Is the taxman chasing shadows?

Just what does it take to get HM Revenue & Customs to listen to the law? The European Court of Justice should be a powerful catalyst in the evolution of European Union tax systems to remove barriers within the single market, but it seems clear to us that it is being hampered by HMRC’s recalcitrance.

Last week’s finance bill simply repeated what HMRC said in the pre-Budget report, which, in our view, is clearly contrary to the ECJ’s ruling in Cadbury Schweppes and is likely to trigger a rash of further legal challenges.

The key point that the ECJ made in Cadbury Schweppes was that the UK’s controlled foreign company rules should not apply where an entity is genuinely carrying out an economic activity. The legislation in the finance bill seeks to limit the circumstances in which it will apply.

Instead of accepting the ECJ’s qualification of the rules as a narrow anti-avoidance measure, as was the court’s obvious intention, HMRC seems to have been searching for a definition of ‘substance’ that would minimise the revenue loss threatened by the judgement.

What is driving this contrariness? It seems to us there are two reasons for the policy of ignoring the ECJ’s intentions and complying only with the letter of its judgements.

The first is short-term revenue concerns. The second is the government’s aversion to yielding any power over its tax system to any supranational body. In a similar vein, many companies and many EU member states favour the introduction of an (optional) common consolidated tax base in Europe where there would be no double taxation, loss relief problems or transfer pricing issues. However, the UK government and HMRC are opposed to this idea, because they insist tax must always be the inalienable prerogative of national governments.

In the long-run though, HMRC must yield to the spirit as well as the letter of ECJ judgements.

The simplest response would be to exempt all dividends from foreign EU companies as most other member states do. So far HMRC has simply announced another consultation document on the taxation of foreign profits generally.

It’s important that business and representative bodies fully engage with this. Could this be the possibility to develop a competitive, EU compliant tax regime, which would incentivise companies to remain in, or even relocate to, the UK?

Chris Morgan is head of international corporate tax, KPMG