UK Foreign companies and EU Tax legislation
The UK HM Revenue & Customs position on foreign subsidiaries appears to be out of touch with the current EU Tax Case Law.
The HMRC will appeal the High Court judgment of Vodafone using a Luxembourg subsidiary as a holding company for European investments. The argument been that interest generated in Luxembourg should be taxable in the UK.
This reasoning goes against the European Court of Justice position in the "Cadbury Schweppes plc & Cadbury Schweppes Overseas Ltd v Commissioners of Inland Revenue" case where it has been clearly established that domestic tax rules, such as UK CFC, can not prevent a company to organize its business affairs in another EU state directly or indirectly. In this case the UK tax rules penalize a more advantageous tax position which could be achieved by legitimately setting a company in Luxembourg.
We trust the Court of Appeal in the next instance or ultimately the House of Lords, will put an end to this trend that does not benefit the trade between UK and other EU states.
As Ralph Cunningham from the International Tax Review explains:
"The UK tax authorities will press on with defending the country's controlled foreign company rules even though a High Court judge decided on July 4 that they should be scrapped in their current form.
HM Revenue & Customs (HMRC) has said it will appeal a High Court judgement that it should end its enquiry into Vodafone's use of Luxembourg subsidiary as a holding company for European investments.
The tax authorities have been battling with Vodafone since 2002 over Vodafone Investments Luxembourg Sarl, which the mobile telecommunications company set up two years earlier.
HMRC claimed that the UK's CFC legislation meant that the interest on money the Luxembourg company lent to German subsidiaries was taxable in the UK.
Vodafone argued that as the European Court of Justice (ECJ) had ruled in the Cadbury Schweppes case in 2006 that a taxpayer could set up a subsidiariy in any part of the EU as long it wasn't only for 'wholly articifial' tax reasons, this meant the UK's CFC rules were unenforceable. The ECJ said it was up to the UK courts to decide if the CFC rules applied only to subsidiaries which were established in other member states to avoid tax.
The UK Special Commissioners ruled in July last year that they could only consider the motive test in the CFC legislation in cases such as Vodafone's. The motive test requires a UK taxpayer to show it didn't set up a CFC to divert profits from the UK and that it didn't use a CFC in transactions to reduce the amount of UK tax it would have to pay. The case has been to the Court of Appeal and the Special Commissioners before.
The CFC rules target subsidiaries that have been set up outside the UK in countries with a lower rate of tax and where the subsidiary pays less than three quarters of the amount of the tax it would have paid if it had been resident in the UK.
Justice Evans-Lombe said in the High Court that he didn't believe the CFC rules complied with the freedom of establishment principle because it was clear that Vodafone could set up a CFC in another member state and that Cadbury Schweppes showed that the UK tax authorities were interfering with that right by trying to tax its profits; that the CFC rules were aimed at using CFCs to avoid tax, but Cadbury-Schweppes showed that taxpayer could set up such a company to obtain a tax advantage as long as it wasn't established to only save tax.
The judge said only adding words to the CFC rules could make them comply with the freedom of establishment principle.
"It is to me a surprising proposition that the court can, by judicial legislation, add a further condition for the application of Section 748(3) in order to cure the invalidity of a statutory provision that would not otherwise comply with European law and be enforceable against certain taxpayers.
"The CFC legislation, which depends on Section 747 and Section 748 for its effectiveness, must be disapplied so that, pending such amending legislation or executive action, no charge can be imposed on a company such as Vodafone under the CFC legislation," the judge concluded. "It follows that HMRC's enquiry into Vodafone's tax return for the Accounting Period has no legitimate purpose and should be closed."
Though many tax professionals described the judgement as comprehensive, HMRC is not giving up the case.
"HMRC intends to appeal this decision, and the Government will continue to defend its ability to enforce the CFC rules, which are designed to counter tax avoidance through artificial shifting of profits to offshore subsidiaries," it said. The next stop is the Court of Appeal with the House of Lords a possibility after that. An application to refer the case to the ECJ was withdrawn in the Special Commissioners.
The ruling puts more pressure on the government to come up with a plan for the taxation of foreign profits that is acceptable under EU law and to taxpayers. The Treasury published a discussion document on the issue in June 2007 that proposed a tax exemption for foreign dividends but also a new controlled companies regime that some taxpayers described as "draconian". ..."
