A landmark legal case could prompt changes to British law after the Treasury was told it can clamp down on companies that reduce bills by setting up in lower-tax European countries - but only under strict conditions.
In a carefully balanced judgment, the European Court of Justice said the UK is entitled to stop companies seeking lower corporate tax rates abroad as long as they have created "wholly artificial" arrangements in doing so.
However, the legal problems involved in proving that companies are not running legitimate businesses may prove insurmountable and make changes to tax law inevitable.
The ruling by Europe's most senior court was based on a complaint from Cadbury Schweppes, the world's largest confectionery group, that Britain's "controlled foreign company" (CFC) rules discouraged companies from exploiting the benefits of EU membership.
Cadbury, which set up in Ireland and took advantage of its low corporate tax `rates, disputed an £8.6m tax demand from the British government for 1996. Yesterday's ruling from the Luxembourg-based court was being followed closely by about 20 other claimants who have hundreds of millions of pounds of cash at stake.
While the UK's tax regime was vindicated to some extent, the court also said there should be an objective assessment - backed by third parties - of what constitutes a wholly artificial tax arrangement.
Experts predicted that attempting to prove in court that tax arrangements are wholly artificial may be extremely difficult in practice.
John Cullinane, president of the Chartered Institute of Taxation, said: "The judgment has very serious consequences for the UK's 'controlled foreign company' regime which the Treasury may seek to downplay.
"Although the court batted the final decision back to the UK courts, it told them they cannot enforce the CFC rules where the controlled foreign company is actually established in the host country (Ireland in this case) and carries out genuine economic activities there. However it is dressed up, this will require significant changes to the UK's CFC rules."
Cadbury argued yesterday it had a real business with confectionery manufacturing plants in Ireland and it was not an artificial subsidiary set up for tax reasons. A spokesperson added: "We welcome the judgment and look forward with confidence to the next stage in the process."
The Treasury said it was studying the ruling and the European Commission welcomed the ruling which, it said, highlighted the potential advantages of its idea of drawing up a common European corporate tax base.Reuse content