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Loose harmony

Already infamous for its VAT rulings, the European Court of Justice has shifted its focus on to direct taxation. Chris Quick explores the growing stock of case law, and asks: Just how far is the ECJ ready to go on harmonisation?

The opponents of European tax harmonisation cheered lustily last month at the news of Oskar Lafontaine’s dramatic resignation as Germany’s finance minister.

But tax experts are warning that the real force behind European Union tax harmonisation is far more powerful than any politician. The European Court of Justice has been causing consternation among Europe’s tax authorities by quietly striking down the tax laws of member countries, causing practitioners to warn of tax harmonisation ‘by the back door’.

Lafontaine’s fall from grace – after a short but colourful career during which his pro-harmonisation views earned him the title of ‘Europe’s most dangerous man’ – is not the end of the story.

While squabbles between EU politicians hinder efforts to bring in direct tax measures for all member states – for example, the proposed savings directive – the ECJ has been confidently handing down judgments which are radically altering European tax systems.

Due to the prolonged and technical nature of many of the cases, these changes are taking place well out of the public eye.

The anonymous nature of the court makes it a far harder target for the policy’s numerous opponents. Lafontaine or fat-salaried Brussels bureaucrats make much easier bogeymen.

The ECJ is already familiar to whose who deal with VAT law, which has a whole EU directive to itself and is in effect a pan-European tax.

It is in the area of direct tax, however – where there is no directive – that the ECJ could most markedly change the face of EU tax. More than 15 direct tax cases have now been heard, and many more are pending. All the cases deal with different situations, but share a single core argument – that the tax law in question violates the non-discrimination principles of the EU treaty, which states that member states cannot discriminate against nationals (or companies) from another state.

None of the cases have generated anything approaching the acres of newsprint devoted to Lafontaine’s utterings, but a relatively well-known case in tax circles is ICI v Colmer, which hinged on an ICI consortium relief claim. The ECJ decided the UK’s group relief rules contravened EU non-discrimination principles. This, said the court, was because the rules contained a British residence requirement which meant relief was not available, even though some consortium members were in EU countries.

While the case progressed, increasing numbers of pan-European groups made ‘protective’ group relief claims, so they could take advantage of the decision when it came. Having found its group relief rules called into question by the decision, the Revenue finally conceded the point last month with a belated announcement that it would accept group relief claims with reference to subsidiaries in EU countries.

Tax practitioners comment that the Revenue seems to have given in with unusual grace on the case, although it is still awaiting a final judgment from the House of Lords.

Some have compared the Revenue to King Canute in its attitude to European tax laws – stubbornly and vainly resisting the inevitable tide of change.

But as the ECJ begins to flex its muscles, the tide will become much more difficult to resist.

The court’s grip on European tax law will tighten as its determinations set precedents for other legal decisions. Some comment that EU states are already reluctant to develop new tax laws, fearing that changes could be made redundant by future ECJ decisions. The court’s influence will also grow as companies realise the huge tax savings to be made by threatening an ECJ court case when negotiating with their national tax authorities.

Privately, many practitioners admit that the Revenue can be ‘persuaded’ to give way quietly on a point involving European law in order to prevent an expensive court case.

The British government appears to be realising slowly that it will have to take ECJ decisions into account when framing new law. For example, chancellor Gordon Brown’s Budget announcement of his decision not to make any radical changes to capital gains rules questioned whether or not capital gains group rules need to be updated in the light of business becoming increasingly international.

But for most commentators, the government is not moving fast enough.

Frank Haskew, technical manager at the English ICA’s tax faculty, argues that there are a number of aspects of UK tax law which remain vulnerable to ECJ decisions. Rather than forcing prolonged and expensive court battles, Haskew calls for the Revenue to study its rules and amend the areas that conflict with EU principles. ‘These issues will not go away and government needs to address the issues properly rather than firefighting, which is all it is doing at the moment,’ he says, adding that the institute has asked these questions continually in representations submitted to the government.

Phil Nicklin, tax partner at Arthur Andersens, agrees. ‘Getting the UK to change its legislation is like extracting teeth’, he says, observing that the Revenue appears sensitive and vulnerable about the issue.

Like other tax advisers, Nicklin is now concentrating on how he can use the ECJ’s decisions and EU non-discrimination principles for the benefit of his clients. He points out that, unlike the UK – where taxpayers win only a minority of cases going to court – ECJ cases are won by the taxpayer in the vast majority of cases.

The results are therefore almost always beneficial to the taxpayer. In stark contrast to Lafontaine’s breed of harmonisation, ECJ decisions are almost always regarded in a positive light by big business – the main driving force in bringing cases to the court.

German chemical giant Hoechst is behind a case registered at the ECJ late last year. It argues that the UK’s advance corporation tax system, abolished this month, contravenes EU law. The case centres on a dividend payment made to Hoechst by a UK subsidiary. Hoechst argues that the subsidiary should not have to account for ACT on the dividend because if it were being paid to a British parent it would be free of ACT, using a group income election.

The company also says that the subsidiary is discriminated against because of differences between UK double-tax agreements with ECU countries. Were the dividend to be paid to a Dutch company, Hoechst argues, it could get a partial ACT refund. The UK-German treaty, however, does not allow for such a refund.

On both issues, the company argues, the UK’s ACT regime violates the non-discrimination principles of the EC treaty. Observers speculate that the case is the real reason behind the UK government’s decision to abolish ACT, and say there is a possibility that if the case succeeds, the government will be forced to return millions in ACT already paid by UK subsidiaries with parent companies in other EU countries.

The speed with which the member states start to feel the force of the ECJ’s decisions will depend partly on the willingness of big business and its advisers to push them through the courts – and lawyers don’t come cheap.

But Heather Self, an Ernst & Young chartered tax adviser, argues that the process could be given a boost if the UK joins the euro. ‘If the UK goes into EMU then everything will become more transparent. At the moment we have to do so much currency conversion that people don’t always see the full picture,’ she says.

Tax experts differ over how far the ECJ will take the EU towards full-scale harmonisation. Nicklin comments: ‘To say that ECJ decisions will lead to complete harmonisation is a bit over the top. What they will do is to make legislation in individual member states more EU orientated.’

Self goes further, however. She says: ‘I think that the ECJ could act as a catalyst, forcing member-state governments to change their laws.

That will help create the momentum for change.’ She adds that any move towards establishing Europe-wide accounting standards could bring yet more pressure for tax harmonisation.

Self believes that complete harmonisation remains a long way off. Making the fundamental point that seems to have been missed by Lafontaine and his cohorts – that each EU country has different methods of calculating taxable profits – she observes that harmonisation remains far more than a simple matter of standardising corporation tax rates.


European banks will miss out on beneficial changes to UK group relief rules announced last month, according to a European Union tax expert.

Phil Nicklin, tax partner at Arthur Andersen, says changes to UK group relief rules as a result of the ICI v Colmer case will discriminate against EU banks with UK branches.

The changes allow group relief between UK subsidiaries with the same parent company in another EU country. But the change does not apply to UK branches of EU companies.

Nicklin points out that many European banks establish branches in the UK for commercial reasons, such as avoiding the regulatory burden of incorporating in more than one country.

He says: ‘European banks must be at a disadvantage to UK banks because they can’t freely group relieve between groups and branches in the UK.

This must make London less attractive as a financial centre. This is just another way in which the UK is discriminating against European banks.

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