Cross-border Grouping - EU Law, ICI-v-Colmer

Cross-border Grouping - EU Law, ICI-v-Colmer

Although the Finance Bill itself does not contain any legislation that will clarify the position in UK law regarding cross-border grouping that follows from the decision of the European Court in the Colmer case of last year, and the subsequent Inland Revenue Press Release of earlier this year, the Budget Day Press Releases contain a hint of what is to come. In Press Release IR11, a statement is made that the Chancellor wishes to consider further a number of issues that arose out of the consultation process as to whether the taxation of capital gains of companies should be reformed in a similar way to that of individuals. These issues include "whether or not the capital gains group rules need to be updated in the light of business becoming increasingly international".

It will be noted that this statement says nothing about the question of whether existing capital gains grouping rules are contrary to EU law, particularly in the light of the decision of the European Court in the Colmer case. This is hardly surprising, as to make any such admission may be to force the Chancellor's hand in any possible future reform.

However, the statement is particularly interesting in the light of the interpretation that has been given by some tax advisers to the recent Inland Revenue Press Release in creating tax grouping schemes that are designed to exploit what these advisers consider to be the current state of the law.

It is worth recapping precisely what is at stake in the Colmer case. The Revenue have in the past considered that the following three statements reflect UK law:

1. A non-resident company cannot be the parent company of a 75% group.

2. If a UK parent company holds all the shares in a non-resident holding company, which in turn holds 75% of the shares in a UK trading company, then group relief cannot be surrendered between the UK parent company and the UK trading company using the link created by the intermediate non-resident company.

3. In a consortium situation, a company cannot be a holding company unless its business consists wholly or mainly of holding shares on UK companies which are 90% subsidiaries and are trading companies.

It was the third of these three statements that was tested in the Colmer case. Although the House of Lords had held that, in UK law, it was necessary for the business of a holding company to consist in the holding of shares in UK resident companies, the European Court decided that this interpretation restricts the freedom of the holding company to establish further subsidiaries in other member states, since to do so may be to prejudice the ability of group relief to flow through the holding company from the UK subsidiaries to the consortium members, and vica versa. However, on the facts of the Colmer case, the holding company would be unlikely to be assisted by this interpretation, as, at least in terms of simple number of subsidiaries, the majority of the subsidiaries of the holding company were resident in non-member states.

(It should be noted that the Court also stated that the test should not be applied simply to the number of subsidiaries, and that other factors, such as turnover and number of staff, should also be used in determining the relative importance of the subsidiaries).

It is now for the House of Lords to determine how this decision of the European Court should be applied in UK law. Hammond Suddards are acting for ICI on this case, and the case is currently listed to appear before the House of Lords on 29 June of this year. In the interim, however, the Inland Revenue have issued a statement as to how they intend to deal with the corporation tax cases which have been kept open pending the European Court's judgment. They have decided that "cases where the existence of a group or consortium is established by reference to a company or companies resident in the European Union ("EU") or European Economic Area ("EEA") may be settled on the basis that a group or consortium relationship does exist for group relief purposes". Furthermore, the Revenue have stated that:

"any corporation tax case which relies on a company or companies resident outside the EU/EEA for the establishment of a group or consortium relationship for group relief purposes will be considered after the final jugment of the House of Lords".

There are two things which are particularly interesting in this statement:

1. Strictly speaking, the European Court was only interested in issues regarding discrimination and freedom of establishment that arose out of a restrictive interpretation of the definition of the term "holding company". This is a definition which is relevant for consortium claims, not group claims. However, the Revenue statement refers to the question of the existence of a group, as well as a consortium. This would seem to indicate that they have decided that they need to revise their position on all three of the questions set out above - in other words, it should be possible to group through a non-UK but EU resident company, and through a non-UK but EU resident parent.

2. Given the fact that, until the House of Lords reconsider their last decision in the light of the decision of the European Court, their last decision remains the law, it is unclear quite on what the basis the Revenue can settle tax returns in the way set out in their statement. Either this is being done on a purely concessionary basis, or EU law is considered to have direct application and so UK law should, if necessary, simply be ignored in order to apply the overriding directives.

Whatever the basis in law of the Revenue statement, tax advisers are already using it in order to suggest group structures which rely on cross-border grouping within the EU being established by a non-UK but EU resident parent. Such structures, it is suggested, achieve two things:

1. Group or consortium relief may be surrendered between groups linked by the EU parent.

2. Provided the linking EU parent is non-UK resident, the groups will not be linked for capital gains purposes. Moreover, a disposal by the EU parent of one of the UK resident groups will not give rise to a UK tax charge, as the EU parent will not be subject to UK tax.

This form of structure may be attractive in a situation where it would be beneficial to enable group or consortium relief to be surrendered between groups that have a common funding parent, but which are, for all other purposes, essentially separate. Classically this will be the case in private equity funding, where it will be desirable to achieve the existence of a commercially separate UK sub-group without triggering a tax charge in the disposing holding company, or for that matter potential secondary liabilities in other members of a wider UK group. This does, however, rely upon the assumption that the Revenue will not consider that the statements of the European Court in the Colmer case do not have a still wider import, and are potentially applicable also in the context of capital gains tax grouping.

It is in this regard that the statement made at the beginning of this article regarding the question of whether capital gains group rules should be reformed in the light of business becoming increasingly international is particularly interesting. It may already be possible to argue under the authority of the judgment of the European Court in the Colmer case that the restriction contained in section 170(2)(a) TCGA 1992 that references to a company apply only to a company which is resident in the United Kingdom is discriminatory under EU law. The consequence of this would be that transfers between sister companies that are linked only by a common EU but non-UK resident parent should be capable of being made on a no gains no loss basis. It would follow from this, however, that such an EU parent should be capable of picking up a secondary liability under section 179(11).

It is far from clear that this is the case, however, and if the suggested reform of capital gains tax grouping does indeed take place that will enable capital losses to be transferred between members of a group, it would seem to follow from the Colmer case that it should be possible to create such groups simply through a link with a common EU resident parent.

To conclude, it may not be sensible to assume that a general reform is not about to take place in order to ensure that the UK's tax group rules conform to EU directives. The question of whether UK group income rules are discriminatory (the Hoechst and Pirelli appeals) has already been avoided, at least for the future, by the abolition of ACT. This, together with the Revenue Press Release regarding Colmer and the Budget Press Release IR11, appears to constitute clear indications of the future direction of tax jurisprudence in the light of EU law.

For further information please contact George Hardy, e-mail: Click Contact Link , 2 Park Lane, Leeds, LS3 IES, UK, Tel: + 44 113 284 7000

This article was first published in the Tax News - Special Finance Bill Edition issue of Hammond Suddards Tax News updates

The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.