Inland Revenue Loses First Round Of The Pirelli Case

by Justin Gorringe, Tax-News.com, London

23 January 2003

The long-running battle between the UK's Inland Revenue and the European Union over the 'integrity' of UK tax law in a European context saw a significant defeat yesterday when the High Court ruled against the Inland Revenue in the eagerly-awaited 'Pirelli' case.

The Court ruled that the Inland Revenue had unlawfully charged Advance Corporation Tax (ACT) on dividend payments from Pirelli's UK subsidiaries to the EU parent company. ACT has now been abolished, but if yesterday's ruling is upheld on appeal, many other EU parent companies would be able to bring similar litigation against the Revenue for past tax payments by their UK subsidiaries.

The ruling significantly broadens the principle established in the European Court of Justice two years ago when German company Hoechst won a similar case - but that applied only to parent companies based in countries where double taxation treaties did not grant treaty tax credits.

Both courts are applying European legislation that establishes the principle of freedom of establishment in the Single Market, and prohibits economic behaviour which would be prejudicial to the ability of EU companies to compete with each other. The Inland Revenue's practice, which was to allow UK subsidiaries to avoid payment of ACT on distributions to their UK parents, while applying different rules to foreign parents, has been held in both cases to contravene this principle.

The Pirelli case was seen as a test case by 190 EU-based groups, which will now eagerly await the outcome of the Inland Revenue's inevitable appeal, and must have an impact on the parallel 'Marks and Spencer' case, in which the Inland Revenue is trying to hold the line on the cross-border deductibility of losses. The recent decision by the UK's tax Appeal Commissioners against Marks and Spencer, preventing the company from offsetting its overseas losses aginst UK profits, seems to fly in the face of the 'freedom of establishment' principle, and is widely expected to be struck down when it eventually reaches the Courts.

The Appeal Commissioners said: 'The denial of UK relief for losses on activities the profits of which are not subject to UK tax can be justified as being for the maintainance of the coherence of the UK tax system.' The Commissioners should be given a special eurosceptic medal, but they probably don't stand much chance against the mighty acquis communautaire!

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