The European Court of Justice heard today (2 May) that UK tax regulations, designed to prevent companies, like Cadbury Schweppes, from sheltering profits in EU member states with lower taxation levels by setting up subsidiaries for that purpose, are valid.

Advocate General Philippe Leger said that UK legislation on ‘Controlled Foreign Companies’ (CFC) should only be applicable to “wholly artificial arrangements intended to circumvent national law.”

UK firm Cadbury Schweppes bought the case before the EU Court of Justice. The confectionary company claimed that taxes levied on its subsidiary Cadbury Schweppes Overseas Limited (CSO) which includes two wholly owned Irish-based units, Cadbury Schweppes Treasury Services (CSTS) and Cadbury Schweppes Treasury International (CSTI), violated single market rules that allow companies to establish businesses across the EU. In 1996, the UK Government taxed Cadbury GBP8.64m on profits made in Ireland that had already been taxed at the lower Irish tax rates.

Ledger said that the UK’s CFC tax regulations can be applied to companies who have shifted funds to avoid national taxes. National governments, he said, should determine whether companies are abusing EU single market rules on a case-by-case basis.

This, Ledger suggested, should be determined by looking at “the degree of physical presence of the subsidiary in the host country…the genuine nature of the activity provided by the subsidiary and, finally, the economic value of that activity to the parent company and the entire group.”

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It is the role of the Advocate General to propose an independent legal solution, however, such advice is not binding. While the court does not have to follow Ledger’s recommendations, in 80% of cases the court’s final ruling reflects such advice. If the ECJ finds against Cadbury, it will be left to UK courts to determine whether CSO is liable for UK taxes.

The European Court of Justice is playing an important role in determining how multinational corporations can be taxed across the 25 EU member states. In December, the Court ruled that losses in EU countries couldn’t be deducted against domestic earnings.