The government is discussing changes to the corporate tax system as a means of protecting the UK's tax revenues from being undermined by future European Court of Justice rulings.
Some drastic measures such as abolishing the ability to offset losses in one subsidiary against the profits of another are being considered as options if the government is forced to rewrite the rule book for corporate taxation. In a growing number of high-profile cases, the Luxembourg-based ECJ has decided that national tax rules are illegal under EU law.
Future cases present “potentially the greatest threat to UK and other EU states' tax revenues in the medium term”, according to Ernst & Young, the professional services firm.
Some tax experts described the silence of Gordon Brown, the chancellor, on the issue in his pre-Budget report as surprising, possibly reflecting its political sensitivity in the run-up to an election.
As well as posing a threat to revenues, the ECJ's dismantling of domestic tax laws that conflict with the EU treaty could be embarrassing for the government, which has resisted proposals to harmonise direct tax regimes across Europe.
Several hundred multinationals are seeking tax refunds from the Inland Revenue estimated to total £10bn-£20bn in a series of challenges to rules that treat domestic and international transactions differently.
But UK companies could face extra costs if the Treasury decides to remove tax privileges from UK-based organisations instead of extending them to non-UK companies in order not to discriminate against other EU companies.
The Inland Revenue is discussing these issues with business and professional groups “with a view to maintaining the competitiveness and fairness of the UK corporation tax system while ensuring that it remains robust”. Over the past 10 years, the ECJ has ruled in favour of the taxpayer in 85 out of 87 cases relating to discriminatory tax legislation.
The government is starting to explore its options in case it loses a court battle next year with Marks and Spencer. The retailer wants to use the losses of its Belgian and French subsidiaries to reduce the taxable profits of its UK parent.
If the government lost, it would be reluctant to harmonise the rules by allowing companies to claim tax relief for losses incurred by overseas subsidiaries.
This step, which critics say would amount to British taxpayers subsidising business failures in other parts of the EU, could lead to the loss of billions of pounds of tax revenues.
Instead, the government could decide to remove companies' ability to offset losses in one UK subsidiary against profits in another, a step the Confederation of British Industry has described as potentially “very, very bad news for the competitiveness of British industry”.
