EU tax ruling could trigger rebates worth millions for UK firms

A ruling in the European courts on controversial tax rules for British companies with subsidiaries in other member states could result in millions of pounds being returned to UK firms and a revision of UK tax laws, as well as putting downward pressure on corporate tax rates across the EU.

In a case brought by confectionary and beverages giant Cadbury Schweppes, the advocate general of the European Court of Justice Miguel Poiares Maduro yesterday argued that the controversial UK tax rules are contrary to EU law unless the subsidiary is proved to be a "letter-box" company used only to dodge higher tax rates in other countries.

The UK's "Controlled Foreign Company," or CFC, laws are designed to stop businesses taking advantage of lower tax rates in other EU member states. UK companies are obliged to pay tax on subsidiary profits and dividends paid back to the parent company.

Mr Maduro said that such rules are only valid if subsidiaries are proved to be "wholly artificial," and said low tax rates are as legitimate a reason to establish a subsidiary company as low wages. If the subsidiary is genuinely established overseas, then the CFC rules are contrary to EU law as they inhibit a company's freedom of establishment.

A final ruling on the case, which was brought by Cadbury in relation to its Irish subsidiaries, will be made by the ECJ either later in 2006 or early 2007. Importantly, the case will be referred back to UK courts following the ECJ's ruling.

David Harkness, a tax partner at Clifford Chance, said: "It seems likely, if the opinion is accepted by the ECJ, that the UK courts would find the CFC rules would require revision. HM Revenue and Customs isn't home free yet and may find itself with a large tax refund on its hands running into millions of pounds."

Waseem Khokhar, a tax lawyer at DLA, said Dr Maduro's argument could set a "very significant precedent" and could provide a major boost to another case being brought by 20 major companies which are seeking similar tax relief as Cadbury as well as another case brought by Vodafone Group. Mr Khokhar said damages recoverable by the claimants could be "very significant."

A Treasury spokesman said; "It is too early to comment in detail. However, we welcome the fact that the advocate general hasn't found CFC rules contrary to EU law." Cadbury said it is "encouraged" by the advocate general's response but withheld further comment until the final ruling.