Tax experts believe the case, in which M&S argues it should be able to reduce its tax bill by offsetting losses incurred on the Continent, could have widespread ramifications for UK companies as well as tax policy in other EU states.
At the first hearing of the case in the European Court of Justice in Luxembourg yesterday, M&S lawyers argued that UK tax laws breach EU rules on being able to invest freely in other countries.
The retailer wants pounds 30m off its tax bill from losses of pounds 100m arising from its disastrous expansion into France, Belgium, Spain and Germany. UK tax rules state that only losses from UK-based subsidiaries can be offset against the group's profits, which M&S says is prejudicial to cross- border investment in the EU.
Graham Aaronson QC, for Marks & Spencer, told the hearing: "The national rules plainly infringe the principle of freedom of establishment and are a very serious obstacle to the internal market." M&S said the UK and other governments oppose the tax relief because they do not want to lose out on revenue.
The Inland Revenue argued that allowing losses made outside the UK to be offset would lead companies deduct losses in low-tax countries to offset gains in higher-tax ones. "It would create a new distortion that would prevent the EU from benefiting from the internal market," said Richard Plender QC, for the Inland Revenue, warning of "grave dangers" to the system.
If M&S wins, hundreds of cases across the EU are expected to come to court. A group of about 60 companies including BT, Carphone Warehouse and Ford, is waiting in the wings for the outcome of the M&S case, hoping for tax rebates of as much as pounds 20bn. This may mean the Government stops companies offsetting losses even from its UK subsidiaries, known as the "group relief" rule. Charles Elphicke, of the solicitors' firm Reed Smith, said: "If M&S win the case, it will almost certainly mean the abolition of group relief for companies in the short term while a longer-term solution is considered.
"This would be a disaster for most companies in the UK that have profit- and loss-making companies in the same group. M&S and others may think they are clever in getting a windfall, but they are likely to bring the house down on a system that works well for UK businesses."
If companies are allowed to recoup taxes from losses made in other countries, the Government will want to change the law so that it can also claim tax on a foreign subsidiary's profits. Chris Morgan, the head of European tax for KPMG, said: "Otherwise the Government would be subsidising investment in to other countries without getting any upside in revenues from it."
A ruling in the case is expected in three months.