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Issue # 2 - April 18, 2005


On March 31, 2005 the United States Court of Federal Claims issued its decision in the Guardian Industries case. It is not our intention to discuss the US international tax issues arising from the case. Rather, we intend to test the case against the Italian tax consolidation rules and see whether its outcome would have been the same had Italy instead of Luxembourg been the foreign country involved (or, putting it in a different - and perhaps more intriguing - prospective, whether US multinationals with international operations in Italy may benefit from the same tax planning technique also under Italian corporate income tax law). We summarize (and simplify) the facts of the case for those who may be unfamiliar with it and to put our analysis in context. Guardian Industries is a US corporation that owns its international operations through a wholly-owned Luxembourg limited liability company, Guardian Industries Europe (GIE) that in turn owns controlling interests in a number of Luxembourg resident subsidiaries engaged in the manufacturing of automotive glass (Guardian’s main product) using plants in several European countries, including Luxembourg. In 2001, the tax year at issue, GIE and its subsidiaries filed a combined tax return in Luxembourg, as a result of which the total income from local manufacturing operations was aggregated at the group level after offsetting individual members’ taxable income and losses and making some other adjustments for certain nontaxable infra-group transactions, and the Luxembourg tax was assessed on the income of the group as a whole. The US parent checked the box on GIE, which was treated as a branch (i.e. a tax nothing) for US tax purposes. The relevant issue of foreign (in this case, Luxembourg) tax law arising from the case boils down to this: who was legally liable for the group’s tax in Luxembourg. If it were the Luxembourg head company (GIE), then the US parent would be entitled to an immediate IRC § 901 foreign tax credit for the total amount of Luxembourg tax paid on income from local manufacturing. If, on the contrary, the single members of the groups were jointly and severally liable for the group’s tax, or, rather, each of them were separately liable for a share of the group’s tax equal to the tax accrued on that member’s taxable income and flowed to the group, then the US parent would be entitled to an IRC § 902 foreign tax credit only when dividends are paid along the chain. After considering several reports from experts of Luxembourg corporate income tax law discussing this issue, the Court was persuaded that GIE was solely liable for the group’s tax under Luxembourg’s tax combined filing rule and held that the US parent was entitled to an immediate IRC § 901 foreign tax credit for the entire amount of the group’s corporate income tax paid in Luxembourg.

Italy’s tax consolidation rules took effect in 2004. Income Tax Code (ITC) sections 117-129 regulate the domestic tax consolidation regime, while ITC sections 130-142 regulate the worldwide tax consolidation regime. Regulatory provisions and administrative guidelines on domestic tax consolidation regime were issued in June 2004 and December 2004 respectively, and the model of worldwide and domestic consolidated income tax return with filling-out instructions was approved in February 2005. The two regimes differ in some material respects (stated very broadly, domestic tax consolidation is easier and triggers a more favorable tax treatment compared to worldwide tax consolidation). Domestic tax consolidation is allowed to parents-subsidiaries that are controlling-controlled companies. For this purpose, “control” requires ownership of more than 50% of (i) voting power, (ii) stock (by value) and (iii) profits interest. Stock owned by a controlled corporation is attributed (pro rata) to the parent. Tax consolidation is elective and taxpayers can pick and choose the controlled subsidiaries they want to consolidate (there is no “all or nothing” rule). The consolidating parent may be a resident corporation, or a foreign corporation if it (i) is resident in a country with an income tax treaty with Italy, (ii) carries out a trade or business in Italy through a PE, and (iii) the subsidiaries’ stock it owns is effectively connected with its Italian PE. The election is binding for a period of three years. Each member of the consolidating group must compute its own taxable income or loss, file an informative income tax return (without computing the tax) and pass the return with all relevant documentation to the consolidating parent. Then, the full amount of income, losses, credits and loss/credit carryovers reported the members of the group are amalgamated and offset with each other, the consolidating parent computes the tax of the group, files the group’s consolidated income tax return and pays the group’s income tax due (or carries over the group’s loss to the next taxable year. The loss can also be allocated back to the members which generated it, pro rata or in full). In computing the group’s taxable income or loss, certain adjustments are allowed for infra-group nontaxable transactions (dividends, sale of goods). With specific regard to the issue of liability for the group’s tax, the rules are contradictory. ITC §§ 118, 122 and 127, par. 2 stand for the principle that the consolidating parent is solely liable for computing and paying the group’s tax. In particular, ITC § 118, par. 3 provides that the obligation to pay the account and balance of the group’s tax falls exclusively upon the parent. ITC § 127, par. 1 provides that a controlled member of the group is liable (jointly and severally with the parent) for any additional taxes (and related interest and penalties) that the tax administration may assess upon the group as a result of an upward adjustment of the taxable income of the member, but does not mention any liability of the controlled members for the group’s tax as initially computed and reported by the parent on the group’s tax return. On the other hand, ITC § 127, par. 3 provides that in case of parent’s failure to pay the group’s tax, the tax is collected primarily from the parent. The tax administration has interpreted this language as if it stood for the rule that in case of parent’s failure to pay for the group’s tax, then all the controlled members of the group would be secondarily liable for payment of such tax. The accuracy of this interpretation is highly disputable. However, in the light of this ambiguity in the law and the position taken by the administration, at least until further guidance is released or Italian courts have an opportunity to take a position on this issue, it is hard to say with a sufficient degree of certainty that under Italian domestic tax consolidation rules the parent is solely liable for the group’s tax, and that on this basis, a case similar to Guardian Industries would be decided in the same way as it has been decided with reference to Luxembourg law.


The Advocate General Luìz Miguel Poiares Pessoa Maduro of the European Court of Justice (ECJ) concluded in his 7 April opinion inMarks & Spencer Plc v. David Halsey (HM Inspector of Taxes) (C-446/03) that the UK group relief rules, allowing a resident company to offset losses of its resident subsidiaries, but not those of its foreign subsidiaries established in other EU member states, violates the freedom of establishment of art. 43 of the EC treaty, and recommended that the ECJ declare them invalid. However, he put a caveat in his opinion and said that such denial of relief for foreign subsidiaries’ losses would be compatible with the EC treaty if it were subject to the condition that such losses can be deducted also in the other member states where the subsidiaries are located, so that the effect of the rule is to deny a double deduction of the same losses by the same taxpayer group both at home and abroad. Marks & Spencer (M&S) is a large retailer based in the UK that expanded its international operations by establishing various subsidiaries in several EU countries. Its european subsidiaries incurred substantial losses and M&S sought to offset such losses against its UK taxable income, for an amount of about £ 30 million. Other multinationals with operations in Europe have similar claims, reaching a total amount of billion of euros. The UK group tax relief regime allows a subsidiary in a group to surrender its losses to another company of the group so that the latter can deduct them from its taxable income. The transferred losses belong only to the transferee company and can no longer be used or carried over by the transferor. However, this regime applies only to domestic companies and does not extend to losses of companies organized in a foreign country (whether in or outside of EU). On its face this regime is discriminatory and violates the non-discrimination principle embedded in the freedom of establishment rule of art. 43 of the EC treaty. Indeed, it treats more favorably a domestic parent with subsidiaries in the UK, than a domestic company with subsidiaries elsewhere in Europe, thus unduly burdening the freedom to establish business operations in the EU through subsidiaries in other EU member states as granted by the EC Treaty. The position taken by the Advocate General on the main issue of the case is straightforward. What is more interesting is the caveat. According to the Advocate General, the limitation of group relief to losses of UK resident companies could be justified if conditioned upon the use of the same losses also in the foreign jurisdiction, so that the effect of the rule is that of denying a “double dipping” or “dual consolidation” of the same losses within the same group, which would occur if the member state of the foreign subsidiary allowed the subsidiary to carryover its losses to future taxable years or to transfer its losses to another member of the group (in that state or abroad). This line of reasoning is intimately connected with the anti-avoidance and cohesion of tax systems arguments brought in support of facially discriminating domestic tax laws, which the ECJ has addressed several times in the past. In that regard, the ECJ developed a strict standard of scrutiny, according to which a discriminating law is valid if it is narrowly drafted so as to apply only to clearly abusive transactions, and if it denies a loss or deduction for the purpose of the same tax and to the same taxpayer who benefits from the corresponding tax advantage. To date, the ECJ has never found that this standard was satisfied and has never upheld a domestic tax law on this basis. It will be very interesting to see how the ECJ will rule on this issue this time following the recommendation of the Advocate General.

TheMarks & Spencer case may have significant implications also in Italy. Italian tax consolidation regime was enacted in 2004 and different rules apply to consolidation of domestic and foreign subsidiaries. In very general terms it can be said that the access to worldwide consolidation is stricter, and the tax treatment of worldwide consolidating groups less favorable, relative to domestic consolidation. Just to mention a few aspects, (i) the election to consolidate is allowed only to publicly traded companies owned by the state or by individuals who do not control other resident or non resident companies; (ii) the election must include all foreign subsidiaries; (iii) income and losses of consolidated subsidiaries are aggregated pro rata, and not in full; (iv) the election is binding for five taxable years (not just three); (v) the consolidating parent cannot join another domestic consolidated group. According to well-settled ECJ case-law, even the slightest discrimination is sufficient to trigger the application of art. 43 of EC treaty. Therefore, this different treatment may be held to violate EC law. Italian multinationals with operations in other EU member states that may benefit from consolidation of income and losses or their EU subsidiaries should watch very carefully the developments of EC law in this area, seriously consider the opportunity to pursue cross-border consolidation beyond the strict limits set out by Italian tax law, and challenge the validity of Italian cross-border consolidation regime before the ECJ if appropriate.


On March 24, 2005 the UK government introduced the 2005 Finance Bill that contains several anti-avoidance measures targeting cross-border tax arbitrage transactions. This term conventionally points to transactions structured in such a way to exploit the interactions between tax laws of different countries, which treat the same transaction differently for tax purposes, so that the taxpayer can obtain favorable tax treatment in both jurisdictions involved. Among the targeted transactions are the use of hybrid entities or hybrid securities to allow a tax deduction to the payor (whose country, typically, treats the transaction as a loan), without income inclusion by the payee (whose country disregards the transaction or treats is as a sale or contribution to capital), or a double dip, that is, the same tax deduction in both countries (as it typically happens with leases, when one country treats the lease as a true lease and allows the lessor to take depreciation deductions with respect to the leased property, while the other country treats the transaction as a sale and allows the lessee/buyer to take depreciation deductions for the same property). The arbitrage provisions require a tax avoidance purpose and a noninsignificant tax reduction, achieved by a qualified scheme. The statute contains a mandatory list of qualified schemes that trigger application of the rules. The UK government just few days ago withdrew the 2005 Finance Bill introduced on March 24 and replaced it with Finance Bill (No. 2) 2005, which leaves out the anti arbitrage provisions but keeps some other anti avoidance measures. However, the UK Treasure announced that the original arbitrage provisions may reappear in future legislation that the government would intend to pass if it is confirmed after the general political elections, and that these rules will apply retrospectively from their original commencement date as announced in the Budget. This appears to be a major development in the area of international taxation and we will watch the matter carefully to see how it evolves in the coming weeks.


On April 1, 2005 the Dutch Supreme Court issued three decisions that deny deduction of costs incurred by a Dutch company in connection with its holdings in foreign subsidiaries. The Dutch Supreme Court applied the provisions of article 13.1 of the Dutch Corporate Income Tax Act as in effect prior to the ECJ’s decision in the Bosalcase and its final repeal in January 2004. The Dutch company also owned stock in non-EU subsidiaries during the years at issue, and the Supreme Court held that the costs related to such stock were nondeductible because the predecessor of article 56 of the EC Treaty on freedom of movement of capital and payments between EU member states did not apply to third countries. The issue still open is whether the new article 56 applies to non-EU countries. Since other taxpayers contested Dutch courts’ rulings for post 1994 years, it is likely that this question will ultimately reach the ECJ.


Among the various US international tax provisions contained in the American Job Creation Act passed into law on October 22, 2004, the anti inversions rules of IRC § 7874 deserve specific attention by foreign multinationals with operations in the US. Indeed, they are overarching and may hit perfectly legitimate transactions, causing serious consequences to unaware foreign taxpayers. The new rules have two basic prongs. First - and more importantly - if, as result of an outbound reorganization, substantially all of the properties of a US corporations are acquired by a new foreign holding company, directly (as in the case of an asset transfer) or indirectly (as in the case of a stock swap), and the former shareholders of the transferred US corporation end up owning 80 per cent or more of the stock of a the transferee foreign holding company, such company is treated as a US domestic corporation for all purposes of the US tax code. Even considering a special rule that disregrads certain stock of the US acquired corporation owned by the new foreign holding company, for the 80 per cent rule to apply it is sufficient that a minuscule amount of stock of the US acquired corporation is owned by a person unaffiliated with the prime foreign shareholder of such corporation, and the new foreign holding company does not have substantial business activities in the US. The rule has the effect that the new foreign holding company is taxable on its worldwide income in the US and subject to the same tax obligations as any other US corporations. In a second situation, if 60 per cent or more but less than 80 per cent of the stock of the new foreign holding company is owned by former stockholders of the US acquired corporation, the 80 per cent rule does not apply but there are restriction on the US acquired corporation that may raise tax liability on any property it transfers to the new foreign holding company. The anti-inversions rules apply retroactively to transfers of stock of inverting US corporations completed after March 3, 2003 and explicitly override inconsistent provisions of US tax treaties.

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