EU court rules on deductibility of losses of sub-subsidiary, losses transferred through merger

By Davide Anghileri, University of Lausanne, Switzerland

The European Court of Justice on (ECJ) released two more decisions on 19 June addressing when EU States are required by EU law to allow a parent company to deduct the final losses of a group member.

In Holmen (C-608/17), the court considered whether the losses of a sub-subsidiary are final and must be deductible in Sweden. In Memira Holding (C-607/17), the court addressed whether losses transferred through merger are final and must be granted a tax deduction in Sweden.

In both cases, the ECH concluded that foreign losses of a foreign subsidiary must be deductable in the State of the parent company only if the parent company can demonstrate that it is impossible for it to deduct those losses elsewhere, including through having the losses taken into account by a third party in a future period.

The topic is important as, under EU case law, a parent company can use foreign losses only if its foreign subsidiary has exhausted all possibilities of having the losses taken into account and it is no longer otherwise possible to use the losses, as stated in paragraph 55 of the landmark decision in Marks & Spencer (C‑446/03).

Holmen and final Spanish losses

In the Holmen case, the parent company, a Swedish resident company, sought to set off losses from its profits made in Sweden not from its subsidiary but from an indirectly and wholly owned subsidiary, a sub-subsidiary. Both the subsidiary and the sub-subsidiary were resident in Spain.

Since 2003, the Spanish companies had formed a tax grouping and were taxed in accordance with the Spanish tax consolidation system.

Under that system, the profits and losses of the entities which are members of the grouping can, without restriction, be set off against each other. That is achieved by the grouping drawing up a joint consolidated tax declaration for revenue. Unused losses may, without limit in time, be carried forward and deducted against any profits in future years.

However, beginning in 2011, the Spanish rules were amended to provide that only a portion of profits may be set off against previous years’ losses. Losses not deducted are carried forward, in the same way as other unused losses, to the following year.  

If a tax group is dissolved because the entities in the grouping are liquidated, any outstanding losses are allocated to the companies in which they arose. In the year of liquidation, only the entity that generates a loss can use the loss.

Sub-subsidiary losses & Marks & Spencer

The ECJ states that losses in an indirectly owned company, like a sub-subsidiary, do not in principle constitute final losses in relation to the parent company of the subsidiary.

In fact, the concept of final losses of a non-resident subsidiary, within the meaning of paragraph 55 of the judgment in Marks & Spencer, does not apply to a sub-subsidiary unless all the intermediate companies between the parent company applying for group relief and the sub-subsidiary sustaining losses that could be regarded as final are not established in the same Member State

Moreover, the ECJ added that, in a situation such as those envisaged by Holmen, and even if all the other impossibilities mentioned in paragraph 55 of the judgment in Marks & Spencer have been met where applicable, the losses would not be characterised as final if there is a possibility of deducting those losses economically by transferring them to a third party before the completion of the liquidation.

Therefore, the ECJ pointed out that if it is possible for the sub-subsidiary to transfer the losses to a third party (a subsidiary for example), final losses in the sub-subsidiary are ruled out.

It is therefore immaterial whether third parties were able to use the loss in the specific case. This is relevant at most for the question whether for such third parties there are final losses in relation to their parent companies.

Consequently, unless Holmen can demonstrate that it is impossible for it to deduct those losses by ensuring, in particular by means of a sale, that they are taken into account by a third party for future periods, the mere fact that the subsidiary’s State of establishment does not allow the transfer of losses in the year of liquidation cannot, in itself, be sufficient for the losses of the subsidiary or of the sub-subsidiary to be regarded as being final, the court said.

A different approach would result in the group having the right to choose whether the Member State of the subsidiary or the Member State of the parent company can use the final losses in the sub-subsidiaries, the court concluded.

Memira Holding and final German losses

In Memira Holding, the point at issue is whether a Swedish parent company has the right, on the basis of Article 49 TFEU in conjunction with Article 54 TFEU, to deduct the losses in a wholly-owned subsidiary established in Germany from its profits if that subsidiary is wound up by way of a merger with the parent company and the subsidiary was not able fully to use its losses made in Germany there.

In particular, Memira Holding AB is the parent company of a group with subsidiaries in several countries, including Germany. The German subsidiary accumulated losses from previous years of around EUR 7.6 million.

The group sought to have the subsidiary to merge with the Swedish parent company in a cross-border merger and to use the German losses in Sweden. The merger means the subsidiary will be dissolved without liquidation. After the merger, the group will have no company remaining in Germany. The group will not operate there, either through the parent company or through any other company in the group.

Under German law, the losses may be deducted from tax by the subsidiary in Germany and unused losses may be carried over and deducted from any profits the subsidiary makes in future years, without limit of time. However, under German law it is not possible through a merger to carry over losses to another company which is liable for tax in Germany.

Hence, the question is whether the German losses can be considered final losses and thus used by the Swedish parent company in the merger.

Losses transferred through merger  

The ECJ pointed out that the mere fact that the subsidiary’s State of establishment does not allow the transfer of losses in the event of a merger cannot, in itself, be sufficient to regard the losses of the subsidiary as being final.

In fact, in the case at stake, it is for Memira to demonstrate that the non-resident subsidiary has exhausted the possibilities available in its State of residence of having the losses taken into account for the accounting period concerned by the claim for relief and also for previous accounting periods, if necessary by transferring those losses to a third party or by offsetting the losses against the profits made by the subsidiary in previous periods.

There must be no possibility for the foreign subsidiary’s losses to be taken into account in its State of residence for future periods either by the subsidiary itself or by a third party, in particular where the subsidiary has been sold to that third party, the court said.

Therefore, if it cannot be excluded from the outset that a third party may take into account for tax purposes the losses of the subsidiary in that subsidiary’s State of establishment, the losses in the subsidiary cannot be considered as final, the court said.