ECJ confirms Marks & Spencer ruling on cross-border losses applies to permanent establishments

The European Court of Justice (ECJ) has confirmed the principles set out in its landmark 2005 decision in Marks & Spencer concerning the ability of a parent company to use the losses of a subsidiary resident in another Member State: A/S Bevola v Skatteministeriet (Case C-650/16) (ECJ, 12 June 2018). The court held that Danish tax rules were incompatible with EU law in denying a deduction for losses of a foreign permanent establishment (PE) which had ceased trading. This was the case despite the existence of an optional international joint tax regime under which it is possible for Danish companies to elect to treat all the companies in the group, resident or non-resident, including their PEs, as taxable in Denmark.

Whilst the restriction on the use of the foreign losses could, in general, be justified by the need to maintain a balanced allocation of taxing rights, the coherence of the tax system and the need to prevent double use of losses, those justifications did not apply to final, definitive losses.

Background

A/S Bevola is a company resident in Denmark. Bevola had a Finnish PE, which closed in 2009 with losses of DKK 2.8m (approximately €375,000). These losses were not and could not be deducted in Finland following the closure of that PE. In those circumstances, Bevola applied to be able to deduct those losses from its taxable income in Denmark for the tax year 2009. The tax authorities rejected the application on the grounds that the corporation tax regime did not allow the inclusion in taxable income of income and expenditure relating to a PE situated in a foreign State, unless the company had opted for the international joint taxation scheme. Bevola challenged that decision arguing that it would have been possible for Bevola to deduct the losses in question if they had been incurred by a Danish PE, and that that difference in treatment constituted a restriction of its freedom of establishment within the meaning of Article 49 TFEU.

Comparability

The court noted that allowing deductions for losses which are incurred by a PE situated in the Member State of the resident company, but not where the losses are incurred by a PE in a different Member State, means that a resident company with a PE in another Member State is treated less favourably than a resident company with a PE in the same Member State. By reason of that difference in treatment, a resident company could be discouraged from carrying on its business through a PE situated in another Member State and this, in principle, gives rise to a restriction on the freedom of establishment.

However, the Danish government argued that the position of a Danish PE and non-Danish PE were not objectively comparable, since the latter is not subject to the tax jurisdiction of Denmark. It relied on the court’s decisions in Nordea Bank Danmark (C 48/13) and Timac Agro Deutschland (C 388/14) that a PE in a different Member State other to that of the company is only in the same situation as a PE in the same Member State if the latter State also subjects the non-resident PE to its tax legislation and therefore taxes the income of that PE.

The court rejected this analysis of it earlier case law. The court’s case law indicated that the comparability of a cross-border situation with an internal situation must be examined having regard to the aim pursued by the particular national provisions. In the Nordea Bank and Timac Agro decisions, the court merely considered that there was no need for it to look at the purpose of the national provisions concerned, since they applied the same tax treatment to PEs abroad and those in the national territory. “Where the legislature of a Member State treats those two categories of establishments in the same way for the purpose of taxing their profits, it recognises that, with regard to the detailed rules and conditions of that taxation, there is no objective difference between their situations which could justify a difference in treatment.” It could not be concluded from those decisions that, where national tax legislation treats two situations differently, they cannot be regarded as comparable.

The court noted that the Danish tax rules exclude from the taxable income of Danish companies the profits and losses attributable to a PE in another Member State, unless the company in question has opted for the international joint taxation scheme. As such, that legislation is intended to prevent double taxation of profits and, symmetrically, double deduction of losses of Danish companies possessing such PEs. In this context, the court has held that, as regards measures to prevent or mitigate the double taxation of a resident company’s profits, companies which have a PE in another Member State are not, in principle, in a comparable situation to that of companies possessing a resident PE (Nordea Bank and Timac Agro Deutschland). However, as regards losses attributable to a non-resident PE which has ceased activity and whose losses cannot be deducted from its taxable profits in the Member State in which it carried on its activity, the situation of a resident company possessing such a PE is not different from that of a resident company possessing a resident PE, from the point of view of the objective of preventing double deduction of the losses.

The court also noted that the Danish tax rules in this case had as their aim more generally to ensure that the taxation of a company possessing such a PE is in line with its ability to pay tax. Yet the ability to pay tax of a company possessing a non-resident PE which has final losses is affected in the same way as that of a company whose resident PE has incurred losses. The two situations are comparable in this respect too.

Accordingly, the court concluded that the difference in treatment in this case did concern situations that are objectively comparable.

Justifications

Denmark argued, nevertheless, that the difference in treatment could be justified, first, by the maintenance of a balanced allocation of powers of taxation between Member States and, second, by the need to ensure the coherence of the tax system.

The court accepted that these justifications, together with the need to prevent the double use of losses, provided the basis for justification of the different treatment.

In particular, as regards the coherence of the tax system, “a direct link must be established between the tax advantage concerned and the offsetting of that advantage by a particular tax levy, the direct nature of that link falling to be examined in the light of the objective pursued by the legislation in question“. In the current case, the tax advantage consisted in the ability of a resident company with a domestic PE to set the losses of that PE off against its taxable results. The direct corollary of that tax advantage is the inclusion in the resident company’s taxable results of any profits made by the domestic PE. Conversely, the Danish rules exempt from tax the profits made by a PE located in another Member State, unless its Danish parent opts for the international joint taxation scheme. The Danish tax provisions, therefore, established a direct link between the tax advantage concerned and the offsetting of that advantage by a particular tax levy. If a company with a non-resident PE were allowed to set off the losses incurred by that PE without being taxed on the profits made by it, that would undermine the coherence of the tax system, which principle therefore “constitutes a convincing justification for the difference in treatment in question”.

Proportionality

On the question whether the restrictions in this case, involving final or “definitive” losses, were proportional, the court has reaffirmed the principles that it set out in its 2005 judgment in Marks & Spencer.

Where there is no longer any possibility of deducting the losses of the non-resident PE in the Member State in which it is situated, the risk of double deduction of losses no longer exists. In such a situation, the Danish legislation went beyond what is necessary for pursuing its objectives. “Alignment of the company’s tax burden with its ability to pay tax is ensured better if a company possessing a PE in another Member State is authorised, in that specific case, to deduct from its taxable results the definitive losses attributable to that establishment.”

However, in order not to compromise the coherence of the Danish tax system, deduction of such losses can be allowed only on condition that the resident company demonstrates that the losses it wishes to set off against its results are definitive. In this respect, it must show that the losses in question satisfy the requirements set out by the court in Marks & Spencer. In particular, the resident company must show, first, that it “has exhausted the possibilities of deducting those losses available under the law of the Member State in which the establishment is situated and, second, it has ceased to receive any income from that establishment, so that there is no longer any possibility of the losses being taken into account in that Member State”.

Comment

The Marks & Spencer decision that the UK was obliged to provide an opportunity for cross-border loss relief despite not directly taxing foreign subsidiaries has created many differences in opinion as to the extent of its application. Indeed, in intervening in this case, the European Commission contended that the court’s decisions in Nordea Bank and Timac Agro contradicted the early cases and should be overruled. It argued that the reason for a difference in treatment should not be taken into account when examining whether the cross-border situation and the internal situation are comparable, otherwise, two situations would be regarded as not comparable merely because the Member State had chosen to treat them differently.

Instead, the court has explained how the purpose of the particular rules should be taken into account in the comparability analysis, as well as confirming the Marks & Spencer principle that denial of relief for final, definitive losses will be disproportionate, even if the restriction is generally justified.

It should be noted that the existence of an optional scheme for joint taxation did not prevent the Danish tax rules being contrary to EU law. This is notwithstanding the fact that the ECJ indicated that the requirements of the scheme to include all subsidiaries and PEs were in line with the need to maintain a balanced allocation of taxing powers. The court noted that if a company were able to choose which entities to exclude or include, and which periods to include or exclude, this would “be tantamount to allowing it to choose freely the Member State in which the losses of the non-resident permanent establishment in question were to be taken into account. Such possibilities would jeopardise both the balanced allocation of powers of taxation between Member States and the symmetry between the right to tax profits and the possibility of deducting losses sought by the Danish tax system.”