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First, throughout that period dividend income received from overseas investments was in principle taxable, subject (as will appear) to certain reliefs. FAC |
Second, until 6 April 1999 Advance Corporation Tax (ACT) was levied on dividends distributed to UK companies shareholders. FAC |
The scope of the issues arising from these features and open on this appeal is, as will appear, itself in some dispute, but the appeal on any view involves a number of conceptually difficult points. FAC |
The principal issues on this appeal can be summarised as follows: I. Does EU law require a tax credit in respect of overseas dividends to be set by reference to the overseas tax actually paid, or by reference to the foreign nominal tax rate (FNR)? II. Ratio |
Is PAC entitled to compound interest in respect of tax which was levied in breach of EU law, on the basis that HMRC were unjustly enriched by the opportunity to use the money in question? III. Ratio |
Subject to HMRCs being granted permission to argue the point, does a claim in restitution lie to recover lawful ACT which was set against unlawful mainstream corporation tax (MCT)? IV. Ratio |
If the answer to (I) is that EU law requires a tax credit to be set by reference to the overseas tax actually paid, PAC seeks permission to cross- appeal on the following question: should the charge to corporation tax on the foreign dividend income under Case V of Schedule D (Income and Corporation Taxes Act 1988 (ICTA... |
Issue I Ratio |
The first issue - Issue I - arises from the approach adopted by UK law in order to avoid or mitigate double taxation of dividends. Ratio |
It is now clear that this was inconsistent with EU law, but in what precise respects and what is due by way of restitution or compensation are live issues. Ratio |
The inconsistency with EU law arose as follows. Ratio |
Domestically, dividends received by one UK-resident company, the source of which was a distribution made by another UK-resident company, were exempt from tax under section 208 of ICTA. Ratio |
The effect is that corporation tax was only levied once, on the latter company which made the profit out of which it distributed the dividend to the former company. Ratio |
In contrast, dividends received by a UK-resident company, the source of which was an overseas company, were in principle subject to DV tax. Ratio |
But where the UK-resident company controlled a certain percentage of the voting power of the relevant overseas company (typically 10%), certain relief was given for foreign tax paid on the underlying profits out of which such dividends were paid. Ratio |
This was done either pursuant to a double taxation treaty or unilaterally under ICTA, section 790. Ratio |
No relief against DV tax was however afforded in respect of portfolio investments, that is investments involving lesser percentage holdings. Ratio |
In Metallgesellschaft Ltd v Inland Revenue Comrs; Hoechst v Inland Revenue Comrs (Joined Cases C-397/98 and C-410/98) EU:C:2001:134; [2001] ECR I-1727; [2001] Ch 620, the European Court of Justice (CJEU) held that the unharmonized domestic tax regime fell under the EC Treaty, and could therefore be challenged if incons... |
Pursuant to a group litigation order dated 30 July 2003, PAC was on 13 November 2003 appointed to conduct the present test case, in which PACs primary contention has been that the UK tax position is inconsistent with article 63 of the FEU Treaty. PRE |
Article 63FEU (ex article 56 of the EC Treaty) provides: 1. STA |
Within the framework of the provisions set out in this Chapter, all restrictions on the movement of capital between member states and between member states and third countries shall be prohibited. STA |
2. Ratio |
Within the framework of the provisions set out in this Chapter, all restrictions on payments between member states and between member states and third countries shall be prohibited. STA |
At an early stage in the present case, a reference to the CJEU was found necessary. Ratio |
But, before that reference was heard, the CJEU determined a separate UK reference, in Test Claimants in the FII Group Litigation v Inland Revenue Comrs (Case C-446/04) EU:C:2006:774; [2006] ECR I-11753; [2012] 2 AC 436 (FII ECJ I - FII standing for franked investment income). Ratio |
In it, the CJEU held, at paras 1 and 2 of the operative part: 1. where a member state has a system for preventing or mitigating the imposition of a series of charges to tax or economic double taxation as regards dividends paid to residents by resident companies, it must treat dividends paid to residents by non-resident... |
[The Treaty provisions] do not preclude legislation of a member state which exempts from corporation tax dividends which a resident company receives from another resident company, when that state imposes corporation tax on dividends which a resident company receives from a non-resident company in which the resident com... |
Article [63FEU] precludes legislation of a member state which exempts from corporation tax dividends which a resident company receives from another resident company, where that state levies corporation tax on dividends which a resident company receives from a non-resident company in which it holds less than 10% of the ... |
2. Ratio |
[The Treaty provisions] preclude legislation of a member state which allows a resident company receiving dividends from another resident company to deduct from the amount which the former company is liable to pay by way of advance corporation tax the amount of that tax paid by the latter company, whereas no such deduct... |
This ruling was re-affirmed in the Reasoned Order by which the CJEU disposed of the reference made by the High Court in the present case: Test Claimants in the CFC and Dividend Group Litigation v Inland Revenue Comrs (Case C- 201/05) EU:C:2008:239; [2008] ECR I-2875; [2008] STC 1513. Ratio |
The issue of a Reasoned Order, without a formal Advocate Generals opinion and with the same juge rapporteur involved as in FII ECJ I, indicates that the CJEU saw the position as relatively straightforward. Ratio |
In the light of these two decisions of the CJEU, it is common ground that the UKs treatment of overseas dividends was incompatible with EU law. Ratio |
In a judgment in the present case, Prudential Assurance Co Ltd v Revenue and Customs Comrs [2013] EWHC 3249 (Ch); [2014] STC 1236, Henderson J held (para 148) that the appropriate means of rectifying this was for PAC to be accorded an appropriate tax credit. RLC |
(This was on the basis that a complete exemption from UK corporation tax would go further than the CJEU had stated that EU law required.) HMRC also accept that PAC is entitled to repayment or restitution of any corporation tax unlawfully charged as a result of the incompatibility: Amministrazione delle Finanze dello St... |
However, the amount to be awarded depends significantly on issues of EU law and domestic law which are either open or which HMRC seek to raise on this appeal. RLC |
Issue I is whether the credit in respect of overseas dividends should under EU law be set by reference to the overseas tax actually paid, as HMRC submit, or by reference to the foreign nominal tax rate (FNR), as PAC submits. Ratio |
HMRC rely in this connection upon the CJEUs judgments in FII ECJ I and on its Reasoned Order in the present case, as well as upon a further judgment of the CJEU in Haribo Lakritzen Hans Riegel BetriebsgmbH v Finanzamt Linz and sterreichische Salinen AG v Finanzamt Linz (Joined Cases C-436/08 and C-437/08) EU:C:2011:61;... |
In all three cases, the juge rapporteur was Judge Lenaerts, now the President of the CJEU. ARG |
In HMRCs submission, these cases demonstrate, first, a difference in principle between portfolio investments, such as PAC held, and non-portfolio investments, conferring a significant measure of control, and, secondly, that at any rate in relation to portfolio investments the credit to be imputed to PAC is in respect o... |
In response, PAC relies upon a later CJEU decision in the FII litigation, Test Claimants in the FII Group Litigation v Revenue and Customs Comrs (formerly Inland Revenue Comrs) (Case C-35/11) EU:C:2012:707; [2013] Ch 431 (FII ECJ II). ARG |
Judge Lenaerts was once again the juge rapporteur. ARG |
In this judgment, PAC submits, the CJEU refined its jurisprudence to require the use of the FNR in respect of all dividends received by PAC from overseas. ARG |
HMRC in reply point out that FII ECJ II was concerned essentially with non-portfolio dividends, and criticise some aspects of its reasoning, particularly its treatment of Haribo. ARG |
Finally, HMRC submit that the European legal position is unclear, and requires a further reference to the CJEU. ARG |
There are further issues which HMRC seek to attach to Issue I. The first, identified before us as issue 4 CA, is whether, when considering the relevant overseas tax position, attention should focus on the overseas company directly responsible for the remission of the dividend to the UK (the overseas waters edge company... |
The second issue, which HMRC submit that the Supreme Court should take into account, was identified as issue 6 CA, and is whether any difference has been shown to exist between the effective rate incurred by domestic companies declaring dividends to PAC and the nominal rate payable by UK companies. ARG |
This is relevant, HMRC submit, because the existence of such a difference was a reason why the CJEU indicated in FII ECJ II that it was appropriate to give a credit for the FNR, rather than the actual tax, incurred on an overseas dividend. ARG |
PAC submits that neither of issues 4 CA and 6 CA is open in this court. ARG |
The Court of Appeal refused permission for either issue to be raised before it, and neither issue is properly part of or essential to the resolution of Issue I. ARG |
The CJEU in FII ECJ I and in its Reasoned Order in the present case clearly established that the discrimination involved in the UKs arrangements for taxation of dividends sourced domestically and from overseas could be resolved by a mixed system, whereby dividends with a domestic source remained exempt, while credit wa... |
HMRC point out that the CJEU in FII ECJ I addressed separately the position of dividends received from non-portfolio and from portfolio companies. ARG |
In relation to the former, the question arose whether a mixed system of exemption in respect of domestically sourced dividends coupled with a credit in respect of dividends received from overseas was compatible with EU law. ARG |
The CJEU dealt with this at paras 46 to 57. ARG |
The claimants drew attention to the situation arising if, under the relevant UK legislation, such an exemption was granted in respect of a nationally- sourced dividend received from a company which for some reason had no corporation tax liability or paid corporation tax at a lower rate than the normal UK rate (para 54)... |
The CJEU understood the UK Government to explain that this arose only exceptionally (para 55), and on that basis contented itself with saying (para 56): In that respect, it is for the national court to determine whether the tax rates are indeed the same and whether different levels of taxation occur only in certain cas... |
The inference seems to be that, were a significant difference to exist between the effective rate of tax paid by the UK source of the dividend (eg because of some relief or allowance available to the company which was the source of the dividend) and the nominal rate of tax to which the exemption under section 208 of IC... |
In other words, the overseas-sourced dividend would not be enjoying, under the tax credit system, any relief or allowance which had reduced the tax actually paid on it, whereas the UK-sourced dividend would enjoy any such relief or allowance. Ratio |
In respect of portfolio dividends, the CJEU faced a more fundamental objection. Ratio |
The UK system was inherently discriminatory, because it failed to give any credit at all for overseas tax paid (paras 61 to 72). Ratio |
The CJEU gave short shrift to the UK Governments argument that practical difficulties in ascertaining the tax actually paid justified a different system for portfolio dividends. Ratio |
It does not however follow from the separate treatment of non-portfolio and portfolio holdings in FII ECJ I that the CJEU saw any significant difference between them regarding the manner in which the deficiencies in the UK tax system needed to be addressed. Ratio |
It is true that the judgment in Haribo in February 2011 concerned portfolio dividends; following FII ECJ I and the Reasoned Order in the present case, it spoke of the need to credit tax actually paid. Ratio |
But it was only in FII ECJ II, where the focus was on non-portfolio holdings, that the CJEU identified the FNR as a more relevant criterion in any context. Ratio |
That therefore in no way indicates that the FNR is not also relevant to portfolio investments. Ratio |
As a matter of logic and principle, there seems no basis in this connection for any distinction between portfolio and non-portfolio holdings, when applying the mixed system of domestic exemption coupled with a credit in respect of overseas- sourced dividends to each. Ratio |
Rather than concentrating on the practical difficulties advanced before the CJEU in FII ECJ II, HMRC now suggest that there are important differences in the approaches and expectations which investors would have with regard to portfolio investments, when compared with non-portfolio investments. Ratio |
There are of course differences between holdings giving a degree of control and smaller holdings, but it is not obvious what relevance they have to the question of central interest on this appeal: that is, the proper treatment of domestically-sourced and overseas-sourced dividends so as to avoid unfair discrimination b... |
The CJEUs change of approach in FII ECJ II arose from correction of the misunderstanding evidenced in paragraph 54 in FII ECJ I. Far from being exceptional, it had been established conclusively that it was commonly the position in the UK that a companys effective rate of tax was (due for example to group relief, or the... |
Pursuant to an order for a further reference made by Henderson J on 20 December 2010, it became necessary for the CJEU to address the implications. Ratio |
The European Commission in written submissions in FII ECJ II said (para 28) that in circumstances where the effective rate borne by the company making the profits from which the dividend came was lower than the nominal rate: 28. Ratio |
to exempt domestic dividends (which in effect amounts to giving credit for the full amount of tax at the statutory rate even where this full amount has not been paid) while giving credit only for the actual amount of tax paid in respect of the profits giving rise to foreign dividends results in more favourable treatmen... |
The Commission drew from this (para 29) that: 29. Ratio |
It can no longer be said that the credit method is equivalent to exemption, because foreign dividends receive less favourable treatment than domestic dividends. Ratio |
To understand why, let us imagine identical resident and non- resident companies which each have revenues of 100 and have, say, a loss carry-forward of 50. Ratio |
The tax rate is 30% in both the source and residence states. Ratio |
A company which is a shareholder in the resident company and receives a dividend from it will have no further tax obligation, even though that company has paid only 15 in tax (that is, has an effective rate of 15%). Ratio |
A shareholder in the non-resident company will receive a credit equivalent to only 15% and will have to pay an additional 15%. Ratio |
The same result will ensue where both states grant, for example, an identical research and development incentive. Ratio |
That is not equal treatment, and it constitutes a serious obstacle to outward investment. Ratio |
The Commission then discussed how the problem might be addressed (paras 31-34): 31. Ratio |
In such circumstances there seem to the Commission to be two ways of ensuring equal treatment. Ratio |
One is to exempt both domestic and foreign dividends. Ratio |
That solution has the drawback, as outlined above, that it may permit excessively favourable treatment of foreign dividends where the tax rate in the source state is lower than in the United Kingdom. Ratio |
The other, which is wholly consistent with the courts reasoning in Case C-446/04 [FII ECJ I], is to have regard solely to the nominal rate of tax in calculating the tax credit on foreign dividends. Ratio |
32. Ratio |
That is to say, recipients of such dividends should receive a tax credit representing the amount which would flow from the application of the nominal rate of tax in the source state to the accounting profits of the distributing company. Ratio |
Such a measure would correspond more truly to the exemption of domestic dividends, since the latter amounts in effect to the grant of a credit for tax at the nominal rate. Ratio |
The court has seen and approved a measure of this kind in Joined Cases C-436/08 and C-437/08 Haribo, judgment of 10 February 2011 see point 99 of the judgment. Ratio |
It would no doubt be desirable for a member state applying such a measure to insert a safeguard clause limiting its scope to dividends distributed by a company which is subject to the normal system of taxation in the source state. Ratio |
33. Ratio |
It should be noted that such a measure would also alleviate to a very large extent the administrative burden faced by taxpayers in relation to foreign dividends, especially taxpayers with small shareholdings. Ratio |
34. Ratio |
Such a solution does not ensure substantive equal treatment in all cases. Ratio |
In particular, where the tax system in the source state is a simple one in which the effective rate is systematically the same as the nominal rate (because the tax base is constituted by accounting profits, with no modifications), foreign dividends will treated less favourably than domestic dividends, since the latter ... |
However, to ensure full substantive equal treatment would require systematic re-calculation of the tax position of the foreign company - essentially a simulation of the tax which it would have paid were it resident in the United Kingdom. Ratio |
Such an approach seems impractical. Ratio |
The solution advocated by the Commission ensures formal equality of treatment, is easy to apply and achieves a fair result. Ratio |
It is worth noting in passing para 33. Ratio |
The Commission evidently had no doubt about the relevance of its proposed solution to overseas portfolio holdings. Ratio |
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