Marks & Spencer: A Case for Pro-European Tax Harmonization

By Alexis Downs, Roxanne Gooch, and Carl Pitchford

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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] 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.

If M&S 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.


Marks & 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.

On March 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.

Previous Decisions

The U.K. 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 (see 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.

On December 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.

After announcing 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 litigation.”

Current Decision

Her Majesty’s 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.

Although 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.

Jurisdictional Issues in Taxation

The M&S 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.

M&S 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 These cases, specifically M&S, highlight the role of the court in settling multijurisdictional tax issues.

Tax Competition Versus Harmonization

Every government 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.

The American 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 machinations.

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?

International Implications

M&S 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.

Alexis 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.




















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