The clause introduces schedule 1 and together, they provide for a small extension to the group loss relief rules for companies, which will allow UK groups to claim corporation tax relief for foreign losses in some very limited circumstances. I put it on the record so that it is clear that existing group relief rules for UK losses, which business is understandably keen to retain, are unaffected by the proposal.
The Government are introducing this small extension to group relief following the decision last December by the European Court of Justice in the case of Marks & Spencer v. Halsey. In that case, the court ruled that the UK’s group loss relief rules are in principle compatible with European law, but they go too far in denying relief for foreign losses in some narrowly defined circumstances: where a UK parent company can show that a foreign subsidiary has exhausted all possibilities of relief in its state of residence.
With effect from 1 April this year, our domestic tax legislation will be changed by the clause to reflect the decision taken by the European Court of Justice, making it clear that relief will be available in some limited circumstances to a UK parent company and its UK subsidiaries for the tax loss of a foreign subsidiary. That foreign subsidiary must either be resident in the European economic area or have made the loss in a permanent establishment based in the European economic area.
Schedule 1 sets out new conditions and rules. To ensure that they are observed the UK claimant company will be responsible for showing that all the conditions for the new relief are met. That is necessary because losses surrendered under the new rules will be from foreign companies that are not generally subject to UK law. Although the relief will be available only in the narrow circumstances set out in the schedule, the Government became aware that some people were planning arrangements with the aim of obtaining relief in the UK where it would not otherwise have been available. My right hon. Friend the Paymaster General announced on 20 February that relief in the UK would be denied where such arrangements are made. The schedule contains provisions that will give effect to the announcement from that date.
Mr. Benton, you are encouraging us to debate new clause 7 at the same time as clause and schedule stand part, so perhaps I may take briefly the opportunity to deal with it. It is interesting that it was tabled by the hon. Member for South-West Hertfordshire (Mr. Gauke), rather than his party’s Front Bench spokesmen, and it will be interesting to see what they do if he presses it to a vote.
This is an extraordinary new clause; it could have been drafted by the European People’s party in the European Parliament—perhaps it was. Its intention is clearly to pretend that the European Union does not exist and, therefore, has no impact on the UK tax system. I explained earlier why, in our view, clause 27 and schedule 1 are necessary and reasonable. Just as importantly, we cannot renege on our treaty commitments in the way that the new clause encourages and suggests that we do; it is impossible for us to do that. Simply seeking to say that existing legislation applies notwithstanding the European Communities Act 1972, does not set aside those commitments, even though the hon. Gentleman may wish to do that.
On the important central point, it is right—it is the Government’s clear policy—that member states should have the power to determine the shape of their own tax systems. Other treaty provisions make it clear that that competence is preserved. We are not endangering that power to determine our own tax policy by introducing the clause and the schedule; we are simply aligning our law with the latest developments in European Union jurisprudence in an area specifically related to the internal market.
In conclusion, clause 27 and schedule 1 make provision for a small extension to the group relief legislation, to make it clear how relief from foreign losses will be available in certain narrow circumstances, and enable us to preserve existing group relief for UK losses. I commend the clause to the Committee.
I am grateful for the opportunity to speak on the clause and on new clause 7. As the Financial Secretary said, the purpose of clause 27 and schedule 1 is to ensure that our group relief laws comply with the European Court of Justice judgment in the Marks & Spencer case. This is not the first occasion—nor will it be the last—on which it is necessary for us to amend our taxation laws to comply with ECJ judgments. I raised the significance of the impact of the ECJ on our corporation tax law during Second Reading and I have no intention of running through the complete history of this matter again.
It is also worth noting that there is a widespread consensus in the UK in opposition to tax harmonisation, particularly relating to direct taxation. I welcome the Financial Secretary’s saying that it is right that we determine our own tax policy. The Chancellor of the Exchequer has stated that
“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”.
It is sometimes tempting to think that tax harmonisation is simply about rates, but it is not. It is broader than that; it is also about exemptions, reliefs and thresholds. Although the Financial Secretary states that it is right that we determine our own tax policy and this measure is only to align group relief with regard to the latest developments in EU jurisprudence, it cannot be considered in isolation. Since 1996, a series of judgments by the ECJ has determined that our tax laws have not been in compliance with European law in respect of provisions relating to freedom of establishment under the single market.
When this matter was debated on Second Reading, the Paymaster General was understandably quick to point out that this is Conservative legislation and that the various ECJ judgments are a consequence of that. However, it is also worth pointing out that at the time of the Single European Act there was no expectation that the various freedoms of establishment and other freedoms set out in that Act would apply to direct taxation. There was no explicit mention of direct taxation. All attempts at giving EU institutions jurisdiction over direct taxation had been rejected by member states. There was also an argument, widely accepted until relatively recently, about the need for fiscal cohesion, and therefore that single market provisions should not be used to strike down national laws.
The Marks & Spencer case determined that it was in breach of European law to allow profits and losses made by UK residents to be offset against each other but not to allow losses made by a subsidiary resident outside the UK, but in the EU, to be offset against the UK group company. As a consequence, the Finance Bill amends our law with the intention of complying with this judgment and subsequent judgments made in the UK courts. But as I said, this is not the first case and it will not be the last where we are required to do this.
Consortium relief, advance corporation tax and thin capitalisation rules have all had to be reformed as a consequence of ECJ judgments. In addition to the reforms of group relief being discussed today, we can expect the ECJ to determine against the UK in respect of franked investment income, and even since Second Reading, the Advocate-General has determined that our rules in respect of controlled foreign companies are illegal. The cost of these judgments to the UK Exchequer is considerable. Vast amounts of tax have to be repaid and the estimates that I have seen suggest that the cost to the Treasury of the Marks & Spencer case will be in the region of £3 billion to £4 billion. I would be interested to know what the Treasury estimates the ongoing annual cost of implementing the provisions contained in clause 27 and schedule 1 will be, as compared with being able to maintain the previous position, as my new clause 7 proposes.
There are those who argue that the change to the law in these circumstances, specifically in relation to group relief, is a good thing and that UK companies will ultimately benefit from the reform of group relief. That may well be the case. However, taken as a whole, I take the view that even with this Government—I am clearly not a supporter—the best interests of the country will be served if decisions about our tax system are taken by the democratically elected legislature of this country and not by a group of Luxembourg-based judges.
That brings me to the purposes behind my newclause 7. As the Financial Secretary has pointed out, new clause 7 amends section 413 of the Income and Corporation Taxes Act 1988 to state that the existing group relief rules shall continue in effect, notwithstanding the terms of the European Communities Act 1972. It reinstates the legal position as existed prior to the Marks & Spencer case. It sets out the law which this Parliament determined and says that that law shall continue to apply. It sets out the law which the Government wished to maintain throughout the Marks & Spencer case. It will also save the Treasury several billion pounds.
Will it be treated as valid by the UK courts? At this point, and at the risk of sounding like my hon. Friend the Member for Stone (Mr. Cash), I need to turn to the Factortame case—not that there is anything wrong in sounding like my hon. Friend. The Factortame case will be familiar at least to the lawyers among us.
Not nearly enough, but we will make a start there. In brief and to simplify, the Factortame cases related to the Merchant Shipping Act 1988, which determined that in respect of shipping quotas, the UK quotas would be available only for UK persons. The ECJ determined that this was in breach of EU law. The House of Lords determined that the terms of the European Communities Act 1972 meant that the terms of EU treaties were to be incorporated into UK law and existing and future Acts of Parliament are subject to EU law.
Consequently, the Income and Corporation Taxes Act 1988, which contains the corporation group relief provisions, is subject to the provisions of EU law, as determined by the ECJ. The Act, in its present form, cannot stand because it is inconsistent with EU law, as the Financial Secretary rightly says. Consequently, the Government have considered it necessary to modify the law in order to comply with the views of the ECJ. However, the will of the current democratically elected legislature is not necessary for the case law of the ECJ to override the 1998 Act. Our role is to plug the gap in the least damaging way possible.
I want to explore the alternative approach that is set out in new clause 7. It is to state explicitly that UK law in its existing, enacted form continues to apply, notwithstanding any contrary principle of EC law. Returning to the Factortame cases, the essence of the judgment was the European Communities Act 1972. It entrenched EC law by giving it the capacity to override a later statute. The statute in question, the Merchant Shipping Act 1988, did not purport to repeal or exclude the effect of the European Communities Act. That gives rise to the essential question whether a later statute may, by express words, repeal or exclude the effect of the European Communities Act in giving effect to EC law.
The suggestion that the 1972 Act cannot be repealed or overridden is surprising, even if that is Parliament’s express intention. If that is not the case, the whole concept of parliamentary sovereignty is thrown out of the window. Some constitutional experts have suggested that that is the natural consequence of the Factortame decision and that the ECJ case law is for the supremacy of EC law. Reassuringly, the English Court of Appeal has refused to accept the argument. In Thorburn v. Sunderland City Council, the weights and measures or metric martyr case, Lord Justice Law stated:
“Whatever may be the position elsewhere, the law of England disallows any such assumption. Parliament cannot bind its successors by stipulating against repeal, wholly or partly, of the 1972 Act. It cannot stipulate as to the manner and form of any subsequent legislation. It cannot stipulate against implied repeal any more than it can stipulate against express repeal. Thus there is nothing in the 1972 Act which allows the Court of Justice, or any other institutions of the EU, to touch or qualify the conditions of Parliament’s legislative supremacy in the United Kingdom. Not because the legislature chose not to allow it; because by our law it could not allow it. That being so, the legislative and judicial institutions of the EU cannot intrude upon those conditions. The British Parliament has not the authority to authorise any such thing. Being sovereign, it cannot abandon its sovereignty. Accordingly there are no circumstances in which the jurisprudence of the Court of Justice can elevate Community Law to a status within the corpus of English domestic law to which it could not aspire by any route of English law itself.”
I am grateful, Mr. Benton. I will not proceed with the quotation, but the direction in which it is going is clear. The purpose behind new clause 7 is to state that the law made by this legislature stands. An argument that may be used against it is that European Union law stands above it. There is nothing that we can do. It would be ineffective. There is an argument that new clause 7 would be entirely ineffective and that the British courts would not recognise it.
My view and that of numerous judicial authorities is that, where Parliament determines, as I propose it does in new clause 7, that an element of European Community law will not stand, Parliament’s will prevails. I should be grateful to know later in the debate whether the Financial Secretary agrees with that interpretation and whether we have that power. That still leaves the issue of our EU treaty obligations. I fully accept that were new clause 7 to be accepted and to become law, there are enormous issues with regard to our treaty obligations. I have no doubt that enforcement action would be taken by the European institutions against the UK. I should be grateful to know what assessment, if any, the Government have made of the likelihood of such action, and what the sanctions or fines are likely to be. I raise the matter because the fiscal costs of the various changes to EU law are considerable—I am talking about billions. We need, at least, to be able to evaluate all the options that are available to us.
My purpose in raising the issue, both on Second Reading and today by speaking to new clause 7, has been to highlight the increasing interference in our tax law by the EU. Secondly, I am trying to obtain a clear statement of Government policy on the matter, both in respect of the M & S case and more generally. Thirdly, I hope to clarify the constitutional position: has Parliament the right to insert an explicit override of EU law within legislation, and do the Government expect UK courts to recognise the validity of such an override?
The ECJ has played a prominent role in our deliberations during the last few sittings of this Committee. We have seen how it has damaged our competitiveness in the art market, and how the Government’s strategy to tackle missing trader intra-Community fraud has been scuppered by an ECJ judgment. Now we see that our corporation tax laws are being fundamentally amended because of the ECJ. We have to ask who should decide our tax laws—the democratically elected UK Parliament, accountable to the British people, or the judges of the ECJ? Is our purpose merely to implement our instructions from European institutions, and do we really think that that would be to the long-term benefit of our tax system and our economy? This might not be the time or place to determine such matters, but we have a responsibility to ask those questions.
I congratulate my hon. Friend on the way in which he made his case for new clause 7. He was right to highlight the way in which the ECJ is shaping the direct tax system in the UK. Of course, he refers particularly to the Marks & Spencer case, which underpins this clause and the schedule. When we discuss amendments to the schedule, I shall come to some of the issues arising from that case and the way in which the Government have responded to that judgment.
We should reflect on the fact that the case brought by Marks & Spencer used two articles—articles 43 and 48, relating to the freedom of establishment and the equality of treatment of member states—to argue the point that group relief should be available in the UK for losses incurred by overseas subsidiaries. Those articles have been used by businesses in other countries to amend or to force through changes to their own tax legislation. My hon. Friend mentioned the changes in capitalisation rules—I think that they were in the Finance Act 2005—that stemmed from a case that sought to unpick the rules on capitalisation in Germany that favour German businesses to the detriment of other businesses located there. In a way, that action helped the UK heads of corporate businesses to try to dismantle barriers in Germany.
It is also worth pointing out that, as a consequence of that case, we have had to amend laws that imposed a considerable bureaucratic burden on UK companies in order to show that transactions within a group took place on an arm’s length basis.
Indeed. As happens in such cases, if the determination of a matter of European law affects one member state, it might well have to be applied to other member states. A tax adviser has told me that the ECJ is interested not in tax avoidance in a particular member state but in tax avoidance that takes place across the European Union as a whole. There will inevitably be situations in which changes in one jurisdiction will lead to changes in other jurisdictions.
My hon. Friend made an eloquent case for effectively carving out direct taxes from the implications of the Single European Act, as that Act has been used to bring the case before us. However, we need to think carefully about the implications of doing so. He made a powerful argument in the context of tax, but I am sure that other legislatures could make equally powerful arguments about other matters covered by the Single European Act. Those seeking to withstand market liberalisation measures introduced by the Act might see a UK carve-out as an argument for a carve-out to protect their own services. Those Governments that seem inclined to protect their own businesses and withstand cross-border flows of transactions might see the carve-out as a reason to seek their own carve-outs from the Single European Act.
If we carve out direct taxes, what will other member states seek to carve out? We must be careful how we tackle the issue, because of what the consequences might be. Although we all subscribe to what the Chancellor said—
“we must explicitly reject old flawed assumptions that a single market should lead inexorably to tax harmonisation”—
the legislative bite required to put it into effect might have a knock-on effect on aspects of our relationships with other member states.
I come to another issue concerning the judgment and its application through the clause and schedule—the Government’s consideration of the ECJ judgment and its elaboration by Mr. Justice Park in the High Court. I shall deal in more detail later with the point that the Government’s interpretation of the ECJ’s judgment is far narrower than Mr. Justice Park’s. He said in his judgment that he did not feel he needed to return to the ECJ to clarify certain points left ambiguous as a consequence of its judgment; he felt that he could do that himself.
The Government’s interpretation and implementation of changes to group relief that are narrower thanMr. Justice Park’s judgment creates a risk that businesses will challenge schedule 1’s interpretation of the ECJ’s judgment, that they will push the Government on issues of timing, arrangements and other aspects and that the Government will incur great costs defending its narrow interpretation of the ECJ, to taxpayers’ detriment.
I shall make one specific point on the Government’s consideration of the application of ECJ judgments to tax policy. Some would argue that although the judgment in the Marks & Spencer case dealt specifically with group relief, which is available only when a parent owns 75 per cent. or more of the subsidiary, it should also apply to consortium relief and the rules for claiming group relief should be reflected in the rules for claiming consortium relief. It is argued in the light of the ECJ judgment that businesses will seek to take the Government to court in the ECJ, saying that if the Government are going to apply the ECJ’s judgment on group relief in a particular way, they should also make the same applications and changes to rules for consortium relief.
The hon. Gentleman gives a reasoned exposition of his views, but he has not been clear about where he stands on new clause 7. Does he support it or not?
I think that I have given that explanation clearly already by highlighting some of the issues and the thought required before such a clause is put to a vote. I hope that, in the light of my remarks and given the thought that needs to go into how such a change might be implemented, my hon. Friend the Member for South-West Hertfordshire will seek the Committee’s leave to withdraw the new clause.
I am grateful. That will give my hon. Friend even more time to think about the matter before it is dealt with towards the end of our proceedings.
I conclude by saying that this stand part debate has raised important issues about the application of European law to tax. We cannot see it in isolation from the wider issues of reducing barriers to business across Europe, which we must examine carefully. We must remember that much of our economic success at home and abroad is due to the free movement of capital, both human and financial. We should be wary of making changes that, while satisfying us on one issue, damage us on a broader range of issues.
I am grateful to the hon. Member for Fareham for rebuking the hon. Member for South-West Hertfordshire on new clause 7, perhaps better than I could have done. The new clause would be a first step towards taking us back to 1971, before the Heath Government rightly negotiated our accession to the European Union—the Common Market, as it was then called. It is a wrecking amendment and would wreck the UK’s position within the European Union. The hon. Member for South-West Hertfordshire was quite clear about that. He cited various cases, but as his colleague the hon. Member for Fareham pointed out, European Union law is a two-way process.
The hon. Member for South-West Hertfordshire mentioned the Factortame case; I assume that he meant Factortame No. 1 rather than No. 2 or No. 3. He did not talk about the debate within the EU, which is perhaps too wide for us to discuss today, on the horizontal applicability of directives in contra-distinction to their political applicability, or about cases such as Foster v. British Gas and the Francovich case in Italy on the applicability of EU directives. The EU is now a club of 25 members, all of which, including the United Kingdom, are at least in theory bound by the same laws. If new clause 7 were accepted, we would be seeking to opt out of that arrangement and see ourselves as distinct from the EU. The huge risk is that other member states would do the same, and we would end up with a fragmented EU. That would not be in the interests of the UK. In particular, it could adversely affect the position of the UK in financial markets, as the hon. Member for Fareham said.
London is the financial centre of the EU; most people would accept that, although perhaps the hon. Member for South-West Hertfordshire would not. One of the ways in which we have built on that position is by taking advantage of the financial rules of the European Union, which are binding on all 25 member states at least in theory and often in practice. If we were to start to resile from those rules, it would weaken the position of London and the UK within the EU, to our detriment. It might satisfy the hon. Gentleman’s view of where the UK should be going as a sovereign state, but it would be something of a little Englander approach and an own goal in financial matters. We have the leading centre within the European Union, a position that has been built upon in large part, though not solely, due to our membership of the EU. New clause 7 would seek to wreck that, and I urge my hon. Friends to vote against it if it is pressed to a Division.
I appreciate the reasonable way in which the hon. Member for South-West Hertfordshire put forward his entirely unreasonable proposal. He has many colleagues who take an equally hostile view of the European Union but have generally framed their arguments in a less temperate tone.
The hon. Member for Fareham was interesting. He encouraged the hon. Member for South-West Hertfordshire to a point and then urged him to be cautious, particularly on the concept of carve-outs, for which he was arguing. My hon. Friend the Member for Wolverhampton, South-West was much clearer and more direct about the risks that such an approach might pose to our national economic interest.
On a number of points, the hon. Member for South-West Hertfordshire touches on the high principles of domestic and European Union jurisprudence. The simple legal fact at the heart of the matter is that the relevant Community laws are those concerning fundamental freedoms prescribed by European Community treaties and relating to cross-border movement between member states.
The hon. Gentleman also asked about costs. It is true that following judgment in the Marks & Spencer plc case, several reports suggested that the cost to the Exchequer would be high. However, they reported the outcome of the case in a way that was misleading;the judgment of the European Court of Justice was much narrower than was implied in those reports. The Government estimate that the cost to the Exchequer of the small extension of group relief proposed in this clause and schedule 1 as a result of the Marks and Spencer judgment, will be about £50 million a year. That estimate was set out and reflected in the Budget documentation. The Government are prepared to accept that cost in order to maintain the existing group relief that we believe is important and beneficial to UK business.
The hon. Member for Fareham made a number of points which, as he said, we will come on to in more detail later, but it is appropriate that I return to two of his points now. He took the Government to task by saying that the provisions in the clause and schedule are in fact narrower than Mr. Justice Park’s judgment. We have studied the ECJ’s judgment carefully and consider that the proposed extension to the group relief legislation is in line with the requirements in the EC treaty. The ECJ’s decision was very narrow—a view that has been reinforced by Advocate General Geelhoed. [Interruption.] I should spell that out for the Committee. The Advocate said that the judgment should be applied restrictively.
The hon. Member for South-West Hertfordshire asked about consortium relief. I am not sure if he is aware, but consortium relief is minute in comparison with group relief and typically accounts for less than a quarter of 1 per cent. of the volume and value of group relief. So we have concentrated our efforts on the effects of group relief because that has the greatest impact and effect on business. To be direct, the implications for consortium relief of the Marks & Spencer judgment are unclear, and we are still considering what—if any—consequences there might be. If we judge that it is appropriate to take action, we will do so, but only if we feel that it is necessary. I commend the clause to the Committee and if the hon. Gentleman wishes to press his new clause, I shall ask my hon. Friends to oppose it.
I am grateful to the Financial Secretary for his kind and generous words. I fear that I will have the worst of both worlds due to the manner in which I addressed the Committee earlier; I presented something that might be unpopular with some colleagues, but in such a way that I shall lose all credibility with some of my Eurosceptic colleagues.
When we evaluate our relationship with the European Union, it is important to take into account both the credit and debit sides. The purpose of new clause 7 is to highlight one of the disadvantages of our relationship with the European Union. Our tax system is being changed to our disadvantage, which is making it more difficult for the Government to raise revenue through corporation tax in the way that they would like. There is also a constitutional point about how there has been no consent from this House that direct taxation, in particular, should be a matter for the European Union. However, one has to accept that there is a wider picture. There are undoubted advantages to our membership of the European Union: anything that means that Peter Mandelson spends most of his time abroad has got to be a good thing.
I merely say that new clause 7 highlights a particular aspect. My hon. Friend the Member for Fareham fairly makes the point that there is a larger debate, but it is not the purpose of this Committee to debate that now. I therefore have no intention of pressing new clause 7.