UK: Marks And Spencer - The Battle To Claim Relief For Foreign Losses

Last Updated: 28 February 2007
Article by Mark Nichols and Michael Boutell

The Court of Appeal has handed down its decision in Marks & Spencer plc. This case concerns the circumstances in which a foreign subsidiary resident in another EU member state may surrender its losses to its UK parent. This article highlights the issues raised by the case. The case itself will be referred back to the Special Commissioners for it to make additional findings of fact and apply the decision of the European Court of Justice ("ECJ") as interpreted by the Court of Appeal.

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The Court of Appeal has handed down its decision in Marks & Spencer plc. This case concerns the circumstances in which a foreign subsidiary resident in another EU member state may surrender its losses to its UK parent. This article highlights the issues raised by the case. The case itself will be referred back to the Special Commissioners for it to make additional findings of fact and apply the decision of the European Court of Justice ("ECJ") as interpreted by the Court of Appeal.

The Special Commissioners will no doubt require expert witnesses from the countries where the Marks and Spencer subsidiaries are resident. However, before then we may yet see a final appeal to the House of Lords - although the Court of Appeal refused leave to appeal an application may be made direct to the House of Lords.

The case has much wider significance than its effect for Marks and Spencer. A substantial number of companies have filed claims in respect of losses incurred by foreign EU subsidiaries and the principles laid down by the ECJ as interpreted by the UK courts will provide the basis for determining whether those claims are successful. Additionally, the case suggests that the UK legislation dealing with the original ECJ decision itself breaches community law!

Rounds one and two

The UK courts first considered this issue in 2002 when the Special Commissioners held that Marks & Spencer (a UK resident company) was not entitled to claim group relief against its profits in respect of losses incurred by subsidiaries resident in Belgium, France and Germany. The Special Commissioners declined to refer the issue to the ECJ but on appeal the High Court made the reference. Broadly, the ECJ held that:

  • permitting a UK subsidiary to surrender its losses to its UK parent but not permitting a non-resident EU subsidiary to do so constituted a restriction on the freedom of establishment and was contrary to articles 43 and 48 of the EC treaty;
  • the restriction could be justified on the grounds of "public interest". The following objectives could provide a public interest justification: protection of the balance of allocation of the power of taxation between member states, ensuring credit for the foreign losses was not given twice (once in the UK and once in the local jurisdiction), and to prevent tax avoidance (by preventing the opportunity to use the losses in the state with the highest tax rate).
  • although the restriction could be justified on this basis the domestic law preventing the surrender of losses by a foreign EU subsidiary would only be EU law compliant if the domestic law went no further than was necessary to achieve these objectives.

Rounds three and four

The case came back to the High Court which decided that the case should be referred back to the Special Commissioners to make findings of fact about whether it was possible for the losses incurred by the foreign EU subsidiaries to be used in the local member state. The High Court did however offer its views on what the ECJ had decided. The High Court addressed two questions, the answers to which were not immediately apparent from a reading of the decision of the ECJ.

The ECJ held that a measure restricting the surrender of foreign losses to the UK parent could not be justified (and would be in breach of EU law) where:

  • the foreign subsidiary had "exhausted the possibilities" available in the local jurisdiction to use the losses (either by use in the accounting period in which they arose, carry back to a previous accounting period or transfer to a third party); and
  • there was "no possibility" for the foreign losses to be carried forward to a future accounting period and used either in the subsidiary incurring the losses or by third party.

This formulation by the ECJ raised 2 key issues:

  • what did the terms "exhausted the possibilities" and "no possibility" mean? Did these terms mean that where under the law of the foreign member state the losses could still be used if sufficient profits were available (e.g. by carrying the losses forward to set against future profits of the subsidiary) the conditions laid down by the ECJ were not satisfied and that therefore there was no breach of EU law? Alternatively, did the terms require not just consideration of the legal possibility but also the factual possibility or likelihood of the foreign subsidiary being able to use the losses? In practical terms if the taxpayer could demonstrate that the likelihood of returning to profit was remote could it be said that the foreign subsidiary had exhausted the possibilities and should be allowed to surrender the losses to the UK parent?
  • At what point in time should the question as to whether there was "no possibility" be answered? The UK Revenue argued that the date should be the end of the accounting period in which the losses arose. In the Court of Appeal Marks and Spencer accepted that the relevant date should be the date on which a final claim for group relief was permitted under UK law. Of course, given that most member states permit the carry forward of losses, the Revenue interpretation would severely restrict the scope of the ECJ’s decision.

On the first question the High Court held that there would not be "no possibility" that the losses would be used in the local member state where the local law permitted indefinite carry forward and the subsidiary was still trading even though there was little likelihood of it returning to profit. The same would also be the case if the trade ceased but the law of the local member state was that the losses could be carried forward and set against other income even though there was no intention that the subsidiary should receive other income. In both cases there could not be said to be "no possibility" that the subsidiary would either return to profit or receive other income.

Although the Court of Appeal slightly varied the High Court formulation by holding that "no possibility" meant "no real possibility" (i.e. fanciful possibilities could be disregarded) it is far from clear that this is significant as the Court of Appeal nevertheless accepted as correct both the examples referred to above which are likely to apply in most cases. It will be for the Court charged with the responsibility for making findings of fact that will determine whether this test is satisfied in a particular case and it seems possible that there will be other cases selected to test the limits of the "no real possibility" formulation.

On the second question the High Court held that the correct time to apply the "no possibilities" test was at the time the claim for group relief was made. The Court of Appeal agreed with this, which brings into question the legality of the Finance Act 2006 measures that extend group relief for losses arising in EU/EEA subsidiaries. For example, the Finance Act 2006 legislation requires the question as to whether losses may be carried forward in the foreign EU subsidiary to be judged at the end of the period in which they arose. This is no doubt a blow for the Revenue and it seems likely that it will apply to the House of Lords for leave to appeal on this point or face having to amend its new legislation and suffer tax loss.

A fundamental question that was raised in the Court of Appeal was whether the ECJ judgment required the automatic disapplication of the UK rule requiring surrendering companies to be resident in the UK. The Court of Appeal dismissed this argument. There can be no breach of Articles 43 and 48 of the EC Treaty unless Marks and Spencer is able to demonstrate that the "no possibility" test is satisfied. If it were not satisfied there would be no breach of Articles 43 and 48 of the Treaty. Necessarily therefore there would be no question of there being a disapplication of the provisions.

There will be further rounds to be played before this case reaches its conclusion. Not only will the Special Commissioners have to look at it again but before it reaches the Specials it could go to the House of Lords. For other taxpayers (whose claims involve different facts) the courts may be required to apply the "no real possibility" test to a range of different fact patterns. The saga continues!

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 22/02/2007.

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