area (EEA) subsidiary to offset revenue of
a U.K. parent company. In order to claim such losses, the U.K.
parent must own 75% of the EEA subsidiary, and the losses of the
EEA subsidiary cannot be available for tax relief in the subsidiary’s
state of residence.
The new group
relief rules settle a U.K. tax issue; however, many questions
remain regarding European integration and the implications for
multinational companies. Specifically, multinationals with taxable
U.K. profits and losses in EU subsidiaries might now appeal for
group relief and request refunds. Indeed, similar cross-border
relief will likely become available throughout the EU. Even a
multinational with a U.S. parent company might have to amend its
tax returns if the IRS, for example, determines that failure to
do so will result in denial of the foreign tax credit, which is
based upon compulsory foreign taxes. According to IRS instructions,
if a corporation does not seek all available remedies to reduce
the amount of foreign tax, a foreign tax credit is not allowed.
Issues in Taxation
case highlights tax jurisdictional issues in the EU. In federalist
structures, such as the United States, tax authority is divided
between the federal, state, and local levels of government. As
a result, the U.S. Supreme Court rules on federal tax cases and
does not generally interfere with states’ tax structures
unless they are clearly discriminatory. Because the EU is a union
of states and not a federal entity, it does not have a unified
central government, which in turn affords it no taxing authority.
However, the EU does have characteristics of a federal system
in that it conveys limited, primarily economic, powers to common
institutions such as the ECJ. While not a federal supreme court
per se, the ECJ has jurisdiction to rule on many questions of
EU law referred to the ECJ by the courts of the member states.
In this capacity, and unlike the U.S. Supreme Court, the ECJ rules
on member states’ tax structures. The rulings of the ECJ
are characterized by “judicial dialogue,” which actually
reflects a sharing of jurisdiction between the member states’
courts and the ECJ. The M&S case provides an illustration
of judicial dialogue. For example, after the ECJ ruled on M&S,
the case reverted to the High Court.
appears to be one in a line of ECJ cases that attempt to reform
member states’ tax structures. In another case, the ECJ
ruled that Finland cannot grant foreign tax credits to Finnish
shareholders while withholding credits from foreign shareholders.
Most recently, on March 29, 2007, in the German case of Rewe
Zentralfinanz (Case C-347/04), the court ruled that “freedom
of establishment” is violated if a parent company resident
in Germany with subsidiaries in EU states (like Rewe) has a less
favorable tax situation than a German parent company with German
subsidiaries (see curia.europa.eu/en/transitpage.htm).
These cases, specifically M&S, highlight the role
of the court in settling multijurisdictional tax issues.
Competition Versus Harmonization
has the right to tax its citizens and to tax activity within its
jurisdictional borders. A nation’s tax structure (its tax
base and tax rate) is designed to yield adequate revenues to finance
public services. When tax rates differ and businesses are mobile,
variation among jurisdiction tax bases and rates stimulate tax
arbitrage, which is the practice of taking advantage of a state
of imbalance between markets. For a company that is subject to
multijurisdictional taxation, tax arbitrage is accomplished by
means of transfer-price manipulations and income-shifting among
subsidiaries. Historically, in the EU, tax base and rate competition,
rather than harmonization, has been the rule. Therefore,
a country such as Ireland can promote its low levels of corporate
tax to attract large amounts of foreign investment. In the face
of tax competition from states such as Ireland, the high-tax countries
might be motivated to reduce their corporate taxes. According
to critics of tax competition, this could lead to a “race
to the bottom” in which countries eliminate corporate income
taxation and rely upon the taxation of individuals, on either
their labor or consumption.
model of tax competition is “competitive federalism,”
which means that states compete with each other. The big difference
between U.S. and EU taxation is that domestic U.S. subsidiaries
pay federal taxes at the same rates as the parent, so, for federal
tax purposes, U.S. firms have little incentive to shift income
or deductions among states. Companies do, however, have incentives
to structure interstate operations for the purpose of lowering
state taxes. Despite such efforts as the Uniform Division of Income
for Tax Purposes Act (UDITPA), state corporate tax laws lack consistency.
EU subsidiaries, on the other hand, pay no EU-level taxes, but
rather pay state taxes at varying rates, so they have every incentive
to shift income or deductions among member states. EU companies
are likely to recharacterize profits—regardless of where
they are earned—as arising in countries with lower levels
of taxation. Although limited by taxing authorities, companies
can, for example, restructure financing to borrow more in high-tax
countries where interest is deductible. The ECJ’s recent
rulings reflect a move away from tax competition toward tax harmonization,
which mitigates the inefficiencies created by financial restructuring
Due to European
integration, each member state of the EU faces some loss of identity
and power. Tax harmonization reflects such loss of power, specifically
a nation’s diminished right to tax its citizens. Faced with
integration, member states may hesitate. One way to maintain national
identity and power is by means of a treaty “opt-out.”
An opt-out is a potentially permanent exemption from a treaty
provision; one notable example is the United Kingdom’s opt-out
from the EU’s single currency, the Euro. The U.K. also opted
out of the Working Time Directive, which mandated a maximum 48-hour
work week. Given the United Kingdom’s track record, however,
it might opt out from a mandated common tax base in the future.
If a common base were mandated, would member states opt out?
is an international case about tax base harmonization. However,
M&S might be called a “pro-European”
policy case, because it implies an over-arching vision of a unified
Europe. A unified Europe implies political, economic, and cultural
integration, as well as cooperation among member states. What
are the implications of such a vision for member states? Is integration
contributing something positive or negative to member states and
to the larger world? Will integrative efforts paradoxically provoke
rigidity as individual states seek to preserve their national
ideals? Can national identity incorporate change? All of these
questions are relevant today, making M&S so much
more than a typical technical tax case.
Downs, PhD, CPA, is an associate professor of accounting
at Emporia State University, Emporia, Kan.
Roxanne Gooch, PhD, CPA, is an associate professor
of accounting at Midwestern State University, Wichita Falls, Texas.
Carl Pitchford is a lecturer at Université
des Science et Technologies de Lille, Lille Cedex, France.