(CN) - Illegal residency requirements in British tax code governing loss-sharing between linked companies spark disparate treatment, Europe's highest court ruled Tuesday.
Hong Kong-based Fortune 500 firm Hutchinson Whampoa owns - either directly or indirectly - a host of companies headquartered throughout the world. Some of those companies set up a consortium to launch telecom venture Hutchinson 3G UK, which is based in the U.K.
Hutchinson 3G UK had sustained heavy losses while setting up a cellphone network when U.K.-based members of the consortium tried to write off their portions of those losses. British tax authorities balked, claiming that the losses could not be transferred to the U.K. divisions for tax purposes because the telecom venture's "link" company was based in Luxembourg.
A British tax court asked the European Court of Justice to weigh in on whether the U.K.'s tax residency requirements align with the freedom of establishment clause in the EU constitution. The EU high court found Tuesday that the British tax scheme creates a "difference in treatment" between companies based in the U.K. and those doing business there but with headquarters elsewhere.
"That difference in treatment makes it less attractive in tax terms to establish a link company in another member state, since the applicable national legislation grants the tax advantage at issue only where link companies are established in the United Kingdom," the Luxembourg-based court wrote.
And while there may be some public-interest justification for the disparity, the court cautioned that a crackdown on tax evasion does not represent a valid reason.
"The court has ruled that in order for a restriction on freedom of establishment to be justified on such grounds, the specific objective of that restriction must be to prevent conduct involving the creation of wholly artificial arrangements which do not reflect economic reality with a view to escaping the tax normally due on the profits generated by activities carried out on national territory," the court wrote.
"That is clearly not so in the case of national legislation such as that at issue in the main proceedings which in no way pursues a specific objective of combating purely artificial arrangements, but is designed to grant a tax advantage to companies that are members of groups generally, and in the context of consortia in particular," the justices continued.
The fact that the ultimate parent company - Hutchinson Whampoa - is headquartered in Hong Kong does not change the high court's opinion either, despite the EU's constitutional silence on third-country undertakings and the freedom of establishment.
"The places of residence of the ultimate parent company and the intermediate companies that control the companies seeking to transfer losses to each other are not of concern to the system of consortium group relief in the United Kingdom as resulting from the legislation at issue in the main proceedings," the court wrote. "Apart from the residence condition for the link company, the provisions of British tax code are silent as to the location of any other company falling within or standing at the top of the chain of interests between the companies claiming and surrendering losses. Thus, as the British government agreed at the hearing, relief on the basis of the same provisions in a case where the link company was established in the U.K. without this being prevented by the fact the ultimate parent company and intermediate group companies were established in a third State."
It is up for the British tax court to rule accordingly, the EU court concluded.