Test Claimants In the Franked Investment Group Litigation v Commissioners of the Inland Revenue & Anor (Rev 2)

This is the judgment of the Court to which all members of the Court have contributed, on an appeal from the judgment of Henderson J dated 27 November 2008. There are cross-appeals from the Judge’s judgment, but in this judgment we refer to an appeal, singular, rather than appeals, plural. The case is a lead case under a group litigation order. It raises important legal issues as to the compatibility of United Kingdom corporate taxation with certain principles of Community law derived from the EC Treaty (“the Treaty”) and as to the liabilities of the Revenue to a taxpayer who has overpaid tax on the basis of incompatible United Kingdom legislation. These issues are also important in terms of the amounts at stake in these proceedings, which we are told may be as much as £5bn. Moreover, the determination of issues in the present proceedings will affect the decision in other pending proceedings. However, there have been a number of important legislative changes affecting the taxing provisions in issue in these proceedings since the payments of tax giving rise to these proceedings were made: in particular Advance Corporation Tax (“ACT”) was abolished with effect from 6 April 1999 (section 31 Finance Act 1998), and since 1 July 2009 both foreign-source and domestic-source dividends have been exempt from corporation tax, subject to certain exceptions (Finance Act 2009, sch. 14). This decision may therefore be mostly relevant to working out the consequences of what has been done in the past.

To put this appeal in its legal context, this case forms part of the extensive and ever-increasing body of case law springing from the application by the Court of Justice of the European Communities, now (following the coming into force of the Lisbon Treaty) the Court of Justice of the European Union (“the ECJ”), of principles of Community law to domestic tax systems. References in this judgment to Member States are to Member States of the European Union or of the European Economic Area (“EEA”). We are told that, for the purposes of the issues on this appeal, there are no relevant differences between the two groups of Member States. When we refer to Third Countries, we refer to countries which are neither members of the European Union nor members of the EEA.

The parties agreed a list of the issues on this appeal. We will answer each of those issues, but before we do so we set out (1) the factual background, which includes an earlier reference to the ECJ; (2) an overview of the opinion of the Advocate General and of the judgment of the ECJ on that reference; (3) an overview of the relevant principles of Community law; (4) relevant domestic law; and (5) an overview of the judgment of the Judge. The relevant provisions of the Treaty appear in Annex 1 to this judgment, in their form prior to the entry into force of the Lisbon Treaty. Following the coming into force on 1 December 2009 of the Lisbon Treaty the EC Treaty is now known as the Treaty on the Functioning of the European Union and the articles of the EC Treaty with which are concerned have been renumbered. However, in this judgment we continue to refer to the articles by their numbers in the EC Treaty, and to Community law rather than European Union law, as the appeal was argued on that basis.

We shall have to set out the relevant legislation in greater detail below (see paragraph [18] below), but the core rule under challenge in these proceedings is the basic rule of United Kingdom corporation tax that United Kingdom-resident companies are not subject to corporation tax on dividends received from other United Kingdom-resident companies, while dividends received from companies resident outside the United Kingdom are subject to corporation tax but carry the right to a credit equal to the amount of any foreign tax paid. There were various implications flowing from this dual exemption/credit system. Prior to 6 April 1999 a United Kingdom-resident company had to pay ACT on dividends which it paid to its shareholders (unless the payment was within a group of companies and a group income election had been made). It could, however, obtain a credit against its liability to ACT by reference to the amount of dividends it received from a United Kingdom-resident company called “franked investment income” (“FII”). A United Kingdom-resident company could not use income which it received from a company which was not resident in the United Kingdom in the same way. Companies receiving dividends from companies not resident in the United Kingdom built up substantial surpluses of unutilised ACT, that is to say, ACT which could not be set against any liability to pay tax. The FII rules were changed in 1994 and a new regime was introduced which enabled companies to elect that dividends which they received from non-resident companies should be designated as “foreign income dividends” (“FIDs”), in respect of which the ACT could be repaid if not utilised.

All but three of the Test Claimants (who we shall call “the Claimants”) are members of the British American Tobacco group of companies (“BAT”). The Judge set out a statement of facts agreed between the parties and relating to the BAT test case and then summarised the evidence of various witnesses (the Judge’s judgment, [29] to [38]). This contained details of the history of the group structure, the dividends it had paid or received within the group and the group’s ACT surplus. It is not necessary for us to set out this information. In these proceedings the United Kingdom-resident company receiving a dividend directly from a company resident outside the United Kingdom has been referred to as a "United Kingdom water's edge company". The company resident in another Member State has been referred to on this appeal as the "EC water's edge company".

The procedural history of this case is dealt with in [1] to [6] of the Judge’s judgment, and we need not repeat it. When the reference to the ECJ was made by the Chancery Division, Park J approved the questions and the order for reference (the “Order for Reference”) setting out the facts and the questions to be decided. However, he did not give a judgment setting out his own opinion on the questions referred. The new Practice Direction supplementing CPR 68 (introduced in 2009 and currently to be found in the second supplement to Civil Procedure 2009) now makes it clear that the schedule to the order for a reference to the ECJ may include the opinion of the referring court. As we see it, the referring court should, where possible, briefly express its views on the answers to the questions which it is posing, for the assistance of the ECJ. This may also help to avoid ambiguity and to ensure that all the questions on which a response is required are answered by the ECJ.

The Treaty contains articles guaranteeing certain freedoms. References in this judgment to an “Article” should be understood to refer to an article of the Treaty unless there is indication to the contrary. From the point of view of the issues in this appeal, the most important freedoms in the Treaty are those set out in Article 43 (freedom of establishment), and Article 56 (free movement of capital). Freedom of establishment applies as between Member States. Free movement of capital applies both between Member States and between Member States and Third Countries. Article 56 is subject to Article 57. Article 57(1) preserves as against Third Countries certain restrictions on movement of capital in force as at 31 December 1993 which would otherwise contravene Article 56.

There have now been many challenges to the compatibility of domestic tax systems with the Treaty freedoms. As a result there is a considerable body of relevant Community jurisprudence. We do no more than highlight some of the most relevant decisions in order to indicate the reach of the Community law principles in issue. We would emphasise that this case law is not yet a settled body of law. Each development of the law made by the ECJ causes a further tranche of issues to arise.

In Case-230/83 Commission v France [1986] ECR 273, it was established that national taxing rights must be exercised in a manner consistent with the Treaty. To be compatible with the Treaty, residents of Member States and non-residents must be treated in the same way unless the difference in treatment relates to a situation that is not objectively comparable, or can be justified by reasons in the public interest. Thus for example, in C-35/98 Staatssecretaris van Financien v Verkooijen [2000] ECR 1-7321, the ECJ held that there was an impermissible restriction on freedom of movement of capital where an exemption in Dutch law from Dutch taxation of dividends paid by Dutch resident companies (on which tax had been imposed) was not extended to dividends paid by non-Dutch resident companies. The Dutch law was treated as a disincentive to investment in non-resident companies. Similarly, in Case C-319/02 Proceedings brought by Petri Manninen [2004] ECR1-7477, the ECJ held that Finnish tax rules which provided that no tax credit was available to a tax resident of Finland in respect of dividends paid to him by a non-Finnish resident company was incompatible with the Treaty freedoms. Discrimination may be justified in certain circumstances, for example if it is genuinely necessary to prevent tax avoidance (Case C-264/96 ICI v Colmer [1998] ECR1-4695) or if and to the extent that it is necessary for the cohesion of the tax system (Case C-204/90 Bachmann v Belgium [1992] ECR 1-249).

The questions referred to the ECJ by Park J covered a large number of topics. They covered the compatibility of the treatment of dividends paid by non-resident companies, ACT, the lawfulness under Community law of new rules introduced from 1 July 1994 relating to FIDs, repayment remedies, Member State liability in damages for sufficiently serious breach of Community law, defences and limitation. In addition, issues were raised as to the applicability of Council Directive 90/435/EC (the “Parent-Subsidiary Directive”). On the reference, however, the ECJ held (Case C-446/04 Test Claimants in the FII Group Litigation v Commissioners of Inland Revenue [2006] ECR I-11753, that this Directive was inapplicable, and accordingly we make no further mention of it.

Significantly, there are considerable differences of approach between the opinion of the Advocate General and the judgment of the ECJ.

The Advocate General (Geelhoed) was of the opinion that it was contrary to Community law for the United Kingdom tax rules to provide a complete exemption from corporation tax for dividends received from a United Kingdom-resident company whilst subjecting dividends received from non-resident companies to corporation tax, even after double taxation relief. The Advocate General also considered that the system for imposing ACT and crediting it against mainstream corporation tax (“MCT”) failed to ensure that non-resident companies were treated on an equal footing with resident companies, and accordingly that there was a violation of the Treaty. In relation to FII, the Advocate General considered that the FID rules described below (see paragraph [18] and Annex 2) were contrary to Articles 43 and 56 of the Treaty to the extent that they required non-resident companies to pay ACT and subsequently reclaim it. However he considered that Article 57(1) applied and that there were restrictions in force on 1 December 1993. Accordingly, the FID rules could be relied upon in relation to dividends from Third Countries.

The approach of the ECJ was different on several issues. In particular it held that it was not incompatible with Articles 43 and 56 of the Treaty for a Member State to have a system whereby domestic-source dividends were exempt from corporation tax whereas foreign-source dividends were granted a tax credit, provided that, firstly, foreign-source dividends were not subject to a higher rate of tax than the rate applicable to dividends from United Kingdom-resident companies; secondly, the recipient of the foreign-source dividend was entitled to a tax credit for the tax already paid by the foreign company; and, thirdly, the relevant tax credit was equal to the amount of tax paid in the Member State of the distributing company up to the limit of the tax charged in the Member State of the receiving company. By foreign-source dividends, we mean dividends paid by companies not resident in the United Kingdom. This is a highly compressed summary of what the ECJ decided and there is a major issue on this appeal as to whether in the first condition the ECJ, when referring to a higher rate of tax, meant effective rates of tax or nominal rates of tax. (We deal with this in Issue 1 below).

As to ACT, the ECJ held that Articles 43 and 56 precluded the United Kingdom from permitting only resident companies to surrender surplus ACT to resident subsidiaries. The ECJ further considered, however, that the ACT regime was an authorised restriction for the purposes of Article 57(1) of the Treaty, and therefore that it was not contrary to Article 56.

In relation to FIDs, the ECJ held that Articles 43 and 56 precluded legislation which exempts resident companies paying dividends to their shareholders from dividends received from resident United Kingdom companies from paying ACT but requires resident companies paying dividends to shareholders from dividends received from other countries to pay ACT and thereafter to recover it.

The ECJ further considered that it was incompatible with Community law for the tax law of the United Kingdom not to grant a credit for a dividend received from a company in which a holding of less than 10% was held. We do not, however, need to consider this part of the ruling of the ECJ as we are concerned only with wholly-owned subsidiaries or virtually wholly-owned subsidiaries.

The ECJ rejected the United Kingdom government's argument that a temporal limitation should be placed on the effects of its judgment. The ECJ considered that such a limitation was not necessary since the government's expectation of the costs of the effects of the judgment (£4,700m) was based on the assumption that the arguments of the Claimants would be adopted on every point. That had not turned out to be the case.

We have already given a very brief description of domestic law. The Order for Reference included a summary of the relevant legislation, which was quoted by the Judge. The Judge also set out the agreed statement of domestic law contained in the Order for Reference. We have set out both the paragraphs of the Judge’s judgment containing this summary and the agreed statement of domestic law in Annex 2 to this judgment.

We shall consider the Judge’s judgment in detail under the relevant issues. The key issues decided by the Judge may be summarised as follows. First, he held that it followed from the judgment of the ECJ that the United Kingdom rules on corporation tax on overseas dividends were not compatible with Community law as regards dividends from companies resident in a Member State. He held that a further reference to the ECJ was needed in relation to the question whether the tax paid on dividends used to fund dividends paid to United Kingdom water's edge companies entitled the United Kingdom group to a credit.

As regards FIDs, the Judge held that the United Kingdom legislative scheme breached Community law.

The Judge held that restitutionary claims could be made for monies paid in respect of the tax which was unlawfully charged. However, no damages claim lay for other losses.

The Judge’s judgment is 152 pages long, with 450 paragraphs. His exposition and analysis of the legislation and the issues, and his discussion and conclusion on the issues, were described in opening by Mr Ewart QC for the Revenue as lucid and comprehensive. We would go further. It has been rightly described as a tour de force. His summaries of the issues and of the effect of the legislation are particularly useful. As will be seen, it does not follow that we agree with all his conclusions; but we and the parties have greatly benefited from his judgment.

We now turn to deal with the issues in this appeal, which we have taken from the useful list of issues agreed between the parties (the “Issues”). The first ten Issues deal with liability. The remainder are concerned with remedies.

In this part of the judgment, we deal with particular issues concerning the compatibility with Community law of two sets of provisions: firstly, those imposing the liability to pay, or conferring reliefs from, corporation tax on dividends received under Case V of Schedule D (Issues 1 to 3), and, secondly, those imposing the liability to pay, or reliefs from, ACT (Issues 4 to 10). The principal issue in relation to Case V is the meaning and effect of the judgment of the ECJ, but there are also other important issues, such as the applicability of Article 56 in relation to dividends from Third Countries and, if applicable, whether the exception from Article 56 created by Article 57(1) applies. On these issues the Claimants’ submissions were made at the hearing of the appeal by Mr Graham Aaronson QC.

This Issue was the subject of the reference to the ECJ. Unfortunately there is controversy between the parties as to what the ECJ decided. Both parties have been able to present to us (as they did to the Judge) cogent submissions in support of opposite conclusions as to the judgment of the Court.

The relevant question was Question 1 in the Order for Reference, which reads as follows:

“Is it contrary to Article 43 or 56 EC for a member state to keep in force and apply measures which exempt from corporation tax dividends received by a company resident in that member state (“the resident company”) from other resident companies and which subject dividends received by the resident company from companies resident in other member states (“non-resident companies”) to corporation tax (after giving double taxation relief for any withholding tax payable on the dividend and, under certain conditions, for the underlying tax paid by the non-resident companies on their profits in their country of residence)?”

As the Judge pointed out, translated into specifically United Kingdom terms, the focus of the question was therefore on the distinction between, on the one hand, the exemption from corporation tax afforded by the Income and Corporation Taxes Act 1988 (“ICTA”) section 208 for dividends received by a United Kingdom-resident parent from a United Kingdom-resident subsidiary, and, on the other hand, the charge to corporation tax under Case V on dividends received by a United Kingdom-resident parent from a subsidiary resident in another Member State, but with the benefit of double taxation relief for any withholding tax on the dividends and (subject to certain conditions) relief for the underlying tax paid on the profits which were distributed.

This Issue involves a question of principle, namely whether (and, if so, subject to what conditions) Community law permits a Member State to have a dual system for preventing double taxation, that is to apply an exemption system for domestic-source dividends and a credit system for foreign-source dividends.

There was a significant difference between the tax treatment of domestic-source dividends and foreign-source dividends received by a United Kingdom company under such a dual system, at least in so far as United Kingdom corporation tax was concerned. As more fully explained in paragraph [7] of Annex 2, domestic-source dividends were exempt from corporation tax and entitled the recipient to a credit which could be used against its liability for ACT on any distribution to its shareholders.  Foreign-source dividends were not exempt from corporation tax and did not entitle the recipient to a tax credit save in relation to foreign tax actually paid on the income before its receipt by a United Kingdom company.

This question was addressed by the Advocate General, and like the Judge we shall set out the part of his opinion setting out the background:

“[2] Prior to setting out the relevant provisions of the UK tax regime at issue, it is important to outline the broader framework for taxation of distributed company profits (dividends) within the EU, which forms the legal and economic backdrop to the case. In principle, two levels of taxation can arise when taxing the distribution of company profits. The first is at the company level, in the form of corporation tax on the company’s profits. The levying of corporation tax at company level is common to all member states. The second is at the shareholder level which can take the form of either income taxation on the receipt of the dividends by the shareholder (a method used by most member states), and/or withholding tax to be withheld by the company upon distribution.

[3] The existence of these two possible levels of taxation may lead, on the one hand, to economic double taxation (taxation of the same income twice, in the hands of two different taxpayers) and, on the other hand, juridical double taxation (taxation of the same income twice in the hands of the same taxpayer). Economic double taxation, when, for example, the same profits are taxed first in the hands of the company as corporation tax, and second in the hands of the shareholder as income tax. Juridical double taxation, when, for example, a shareholder suffers first withholding tax and then income tax, levied by different States, on the same profits.

[4] The present case concerns the legality under Community law of a system set up by the UK with the principal aim and effect of providing a measure of relief for shareholders from economic double taxation.

[5] In deciding whether and how to achieve such an aim, there are essentially four systems open to member states, which may be termed the “classical”, “schedular”, “exemption” and “imputation” systems. States with a classical system of dividend taxation tax have chosen not to relieve economic double taxation: company profits are subjected to corporation tax, and distributed profit is taxed once again at the shareholder level as income tax. In contrast, schedular, exemption and imputation systems aim at fully or partially relieving economic double taxation. States with schedular systems (of which various forms exist) choose to subject company profits to corporation tax, but tax dividends as a separate category of income. Those with exemption systems choose to exempt dividend income from income taxation. Finally, under imputation systems, corporation tax at company level is fully or partially imputed onto the income tax due on the dividends at shareholder level, such that the corporation tax serves as a pre-payment for (part of) this income tax. Thus, shareholders receive an imputation credit for all or part of the corporation tax attributable to the profits out of which the dividends were paid, which credit can be set against the income tax due on these dividends.

[6] At the time relevant to the present case, the UK used a partial imputation system of dividend taxation.”

As appears from this account, the Advocate General, and subsequently the ECJ, referred to what we call a credit system as an imputation system. The difference in nomenclature is irrelevant.

Paragraphs [36] to [56] of the Advocate General’s opinion can be taken from the summary at paragraph [45] of the Judge’s judgment:

“[45]…..

(1)

Although direct taxation falls within the competence of member states, the ECJ has consistently held that they must exercise that competence consistently with Community law. This includes the obligation to comply with Article 43, which prohibits restrictions on the setting up of agencies, branches or subsidiaries by nationals of any member state established in the territory of any member state (para 37).

(2)

Article 43 will be infringed where there is a difference in the tax treatment by a member state of cross-border and purely internal situations, if the difference in treatment involves restrictions on freedom of establishment “that go beyond those resulting inevitably from the fact that tax systems are national, unless these restrictions are justified and proportionate” (para 38).

(3)

Where a member state chooses to include foreign-source income of its residents in its tax base, it must not discriminate between foreign-source and domestic income, and in particular its legislation should not treat foreign-source income less favourably than domestic-source income (para 40).

(4)

In principle, the choice of whether and how to relieve economic double taxation of dividends lies purely with member states, and provided that the system chosen is applied in the same way to foreign-source and domestic-source dividend income, each of the four systems identified by the Advocate General in paragraph 5 of his opinion is perfectly compatible with Article 43 (para 43).

(5)

So, for example, the application by the UK of a credit-based system for relieving economic double taxation on foreign-source dividends would not be objectionable, even if the foreign tax for which credit was given was levied at a higher rate than UK corporation tax, with the result that some of the foreign tax would be unrelieved (because the UK gives credit only up to the UK corporation tax rate) and the foreign-source dividends would therefore bear a higher aggregate tax burden in the two states concerned in comparison with dividends paid by UK subsidiaries to a UK parent (para 43, where the Advocate General described this as “a good example of a restriction flowing purely from disparities between national tax systems, with which Article 43 EC is not concerned”).

(6)

There is accordingly no problem in principle under Article 43 with the application of a credit system of relieving double economic taxation (para 46).

(7)

The answer to the question whether Article 43 permits a member state to apply an exemption system for domestic-source dividends and a credit system for foreign-source dividends “depends on whether this distinction has the effect that the UK treats foreign-source dividends less favourably than domestic-source dividends”.”

Paragraphs [48] to [52] of the Advocate General’s opinion set out his crucial reasoning:

“[48] In this regard, the UK and the Commission argue that, in a domestic context, the effect of exemption and credit systems of economic double taxation relief would be precisely the same. The adoption of a credit system for domestic-source income, however, would mean pointless extra administration costs, while an exemption system, which leads to the same result, is far simpler and less costly to run. Similarly, the effect of the regime for domestic-source dividends (exemption) and foreign-source dividends (credit) is the same: in each case, economic double taxation is relieved.

[49] The Test Claimants dispute this conclusion. They argue that a difference exists between the exemption and credit systems in cases where the UK distributing subsidiary has, pursuant to particular UK corporation tax exemptions and benefits (e.g. for investment or Research & Development), in fact paid a lower net rate of corporation tax than the standard UK rate. Under an exemption system, this is “passed on” to the recipient parent company – i.e. the dividends distributed will ultimately thus have borne a tax rate lower than the standard UK corporation tax rate. Under a credit system applied in a domestic context, however, in a case where a lower effective corporation tax rate had been originally borne by the profits pursuant to exemptions and allowances, this rate would always be “topped up” to the standard UK corporation [tax] rate upon distribution to the parent company. Similarly, in the case of foreign-source dividends, the effect of a credit system is that the UK in all cases tops up the effective foreign corporation tax paid to the standard UK rate, without taking account of underlying corporation tax allowances granted at subsidiary level.

[50] It would seem, therefore, that the application of a credit system by the UK for the relief of double economic taxation on foreign-source dividends can in certain cases have less favourable effects than the pure exemption system applied to domestic-source dividends. While, under an exemption system, the benefits of underlying corporation tax exemptions and allowances may be passed on to the parent company receiving the dividends, under a credit system these benefits cannot be passed on as the tax borne by the dividends is topped up to the standard UK corporation tax rate. In such cases, the effect of this could be seen as the application by the UK of a different (lower) tax rate to domestic-source dividends than to foreign-source dividends.

[51] A further question arises as to whether such discriminatory treatment can be justified. [The Advocate General then considers an argument based on the principle of fiscal cohesion]. While the UK’s arguments certainly show that, as I observed above, in principle the application of a credit system can be perfectly in accordance with Article 43 EC, they do not go towards justification of the possible difference in treatment, discussed above, between foreign-source and domestic-source income as regards the potential ability to pass on the benefit of underlying tax allowances to recipient parent companies.

[52] In the absence of a mechanism enabling such tax allowances to be taken into account in a similar way for foreign-source dividends as for domestic-source dividends, therefore – the presence of which has not been contended in the present case – it is my view that the UK taxation rules for non-portfolio dividends infringe Article 43 EC.”

It can be seen that the crucial factor leading to the Advocate General’s conclusion was the fact that under a credit system, as opposed to an exemption system, the benefit of allowances is not passed on to the parent company as the foreign tax paid is always “topped up” to the standard rate of United Kingdom corporation tax. His conclusion, at paragraph [140] of his opinion was in the following terms:

“[148]….

It is contrary to Articles 43 and 56 EC for a member state to keep in force and apply measures such as those at issue in the present case, which exempt from corporation tax dividends received by a company resident in that member state from other resident companies and which subject dividends received by the resident company from companies resident in other member states to corporation tax, after giving double taxation relief for any withholding tax payable on the dividend and, under certain conditions, for the underlying tax paid by the non-resident companies on their profits in their country of residence.”

The Claimants pursued this point in their oral observations to the Court. Mr Paul Farmer, who presented their observations on this issue, submitted:

“The first point, the taxation of dividends point, is perhaps the simplest to explain. The problem is essentially this:

Where a UK parent company receives dividends from a domestic subsidiary or company, it is exempt from corporation tax on the dividends.

Where it receives dividends from a foreign company, it is subject to corporation tax on the dividends. It receives double tax relief in the form of a tax credit for any withholding tax on the dividend and, in a parent-subsidiary situation, for the underlying corporation tax incurred by the subsidiary.

In other words, the UK applies the exemption method of giving double taxation relief for domestic dividends but applies the tax credit method for foreign dividends.

It is suggested by the UK that the two methods are equivalent, and I note that the Commission appears to have made that assumption. In fact they are not equivalent.

In saying that I am not referring to the argument that the tax credit method itself is unlawful because it neutralises lower levels of tax in other member states. I am happy on that point to refer to the arguments set out in our written observations.

However fascinating that issue may be, there is in fact no need for the Court to decide it in this case. That is because it is clear that even in terms of the UK tax burden the tax credit method and the exemption method produce different results.

Where a UK parent company receives a dividend from a foreign subsidiary it is subject to tax on the dividend at the UK nominal rate of tax, currently 30%.

By contrast where it receives a dividend from a UK subsidiary it is exempt from tax on the dividend, and that is so whatever the actual tax burden incurred by the subsidiary.

It is important to note the actual tax burden on a UK subsidiary’s distributed profits will never be equal to the UK nominal tax rate applied to foreign dividends. It is not simply a matter of taking 30% of the subsidiary’s accounting profits. A UK company’s accounts are adjusted by a series of reliefs and allowances in computing their taxable profits. They may receive R&D credits or capital allowances. There may be exemptions for gains such as the substantial shareholder exemption. A foreign subsidiary may make a gain which is exempt locally but taxed in the UK. They may also receive the surrender of losses or allowances from other companies which reduce their taxable profits. The list can go on. My instructing solicitors have given me a 2 page list of such reliefs. I do not think I need to read them out. I think the point is made.

Thus, a company may pay no mainstream corporation tax but still make a distribution which will be exempt in the hands of the parent company. By contrast a parent company always pays tax on foreign dividends at the UK nominal rate.

In addition, there is a significant difference in the compliance burden. The exemption method, used domestically, is much easier to apply and imposes a lower administrative burden than the tax credit method, which requires parent companies to track the underlying tax of multiple tiers of subsidiaries.

So it is clear that the UK rules are far from being even-handed. What is more, there is really no excuse. The UK could easily achieve equal treatment by applying the tax credit method internally.” (emphasis added by Mr Farmer)

The difference in effective levels of taxation was not addressed by the United Kingdom in its written observations. Paragraphs 46 and 47 of its written observations were as follows:

“[46] In the present case it is important to note that the sole aim of the relevant UK legislation is to eliminate economic double taxation, both in respect of domestic and cross-border situations. In the purely domestic situation, the resident subsidiary is liable to corporation tax on its profits. Absent the exemption from corporation tax on the dividend in the hands of the Claimant parent company, the same amount of profits would be taxed twice at the same rate. This is because both parent and subsidiary would be chargeable to the same tax, at the same rate, on the same profits.⁴⁷ This economic double taxation can be effectively dealt with by a simple exemption of the dividend from corporation tax. The effect is the same as if a tax credit were granted to the Claimant at the rate of corporation tax payable by the resident subsidiary on its profits.

[47] The cross-border situation is not so simple. The rate of corporation tax on the profits of a non-resident subsidiary will vary from country to country and in most cases will not coincide with the rate of corporation tax in the UK. Hence a simple exemption of the dividend from UK corporation tax would not be an appropriate method for relieving economic double taxation, if the UK’s policy (or principle) of “capital export neutrality” is to apply. In such situations, tax credits are the more appropriate method. Under UK tax rules, therefore, such cross-border distributions are dealt with by the grant of credit for the foreign tax paid by the non-resident subsidiary in its state of residence. It follows that the grant of such exemptions and tax credits respectively are necessary and appropriate to achieve the aim of relieving double taxation in the two contrasting situations, whilst ensuring in each case the cohesion of the UK tax system.”

Footnote 47 is important:

“In very exceptional circumstances, not applicable on the facts of the present case, the subsidiary and the parent may be liable to differing rates of corporation tax due to the availability of small companies relief.”

We can now come to the judgment of the Court:

“[43] It must be pointed out, first of all, that a member state which wishes to prevent or mitigate the imposition of a series of charges to tax on distributed profits may choose between a number of systems. In the case of shareholders receiving those dividends, those systems do not necessarily have the same result. Thus, under an exemption system, a shareholder who receives a dividend is not, in principle, liable to tax on the dividends received, irrespective of the rate of tax to which the underlying profits are subject to tax in the hands of the company making the distribution and the amount of that tax which that company has in fact paid. By contrast, under an imputation system, such as the system at issue in the main proceedings, a shareholder may offset tax due on the dividends paid only to the extent of the amount of tax which the company making the distribution has actually had to pay on the underlying profits, and that amount may be offset only up to the limit of the amount of tax for which the shareholder is liable.

[44] …

[45] However, in structuring their tax system and, in particular, when they establish a mechanism for preventing or mitigating the imposition of a series of charges to tax or economic double taxation, member states must comply with the requirements of Community law and especially those imposed by the Treaty provisions on free movement.

[46] It is thus clear from case-law that, whatever the mechanism adopted for preventing or mitigating the imposition of a series of charges to tax or economic double taxation, the freedoms of movement guaranteed by the Treaty preclude a member state from treating foreign-sourced dividends less favourably than nationally-sourced dividends, unless such a difference in treatment concerns situations which are not objectively comparable or is justified by overriding reasons in the general interest (see, to that effect, Case C-315/02 Lenz [2004] ECR I-7063, paragraphs 20 to 49, and Case C-319/02 Manninen [2004] ECR I-7477, paragraphs 20 to 55). …

[47] As regards the question whether a member state may operate an exemption system for nationally-sourced dividends when it applies an imputation system to foreign-sourced dividends, it must be stated that it is for each member state to organise, in compliance with Community law, its system for taxing distributed profits and, in particular, to define the tax base and the tax rate which apply to the company making the distribution and/or the shareholder receiving them, in so far as they are liable to tax in that member state.

[48] Thus, Community law does not, in principle, prohibit a member state from avoiding the imposition of a series of charges to tax on dividends received by a resident company by applying rules which exempt those dividends from tax when they are paid by a resident company, while preventing through an imputation system, those dividends from being liable to a series of charges to tax when they are paid by a non-resident company.

[49] In order for the application of an imputation system to be compatible with Community law in such a situation, it is necessary, first of all, that the foreign-sourced dividends are not subject in that member state to a higher rate of tax than the rate which applies to nationally-sourced dividends.

[50] Next, that member state must prevent foreign-sourced dividends from being liable to a series of charges to tax, by offsetting the amount of tax paid by the non-resident company making the distribution against the amount of tax for which the recipient company is liable, up to the limit of the latter amount.

[51] Thus, when the profits underlying foreign-sourced dividends are subject in the member state of the company making the distribution to a lower level of tax than the tax levied in the member state of the recipient company, the latter member state must grant an overall tax credit corresponding to the tax paid by the company making the distribution in the member state in which it is resident.

[52] Where, conversely, those profits are subject in the member state of the company making the distribution to a higher level of tax than the tax levied by the member state of the company receiving them, the latter member state is obliged to grant a tax credit only up to the limit of the amount of corporation tax for which the company receiving the dividends is liable. It is not required to repay the difference, that is to say, the amount paid in the member state of the company making the distribution which is greater than the amount of tax payable in the member state of the company receiving it.

[53] Against that background, the mere fact that, compared with an exemption system, an imputation system imposes additional administrative burdens on taxpayers, with evidence being required as to the amount of tax actually paid in the State in which the company making the distribution is resident, cannot be regarded as a difference in treatment which is contrary to freedom of establishment, since particular administrative burdens imposed on resident companies receiving foreign-sourced dividends are an intrinsic part of the operation of a tax credit system.

[54] The claimants in the main proceedings nonetheless point out that when, under the relevant UK legislation, a nationally-sourced dividend is paid, it is exempt from corporation tax in the hands of the company receiving it, irrespective of the tax paid by the company making the distribution, that is to say, it is also exempt when, by reason of the reliefs available to it, the latter has no liability to tax or pays corporation tax at a rate lower than that which normally applies in the UK.

[55] That point is not contested by the UK Government, which argues, however, that the application to the company making the distribution and to the company receiving it of different levels of taxation occurs only in highly exceptional circumstances, which do not arise in the main proceedings.

[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 cases by reason of a change to the tax base as a result of certain exceptional reliefs.

[57] It follows that, in the case of the national legislation at issue in the main proceedings, the fact that nationally-sourced dividends are subject to an exemption system and foreign-sourced dividends are subject to an imputation system does not contravene the principle of freedom of establishment laid down under Article 43 EC, provided that the tax rate applied to foreign-sourced dividends is not higher than the rate applied to nationally-sourced dividends and that the tax credit is at least equal to the amount paid in the member state of the company making the distribution, up to the limit of the tax charged in the member state of the company receiving the dividends.”

The relevant part of the dispositif or order of the Court was as follows:

“Articles 43 EC and 56 EC 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 company holds at least 10% of the voting rights, while at the same time granting a tax credit in the latter case for the tax actually paid by the company making the distribution in the member state in which it is resident, provided that the rate of tax applied to foreign-sourced dividends is no higher than the rate of tax applied to nationally-sourced dividends and that the tax credit is at least equal to the amount paid in the member state of the company making the distribution, up to the limit of the amount of the tax charged in the member state of the company receiving the distribution.”

The Judge came to the conclusion that the ECJ misunderstood the argument of the United Kingdom government on Issue 1. He considered that in paragraph [55] of its judgment the ECJ had misinterpreted the statement in footnote 47 to the written observations of the United Kingdom government that it was only in very exceptional circumstances that the subsidiary and parent would be liable to different rates of tax as a reference to effective rates of tax. The Judge took the view that, had the ECJ correctly understood the submissions to it, it would have agreed with the Advocate General that there was discrimination in the way that foreign-source dividends were taxed. He took the view that in principle the ECJ agreed with the Advocate General that a difference in effective rates would constitute discrimination. He used the French text to take him to the conclusion that the precondition stated by the ECJ in paragraph [49] of its judgment could not be satisfied. This appears from paragraphs [59] to [66] of his judgment:

“[59] Paragraph 55 of the judgment then says, and for convenience I will set it out again:

'55. That point is not contested by the United Kingdom Government, which argues, however, that the application to the company making the distribution and to the company receiving it of different levels of taxation occurs only in highly exceptional circumstances, which do not arise in the main proceedings.'

I cannot escape the impression that at this critical point the ECJ must have misunderstood the argument being advanced for the UK government. I say this because the detailed written observations submitted by the UK did not deal at all with the distinction between nominal and effective rates of tax. However, in the course of arguing that the sole aim of the relevant UK legislation, both in domestic and in cross-border situations, was to eliminate economic double taxation, the submissions pointed out (in paragraph 46) that in the domestic context the effect of ICTA, section 208 was to prevent the same amount of profits being taxed twice over at the same rate:

‘This is because both parent and subsidiary would be chargeable to the same tax, at the same rate, on the same profits.'

There was then a footnote, numbered 47, which said:

'In very exceptional circumstances, not applicable on the facts of the present case, the subsidiary and the parent may be liable to differing rates of corporation tax due to the availability of small companies relief.'

The reference to 'small companies relief' was not further explained, nor was any statutory reference given.

The principal contentions of the parties on this appeal on the meaning of the ECJ’s judgment may be shortly put. For the Revenue, Mr David Ewart QC submits that the ECJ’s conclusion was clear and categorical: provided foreign dividends are subject to the same (nominal) tax rate as United Kingdom dividends, and full credit is given for all the tax paid by the foreign dividend-paying company, there is no breach of Article 43. That ruling is explicitly and clearly set out in paragraphs [49] and [50] of the judgment, and repeated in paragraph [57]. That this was the ruling of the Court is emphasised or made clear by the repetition of that paragraph in the dispositif. The reference in [55] to “different levels of taxation” arises from footnote 47 of the United Kingdom’s written observations, and is to small company relief, which does lead to a different rate of taxation being applied. It follows that in paragraph [56] the Court used the expressions “tax rates” and “levels of taxation” to refer to nominal rates of taxation. It further follows that since, as is common ground, small company relief is only applicable in exceptional cases, none of which apply to the present Claimants, and apart from that there is no difference in the tax rates applied to dividends received from abroad and those that are paid by domestic companies, and full credit for foreign tax is given in respect of the latter, the United Kingdom system complied with the requirements of Article 43.

Mr Graham Aaronson QC, for the Claimants, submits and the Judge accepted, that this interpretation of the judgment is mistaken. The point made by the Claimants and the Advocate General was that different effective levels of tax apply to foreign dividends received in the United Kingdom and domestic dividends received here. The ECJ accepted that a difference in effective levels of tax would be discriminatory and in breach of Article 43, and directed the national court to ascertain whether the Claimants’ assertions as to the provisions of United Kingdom law were correct. Hence the reference to nominal rates and to (effective) levels of taxation in paragraph [56]. On the Claimants’ submission any other interpretation of the judgment fails to give effect to the ECJ’s use of both rates of taxation (i.e. nominal rates) and to levels of taxation (i.e. effective levels of taxation) in paragraph [56].

Arden and Stanley Burnton LJJ, are unable to agree with the Judge’s conclusion on this point. Etherton LJ, agrees with the conclusion of the Judge. Their reasons are set out in Annex 3 to this judgment.

Arden and Stanley Burnton LJJ recognise, however, that the views of Etherton LJ and the Judge have substance, and that it would be unsatisfactory if the point on which very considerable sums of money turn were to be resolved by two members of the Court forming one view and Etherton LJ and the Judge another. In addition, the judgment of the ECJ on this point does not, with very great respect, make it clear to the Claimants why important parts of their case have been rejected. In the unusual circumstances of this case, all the members of the Court therefore consider that there should be a reference back to the ECJ to clarify its decision on this important point. This, in our judgment, is the principled approach and is far preferable to ruling against one party on the hypothesis that the ECJ misunderstood submissions made to it. The jurisprudence of the ECJ specifically contemplates that a national court may in an appropriate case refer a question of law to it where it encounters difficulty in applying its judgment (Case 14/86 Pretore di Salo [1987] ECR 2545 at paragraph [12]). That was the approach adopted in O'Byrne v Aventis Pasteur SA [2008] UKHL 34, [2008] 4 All ER 881 in which the House of Lords made a further reference to the ECJ in circumstances where the previous judgment of the ECJ was not “so obvious as to leave no scope for any reasonable doubt as to its application” (per Lord Rodger at [23]). We consider for the reasons given that that course is justified in this case.

This Issue is relevant to dividends sourced from Third Countries. We proceed to consider it on the hypothesis that the ECJ rules in favour of the Claimants on the reference back of Issue 1.

This Issue was precisely and conveniently described by the Judge in paragraph [67] of his judgment as follows:

“The next group of issues that I have to consider concerns dividends received by a UK parent company from a subsidiary which is resident in a third country, i.e. a country other than a member state of the EU. The basic question which arises is whether the subjection of such dividends to the Case V charge infringes Article 56 EC. There could be no question of infringement of Article 43, because that article protects freedom of establishment in member states alone and has no application to the establishment of subsidiaries in third countries. Article 56, however, prohibits restrictions on the free movement of capital not only between member states, but also between member states and third countries, although in its application to third countries it is subject to an important "standstill" proviso (now contained in Article 57 EC) which preserves the effect of restrictions under national or Community law which existed on 31 December 1993.”

The argument for the Revenue is that Article 43 alone, that is to say to the exclusion of Article 56, applies in the following situations. The first is where the purpose of the legislation is directed solely at establishment, that is to say where a shareholding is such as to enable the shareholder to exercise definite influence over the decisions of the company and to determine its activities. The second is where the practical effect of the legislation embraces exclusively or primarily such situations. The third is where the purpose of the legislation and its practical effect are not so limited and embrace movement of capital as well as establishment, but the factual situation under consideration by the Court is one of establishment. The effect of that analysis is that there can have been no infringement of the Community law prohibition on restriction of movement of capital under Article 56 by virtue of the Case V charge on dividends paid to the Claimants from Third Country subsidiaries. The Case V charge is not directed exclusively or primarily to establishment or movement of capital since it applies generally to income from foreign possessions. The factual situation before the Court, however, does concern establishment since the Third Country subsidiaries of the Claimants are wholly owned by the Claimants. That situation does not fall within the scope of Article 43 since that Article is concerned only with dividends paid by subsidiaries in Member States. The result is that, on the Revenue’s approach, neither Article 43 nor Article 56 can apply.

The Claimants, on the other hand, submit that, if the tax legislation, like the Case V charge, is not aimed solely or primarily at establishment situations, Article 56 may be engaged in the case of a distribution by a Third Country subsidiary to its parent company in a Member State, regardless of the size of the parent’s shareholding and the extent of its control and influence. Accordingly, on that approach, Article 56 may be relied upon even where, as in the present case, the Third Country subsidiaries are all wholly-owned subsidiaries.

The Judge accepted the Claimants’ argument. In our judgment, he was right to do so. On proper analysis, there is no authority for the Revenue’s proposition that, in a case involving a Third Country subsidiary, Article 56 can have no application merely because the factual situation before the Court is one in which the shareholding of the parent is such as to enable it to exercise definite influence over the decisions of its subsidiaries and to determine its activities.

It is common ground that the Order for Reference did not ask the ECJ to deal with this issue. Question 1 of the Order for Reference asked the ECJ only to address the comparative tax treatment of dividends received by a company resident in a Member State from a company resident in another Member State, on the one hand, and dividends from a company resident in the same Member State, on the other hand. Mr Ewart submitted that, nevertheless, the approach taken by the ECJ supports the Revenue’s approach on the meaning and effect of Article 56. He referred to the following passages in the opinion of Advocate General Geelhoed:

“[30] As the national court has raised both Articles 43 and 56 EC in questions 1 to 4, it is necessary as a preliminary matter to consider which of these articles applies in the present case. Just as I observed in my Opinion in Test Claimants in Class IV of the ACT Group Litigation, it is my view that the UK legislation at issue may in principle fall within the ambit of either Article 43 or 56 EC, depending on the quality of holding that a given parent company possesses in the relevant foreign subsidiary. The Court has consistently held that a company established in one Member State with a holding in the capital of a company established in another Member State which gives it ‘definite influence over the company’s decisions’ and allows it to ‘determine its activities’ is exercising its right of establishment. As a result, in the case of UK-resident parent companies whose holdings in non-UK companies satisfy the criterion, therefore, it is the compatibility of the UK legislation with Article 43 EC that should be assessed. The application of this criterion in a given case is a matter for the national courts after analysis of the circumstances of the claimant company.

[31]. In the case of the test claimants in the present reference, it seems clear from the order for reference that these are UK resident companies (all members of the BAT group) with wholly-owned non-UK resident subsidiaries. As a result, the test case falls to be considered under Article 43 EC. As I observed in my Opinion in Test Claimants in Class IV of the ACT Group Litigation, although the exercise of freedom of establishment by these UK-resident companies will also inevitably involve the movement of capital out of the UK in so far as this is necessary to establish a subsidiary, this is a purely indirect consequence of the exercise of freedom of establishment. As a result, Article 43 EC takes priority of application for such companies.

[32] In the case of UK-resident companies holding an investment in a non-UK-resident company which does not give them a ‘decisive influence’ over the latter’s activities, or allow them to determine that company’s activities, the UK legislation should be assessed for compatibility with Article 56 EC. I note in this regard that the UK legislation at issue clearly concerns what can be termed ‘movement of capital’.

[33] In principle, therefore, due to the nature of the present case as a group action where the particular circumstances and nature of shareholding of each claimant have not been put before the court, it is necessary to consider the compatibility of the UK legislation at issue with both Articles 43 and 56 EC.

[34] I would add that, although the substantive principles for analysis of whether a breach has occurred are the same for both articles, the geographic and temporal scope of Article 56 EC differs from that of Article 43 EC; Article 43 EC applies only to restrictions on the exercise of freedom of establishment between member states and entered into force as part of the Treaty of Rome, while Article 56 EC also prohibits restrictions on the movement of capital between member states and third countries and entered into force on 1 January 1994 (although the principle of free movement of capital had already been established by Directive 88/361.) Moreover, Article 56 EC is subject to a ‘standstill’ provision – Article 57(1) EC – as regards third States.

[35] As a result, as regards the substantive principles for assessment of compatibility, I will only expressly consider Article 43 EC, as the same principles apply to the assessment under Article 56 EC. I will deal separately with certain issues of temporal and geographic scope particular to Article 56 EC (raised in Question 5). ”

Mr Ewart submitted that this expresses precisely the approach for which the Revenue contends: in cases where the United Kingdom parent has definite influence over the subsidiary’s decisions, allowing the parent to determine the subsidiary’s activities, then the situation is only to be investigated in the context of Article 43. Any restriction on capital movements is simply incidental. It is only in cases where there is no such influence and control that Article 56 is capable of applying, and that is so whether the subsidiary is in a Member State or a Third Country. In the latter situation, Article 43 would have no application since Article 43 only applies in cases of establishment in a Member State.

Mr Ewart submitted that on the reference from Park J the ECJ took the same line as the Advocate General. Mr Ewart referred, first, to paragraphs [37] and [38] of the ECJ’s judgment, which were as follows:

“[37] The order for reference shows that the cases chosen as test cases in the proceedings before the national court concern UK-resident companies which received dividends from non-resident companies that are wholly owned by them. As the nature of the interest in question will confer on the holder definite influence over the company’s decisions and allow it to determine the company’s activities, the provisions of the EC Treaty on freedom of establishment will apply (Case C-251/98 Baars [2000] ECR I-2787, paragraphs 21 and 22; Case C-436/00 X and Y [2002] ECR I-10829, paragraphs 37 and 66 to 68; and Case C-196/04 Cadbury Schweppes and Cadbury Schweppes Overseas [2006] ECR I-0000, paragraph 31).

[38] As the Advocate General stated at point 33 of his Opinion, the nature of the holdings of the other companies which are parties to the dispute has not been put before the court. It may therefore be that the dispute also relates to the effect of the national legislation at issue in the main proceedings on the situation of resident companies which received dividends on the basis of a holding which does not give them definite influence over the decisions of the company making the distribution and does not allow them to determine its activities. That legislation must therefore also be considered in the light of the Treaty provisions on the free movement of capital.”

Mr Ewart then referred to subsequent paragraphs in the ECJ’s judgment which referred back to paragraphs [37] and [38]. He laid particular weight on paragraph [165] in a section of the ECJ’s judgment addressing question 4 of the reference. Question 4 raised an issue regarding the payment of ACT on a distribution by a company to its shareholders when the company had itself received a distribution from a non-resident company, including a Third Country subsidiary. Paragraph [165] was as follows:

“[165] In so far as, according to the national court, that question also concerns companies established in non-member countries which, accordingly, do not fall within the scope of Article 43 EC on freedom of establishment, and for the reason set out in paragraph 38 of this judgment, the question arises whether national measures such as those at issue in the main proceedings also contravene Article 56 EC on the free movement of capital.”

Mr Ewart submitted that the ECJ was clearly stating in paragraph [165] that Article 56 only has relevance if the parent of the Third Country subsidiary does not have a shareholding which gives it definite influence over the decisions of the subsidiary and does not allow it to determine the subsidiary’s activities.

Mr Ewart also laid particular weight on the analysis of the ECJ in Case C-303/07 Aberdeen Property Fininvest Alpha Oy [2009] ECR 00. Advocate General Mazák said in that case:

“[26] Depending on the individual case, it is possible for the decision to be based on freedom of establishment or free movement of capital. According to case law, the decisive criterion is a shareholding which gives the parent company definite influence over its subsidiary’s decision, and allows it to determine its subsidiary’s activities.

[27] As is apparent from the order for reference, Alpha is a wholly owned subsidiary of Nordic Fund SICAV. It is therefore clear that Nordic Fund SICAV has a substantial influence over Alpha’s management. That means that the main proceedings are concerned with freedom of establishment, and that is why I shall seek to answer the question referred on the basis of the Treaty provisions on freedom of establishment.”

In the same case the ECJ said:

“[33] It is therefore clear that the main proceedings relate exclusively to the effect of the national legislation at issue in those proceedings on the situation of a resident company which distributes dividends to shareholders whose holdings give them definite influence over the decisions of that company and enable them to determine its activities (see, to that effect, Case C-446/04 Test Claimants in the FII Group Litigation v IRC [2006] ECR I-11753, paragraph 38, and Case C-284/06 Finanzant Hamburg-Am Tierpark v Burda GmbH (formerly Burda Velagsbeteiligungen GmbH) [2008] ECR I-4571, paragraph 72).

[34] According to settled case law, where a company has a shareholding in another company which gives it definite influence over that company’s decisions and allows it to determine that company’s activities, it is the provisions of the Treaty on the freedom of establishment that are to be applied (see, inter alia, Cadbury Schweppes and Cadbury Schweppes Overseas, paragraph 31; Test Claimants in Class IV of the ACT Group Litigation v IRC, paragraph 39; Case C-524/04 Test Claimants in the Thin Cap Group Litigation [2007] ECR I-2107, paragraph 27; Case C-231/05 Proceedings brought by Oy AA [2007] ECR I-6373, paragraph 20; and Burda, paragraph 69). ”

Mr Ewart drew attention to the references in paragraphs [33] and [34] of the judgment in Aberdeen, to paragraph [38] of the judgment of the ECJ in this case and paragraph [27] in the judgment in C-524/04 Test Claimants in the Thin Cap group Litigation v Commissioners of Inland Revenue [2007] ECR I-2107 (“Thin Cap”) respectively. Thin Cap concerned the compatibility with the Treaty’s free movement provisions of the United Kingdom’s “thin capitalisation” rules, by which the United Kingdom restricted the deductibility of interest payments made by United Kingdom subsidiaries to non-resident parents or intermediate group companies, including those in Third Countries. Paragraph [27] of the judgment in Thin Cap was as follows:

“[27] In accordance with settled case-law, national provisions which apply to holdings by nationals of the Member State concerned in the capital of a company established in another Member State, giving them definite influence on the company’s decisions and allowing them to determine its activities, come within the substantive scope of the provisions of the EC Treaty on freedom of establishment (see, to that effect, Case C-251/98 Baars [2000] ECR I-2787, paragraph 22; Case C-436/00 X and Y [2002] ECR I-10829, paragraph 37; and Case C-196/04 Cadbury Schweppes and Cadbury Schweppes Overseas [2006] ECR I-0000, paragraph 31).”

Case C-196/04 Cadbury Schweppes and Cadbury Schweppes Overseas [2006] ECR I-7995 concerned the compatibility with Community law of United Kingdom legislation on “controlled foreign companies” (“CFCs”). These were subsidiaries of a United Kingdom parent established in a country, including Third Countries, which applied a much lower rate of taxation than in effect in the United Kingdom. Paragraph [31] of the judgment was in similar terms to paragraph [27] of the judgment in Thin Cap.

Case C-157/05 Winfried L. Holböck v Finanzamt Salzburg-Land [2007] ECR I-4051 concerned Austrian income tax legislation under which profit distributions by domestic companies to natural persons resident in Austria were taxed at a reduced “half-tax rate” whereas profit distributions by foreign companies made to a natural person resident in Austria were subject to ordinary income tax. Mr Holböck was resident in Austria, and was the manager of a company whose registered office was in Austria. The sole shareholder of that company was another company registered in Switzerland of which Mr Holböck held two-thirds of the shares. Under the Austrian legislation dividends received by Mr Holböck from the Swiss company were taxed in Austria at the full income tax rate. Mr Holböck claimed that the tax treatment of the dividends fell within the scope of Article 56. The ECJ determined the matter without a prior opinion of an Advocate General. The ECJ held that, even if a taxpayer in Mr Holböck’s position was justified in invoking Article 56, the legislation fell within the exception laid down in Article 57(1).

The Judge considered that the ECJ’s judgment in Holböck clarified the position as to the scope of Article 56 in the manner for which the Claimants contend. Mr Ewart submitted that it was wrong to draw that conclusion, and that Holböck merely decided that, even if Article 56 would otherwise have applied, the legislation fell within the exception in Article 57(1). We agree with the Judge’s analysis.

In Holböck the French and Dutch governments claimed that the Austrian legislation should be considered only in terms of the rules regarding freedom of establishment, and not those regarding the free movement of capital. This was therefore a critical issue before the ECJ. The ECJ noted that, should it be necessary to consider the Austrian legislation in terms of the free movement of capital, the French, Dutch and United Kingdom governments and the Commission took the line that the legislation was, in any event, caught by the exception in Article 57(1). It is to be noted that, although the ECJ considered that the exception in Article 57(1) did indeed apply, the Court did not, as it could have done consistently with Mr Ewart’s analysis, go straight to that decisive issue. On the contrary, the ECJ considered in detail, in paragraphs [22] to [24] of its judgment, the question of whether the legislation was to be considered only in the context of freedom of establishment under Article 43 rather than the free movement of capital under Article 56. In considering that issue, the starting point for the ECJ was that the first stage is to consider the purpose of the legislation. The ECJ noted that, unlike the situations in Cadbury Schweppes and Thin Cap, the Austrian legislation in issue was not intended to apply only to those shareholdings which enable the holder to have a definite influence on a company’s decisions and to determine its activities. The ECJ went on to say that legislation which makes the receipt of dividends liable to tax, where the rate depends on whether the source of those dividends is national or otherwise, irrespective of the extent of the holding which the shareholder has in the company making the distribution, may fall within the scope of both Article 43 and Article 56. Having reached that conclusion, the ECJ then stated that, on the facts of the case, neither Article 43 nor Article 56 precluded the application of the Austrian legislation. The ECJ noted that Article 43 does not extend to situations which involve the establishment by a Member State parent of a Third Country subsidiary. For that reason, Article 43 could have no application in the circumstances under consideration. The ECJ then stated, in paragraph [30] of its judgment, that the effect of the Austrian legislation was that “such legislation constitutes a restriction on the free movement of capital which is, in principle, prohibited by Article 56(1)”. That was a clear finding of the ECJ that Article 56(1) was engaged, subject to any exception in Article 57. It was only after reaching that conclusion that the ECJ went on to hold that the Austrian legislation was to be regarded as having existed on 31 December 1993 for the purposes of Article 57(1).

Mr Ewart submitted that, if Holböck is properly to be regarded as support for the Claimants’ analysis of Article 56, as the Judge held and we agree, then it is out of line with ECJ authority both preceding and coming after it and should be ignored for that reason. We do not agree with that submission.

Cadbury Schweppes and Thin Cap, which were decided before Holböck, and Aberdeen, which was decided after it, all concerned legislation intended to apply exclusively to establishment situations. For that reason, in accordance with Community law, they necessarily fell to be decided under Article 43, to the exclusion of Article 56.

We do not accept that the judgment of the ECJ in this case is in any way inconsistent with the Claimants’ analysis. Paragraphs [37] and [38] of the judgment in that case, on which Mr Ewart placed reliance, were in the context of the ECJ’s answer to question 1 of the Reference. Question 1, as we have said, was dealing only with the issue of dividends received by a company resident in a Member State from a subsidiary in another Member State. Only question 4 raised directly the issue of the treatment of distributions received by companies resident in a Member State from companies resident in Third Countries in the context of Articles 43 and 56. Paragraph [165] of the ECJ’s judgment, on which Mr Ewart relied, was in the context of the ECJ’s answer to question 4, but we do not agree with Mr Ewart’s interpretation of it. He submitted that the effect in paragraph [165] of the cross reference to paragraph [38] was to confine Article 56 to Third Country involvement, and in addition, that is to say cumulatively, the circumstances were that the company receiving the dividend did not have definite influence over the decisions of its Third Country subsidiary and was not able to determine its activities. In our view, the better interpretation of paragraph [165] is that it is describing two separate categories: namely, those cases which do not fall within the scope of Article 43 because they concern Third Country subsidiaries, and also those cases, whether or not they involve Third Country subsidiaries, in which the company resident in the Member State does not have control over the decisions and activities of the subsidiary. Certainly, nothing in the judgment of the ECJ in this case points firmly to a contrary interpretation. That no such contrary interpretation was intended is supported by the fact Judge Lenaerts was the Juge Rapporteur in both this case and Holböck.

Moreover, the ECJ’s analysis of Article 57(1) also supports the Claimants’ submissions on the scope of Article 56. Article 57(1) exempts from Article 56 restrictions which existed on 31 December 1993 under national or Community law in respect of movement of capital to and from Third Countries involving “direct investment… establishment”. In paragraphs [32] to [36] of its judgment in Holböck the ECJ explained the concept of “direct investments” as concerning “investments of any kind undertaken by natural or legal persons and which serve to establish or maintain lasting and direct links between the persons providing the capital and the undertakings to which that capital was made available in order to carry out an economic activity” (paragraph [34]), and that that objective of establishing or maintaining such economic links presupposes that the shares held by the shareholder enable him “to participate effectively in the management of that company or in its control” (paragraph [35]). The exception in Article 57(1), therefore, presupposes that Article 56 is capable of applying to restrictions on establishment.

The point that Article 57(1) supports the Claimants’ submissions on Article 56 emerges even more clearly from Case C-101/05 Skatteverket v A [2007] ECR I-11531. That case concerned the movement of capital by way of distribution by a parent company established in a Third Country of dividends, in the form of shares in a Third Country subsidiary, to a shareholder residing in a Member State. As Advocate General Bot said in paragraph [90] of his opinion, such an operation might, in certain circumstances, give the shareholder a holding in the foreign subsidiary of the distributing company of such an extent that it enabled the holder to have a definite influence on that subsidiary’s decisions. He went on to say that it is clear from the ECJ’s case law that, where the purpose of the legislation of a Member State concerns situations in which a shareholder’s holding enables him to have a definite influence on a company’s decisions and to determine its activities, that legislation must be examined in the light of the articles in the Treaty relating to freedom of establishment and those articles alone. In such cases, the restrictive effects such legislation might have on the free movement of capital would be the unavoidable consequence of any restriction on freedom of establishment, and would not therefore justify an examination of that legislation in the light of Article 56. He went on to say the following about national legislation which makes the receipt of dividends liable to tax, where the rate depends on whether the source of those dividends is national or otherwise, irrespective of the extent of the holding which the shareholder has in the distributing company:

“[94] It is true, however, that the national legislation which makes the receipt of dividends liable to tax, where the rate depends on whether the source of those dividends is national or otherwise, irrespective of the extent of the holding which the shareholder has in the distributing company, may be covered by the free movement of capital. It is therefore conceivable that a shareholder who is a national of a third country and is established outside the Union and who has a significant holding in the capital of a company that is resident in a Member State, may rely on Article 56(1) EC in order to challenge that legislation.

[95] The fact that the extent of his holding in the capital of a company that is resident in a Member State enables a shareholder to have a definite influence on the company’s decisions and to determine its activities does not in itself appear to constitute sufficient justification to exclude the application of Article 56(1) EC, in the light of Article 57(1) EC. The latter provision, as was seen above, provides that the Member States may maintain restrictions existing on 31 December 1993 on the movement of capital to or from third countries where such movement involves ‘establishment’. It may therefore be deduced from that provision that the movement of capital to or from third countries may involve establishment.

…

[97] It is in the light of those considerations that I take the view that the concepts of ‘movement of capital’ and ‘restrictions’ used in Article 56(1) EC should be interpreted in the same manner, both as regards relations between member states and third countries and as regards intra-Community relations.”

That analysis is precisely the one for which the Claimants contend. Mr Ewart submitted that it was simply incorrect. The ECJ in Skatteverket did not, in the event, need to address the point since it considered that Article 56 did not apply on the facts for reasons unconnected with the Advocate General’s analysis. Moreover, it is established Community jurisprudence that, where the ECJ remains silent on an issue considered by the Advocate General because the ECJ disposes of the case on different grounds, the Advocate General’s Opinion stands as a legal authority in its own right: see Tridimas, The Role of the Advocate General In The Development of Community Law: Some Reflections (1997) CML Rev 1349 at 1362. It is not in any way binding, but “may prove useful in a future case where the same issue falls to be examined by the [ECJ]” (ibid, at 1350).

The most recent relevant decision of the ECJ in Case C-182/08 Glaxo Wellcome Gmbh & Co. KG v Finanzamt Munchen II [2009] ECR I-0000 also provides a helpful analysis. The case concerned the application of Articles 43 and 56 to German legislation. The Advocate General was Advocate General Bot, who had also given the opinion in Skatteverket. He concluded that the German legislation was designed to apply irrespective of the size of the shareholder’s holding in the distributing company, and so might fall within the scope of both Article 43 and Article 56. He considered, however, that the legislation in question should be considered only in the light of Article 56 in view of the specific circumstances of the case and the objectives of the legislation. He did not give any indication that he had changed the views he had expressed in Skatteverket. He also gave no indication, along the lines of Mr Ewart’s submissions, that the choice between Article 43 and Article 56, in the context of legislation designed to apply irrespective of the extent of the shareholding in the company making the distribution, depends merely upon whether the factual circumstances of the case in question involve establishment.

The analysis of the ECJ in Glaxo was very similar to that of Advocate General Bot. The ECJ said that, in order to determine whether the national legislation falls within the scope of Article 43 or Article 56, the purpose of the legislation concerned must be taken into consideration. The ECJ, in principle, examines the measure in dispute in relation to only one of those two freedoms if it appears, in the circumstance of the case, that one of them is entirely secondary in relation to the other. The ECJ confirmed that movements of capital for the purposes of Article 56 include direct investments in the form of participation in the undertaking through the holding of shares which confers the possibility of participating effectively in its management and control. It was common ground that the application of the German legislation did not depend on the size of the shareholdings, and was not limited to situations in which the shareholder could exercise definite influence on the decisions of the company concerned and determine its activities. In addition, having regard to its purpose, the free movement of capital aspect of the legislation prevailed over that of the freedom of establishment. Consequently, even if the legislation had restrictive effects on the freedom of establishment, they were the unavoidable consequences of the restriction of the free movement of capital, and did not justify independent examination of the legislation under Article 43. In the course of that analysis, the ECJ referred to, and relied upon, the decision in Holböck thereby clearly indicating, contrary to Mr Ewart’s submission, that the decision in Holböck was part of an established and approved chain of case law.

Holböck, Skatteverket and Glaxo clearly support the Claimants’ submission that Article 56 is capable of applying where the factual situation concerns distributions to a parent company resident in a Member State from a wholly-owned Third Country subsidiary. Article 56 will not apply if the purpose of the legislation or its practical effect exclusively or primarily concern establishment. Moreover, in cases where the purpose or practical effect of the legislation is not so restricted, but the factual situation before the Court concerns an establishment situation solely involving companies resident in Member States, there is no practical difference between the principles applicable under Article 43 and Article 56, so the Court is likely for practical reasons only to consider the freedoms in the context of Article 43 (unless the exemption under Article 57(1) is in issue): see, for example, paragraphs [34] and 35 of the Advocate General’s opinion in this case. Where the case concerns a Third Country subsidiary, however, Article 43 is irrelevant.

In the present case the relevant tax is corporation tax charged under Case V of Schedule D. That head of charge is long-standing. It is not aimed at, and is not practically restricted to, establishment situations. It applies to all streams of income from overseas. Accordingly, the Judge was correct to hold that Article 56 is capable of being engaged in cases of distributions by Third Country subsidiaries to the Claimants.

As with Issue 2, we proceed to consider this Issue on the hypothesis that the ECJ rules in favour of the Claimants on the reference back of Issue 1.

The Case V charge was already in existence on 31 December 1993. The Claimants accept that the way the Case V charge applied to dividends received from Third Country subsidiaries constituted a restriction involving direct investment for the purposes of Article 57(1), with the result that the application of Article 56 to such dividends on 1 January 1994 was disapplied by Article 57(1). The Claimants contend, however, that the changes brought about by the introduction of the Eligible Unrelieved Foreign Tax (“EUFT”) rules for dividends received on or after 31 March 2001 were so substantial as to constitute a new restriction not permitted by Article 57(1).

The ECJ’s jurisprudence on the meaning of the words “any restrictions which exist on 31 December 1993 under national or Community law” in Article 57(1) was considered by it in the present case in the context of the Court’s discussion of the FID regime (which was introduced with effect from 1 July 1994). The relevant part of the ECJ’s judgment is contained in paragraphs [189] to [192]:

"[189] It is necessary first of all to clarify the concept of "restrictions which exist" on 31 December 1993 within the meaning of Article 57(1) EC.

[190] As the claimants in the main proceedings, the United Kingdom and the Commission propose, reference should be made to Case C-302/97 Klaus Konle v Republic of Austria [1999] ECR I-3099, in which the court had to provide an interpretation of the concept of "existing legislation" contained in a derogating provision in the Act concerning the conditions of accession of the Republic of Austria, the Republic of Finland and the Kingdom of Sweden and the adjustments to the Treaties on which the European Union is founded …, allowing the Republic of Austria to maintain its existing legislation governing secondary residences for a limited period.

[191] While it is, in principle, for the national court to determine the content of the legislation which existed on a date laid down by a Community measure, the court held in that case that it is for the Court of Justice to provide guidance on interpreting the Community concept which constitutes the basis of a derogation from Community rules for national legislation "existing" on a particular date (see, to that effect, Konle, paragraph 27).

[192] As the court stated in Konle, any national measure adopted after a date laid down in that way is not, by that fact alone, automatically excluded from the derogation laid down in the Community measure in question. If the provision is, in substance, identical to the previous legislation or is limited to reducing or eliminating an obstacle to the exercise of Community rights and freedoms in the earlier legislation, it will be covered by the derogation. By contrast, legislation based on an approach which is different from that of the previous law and establishes new procedures cannot be regarded as legislation existing at the date set down by the Community measure in question (see Konle, paragraphs 52 and 53)."

Community law requires the derogation in Article 57(1) to be interpreted strictly since it is a derogation from the fundamental principle of the free movement of capital: Case C-315/02 Anneliese Lenz v Finanzlandesdirektion für Tirol [2004] ECR I-7063 at paragraph [26], Manninen at paragraph [28]. It is common ground that, in identifying the relevant restriction and answering the question whether it remained continuously in force from 31 December 1993, the matter should be considered from BAT’s point of view.

The parties agree that the Judge accurately and sufficiently summarised as follows the effect of the introduction of the EUFT regime for dividends paid from the end of March 2001:

“[102] Before the introduction of EUFT, credit for foreign taxes was in principle given on a source-by-source basis, and was subject to an upper limit equal to the amount of UK corporation tax chargeable on the dividend. The relief extended both to any withholding tax charged when the dividend was paid by the foreign water's edge company and (where, as is usually the case, the relevant double tax treaty so provided, as well as in all relevant cases of unilateral relief under ICTA section 790) to underlying tax on the profits out of which the dividend was paid, whether charged on the water's edge company paying the dividend or on companies further down the chain. The detailed rules were contained in Chapter II of Part XVIII of ICTA, including in particular section 797 (the upper limit) and section 799 (underlying tax). It was a consequence of this system that, in principle, the underlying foreign tax on a dividend from a country with a higher rate of local corporation tax than the UK rate ("a high tax country") would be capped at the UK rate, and any excess tax from one source could not be credited against the UK liability on a dividend from another source, such as a country with a local corporation tax rate lower than the UK rate ("a low tax country").

[103] However, the pre-EUFT rules permitted this disadvantage to be mitigated to a very considerable extent, because UK groups were free to arrange their affairs so as to pay dividends from low tax and high tax countries to the UK through a non-resident "mixer" company. A single dividend could then be paid to the UK from the mixer company with an averaged rate of tax, thereby minimising the loss of double tax credit. This process was commonly known as "offshore pooling", and became standard procedure for most UK multi-national groups. Following the merger of the BAT group with Rothmans in the late 1990s, the claimants adopted this structure by arranging to pay dividends to the UK via a Netherlands holding company, namely the seventh claimant, BAT International BV.

[104] The procedure which the BAT group adopted is described in more detail in the witness statement of Robert Fergus Heaton, who is a chartered accountant and was a senior tax manager reporting to Mr Hardman from 1997 onwards. He was not cross-examined on his written evidence, which I accordingly accept. He explains that prior to the abolition of ACT in 1999 the group held most of its interests in its end market trading subsidiaries directly from the UK, and maximising the use of excess tax credits from subsidiaries in high tax countries was not seen as a major concern, because the group's liability to tax on Case V income was one of the few sources of corporation tax against which ACT could be utilised. However, the abolition of ACT for dividends paid after 4 April 1999, and the shadow ACT regime which replaced it, exposed the group for the first time to liabilities to tax on its Case V income which it would be unable to shelter with surplus ACT. Accordingly, the group was rearranged following the merger with Rothmans in the way which I have described. It was group policy that subsidiaries should, where possible, distribute 100% of their profits, and for the most part these would ultimately be received by BAT International BV. A calculation would then be made on a quarterly basis of the underlying rate of tax on the dividends received – which was by no means a straightforward exercise – and a decision would then be made on the amount of the dividends to be paid from BAT International BV into the UK. Mr Heaton would review the calculations, and also take into account any other reliefs that might be available in the UK (such as group relief) to shelter any liabilities to tax upon receipt of the Case V income which would not be covered by double tax relief. It was always group policy to pay dividends through the group and into the UK as quickly as possible, and Mr Heaton would only raise concerns about the proposals if it looked likely that there would be a significant adverse tax impact.

[105] The EUFT system had a complex and prolonged gestation, which is described by Mr Heaton. On 21 March 2000 the Chancellor announced the introduction of legislation which would make it no longer possible for UK multi-nationals to mix high and low tax dividend income offshore in order to produce dividends carrying a rate of underlying tax similar to the UK corporation tax rate. A period of consultation ensued, in response to which the Revenue announced that amendments would be made to the draft rules and their introduction would be deferred until 31 March 2001. In June 2000, the Revenue then announced that, while the Government was committed to the abolition of offshore mixing, it would introduce a limited form of onshore pooling. Further lobbying continued, which led to further announcements of changes to the proposals in November 2000 and March 2001, and the promulgation of draft regulations concerning the surrender of EUFT at the end of March 2001. The new rules then took effect for dividends paid from the end of that month.

[106] The EUFT rules are complex in detail, but the broad principles can be stated quite briefly. The advantages of offshore mixing were largely nullified by the introduction of a "mixer cap", which operated to restrict the amount of underlying foreign tax which could be credited against the UK corporation tax liability on foreign dividends. The cap applied not only where a dividend was paid by a non-resident company direct to the UK, but also, and critically, where a cross-border dividend was paid at any earlier stage within the group by one non-resident company to another. The mixer cap limited the creditable underlying tax to the UK corporation tax rate. Any unrelieved foreign tax (EUFT) would then be eligible for onshore pooling, and could be offset against the UK corporation tax payable on certain dividends from low tax countries. However, the dividends against which EUFT could be offset ("qualifying foreign dividends", or "QFDs") excluded certain important categories of dividend, including in particular:

(a)

dividends paid indirectly to the UK in respect of which EUFT had arisen at any point in the corporate chain, subject to a right to disclaim the underlying tax concerned in order to prevent EUFT from arising at that point and thereafter "tainting" the dividend; and

(b)

dividends paid by a controlled foreign company ("CFC") which escaped the application of the CFC rules by pursuing an "acceptable distribution policy", which in practice meant distributing 90% or more of its profits.

Furthermore, the amount of EUFT which could be relieved was subject to an upper limit of 45% of the aggregate amount of the dividend declared and the underlying tax (including any withholding tax incurred by an intermediate company). There were, however, also some countervailing advantages, which had not been available under the previous regime. For example, surplus EUFT could be carried back and set off against tax payable on QFDs of the same company in the previous three years, and could also be carried forward indefinitely by the same company or surrendered to another group company.

[107] Within the BAT group, it was estimated that if nothing was done the effect of the EUFT rules would be to increase the group's UK tax liability by at least £60 million per year. A complex restructuring operation was therefore undertaken, and given the name "Project Frankenstein". In very broad terms, the purpose of the exercise was to undo the restructuring which had followed the merger with Rothmans, and to ensure that the separate streams of dividends from the end market subsidiaries did not mix before they reached the UK, and then to transfer the residence of BAT International BV from the Netherlands to the UK. Mr Heaton was the manager of the project, and it occupied him full time for six months. A team of external advisers was brought in to assist, and the overall cost of the exercise came to about £5 million.”

The Judge rejected the Claimants’ case that the introduction of the EUFT rules constituted a new restriction not permitted by Article 57(1). Basing himself on an analysis of the ECJ in Skatteverket, he said:

“[99] If that approach is applied to the facts of the present case, it seems to me that the relevant restriction must be identified as the exclusion of third country-source dividends from the exemption given to UK-source dividends by ICTA section 208. That exclusion was in place on 31 December 1993 and has remained in place ever since, so Article 57(1) applies and prevents a recipient of such dividends in a member state from complaining that the exclusion infringes Article 56. The fact that there may have been changes since 1993 in the Case V regime which subjects the dividends to tax in the UK is, on this analysis, irrelevant. Such changes might be relevant to the question whether Article 56 had been infringed, and (if so) to the quantification of the loss suffered by the claimant; but the changes are not relevant to the continued existence of the basic restriction itself, which is simply the inability to take advantage of the exemption in section 208.”

The Judge went on to consider whether the position would be different if the question whether the relevant restriction under Article 57(1) remained in force continuously from 31 December 1993 was to be answered by reference to the operation generally of the Case V charge in the context of the test laid down by the ECJ in Case C-302/97 Klaus Konle v Republic of Austria [1999] ECR I-3099 and in paragraphs [189]-[192] of the judgment of the ECJ in this case. The Judge did so in response to Mr Aaronson’s submission that, if there were a major change in the relief rules applicable to the Case V charge, such as the introduction of EUFT, the relevant restriction would no longer be the same as it was on 31 December 1993 and the standstill in Article 57(1) would be lost. The Judge’s analysis and conclusion on that approach were set out in paragraph [108] of his judgment as follows:

“[108] Against this background, can it be said that the introduction of the EUFT regime changed the legislative approach upon which the Case V charge was based and established new procedures (compare Konle at paragraphs 52 and 53, and the judgment of the ECJ in the present case at paragraph 192)? The EUFT system certainly established new procedures for the relief of foreign tax, but I do not consider that it changed the general approach upon which the Case V charge was based. As before, the general philosophy of the system was to grant relief in the UK for foreign withholding and underlying tax attributable to the dividends received, subject to an upper limit fixed by reference to the UK corporation tax rate. All that changed were the detailed rules relating to the utilisation of foreign tax which would otherwise have been unrelieved, and the introduction of a new system of onshore pooling to replace the offshore pooling which no longer carried any fiscal advantages. In some respects the new system was less attractive to UK multi-national groups than the system which it replaced, but the new system also introduced important elements of flexibility which had not previously been available. If one stands back from the small print and the detail, the overall nature of the Case V charge was in my judgment still in substance the same after the introduction of EUFT as it had been before. It is true that the changes would have cost the BAT group a substantial amount in extra tax, if Project Frankenstein had not been undertaken to mitigate the position. But the reorganisation was no greater than that which followed the merger with Rothmans and the abolition of ACT, and the claimants no longer contend that the abolition of ACT itself forfeited the protection of Article 57(1). Moreover, nobody suggests that a mere increase in the nominal rate of UK corporation tax would have been fatal, so the increased tax cost of the changes to a typical UK multi-national could not of itself be determinative. The test is essentially a structural one, and in my view the focus should be on the main features of the structure rather than the fine points of detail. Accordingly, if it were necessary for me to decide the question, I would hold that the introduction of the EUFT system did not cause the protection of Article 57(1) to be lost.”

The Claimants submit that the Judge’s approach was wrong both in the way he characterised “the restriction” for the purposes of Article 57(1), and in the way he analysed the effect of the EUFT regime for the purposes of that Article. Mr Aaronson emphasised the large practical implications of the introduction of the EUFT regime. It transformed, he said, the way relief was given for overseas tax because it had become the practice for groups of companies, like the Claimants, to use Dutch “mixer” companies which received dividends from foreign companies lower down the corporate chain, which had been paid out of profits subjected to different rates of tax. By utilising a Dutch mixer company it was possible to maximise the tax which could be set off against United Kingdom corporation tax on payment of the dividend from the Dutch mixer company to its United Kingdom parent. The arrangement was beneficial because the Netherlands applied an exemption system of taxation, so that all the dividends could flow into the Netherlands without any further charge to tax. The Netherlands did not give relief for overseas tax paid since it did not impose a charge on the dividends. Accordingly, the overseas tax paid remained in the hands of the Dutch mixer company. By mixing overseas credit and overseas taxation rates, the Dutch company could pay a dividend to the United Kingdom parent which had borne overseas tax averaged at 30 per cent, which could be offset against United Kingdom corporation tax of 30 per cent on that dividend.

The effect of the EUFT regime was that the mixing had to be done onshore to obtain the most effective tax relief benefit. One of the problems was that it was not possible to mix onshore dividends paid by CFCs, which paid those dividends for the very purpose of complying with the CFC rules. The basic principle of the CFC rules was that, if there was a major shareholding in a subsidiary in a low tax territory, the profits of that subsidiary were imputed to the parent company. They came into the tax base of the parent company unless it was possible to comply with “safe havens”. For example, if 90 per cent of the profits were paid out in dividends, the profits of the subsidiary were not imputed to the United Kingdom parent. Those dividends were not, however, eligible for EUFT. They will have borne lower rates of tax. It was not possible, therefore, to set off dividends paid out of profits with higher rates of tax against those from CFCs which would have borne lower rates of tax.

The other major problem was that, if a dividend passed from one overseas company to another, it would not be eligible for EUFT. The result was that, in order to obtain the greatest tax advantage from the EUFT regime, it was necessary to “flatten” the corporate group, so that, instead of having one European holding company owning many subsidiaries, the United Kingdom company had to own many subsidiaries, all sending their dividends into the United Kingdom. If there was a mixer company anywhere below the level of the water’s edge company overseas, dividends going through that mixer company were not eligible for EUFT.

The implications of these changes and the new regime for the BAT group were summarised by the Judge in paragraph [107] of his judgment, which we have set out above.

Mr Aaronson submitted that, in applying the test in Konle (is the approach of the legislation different from that of the previous law and does it establish new procedures?), the Judge misunderstood the analysis in Skatteverket, and wrongly concluded that those authorities required him to identify the relevant restriction as the exclusion of dividends from Third Country subsidiaries from the exemption given in respect of dividends from United Kingdom companies by ICTA section 208. Mr Aaronson said that the important feature of Skatteverket was that the complainant in that case was subject to a consistent tax rule. There were no reported changes to the tax rules in so far as they applied to him. What had happened was that certain other Swedish rules were changed to the detriment of other people.

Mr Aaronson submitted that the issue under Article 57(1) in the present case was whether the Case V charge, if there was no exemption under ICTA section 208, changed significantly as a result of the EUFT regime, that is to say whether the practical effect of the EUFT rules was to impose a significantly different tax regime. He submitted that it was clear that such a test was satisfied because the new legislative approach introduced a new restriction as to offshore mixing, and it excluded dividends paid out of profits that had been subject to low rates of tax. The practical impact on the BAT group, described in paragraph [107] of the Judge’s judgment, showed clearly, he submitted, that the Konle test was satisfied in the circumstances. The changes brought about were significantly greater than those held in Konle to have established a new approach to the law and new procedures. The Judge’s conclusion that the Case V charge was still “in substance the same” after the introduction of EUFT was, he submitted, plainly wrong.

Attractively as those submissions were made, we reject them. We consider that the Judge’s analysis in paragraph [99] of his judgment was correct. Article 56 prohibits “restrictions” on the movement of capital between Member States and between Member States and Third Countries. Article 57(1) exonerates those “restrictions” which existed on 31 December 1993 that would otherwise contravene Article 56. On the hypothesis that the ECJ holds in favour of the Claimants on Issue 1, the contravention of Article 56 was the exclusion of Third Country-source dividends from the exemption conferred in respect of domestic-source dividends by ICTA section 208. That exclusion existed on 31 December 1993.

There is an alternative way of looking at the matter, with the same result. Paragraphs 49 and 50 of the ECJ’s judgment in this case specify the minimum requirements of an exemption/imputation system in order to be compatible with Community law. First, the foreign-source dividends must not be subject in the Member State to a higher rate of tax than the rate that applies to domestic-source dividends. Secondly, the Member State must prevent foreign-source dividends from being liable to a series of charges to tax, by offsetting the amount of tax paid by the non-resident company making a distribution against the amount of tax for which the recipient company is liable, up to the limit of the latter amount. If there was a violation of Article 43 or Article 56 in this case, it was that the effective rate of tax applied to domestic-source dividends could and would normally be lower than the rate on foreign-source dividends. It is that which falls for consideration under Article 57(1). That restriction existed on 31 December 1993 and continued unchanged subsequently. The introduction of the EUFT regime had nothing to do with that restriction, but was directed at the way in which credit was to be calculated and given for the amount of tax paid by the non-resident company making the distribution against the amount of tax for which the recipient company is liable, up to the limit of the latter amount. It was concerned only with the requirement described in paragraph [50] of the ECJ’s judgment in this case and obligatory under the Parent-Subsidiary Directive. It is not suggested that such requirement ceased to be satisfied by virtue of the EUFT regime. The principle remained, as before, that there was double tax relief for all tax paid by the foreign company subsidiaries on the profits distributed, subject to the limit of the United Kingdom corporation tax: ICTA sections 797(1) and (2), and 800.

As Mr Ewart submitted, the United Kingdom system, both before and after the EUFT regime, went further than was required by Community law in at least two respects. It gave relief for underlying tax down the chain of corporate subsidiaries (ICTA section 801), and it permitted excess relief to be transferred across the corporate structure and to be used to offset other dividends. In short, the EUFT restrictions altered the way that tax credit was to be calculated, but that had nothing to do with the restriction which, subject to Article 57(1) and on the hypothesis that the Claimants are correct about Issue 1, infringed Article 56.

The effect of Mr Aaronson’s analysis is to treat the whole of the Case V charge as comprising the relevant restriction, which, in our judgment, is wrong.

Accordingly, on this Issue, we conclude that, if Case V of Schedule D infringes Article 56, then the standstill provisions of Article 57(1) apply to permit such infringement; the introduction of the EUFT rules did not constitute a new restriction that would operate to oust Article 57(1).

Issues 4 to 10 deal with the responses given by the ECJ to the questions referred to it concerning ACT. Domestic-source dividends carry a credit for ACT which can be passed on to the shareholders of the parent company when a distribution is made to them. The Revenue argued unsuccessfully before the ECJ that, as no tax was paid in the United Kingdom on profits earned in other Member States, foreign-source dividends were not required to be exempt from ACT in order to avoid discrimination with domestic-source dividends. The ECJ considered that the payment of ACT was simply an advance payment of MCT. Accordingly it held by way of answer to question 2 in the order for reference that:

“Articles 43 EC and 56 EC 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 deduction is permitted in the case of a resident company receiving dividends from a non-resident company as regards the corresponding tax on distributed profits paid by the latter company in the state in which it is resident.”

The question whether the answer applies where the non-resident company making the distribution (that is, the EC water’s edge company) was exempt from tax in its country of residence was not put to the ECJ. The Judge, having heard argument, expressed the view that the Claimants were right to say that account should be taken of tax paid not just by the EC water’s edge company but also by its subsidiaries. He made the point that double taxation relief would in principle be available in that situation and this was a sufficiently close analogy for him to conclude that ACT should be treated as giving economic relief to the same extent. However, he took the view that the answer to this question was not so clear that he could provide it himself. Mindful of the fact that over £1bn might turn on his answer, he unsurprisingly considered that he should make a further reference to the ECJ. This was a provisional conclusion, and he was not inclined to make an order for reference if there was an appeal (judgment, paragraph [450]). There is therefore no order for reference on this point. Each party has sought to persuade us on this appeal that the answer to the question is so obvious that no reference is required.

The conclusions of the Judge which expressed the preliminary view in favour of the Claimants are to be found in paragraphs [139] to [141] of his judgment:

“[139] My own view, which I express briefly and with considerable hesitation, is that as a matter of Community law Mr Aaronson's submissions are to be preferred. The governing principle of relieving or mitigating economic double taxation of dividends is a powerful one, whereas the corporate tree points are technical in nature and depend, it may be said, on a rather literal and blinkered approach to the ECJ's judgment. In the light of the governing principle, the situation expressly considered by the ECJ may be seen as a paradigm one, and a similar line of reasoning should in my judgment lead to the conclusion that there is also a breach of Articles 43 and 56 in situations where: (a) foreign underlying tax has been borne by lower-tier companies resident in a member state; and/or (b) the only reason why the UK company which receives the dividend is not itself liable to account for ACT when it pays the dividend on to its parent is that it makes the distribution under a group income election.

[140] As regards situations of type (a), the UK rules on double taxation relief provide a credit for such underlying tax, so if one accepts the ECJ's premise that the ACT system has the object of relieving economic double taxation, it seems logical to compare it with all factual situations where double taxation relief would in principle be available to the UK company which receives the foreign dividend. It is true that the UK rules for relief of double taxation are more sophisticated than the ACT regime, but the benefit of a payment of ACT can in practice be passed up a group in such a way that ACT is paid once only in respect of the same underlying profits. That provides a close enough analogy, to my mind, to justify a comparison with situations where underlying tax is paid by a lower-tier company and a higher-level company subsequently pays a dividend with the benefit of a credit for that underlying tax, even though it does not pay corporation tax itself.

[141] As regards situations of type (b), the ability to make group income elections only applies in situations where ACT would otherwise be payable, and its basic function is to enable the group to decide at what level in the corporate hierarchy ACT is to be paid. In my view the ability to make such elections cannot sensibly be segregated from the rest of the ACT regime, because it serves the same basic purpose of ensuring that ACT is paid once only within the group in respect of the same profits. It should not therefore matter, in the present context, whether the company which receives the foreign dividend itself pays ACT, or whether it pays the dividend to its parent under a group income election. Equally, it should not matter whether or not the company which receives the dividend happens to have FII available to it from other sources. The important point is that in all cases the foreign dividend is incapable of generating any relief from ACT in the hands of the recipient company, yet it will inevitably generate a liability to ACT at some point before it ultimately leaves the group. Viewed from a group perspective, therefore, it will give rise at some stage to an unrelieved charge to ACT within the group, in addition to the foreign tax which it has already borne at source. By contrast, UK profits which are paid up through the group are in practice liable to ACT once only, and they are then liable to a reduced charge to MCT because the ACT discharges an equivalent part of the MCT liability at the level at which it is paid. In other words, the former situation involves full economic double taxation, whereas the domestic UK regime does not.”

The Claimants contend that the principle behind the decision of the ECJ on Issue 1 was that a United Kingdom-resident company receiving foreign-source dividends had to be placed in the same position as a United Kingdom-resident company receiving domestic-source dividends. Thus account must be taken not simply of the tax paid by the EC water's edge company, but also by companies paying dividends to it.

The Revenue contends that there is no discrimination if the EC water’s edge company was exempt from tax in the jurisdiction in which the profits were taxed. The Revenue does not accept that an analogy should be drawn with double taxation relief.

The Claimants seek to uphold the decision of the Judge. They point out that the reason why the paying company is exempt in a domestic group is that a group income election is in force. A group income election can only apply to United Kingdom-resident companies. If there were no such election in force, ACT would be paid but would only be paid once.

We can state our conclusions briefly. The question is not simply, as the Claimants suggest, whether an additional burden is borne by foreign-source dividends that is not borne by domestic-source dividends. A Member State which decides to grant relief against economic double taxation is not required to eliminate all the consequences of it but it must not take any measures which amount to discrimination contrary to Article 43. As to the points made by the Judge in paragraph [141] of his judgment, we consider that it is for the ECJ to determine whether it would have given the same answer to question 2 where no tax was paid in the Member State of the company making the distribution, but the dividend had been paid out of profits earned in other Member States or indeed outside the European Union altogether. The answer is not obvious, and the question is one of Community law. It is also a question of considerable magnitude to the parties. In those circumstances the appropriate course is that there should be a reference to the ECJ on this Issue. In any event, as we indicated in argument to Mr Ewart we consider that as a matter of Community law there would in this case be difficulties in revoking any decision of the judge to refer a question to the ECJ (Case C-210/06 Cartesio [2008] ECR I-0000 at [93] - [98] and Case C-525/06 De Nationale Loterij NV v Customer Service Agency BVBA [2009] ECR I-0000 at [6] - [7]). Accordingly we will dismiss the appeal on this Issue.

This Issue is more conveniently dealt with under Remedies: see Issue 14 below.

We have reworded this Issue to make it clear that this question is about conforming interpretation, that is, the question whether the ACT provisions can be read in a manner which is compatible with Community law as declared by the ECJ in this case. It is well-established that the court must interpret a statute which is on the face of it inconsistent with Community law so far as possible so that it is compatible with Community law. This enables the court to read in words or limit provisions, provided that this can be done by the process of interpretation properly so called and does not go against “the grain” or cardinal features of the legislation: R (IDT Card Services Ireland Ltd) v Customs and Excise [2006] EWCA Civ 29, [2006] STC 1252; and Vodafone 2 v HMRC [2009] EWCA Civ 446, [2010] 2 WLR 288.

Attention has centred on ICTA section 231 which sets out the principal rule as to entitlement to a credit corresponding to the ACT paid. The question is whether that section can be read in conformity with Community law so that the entitlement to a tax credit is available not just to resident companies but also to all other persons entitled under Community law to be treated in the same way. The question is not important for the future administration of ACT because the Finance Act 2009 materially amended section 231. It is, however, important for the past so that the Claimants and others in their position know what domestic law would have permitted if it had been read compatibly with Community law.

At the material time, section 231(1) of ICTA provided:

“231.

Tax credits for certain recipients of qualifying distributions

(1)

Subject to sections 95(1)(b) and 247, where a company resident in the United Kingdom makes a qualifying distribution and the person receiving the distribution is another such company or a person resident in the United Kingdom, not being a company, the recipient of the distribution shall be entitled to a tax credit equal to such proportion of the amount or value of the distribution as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made.

(2)

Subject to section 241(5), a company resident in the United Kingdom which is entitled to a tax credit in respect of a distribution may claim to have the amount of the credit paid to it if –

(a)

The company is wholly exempt from corporation tax or is only not exempt in respect of trading income; or

(b)

The distribution is one in relation to which express exemption is given (otherwise than by section 208), whether specifically or by virtue of a more general exemption from tax, under any provision of the Tax Acts.”

At the hearing before the Judge, the Claimants put forward alternative conforming interpretations. These interpretations involved removing the qualifying requirement for a tax credit that the company making the distribution should be resident in the United Kingdom. The Revenue opposed these approaches on the grounds that they gave the company receiving the dividend a right to a tax credit irrespective of the amount of foreign tax paid by it. The Judge rejected the Revenue’s submissions, and held that either of the alternatives advanced by the Claimants would achieve compatibility with Community law. He held that, as a United Kingdom-resident company was entitled to a credit at the full rate even if it had in fact no liability to tax as a result of the reliefs to which it was entitled, there should similarly be an entitlement to a tax credit for foreign-source dividends, which should be treated as franked investment income in the hands of the recipient.

The Judge also considered that this interpretation would circumvent some of the practical difficulties that the Claimants would encounter in proving their claims, bearing in mind that the dividends in issue went back to 1973, and thus avoid a possible breach of the Community law principle of effectiveness.

The difficulty with the Judge’s approach is that it is liable to confer a windfall on taxpayers since it applies to all foreign-source dividends and not just those where Community law rights have been infringed. It is thus outside the scope of conforming interpretation unless mandated by the Community law principle of effectiveness (see generally Foster Wheeler v Hanley [2009] EWCA Civ 651, [2009] 3 CMLR 1645).

Accordingly the Claimants have on this appeal again relied on the Community law principle of effectiveness. This is a principle to which we shall refer again in the context of remedies. For present purposes it is sufficient to state that it applies in particular where Community law requires national law to lay down rules for the repayment of tax levied but not due. To comply with the principle of effectiveness, the national rules must not render virtually impossible or excessively difficult the exercise of a right to repayment conferred by Community law. This principle may result in rules of domestic law, whether they are rules of adjectival law (such as the law of evidence) or substantive law (such as rules as to the conditions that must be satisfied before a tax repayment can be made) being set aside in order to ensure that rights conferred by Community law are effective.

The Claimants’ concern is that given that there were no relevant tracing or matching rules at the time it would be impossible to trace dividends once they were distributed by EC water’s edge companies to the United Kingdom group. The Revenue, however, contend that, if the Claimants seek reimbursement or reparation for an infringement of their Community rights, it is for them to prove their claim in accordance with the normal rules of national law.

We do not consider that the principle of effectiveness affects the interpretation of a statute in circumstances such as arise in the present case. All the Court is entitled and bound to do is to see whether section 231 can be read so that the right to a credit which is conferred extends not only to those expressly mentioned in section 231, namely resident companies, but also takes into account the rights of persons under Community law. Once that question is answered and the interpretation is given, the task of conforming interpretation is at an end. There is no further test to be applied about the ease of enforcing the rights thereby conferred or protected because persons entitled to tax credits as a matter of Community law are put on to the same footing under the section as other persons entitled to rely on the section as a matter of domestic law. True, the conforming interpretation in this case is ascertained with retrospective claims in mind. But even retrospective claims are not inevitably difficult to enforce, and the interpretation we prefer makes sense without taking account of the difficulties of enforcement that some beneficiaries of the new right will meet. In those circumstances we do not consider that the Judge’s interpretation can stand even with the arguments made on behalf of the Claimants.

There is a further reason for rejecting the Claimants’ submissions that section 231, as interpreted on the lines set out in the foregoing paragraph, would contravene the Community law principle of effectiveness. Their individual claims have not yet been made, and thus, although the Judge took the view that “it would in practical terms be impossible for any kind of accurate reconstruction to be made of the course that foreign dividends followed through the group over a period of some 25 years” (paragraph [153] of his judgment), we consider that that conclusion cannot properly be drawn at this stage. Thus the application of the effectiveness principle is best considered when those claims come to be made, and it may need to be considered on a case by case basis rather than as a general issue of principle under a GLO. If there is a breach of the principle of effectiveness, the court can then consider the appropriate remedy. The remedy could then be geared to ameliorating the evidential difficulties rather than altering substantive entitlements.

It therefore falls to this Court to determine the appropriate conforming interpretation. In our judgment, a conforming interpretation can be achieved simply by reading in words that make it clear that it is not just resident companies that can claim a credit under section 231 but also other persons entitled to do so by Community law to the extent that they are so entitled. The extent of that entitlement can then be investigated when the section falls to be applied, rather than the difficulties more properly arising at the point of application being erected as an objection to conforming interpretation. It will apply even if the extent of the entitlement is not fully ascertained until after the ECJ has answered any question put to it in a further reference.

This interpretation does not cut across “the grain” or cardinal features of section 231; had it done so, it would not have been appropriate to interpret section 231 in this way, even to make it Community law-compliant: see generally R (IDT Card Services Ireland Ltd) v Customs and Excise [2006] EWCA Civ 29, [2006] STC 1252 and Vodafone 2 v HMRC [2009] EWCA Civ 446, [2010] 2 WLR 288. Nor does section 231 contain features that would make it impossible to interpret it so as to make it compatible with Community law. There is no impediment therefore to applying the presumption that Parliament intended to comply with its obligation under the Treaty.

For these reasons, we would allow the appeal on Issue 6.

Question 3 in the reference for a preliminary ruling asked the ECJ whether it was “contrary to articles 43 EC or 56 EC for the Member State to keep in force and apply measures which provide for the ACT liability to be set against the liability of the dividend-paying company, and that of other companies in the group resident in Member State, to corporation tax in the Member State upon their profits". The ECJ answered this question at paragraph [139] of its judgment:

“Article 43 EC precludes legislation of a Member State which allows a resident company to surrender to resident subsidiaries the amount of advance corporation tax paid which cannot be offset against the liability of that company to corporation tax for the current accounting period or previous or subsequent accounting periods, so that those subsidiaries may offset it against their liability to corporation tax, but does not allow a resident company to surrender such an amount to non-resident subsidiaries where the latter are taxable in that Member State on the profits which they made there.”

At no point in its reasoning did the ECJ deal with the question whether non-resident companies could utilise surrendered losses against foreign profits. The Court states at paragraph [115] of its judgment that the arguments presented to the Court had been limited to the inability of a resident company to surrender surplus ACT to non-resident subsidiaries so that it could set off against the corporation tax which they were liable in respect of their United Kingdom activities. The Judge held that the ECJ was mistaken about this. The Revenue does not dispute that the Claimants advanced an argument that ACT should be available against foreign profits. In those circumstances, the Judge held that there should be a further reference to the ECJ.

Mr Ewart submits that there is no point in a reference because the answer is clear. He submits that the Claimants do not seek set off, but the equivalent right to set off, that is, the right to repayment of the ACT. This would be an additional advantage not enjoyed by groups of United Kingdom-resident companies. Mr Aaronson submits that the answer ought to be given in his client’s favour. He relies on passages from the opinion of the Advocate General.

It is accepted that the original question put to the ECJ was sufficiently wide to cover the possibility of a surrender of ACT to a foreign subsidiary which might wish to use the ACT so surrendered to it against foreign corporation tax. It is also clear from paragraph [115] of its judgment that the ECJ misunderstood the scope of the question put to it. The answer to the question is not obvious, and the question is one of Community law. We agree with the Judge that in the circumstances of this case the appropriate course is for there to be a reference to the ECJ and we accordingly dismiss the appeal on this Issue. Our observation in the penultimate sentence of paragraph [95] applies here also.

For the purposes of this Issue, it is sufficient to refer to the brief description of the FID regime in paragraphs [23] and [24] of Annex 2. Question 4 of the Order for Reference asked whether the FID regime was compatible with Articles 43 and 56 EC. In its answer, the ECJ held:

“Articles 43 EC and 56 EC preclude legislation of a Member State which, while exempting from advance corporation tax resident companies paying dividends to their shareholders which have their origin in nationally-sourced dividends received by them, allows resident companies distributing dividends to their shareholders which have their origin in foreign-sourced dividends received by them to elect to be taxed under a regime which permits them to recover the advance corporation tax paid but, first, obliges those companies to pay that advance corporation tax and subsequently to claim repayment and, secondly, does not provide a tax credit for their shareholders, whereas those shareholders would have received such a tax credit in the case of a distribution made by a resident company which had its origin in nationally-sourced dividends.”

The detail of the ECJ’s reasoning does not matter for present purposes. It is clear from the ECJ’s answer that the same issues arise with respect to FIDs as arose in relation to ACT under Issues 4 and 5. The Claimants contend that it should be decided in their favour but we consider that in the circumstances the appropriate course is that proposed by the Judge, namely that there should be a reference to the ECJ on these matters. Our observation in the penultimate sentence of paragraph [95] applies here also.

In addition to the summary of the FID regime contained in paragraphs [23] to [25] of his judgment, the Judge gave the following description of the FID regime:

“[165] The governing legislation in ICTA sections 246A to 246Y was long and complex, but it is unnecessary for me to refer to it in any great detail. A helpful thumbnail sketch may be found in Moores Rowland's Yellow Tax Guide for 1995–96 (Butterworths), Pt I, Commentary on Statutes, pp 120–122, to which I was referred by Mr Aaronson. I will, however, mention some aspects of the legislation upon which Mr Aaronson placed particular emphasis.

[166] The starting point is that where a company resident in the UK paid a dividend in cash, it could elect that the dividend should be treated as a FID: sections 246A(1) and (2). An election could not be made unless it was made in respect of all the dividends on the same class of share; and where a company had more than one class of share capital, ignoring any fixed-rate preference shares, it could only elect for a dividend to be a FID if it paid a dividend at the same time, and on the same terms, in respect of each share of each class, and opted for each of those dividends to be a FID: sections 246A(4) to (9). It follows from these provisions that a company could not elect, for example, that a dividend payable on a particular class of shares should be a FID for recipients who were liable to UK income tax, but not a FID for exempt shareholders. An election had to be made on an all or nothing basis. This point is of central importance to the issue of enhancement of FIDs, to which I will come later in this judgment in my discussion of remedies.

[167] The next important point is that an election had to be made to an inspector in an approved form no later than the time when the dividend was paid, and the election was then irrevocable after the dividend was paid: sections 246B(1). The company therefore had to commit itself to the FID regime before the dividend was paid, even though in many cases the company would not yet know for sure whether it had sufficient distributable foreign profit to match with the dividend.

[168] A FID did not carry a tax credit, nor was it treated as a franked payment made by the company: sections 246C and 246E. A FID received by an individual shareholder, personal representatives of a deceased individual or trustees of a discretionary trust was, however, treated as income which had borne income tax at the lower rate, although no claim could be made for repayment of any such tax: section 246D.

[169] Because a FID did not carry a tax credit, it could not generate FII in the hands of a corporate recipient. However, a company had to pay ACT only on the excess of the FIDs which it paid over the FIDs which it received in an accounting period: sections 246F(1) and (2). Furthermore, any excess of FIDs received over FIDs paid could be carried forward to the next accounting period and was then treated as a FID received in that period: section 246F(3). These provisions therefore produced a similar effect, within the FID regime, to the franking of franked payments by FII, and ensured that ACT had to be paid once only on a FID within the group.

[170] The rules for the matching of FIDs with distributable foreign profit were contained in sections 246J to 246M. 'Distributable foreign profit' was defined in sections 246I as, in effect, the amount of the company's foreign source profit after deducting the amount of foreign tax payable in respect of that profit or (if less) the amount of corporation tax payable in respect of the foreign profit before double taxation relief. The matching rules were relatively generous, and enabled a FID to be matched with distributable foreign profit of any subsidiaries in the current or preceding accounting period. An unmatched FID of the parent could also be matched with distributable foreign profit of the subsidiary in a subsequent period.

[171] Sections 246N, 246P and 246Q contained the provisions for repayment or set off of ACT which had been paid on FIDs during an accounting period. The drafting of these sections was exceedingly dense, but in very broad terms they provided for the repayment to the company of whichever was the lesser of:

(a)

the actual surplus ACT available to the company in the accounting period, and

(b)

the notional surplus ACT available to the company for the period in respect of the matched FIDs which it had paid,

the available amounts in each case being calculated on the basis of various assumptions and hypotheses. The critical point which Mr Aaronson emphasises is that the system did not provide for an automatic repayment of all of the ACT paid in respect of FIDs which had been matched, but only for the repayment of a surplus amount. In particular, the detailed provisions relating to set off meant, again in broad terms, that ACT (whether actual or notional) had to be set off against any MCT for which the company was liable before any repayment could be made.

[172] The basic structure of the provisions can be seen from the first four subsections of section 246N:

'(1) This section and section 246Q apply where—

(a)

a company pays a [FID] in an accounting period (the relevant period), and

(b)

…

(2)

In a case where—

(a)

the company pays an amount of [ACT] in respect of qualifying distributions actually made by it during the relevant period,

(b)

the amount, or part of it, is available to be dealt with under this section, and

(c)

there is as regards the company an amount of notional foreign source [ACT] for the relevant period,

an amount of the [ACT] paid shall be repaid to the company, or set off, or partly repaid and partly set off, in accordance with this section and section 246Q.

(3)

In the following provisions of this section “the relevant [ACT]” means the [ACT] paid as mentioned in subsection (2)(a) above.

(4)

The amount of the relevant [ACT] to be repaid or (as the case may be) set off, or partly repaid and partly set off, is whichever of the following is smaller—

(a)

so much of the relevant [ACT] as is available to be dealt with under this section;

(b)

so much of the relevant [ACT] as is equal to the amount which is, as regards the company, the amount of notional foreign source [ACT] for the relevant period (found under section 246P).'

The remainder of section 246N then provided the rules for determining how much of the relevant ACT was available to be dealt with under the section, while section 246P said how notional foreign source ACT was to be calculated. The smaller of the amounts so found was then available in principle for repayment or set off, and section 246Q(2) provided that it must first be set off against any unpaid liability to MCT:

'(2) If at the time when it falls to be determined whether the amount mentioned in subsection (1) above is to be repaid or set off—

(a)

[ACT] paid (or treated for the purposes of section 239 as paid) by the company in respect of distributions made by it in the relevant period has so far as possible been set against its liability to [MCT] for the period under section 239(1), but

(b)

the company's liability to [MCT] for the period is to any extent undischarged,

the amount mentioned in subsection (1) above shall so far as possible be set off against the company's liability to [MCT] for the relevant period (and an amount of that liability equal to the amount so set off shall accordingly be discharged); and any excess of the amount mentioned in subsection (1) above over the amount so set off shall be repaid.'

Subsection 246Q(3) then provided that where ACT had been paid, and there was no outstanding liability to MCT, 'the whole of the amount mentioned in subsection (1) above shall be repaid.'”

The FID regime applied to dividends received from companies resident in Third Countries. We gratefully adopt the Judge’s description of it. Neither party to this appeal has suggested that the Judge’s description of the regime is in any material respect inaccurate.

The question that we have to decide under this Issue is whether Article 56 applies to the FID regime. We have already set out the principles that determine the application of that Article in [44] to [70] of this judgment. We concluded that Article 56 is capable of applying where the factual situation concerns distributions to a parent country resident in a Member State from a wholly-owned subsidiary resident in a Third Country unless the legislation is directed at establishment or its practical effect exclusively or primarily relates to establishment, that is, situations where the shareholder exercises a definite influence over the decisions of the company and to determine its activities.

Applying these principles to the FID regime, we consider that there is no ground for holding that Article 56 does not apply to it. In those circumstances it follows from the answer given by the ECJ to question 4 (see paragraph [52] above) that, unless Article 57(1) applies (see Issue 10 below), Article 56 was infringed.

Article 57(1) is set out in Annex 1. We have already described the jurisprudence on the meaning of “restriction” for the purposes of Article 57 under Issue 3 above (see paragraphs [71] to [88] above).

The question here, as in Issue 3, is whether the introduction of the FID regime amounted to a new restriction so that the United Kingdom could not rely on the standstill provision in Article 57(1). The ECJ noted that the objective of the FID regime was to limit the restrictive effects arising from the existing legislation for resident companies receiving foreign-source dividends. In particular, it offered companies the opportunity to obtain a repayment of surplus ACT when they paid dividends to their own shareholders. The ECJ left it to the national court to determine the question whether Article 57(1) applied, with the following observations:

“[194] It is, however, for the national court to determine whether the fact that, as the claimants in the main proceedings point out, shareholders receiving a FID are not entitled to a tax credit, must be regarded as a new restriction. While it is true that, in the national system of which the FID regime forms part, the grant of such a tax credit to a shareholder receiving a distribution is the counterpart of the payment by the company making the distribution of the ACT on that distribution, it cannot be inferred from the description of the national tax legislation provided in the order for reference that the fact that a company which has elected to be taxed under the FID regime is entitled to be reimbursed surplus ACT justifies, under the logic governing the legislation which existed on 31 December 1993, its shareholders not being entitled to any tax credit.”

The Judge considered that the FID regime created a new restriction because, while it provided a method of reducing ACT surpluses built up by groups in receipt of foreign-source dividends, it did not provide any tax credit. The ACT released had first to be set against the resident company’s liability for MCT, and would only then be repaid. The Judge concluded that the FID regime involved a new restriction and that the United Kingdom had forfeited the protection of Article 57(1) by introducing the FID regime, even though that regime was intended to mitigate the ACT consequences of the regime otherwise applicable to foreign dividends (judgment, paragraph [190]).

On this appeal the Revenue challenges the Judge’s conclusion. Mr Ewart submitted that the question referred to the national court by the ECJ could be answered by reference to the decision in the House of Lords in Pirelli Cable Holding NV v IRC [2006] UKHL 4, [2006] 2 All ER 81. On his submission, that decision showed that there was an inextricable link between the payment of ACT and the receipt of a tax credit. The issue was whether, if it were unlawful for a subsidiary and its non-United Kingdom resident parent company to make a group income election, the tax credits envisaged under the relevant double taxation conventions would not be payable. Lord Nicholls, Lord Hope and Lord Walker each held that there was a link between the tax credit and the payment of ACT. Lord Nicholls said that “this unspoken linkage” lay at the heart of the legislative scheme. Lord Hope also held that the prerequisite for the giving of a tax credit was the making of the qualifying distribution, which was liable to ACT ([39]). He added that “A group income election extinguished that liability and with it the right to the tax credit that was that the counterpart of the liability” ([39]). Lord Walker also held that, if the payment of a dividend was not accompanied by a payment of ACT, the dividend would not give rise to a tax credit ([103]). It followed, on Mr Ewart’s submission, that it was consistent with the legislative scheme for ACT to deny a tax credit where ACT was about to be repaid.

The Judge distinguished the passages in Pirelli on the basis that the FID regime denied any tax credit to shareholders of the parent company even though it did not provide for the automatic reimbursement of the ACT which was paid, and instead gave priority to the setting off of ACT, which would otherwise be repayable, against any outstanding ability to MCT (judgment, paragraph [190]).

Mr Ewart submits that the Judge fundamentally misunderstood the purpose of the FID regime, and the reason why companies chose to pay dividends as FIDs rather than as normal dividends. By using the FID regime, companies could reduce their ACT surplus by allowing the unutilised ACT to be repaid. Companies could, therefore, pay both FIDs (which they would do if they would otherwise have unutilised ACT) and ordinary dividends in the same year. A FID did not carry a tax credit, since it was intended and was the case in practice that a FID was used only in cases where the company calculated that the ACT would not be used and would therefore be repaid in full. If FIDs had always carried a tax credit, the result would have been that all payments of dividends would have been made as FIDs, thus entitling shareholders to tax credits even though most or all of the ACT was subsequently be repaid. This would break the “unspoken linkage" between the payment of ACT and entitlement to a tax credit.

Mr Aaronson sought to uphold the Judge’s judgment. He submitted that the FID scheme linked the repayment of ACT to distributable profits and that the refusal of a tax credit was not linked to the repayment of ACT. He further submitted that the FID scheme contained restrictions that meant that, if the effective rate of foreign corporation tax were less than the United Kingdom MCT, there would be ACT which would not be eligible for repayment. There was no automatic right to payment of ACT where the FID was paid and the tax credit lost. Mr Thomas David Bilton, who gave evidence on the Claimants’ behalf, stated that:

Mr Bilton’s evidence on this point was not contested. The Revenue adduced no evidence and merely contended that it was not relevant that it might not work out in practice that the ACT would not be repaid. That was not what was intended to happen.

In sum, Mr Aaronson submitted that the removal of the tax credit where a dividend was paid as a FID did not follow the logic of the ACT arrangements. He submitted therefore that the fact that shareholders were not entitled to any tax credit was a new restriction.

The question that the ECJ required the national court to consider was whether the FID scheme justified the absence of a tax credit for shareholders. The fact is that a company could fall between two stools. There was nothing which prevented it from electing to make a FID and then finding that it could not in fact obtain repayment of ACT under the restrictions applying to the foreign tax admitted for FID regime purposes. No doubt this would not happen to a company that was well advised, and could be avoided with planning. Nonetheless the circumstances postulated could occur. The company would have paid ACT and not be able to claim repayment of that ACT, and yet the dividend paid by it would carry no tax credit. That was inconsistent with the logic of the legislation as it did not respect the "unspoken" link between the payment of ACT and the entitlement to a tax credit. Thus there was a new approach and new restriction in the FID regime, which meant that Article 57(1) did not apply to it.

We would dismiss the appeal on this point.

In this part of the judgment, we deal with particular issues concerning remedies, namely: the extent of the remedies that Community law requires in connection with the taxes that were unlawfully charged (Issue 11); the nature of the equivalent remedies in English law (Issue 12); the remedies (if any) required in respect of reliefs utilised in consequence of the unlawful charge to tax (Issue 13) and in respect of ACT paid by the upstream parent of the United Kingdom water’s edge company (Issue 14); whether a defence of change of position is available to the Revenue (Issues 15, 16 and 17); whether the United Kingdom is liable in damages to the Claimants for its breaches of Community law (Issues 18 and 19); and various issues relating to statutory provisions limiting liability (Issues 20-23). On the restitutionary claims, the Claimants’ main submissions were made at the hearing of the appeal by Mr David Cavender with the Claimants’ submissions on the other remedy issues being made by Mr Aaronson.

In addition to a cause of action in damages for serious breach of Community law, Member States are required to provide persons with an effective restitutionary remedy for repayment of charges levied in breach of Community law. Such restitutionary claims are commonly called San Giorgio claims, by way of a shorthand reference to the principles applied by the ECJ in Case 199/82 Amministrazione delle Finanze dello Stato v San Giorgio SpA [1983] ECR 3595 and other cases.

It is common ground that, subject to the Revenue’s defences which we consider below, the Claimants’ San Giorgio claims include the right to recover in restitution unlawfully levied corporation tax together with interest and any penalties paid in relation to that tax and losses constituted by the unavailability of sums paid as a result of tax levied prematurely. Mr Cavender submitted that the reliefs that had been utilised by the Claimants against their liabilities for unlawfully exacted ACT could also be the subject of restitution claims under both Community and English law. Mr Ewart submitted that such reliefs cannot be the subject of a claim in restitution either under Community or English law.

Of the two remedies potentially available to the Claimants, restitution and compensatory damages, the Claimants seek to maximise the scope of their right to restitution. The reasons are obvious. First, their claim for damages requires them to establish that the Revenue’s breach of their Community rights was sufficiently serious. As the Advocate General and the ECJ made clear, and will be discussed below, that is a particularly high hurdle in the present case. The claim for restitution is not subject to this requirement. Secondly, and as will be discussed below, there may be different limitation provisions applicable to these claims.

Mr Cavender submitted that realism requires the Court to be generous in defining the scope of their restitution claim. He referred to the obstacle to their recovery of compensation posed by the requirement of a sufficiently serious breach. If their restitution claim is unduly restricted, this obstacle may, he submitted, prevent the Claimants from obtaining just and effective satisfaction.

The Advocate General would seem to have supported this submission in paragraph [134] of his opinion:

“[134] In principle, it is for the national court to decide how the various claims brought should be characterised under national law. However, as I observed above, this is subject to the condition that the characterisation should allow the test claimants an effective remedy in order to obtain reimbursement or reparation of the financial loss which they had sustained and from which the authorities of the member state concerned had benefited as a result of the advance payment of tax. This obligation requires the national court, in characterising claims under national law, to take into account the fact that the conditions for damages as set out in Brasserie du Pêcheur may not be made out in a given case and, in such a situation, ensure that an effective remedy is nonetheless provided.”

We do not agree, and we are clear that the ECJ rejected this approach. The ECJ established the requirement of a sufficiently serious breach because it considered it just to do so. The difficulty that this creates for the Claimants is not an acceptable basis for striving to circumvent the requirement by enlarging the scope of a remedy that is not subject to this requirement. A claimant who cannot establish a sufficiently serious breach is not for this reason deprived of an effective remedy: he is not entitled to an effective remedy.

In paragraph [28] of his opinion in the present case, the Advocate General set out the questions relating to remedies in the Order for Reference:

“6.

In the event of any of the measures set out in Questions 1 to 5 being in breach of any of the Community provisions referred to herein, then in circumstances where the resident company or other companies in the same group of companies make the following claims in respect of the relevant breaches;

(i)

a claim for the repayment of corporation tax unlawfully levied in the circumstances to which Question 1 relates;

(ii)

a claim for the reinstatement (or compensation for the loss) of reliefs applied against the corporation tax unlawfully levied in the circumstances to which Question 1 relates;

(iii)

a claim for repayment of (or compensation for) ACT which could not be set off against the company's corporation tax liability or otherwise relieved and which would not have been paid (or would have been relieved) but for the breach;

(iv)

a claim, where the ACT has been set off against corporation tax, for loss of use of money between the date of payment of the ACT and such set-off;

(v)

a claim for repayment of corporation tax paid by the company or by another group company where any of those companies incurred a corporation tax liability by disclaiming other reliefs in order to allow its ACT liability to be set off against its corporation tax liability (the limits imposed on set-off of ACT resulting in a residual corporation tax liability);

(vi)

a claim for loss of use of money due to corporation tax having been paid earlier than would otherwise have been the case or for reliefs subsequently lost in the circumstances set out in (v) above;

(vii)

a claim by the resident company for payment of (or compensation for) surplus ACT which that company has surrendered to another company in the group and which remained unrelieved when that other company was sold, demerged or went into liquidation;

(viii)

a claim, where ACT has been paid but subsequently reclaimed under the provisions described in Question 4, for loss of use of money between the date of payment of the ACT and the date on which it was reclaimed;

(ix)

a claim for compensation where the resident company elected to reclaim the ACT under the arrangements described in Question 4 and compensated its shareholders for the inability to receive a tax credit by increasing the amount of the dividend,

in respect of each of those claims set out above, is it to be regarded as:

a claim for repayment of sums unduly levied which arise as a consequence of, and adjunct to, the breach of the above-mentioned Community provisions; or

a claim for compensation or damages such that the conditions set out in Joined Cases C-46/93 and C-48/93 Brasserie du Pêcheur and Factortame must be satisfied; or

a claim for payment of an amount representing a benefit unduly denied?

7.

In the event that the answer to any part of Question 6 is that the claim is a claim for payment of an amount representing a benefit unduly denied:

(i)

is such a claim a consequence of, and an adjunct to, the right conferred by the above-mentioned Community provisions; or

(ii)

must conditions for recovery laid down in Joined Cases C-46/93 and C-48/93 Brasserie du Pêcheur and Factortame be satisfied; or

(iii)

must some other conditions be met?

8.

Does it make any difference to the answers to Questions 6 or 7 whether as a matter of domestic law the claims referred to in Question 6 are brought as restitutionary claims or are brought or have to be brought as claims for damages?

9.

What guidance, if any, does the Court of Justice think it appropriate to provide in the present case as to which circumstances the national court ought to take into consideration when it comes to determine whether there is a sufficiently serious breach within the meaning of the judgment in Joined Cases C-46/93 and C-48/93 Brasserie du Pêcheur and Factortame, in particular as to whether, given the state of the case law of the Court of Justice on the interpretation of the relevant Community provisions, the breach was excusable or as to whether in any particular case there is a sufficient causal link to constitute a "direct causal link" within the meaning of that judgment?”

The Advocate General addressed these questions from paragraph [125] of his opinion. For present purposes, the relevant part of his opinion begins at paragraph [132]:

“[132] In the present case, it seems to me that, with one exception, the claims described in the national court's sixth question should be considered equivalent to claims for recovery of sums unduly paid, that is to say, claims for recovery of charges unlawfully levied within the meaning of the court's case law, which the UK is in principle obliged to repay. The underlying principle should be that the UK should not profit and companies (or groups of companies) which have been required to pay the unlawful charge must not suffer loss as a result of the imposition of the charge. As such, in order that the remedy provided to the test claimants should be effective in obtaining reimbursement or reparation of the financial loss which they had sustained and from which the authorities of the member state concerned had benefited, this relief should in my view extend to all direct consequences of the unlawful levying of tax. This includes to my mind: (1) repayment of unlawfully levied corporation tax (Questions 6(i), (iii) and (vii)); (2) the restoration of any relief applied against such unlawfully levied corporation tax (Question 6(ii)); (3) the restoration of reliefs foregone in order to set off unlawfully levied corporation tax (Question 6(v)); (4) loss of use of money insofar as corporation tax was, due to the breach of Community law, paid earlier than it would otherwise have been (Questions 6(iv), (vi), and (viii)). In each case, it would be for the national court to satisfy itself that the relief claimed was a direct consequence of the unlawful levy charged.

[133] On this point, I am not convinced that the head of claim outlined in Question 6(ix) should qualify as equivalent to a claim for repayment of charges unlawfully levied. The test claimants essentially argue that the UK's discriminatory failure to grant equivalent imputation credits to shareholders of UK companies receiving FIDs caused those companies to enhance their distributions to compensate these shareholders. However, it does not seem to me that such actions on the part of the distributing company to increase the amount of distributions should be considered to be a direct consequence of the UK's unlawful failure to grant an equivalent credit to the shareholders. Rather, the direct consequence of this failure is simply the extra tax levied on those shareholders than would have been the case had the UK complied with its Community law obligations--which loss is suffered by the shareholders, and not the distributing companies. In contrast, any increase by these companies in the amount of dividend distributed to its shareholders does not seem to me to follow inevitably from the denial of tax credit, nor it is possible without more to conclude that the distribution of an increased dividend necessarily qualifies as a loss incurred for the distributing companies.”

Thus the Advocate General supported the claim in question 6(ii) for reinstatement of reliefs applied against unlawful corporation tax. The ECJ addressed the issues raised in questions 6 to 9 in paragraph [197] and following:

“[197] By Questions 6 to 9, which should be considered together, the national court essentially asks whether, in the event that the national measures referred to in the preceding questions are incompatible with Community law, claims such as those brought by the claimants in the main proceedings in order to remedy that incompatibility should be classified as claims for the repayment of sums unduly levied or benefits unduly claimed or, conversely, as claims for compensation for damage suffered. In the latter case, it asks whether it is necessary to satisfy the conditions laid down in the Brasserie du Pêcheur and Factortame judgment and, if so, whether account should be taken of the form in which such claims must be brought under national law.

[198] As regards the application of the conditions in which a member state is liable to make reparation for the loss and damage caused to claimants as a result of an infringement of Community law, the national court asks the court to provide guidance as to the need for a sufficiently serious breach of Community law and the need for a causal link between the breach of the obligation imposed on the member state and the loss and damage suffered by those affected.

[199] The claimants in the main proceedings argue that each of the claims referred to in Question 6 falls to be categorised as a claim for repayment, both because those claims seek repayment of the excess tax that was unlawfully levied or of the loss arising from the loss of use of money due to premature payment of taxes, and because those claims seek reinstatement of tax reliefs or reimbursement of the amount by which the resident companies concerned had to increase the amount of FIDs in order to compensate for the lack of any tax credit in the hands of their shareholders. Should Community law provide that only a claim for damages was competent under national law, such a claim would, in any event, be a different type of claim from that which formed the subject matter of Brasserie du Pêcheur and Factortame.

[200] Conversely, the UK government contends that each of the remedies sought by the claimants in the main proceedings constitutes a claim for damages which is subject to the conditions laid down in Brasserie du Pêcheur and Factortame. The way in which those claims were brought under national law has no bearing on how they are to be classified in Community law.

[201] It must be stated that it is not for the court to assign a legal classification to the actions brought before the national court by the claimants in the main proceedings. In the circumstances, it is for the latter to specify the nature and basis of their actions (whether they are actions for repayment or actions for compensation for damage), subject to the supervision of the national court (see Metallgesellschaft, paragraph 81).

[202] However, the fact remains that, according to established case law, the right to a refund of charges levied in a member state in breach of rules of Community law is the consequence and complement of the rights conferred on individuals by Community provisions as interpreted by the court (see, inter alia, Case 199/82 Amministrazione delle Finanze dello Stato v San Giorgio SpA [1983] ECR 3595, paragraph 12, and Metallgesellschaft and Others, paragraph 84). The member state is therefore required in principle to repay charges levied in breach of Community law …

[203] In the absence of Community rules on the refund of national charges levied though not due, it is for the domestic legal system of each member state to designate the courts and tribunals having jurisdiction and to lay down the detailed procedural rules governing actions for safeguarding rights which individuals derive from Community law, provided, first, that such rules are not less favourable than those governing similar domestic actions (principle of equivalence) and, secondly, that they do not render virtually impossible or excessively difficult the exercise of rights conferred by Community law (principle of effectiveness) …

[204] In addition, the court held in paragraph 96 of its judgment in Metallgesellschaft, that, where a resident company or its parent have suffered a financial loss from which the authorities of a member state have benefited as the result of a payment of advance corporation tax, levied on the resident company in respect of dividends paid to its non-resident parent but which would not have been levied on a resident company which had paid dividends to a parent company which was also resident in that member state, the Treaty provisions on freedom of movement require that resident subsidiaries and their non-resident parent companies should have an effective legal remedy in order to obtain reimbursement or reparation of the loss which they have sustained.

[205] It follows from that case law that, where a member state has levied charges in breach of the rules of Community law, individuals are entitled to reimbursement not only of the tax unduly levied but also of the amounts paid to that state or retained by it which relate directly to that tax. As the court held in paragraphs 87 and 88 of Metallgesellschaft, that also includes losses constituted by the unavailability of sums of money as a result of a tax being levied prematurely.

[206] In so far as the rules of national law governing the availability of tax relief have prevented a tax, such as ACT, levied in breach of Community law, from being recovered by a taxpayer who has accounted for it, the latter is entitled to repayment of that tax.

[207] However, contrary to what the claimants in the main proceedings contend, neither the reliefs waived by a taxpayer in order to be able to offset in full a tax levied unlawfully, such as ACT, against an amount due in respect of another tax, nor the loss and damage suffered by resident companies which elected to be taxed under the FID regime because they saw themselves as having to increase the amount of their dividends so as to compensate for the lack of a tax credit in the hands of their shareholders, can form the basis of an action under Community law for the reimbursement of the tax unlawfully levied or of sums paid to the member state concerned or withheld by it directly against that tax. Such waivers of relief or increases in the amount of dividends are the result of decisions taken by those companies and do not constitute, on their part, an inevitable consequence of the refusal by the UK to grant those shareholders the same treatment as that afforded to shareholders receiving a distribution which has its origin in nationally-sourced dividends.

[208] That being the case, it is for the national court to determine whether the waivers of relief or the increases in the amount of dividends constitute, on the part of the companies concerned, financial losses suffered by reason of a breach of Community law for which the member state in question is responsible.”

Mr Cavender submitted that, subject to the specific issue of enhancement of FIDs, the ECJ was applying in paragraphs [205] to [207] of its judgment the same broad principle as the Advocate General in paragraph [132] of his opinion. Mr Cavender distinguished between two different groups of relief. He placed in one category ACT, group relief and management expenses, all of which were set off pound for pound against the unlawful Case V charge. All of those, he submitted, are recoverable pursuant to the principles in paragraphs [205] and [206] of the ECJ’s judgment. He accepted that, on the other hand, disclaimers of capital allowances and enhanced payments of FIDs were held in paragraph [207] of the ECJ’s judgment not to be San Giorgio claims protected by Community law.

Mr Cavender said that the general background to the ECJ’s judgment in this case on this issue was the decision of the ECJ in Case C-397/98 Metallgesellschaft Ltd and Ors and Hoechst AG and Hoechst (UK) Ltd v Commissioners of Inland Revenue, HM Attorney General [2001] ECR I-1727. In that case the ECJ, having found that it was contrary to Community law that United Kingdom subsidiaries of companies in another Member State were required to pay ACT (in effect an advance payment of MCT) whereas resident subsidiaries of United Kingdom parent companies were able to avoid that requirement, held that the taxpayers were entitled to interest on the tax paid on the date of its premature payment until the date on which MCT fell due. That was a recognition that Community law requires recovery of more than just unlawful tax and penalties. Mr Cavender also submitted that the ECJ was fully aware of the different categories of reliefs which were in issue in this case. They were set out in paragraph [31(6)] of the ECJ’s judgment. Importantly, he said, they were described in the written observations of the Commission, whose position was that they were all San Giorgio claims, other than the enhanced FIDs.

Mr Cavender placed weight on the word “also”, where it twice appears in paragraph [205] of the ECJ’s judgment in this case, as highlighting something other than tax and interest. He submitted that “retained” in paragraph [205] must be a reference to retention of reliefs. He observed that the reference in paragraph [207] to the waiving of relief by the taxpayer “in order to be able to offset in full a tax levied unlawfully, such as ACT, against an amount due in respect of another tax” can only be referring to capital allowances, since the concept of “waiver” cannot apply to ACT, management expenses or group relief, which were all applied by way of set-off. By contrast, he submitted, it is legitimate to speak of those three reliefs as being transferred to, and retained by, the Revenue within the meaning of paragraph [205] since, once utilised, they were no longer available to the taxpayer to reduce tax in the future. He said that the Revenue therefore benefited because it would receive more tax in the future than would otherwise have been the case. Mr Cavender also observed that paragraph [208] of the ECJ’s judgment refers only to “waivers of relief” and increases in FIDs, which supports the Claimants’ restrictive interpretation of paragraph [207], and indicates that, on the Revenue’s interpretation of paragraph [205], there would be a lacuna in paragraphs [205] to [208] in failing to deal with ACT, group relief and management expenses. He submitted that the true and overriding statement of principle is in paragraph [205], and that paragraph [207] was dealing only with issues of remoteness.

The Judge’s analysis and conclusions on those matters are conveniently stated in the following paragraphs of his judgment:

“[231] Mr Ewart submitted that the ECJ adopted a very different approach from the Advocate General in this part of the case, but I do not agree. It seems to me that if the court had disagreed in principle with the clearly stated views of the Advocate General about the potential width of the San Giorgio principle, they would have said so; and they would certainly not have confined their comments to the relatively narrow point whether the claims based on waiver of reliefs, as well as those based on the FID enhancements, fell outside the principle. The reasoning of the court in paragraphs 204 and 205 makes the point that the San Giorgio principle, as applied in Hoechst, extends not only to the repayment of tax unduly levied, but also to amounts paid to the State, or retained by it, "which relate directly to that tax". In Hoechst, the claim in question was for the time value of the ACT which had been levied prematurely. In my judgment, this passage reflects essentially the same approach as the Advocate General's view that the San Giorgio principle should "extend to all direct consequences of the unlawful levying of tax" (paragraph 132 of his opinion), and so understood it leads on naturally to the discussion which follows.

[232] Paragraph 206 of the judgment is very compressed, but I read it as directed principally to the recovery of surplus ACT which has been unlawfully levied and which the taxpayer company has been unable to utilise. The difference from Hoechst is that in these cases the claim is for recovery of the unlawfully levied tax itself, and is not a direct consequential claim for the time value of ACT which was levied prematurely (because UK domestic law did not allow the making of a group income election) but which the company concerned was subsequently able to set off against its MCT or utilise in some other way.

[233] Paragraph 207 then sets out the one point of substance on which the court differed from the Advocate General, namely how to characterise the waiver of relief claims. It will be recalled that these claims, as summarised in Question 6(v), relate to situations where a company disclaimed reliefs to which it would otherwise have been entitled (such as capital allowances) in order to set off surplus ACT against its MCT liability, and as a result of which it had to pay MCT on the relevant slice of its taxable profits at the difference between the MCT and ACT rates. The claims were therefore for recovery of part of the MCT which the company had paid, and which was itself (it must be assumed) lawfully levied.

[234] It is interesting to note that the ECJ did not deal with this point by saying that a claim in respect of lawfully levied tax would automatically fall outside the scope of the San Giorgio principle. Instead, they founded their decision on the point that, as with the enhancement of the FIDS, the waivers were "the result of decisions taken by those companies", and were not "an inevitable consequence" of the unlawful ACT regime. In other words, they saw the chain of causation as having been broken at the stage when these separate decisions were made.

[235] On the other hand, it is also clear, to my mind, that the test of causation for the recovery of consequential loss under the San Giorgio principle must be a strict one. The Advocate General used the phrase "direct consequences", and the ECJ used the phrase "an inevitable consequence" (in French, "une conséquence inévitable"). I do not regard these expressions as necessarily conflicting with each other, or as intended to provide an exhaustive definition. They reflect rather the need for a direct and unbroken causal link, and an approach to causation which is considerably more stringent than that applicable to a Factortame damages claim (where "it is for the national court to assess whether the loss and damage claimed flows sufficiently directly from the breach of Community law to render the State liable to make it good": see paragraph 218 of the judgment).

“[271].… In the present context, the ECJ has held that the waiver of reliefs in order to be able to offset a tax levied unlawfully, such as ACT, against an amount due in respect of another tax cannot form the basis of an action under Community law for reimbursement (paragraph 207 of the judgment). I do not find the intended scope of this exception altogether clear, and in particular I am puzzled by the reference to "unlawfully" levied ACT. If the ACT was levied unlawfully, it can be recovered in any event. It seems to me that the further claims under this head are concerned with the use of lawful ACT rather than unlawfully levied ACT. That point aside, however, it seems reasonably clear to me that this exception covers all of the claims in the present case which depend on a waiver of reliefs, or some other similar act, on the part of a claimant company. It therefore clearly covers the ACT claims which are based on disclaimed capital allowances; and I note that in the Eighth Amended Particulars of Claim these are in any event pleaded only as claims for compensation. The position with regard to the other ACT claims is less clear, but for the reasons which I have given I do not regard any of them as a direct, and still less as an inevitable, consequence of the unlawful charge to ACT. I therefore do not consider that they fall within the San Giorgio principle. It is important to note in this connection that, although the Advocate General said that all of the types of claim set out in Question 6 (apart from the FID enhancements) were potentially San Giorgio claims, he also said (at the end of paragraph 132 of his opinion) that in each case it would be for the national court to satisfy itself that the relief claimed "was a direct consequence of the unlawful levy charged". I do not understand the ECJ to have dissented in any way from that proposition, and their use of the word "inevitable" in paragraph 207 suggests, if anything, an even more stringent test.”

Mr Cavender submitted that the Judge was correct to agree with the Claimants that the ECJ was not differing materially from the principles endorsed by the Advocate General, save in relation to FIDs, but he said that the Judge was wrong in his application of the remoteness test.

We do not agree with the Claimants’ submissions on the meaning and effect of paragraphs [205] to [208] of the ECJ’s judgment for the following reasons.

The ECJ did not agree with the Advocate General’s view that the Claimants were entitled to the reliefs identified in paragraph [132(2)] and [(3)] of his opinion. It seems clear that the Advocate General was applying a much broader test in paragraph [132] of his opinion than the ECJ in paragraphs [205] and [207] of its judgment.

We consider that the principles in paragraphs [205] to [207] of the ECJ’s judgment are clear. Paragraph [205] holds that individuals are entitled to reimbursement of the unlawfully levied tax and any other amounts paid to or retained by the Member State which relate directly to that tax. That will include interest, under the Hoechst principle, and penalties. It also will include, in our judgment, ACT set against the unlawful Case V charge since the jurisprudence of the ECJ treats ACT as an advance payment of MCT.

The analysis in paragraph [207] of the ECJ’s judgment excludes from San Giorgio claims reliefs which do not constitute an inevitable consequence of the unlawful charge to tax, but are the result of discretionary tax planning or purely commercial decisions taken by the taxpayer companies. It is true that the language of paragraph [207] to describe such reliefs is not the language which would be used in our own jurisprudence. The expression “reliefs waived by a taxpayer in order to be able to offset in full the tax levied lawfully” is accepted by the Claimants as intended to apply to the disclaimer of capital allowances, but is not a technically accurate description of what was being done. The ECJ is plainly referring to “waiver” of reliefs in the opening lines of paragraph [207] in a non-technical descriptive sense. The use of group relief and management expenses to reduce tax was the result of tax planning and commercial decisions that were entirely within the discretion of the Claimants. They are, therefore, excluded from San Giorgio protection and relief by the principle in paragraph [207] of the ECJ’s judgment.

The same language as is contained in paragraphs [207] and [208] of the judgment of the ECJ in this case was used in paragraphs [113] and [114] of the judgment in Thin Cap. There was, however, no separate or independent reasoning on this aspect in Thin Cap, and so the reproduction of similar language in the judgment in that case carries the matter no further.

Accordingly we conclude that, in addition to reimbursement of tax paid pursuant to an unlawful Case V charge and of unlawful ACT, the claim in respect of ACT set against the unlawful Case V charge is also a San Giorgio claim, but the claims in respect of group relief and management expenses to reduce tax are not.

The Judge summarised the relevant restitutionary claims available to the Claimants in English law in paragraph [245] of his judgment as follows:

“[245] It is common ground that two types of restitutionary claim in English law are relevant in the present case. The first is a claim for restitution of tax unlawfully demanded under the principle established by the House of Lords in Woolwich Equitable Building Society v IRC [1993] AC 70 ("Woolwich"). The second, established by the decision of the House of Lords in DMG, is a restitutionary claim for tax wrongly paid under a mistake of law. The two types of claim are, at any rate as the law now stands, conceptually distinct and subject to differing requirements. As Lord Hoffmann pointed out in DMG at paragraph 21, English law as yet "has no general principle that to retain money paid without any legal basis (such as debt, gift, compromise, etc.) is unjust enrichment". Accordingly, a claimant in England "has to prove that the circumstances in which the payment was made come within one of the categories which the law recognises as sufficient to make retention by the recipient unjust" (ibid). So, for example, mistake is not a necessary ingredient of the Woolwich cause of action, whereas it is obviously a crucial ingredient of the second type of claim. Conversely, a Woolwich claim must involve, at least in some sense, the making of a demand by the Revenue, whereas there is no need for a demand in cases of the second type.”

The Judge accepted the Claimants’ submission that both causes of action are required in order to fulfil the United Kingdom’s obligation to provide a remedy for the Claimants’ San Giorgio claims. His reasons are set out in paragraph [260] of his judgment as follows:

“[260] In the first place, I am unable to accept Mr Ewart's submission that the Woolwich principle alone provides a sufficient UK remedy for claims which as a matter of Community law fall under the San Giorgio principle. As I have already explained, it seems to me that the Court of Justice has adopted a relatively wide view of the San Giorgio principle in the present case, whereas the Court of Appeal in NEC Semi-Conductors has strictly confined the ambit of the Woolwich cause of action to cases where the tax in question was itself unlawfully demanded. It has given no encouragement to attempts to broaden the concept of a "demand", or to permit recovery of losses which go beyond the unlawfully demanded tax and interest. I therefore agree with Mr Cavender that the UK cause of action in mistake-based restitution is also needed in order to provide an effective UK remedy for many San Giorgio claims. I also agree with him that, since the decision of the House of Lords in DMG, the Woolwich cause of action is likely to play a subsidiary role in cases such as the present one. Woolwich was decided in 1992, several years before the House of Lords overturned the "mistake of law" rule in Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349 ("Kleinwort Benson"), and before the House of Lords held in DMG that the Kleinwort Benson principle extended to wrongly paid tax. Mistake is not a necessary ingredient of the Woolwich cause of action. As Lord Hoffmann said in DMG at paragraph 13, it is indifferent as to whether the taxpayer paid the tax because he was mistaken, or for some other reason. Where mistake is present, however, a restitutionary claim based on the mistake is likely to cover all the ground that a Woolwich claim could cover, but also has the potential to extend considerably further.”

If that is correct, the Woolwich cause of action is not available in respect of the payment by the Claimants of unlawful ACT. This is because ACT was a self-assessed tax. It was not paid pursuant to a demand in the nature of an assessment raised by the Revenue. If, however, payment was not made on time, an assessment could have been raised and penalties could have been imposed.

It may seem counter-intuitive for the Claimants to be arguing for a narrower approach to Woolwich than the Revenue, but the reason is tactical. Woolwich claims are, generally speaking, subject to a 6 year limitation period. Restitutionary claims based on mistake are, generally speaking, subject to the extended limitation period under the Limitation Act 1980 section 32(1)(c).

As a preliminary observation, we record that neither side argued for the civilian or “absence of basis” approach to restitution advanced by the late Professor Peter Birks in his book Unjust Enrichment (2^nd ed., Oxford University Press, 2005). Under that approach, there is a single ground of restitution, namely that there is no explanatory basis for the enrichment of the defendant. It is to be contrasted with the existing jurisprudence, under which a specific ground of restitution must be identified and alleged, such as duress or, in the present case, mistake.

In our judgment, the Judge was wrong to reject the Revenue’s submission that Woolwich alone provides a sufficient United Kingdom remedy for the San Giorgio claims of the Claimants. He did so because he considered that he was bound by authority to hold that it is an essential ingredient of the Woolwich cause of action that the tax was paid pursuant to a “demand”. We consider that authority does not require a demand, and that it is sufficient that the State has exacted tax, which was not lawfully due, by voluntary compliance by the taxpayer with the legislative imposition of the tax.

As a matter of principle, we do not see why a demand should be a requirement of a Woolwich claim. The underlying principle is that the Revenue should repay tax that has been exacted without legal justification. We can see no reason why the cause of action should be confined to those taxes that are payable on demand as against those, such as VAT, that are payable without a demand. Moreover, it is impossible to see why the citizen who duly accounts for and pays, by way of example, VAT, without waiting for a demand, on the assumption that the applicable legislation is valid, should be disadvantaged as against the taxpayer who refuses to account or to pay until a peremptory demand is received.

Woolwich itself (Woolwich Equitable Building Society v IRC [1993] AC 70) concerned a tax that had been the subject of a demand. Counsel for Woolwich confined their submissions to the facts of their client’s case, and therefore formulated their proposed principle as a right of restitution on the part of a citizen who makes a payment in response to an unlawful demand for tax. It was therefore unnecessary for the House of Lords to consider whether the demand was an essential ingredient of the cause of action. Nevertheless, the reasoning of the majority of the Appellate Committee in Woolwich strongly supports the conclusion that a demand is not essential.

Lord Goff, at the very outset of his speech in Woolwich, poses the question in terms of “exaction of tax” at page 163C:

“The question which lies at the heart of the appeal is whether money exacted as taxes from a citizen by the Revenue ultra vires is recoverable by the citizen as of right”.

Similar language is used elsewhere in Lord Goff’s speech as follows:

“Woolwich … now adopts a similar stance about the obligations of the Revenue to repay tax exacted without lawful authority”. (page 163F).

“The … retention by the state of taxes unlawfully exacted is particularly obnoxious, because it is one of the most fundamental principles of our law – enshrined in a famous constitutional document, the Bill of Rights 1688 – that taxes should not be levied without the authority of Parliament; and full effect can only be given to that principle if the return of taxes exacted under an unlawful demand can be enforced as a matter of right.” (page 172E).

“In the end, logic appears to demand that the right of recovery should require neither mistake nor compulsion, and that the simple fact that the tax was exacted unlawfully should prima facie be enough to require its repayment.” (page 173E/F).

“… it is possible to envisage, especially in modern taxation law which tends to be excessively complex, circumstances in which some very substantial sum of money may be held to have been exacted ultra vires from a very large number of taxpayers.” (page 174 D/E).

Lord Goff was impressed with the reasoning of Wilson J in her dissenting judgment in Air Canada v British Columbia 59 DLR (4^th) 161, in which she considered that money paid under unconstitutional legislation was generally recoverable. She said as follows at page 169:

“The taxpayer, assuming the validity of the statute as I believe it is entitled to do, considers itself obligated to pay. Citizens are expected to be law-abiding. They are expected to pay their taxes. Pay first and object later is the general rule. The payments are made pursuant to a perceived obligation to pay which results from the combined presumption of constitutional validity of duly enacted legislation and the holding out of such validity by the legislature. In such circumstances I consider it quite unrealistic to expect the tax payer to make its payments ‘under protest’. Any taxpayer paying taxes eligible under a statute which it has no reason to believe or suspect is other than valid should be viewed as having paid pursuant to the statutory obligation to do so.

…[S]hould the individual taxpayer, as opposed to taxpayers as a whole, bear the burden of government’s mistake? I would respectfully) suggest that it is grossly unfair that X, who may not be (as in this case) a large corporate enterprise, should absorb the cost of government’s unconstitutional act. If it is appropriate for the courts to adopt some kind of policy in order to protect government against itself (and I cannot say that the idea particularly appeals to me), it should be one that distributes the loss fairly across the public. The loss should not fall on the totally innocent taxpayer whose only fault is that it paid what the legislature improperly said was due.”

Lord Goff expressed his agreement with those views at page 176D/E, as follows:

“I cannot deny that I find the reasoning of Wilson J most attractive. Moreover I agree with her that, if there is to be a right to recovery in respect of taxes exacted unlawfully by the Revenue, it is irrelevant to consider whether the old rule barring recovery of money paid under mistake of law should be abolished, for that rule can have no application where the remedy arises not from error on the part of the taxpayer, but from the unlawful nature of the demand by the Revenue. Furthermore, like Wilson J, I very respectfully doubt the advisability of imposing special limits upon recovery in the case of “unconstitutional or ultra vires levies”. ”

The principle described by Wilson J, and endorsed by Lord Goff, does not depend on anything in the nature of a formal demand by the Revenue. What is important is that the taxpayer pays “pursuant to a perceived obligation to pay which results from the combined presumption of constitutional validity of duly enacted legislation and of the holding out of such validity by the legislature” (in the words of Wilson J).

It is significant that Lord Goff refers to San Giorgio itself in terms of the unlawful levying of tax. He said at page 177C/E:

“I refer to the decision of the European Court of Justice, in Amministrazione delle Finanze dello Stato v S.p.A. San Giorgio (Case 199/82) [1983] ECR 3595, which establishes that a person who pays charges levied by a member state contrary to the rules of Community law is entitled to repayment of the charge, such right being regarded as a consequence of and an adjunct to, the rights conferred on individuals by the Community provisions prohibiting the relevant charges: see paragraph 12 of the judgment of the court, at p.3612.

…I only comment that, at a time when Community law is becoming increasingly important, it would be strange if the right of the citizen to recover overpaid charges were to be more restricted under domestic law than it is under European law.”

Lord Browne-Wilkinson agreed with the reasons given by Lord Goff for giving a right of recovery. He considered that there were two streams of authority “relating to moneys wrongly extracted by way of impost” (page 197E). He said that one stream is founded on the concept that money paid under an ultra vires demand for a tax or other impost has been paid without consideration; and the other is based on the notion that such payment has been made under compulsion, the relative positions and the powers of the two parties being unequal (page 197E/F). The latter does not, in our judgment, rest on the making of a formal demand, for the element of compulsion can be the fact that failure voluntarily to pay will ultimately result in some sanction. This is inevitably the case with self-assessment under the United Kingdom’s tax laws.

That was the approach of Kitto J in Mason v New South Wales 102 CLR 108 at page 129, who considered it sufficient that:

“the plaintiffs had quite enough compulsion upon them from the terms of the Act itself, apart from anything that may have been said or done by officers of government. Under that compulsion they parted with their money.”

That passage was quoted in Woolwich by Lord Slynn, who also referred to the “forceful judgment” of Wilson J in Air Canada v British Columbia at pages 169 to 170.

The Judge was wrong, in our judgment, to consider that he was bound by the Court of Appeal’s decision in NEC Semi-Conductors Ltd v Inland Revenue Commissioners [2006] EWCA Civ 25, [2006] STC 606 (affirmed on different grounds [2007] STC 1265) to hold that the Woolwich cause of action is restricted to cases where there has been an unlawful demand of tax. It is ironic that the taxpayer and the Revenue in NEC Semi-Conductors, represented by Mr Aaronson, leading Mr Cavender and Mr Farmer, and Mr Ewart respectively, were adopting on this point diametrically opposite positions to those they enthusiastically advanced before us. In NEC Semi-Conductors Mummery LJ, accepting the Revenue’s argument in that case, concluded that the Woolwich cause of action could not apply in relation to the payment of ACT, since ACT was not collected through the machinery of demand but by self-assessment. Mummery LJ considered that, in this respect, the Court of Appeal was bound by the judgment of Court of Appeal in Deutsche Morgan Grenfell Group plc  v Inland Revenue Commissioners and another [2006] UKHL 49, [2007] 1 AC 558 (“DMG”) to hold that tax can only be recovered under statutory provisions or where there has been an unlawful demand. We do, of course, give the judgments of the Court of Appeal in NEC Semi-Conductors, and particularly that of Mummery LJ who gave the lead judgment on this point, the greatest respect. His observations were, however, obiter. The point did not strictly arise for decision since the Court of Appeal held that the non-discrimination provisions in the relevant double taxation conventions, on which the Claimants relied for their allegation that the ACT provisions were unlawful, were not given effect in United Kingdom law. Furthermore, Mummery LJ’s statement, at paragraph [162], that “the claims in respect of overpaid or prematurely paid ACT can only succeed on the basis of Woolwich by establishing an unlawful demand for payment of ACT” elides two issues: whether the payment of ACT was lawfully due and whether it was demanded. Lloyd and Sedley LJJ agreed with Mummery LJ, and their judgments do not call for separate consideration.

DMG went to the House of Lords, but the question whether or not the Woolwich cause of action required a formal demand did not need to be decided and was not the subject of any scrutiny. The decision of the majority of the House of Lords was that under the common law a taxpayer who paid tax under a mistake of law was entitled to a restitutionary remedy against the Revenue; and the fact that the taxpayer might have a concurrent Woolwich cause of action, which had a shorter limitation period, did not prevent the taxpayer pursuing a claim based on mistake of law if the longer limitation period best suited the taxpayer’s interest.

Further, it is notable that Lord Walker appears to have taken care in DMG at paragraphs [135] and [140], as he later did in Sempra Metals Ltd v Inland Revenue Commissioners [2007] UKHL 34, [2008] 1 AC 561 at paragraph [162], to refer to the Woolwich cause of action as one concerning tax “unlawfully exacted” from the taxpayer.

Nor, in our judgment, does the decision of the Court of Appeal in DMG oblige us to hold that a Woolwich claim can only be brought if there was a formal demand. It was not necessary for the Court of Appeal to decide that point in answering the question before it. That question was described in paragraph [1] of the judgment of Jonathan Parker LJ in the following way:

“The instant appeal raises a question of general importance as to the scope of the principle established by [the decision in Kleinwort Benson] [sc. that a restitutionary claim lies in respect of money paid under a mistake of law]. The question is whether the principle applies where the payment in question is a payment to the revenue on account of a supposed liability to tax (in the instant case, advance corporation tax …). The appellants on this appeal contend that it does not apply to such a payment, given (a) that statute [viz. s.33 of the Taxes Management Act 1970] provides for the recovery of tax overpaid by error or mistake in certain, albeit limited, circumstances …; and (b) that, as the House of Lords held in Woolwich ... , a party who has made a payment to the revenue pursuant to an unlawful demand is entitled as of right to the restitutionary remedy, regardless of whether in making the payment the party was acting under a mistake of law.”

Accordingly, on this Issue, we conclude that there is no authority binding on us which requires the Woolwich cause of action to be limited to circumstances in which there has been a formal demand. The language used by the majority of the House of Lords in Woolwich, and the principles and policy endorsed by them, point away from such a limitation and support the application of Woolwich to any case where tax has been unlawfully exacted from a person by virtue of a legislative requirement, including compulsory self-assessment. It follows that the Woolwich cause of action provides an effective remedy for all the Claimants’ San Giorgio claims under Community law.

If, however, contrary to our conclusion, a wrongful demand is an essential ingredient of the Woolwich cause of action in a purely domestic case, that requirement must be displaced in the context of Community law. The San Giorgio principle requires our domestic law to provide an effective remedy for the repayment of unlawful tax. Neither the domestic Woolwich cause of action (if it is dependent on there having been an unlawful demand) nor the cause of action for monies paid under a mistake satisfy San Giorgio, the latter cause of action because it depends on the claimant having been mistaken when the payment was made. In these circumstances, the cause of action for the repayment of a tax unlawful under Community law must be held not to require an unlawful demand. In effect, that is Woolwich without the requirement of an unlawful demand.

The Claimants contend that English law provides relief for ACT, group relief and management expenses which were set off against the unlawful Case V charge. That was rejected by the Judge on the grounds of remoteness. He said:

“[264] These general reflections about the essentially subtractive nature of unjust enrichment claims lead me to be very wary of Mr Cavender's siren call to extend the frontiers of the law of unjust enrichment by allowing recovery, on a so-called incremental basis, for claims which go beyond the repayment of mistakenly paid tax and the reversal of directly associated benefits to the Revenue which can reasonably be seen as arising from the mistaken payment. In my judgment the "but for" test of causation has no role to play in this context, except as a minimum requirement for linking the mistake made by the claimant with the types of recovery that, as a matter of general principle, a restitutionary claim can properly encompass. In other words, it cannot itself be used as a test to define the types of loss which are recoverable, and thus to bring within the scope of the law of restitution the same types of consequential loss as a claimant suing in contract or tort (or, I would add, for breach of statutory duty) might hope to recover.”

“[270] … Consequential steps that were taken within the group to utilise surplus ACT, for example by setting it off against unlawful Case V corporation tax, or by setting it off against lawful corporation tax increased in amount by the disclaimer of capital allowances, may in principle give rise to a claim for compensation, subject to proof of loss and causation, and subject to a sufficiently serious breach being established; but they do not in my judgment give rise to a restitutionary claim, because the whole point of these steps was that tax was not paid to the Revenue, and any consequential enrichment of the Revenue cannot in my view be seen as a direct result, or concomitant, of any unlawful tax charge. So, for example, if lawfully paid ACT was used to offset an unlawful liability to Case V corporation tax, the result was that the company concerned did not pay corporation tax which, if it had done so, it would admittedly now be able to recover. If the Revenue was enriched at all, it was certainly not by the receipt of unlawfully levied corporation tax, but rather as a result of the group then having less ACT available to use for other purposes. An enquiry into whether (and if so how) such ACT would otherwise have been used within the group can in my judgment only form part of a claim for consequential loss. I do not see how it could be said that the Revenue was immediately and directly enriched at the group's expense by an amount equal to the ACT so used.”

Restitutionary claims for reimbursement in respect of the other reliefs were rejected on similar grounds in paragraphs [271] and [276] of the Judge’s judgment.

Mr Cavender relies on Sempra Metals, both in its result and in statements of principle contained in the speeches, in support of the proposition that the Revenue must restore the whole of the benefit of the enrichment which it has obtained by the unlawful tax regime: see, for example, paragraphs [31] (Lord Hope), [102] [112] and [119] (Lord Nicholls) and [178] (Lord Walker). Mr Cavender submitted, as we have already said, that the Revenue were enriched by the use of reliefs by the Claimants to reduce the unlawful Case V charge since those reliefs could and should have been available to reduce their tax burden in later years. The reliefs would have been available if the unlawful Case V charge had not been imposed and the Claimants had not been mistaken as to its lawfulness.

The Claimants also criticise the Judge’s application of the test for causation and remoteness in paragraph [264] of his judgment. He limited repayment to tax mistakenly paid and the reversal of “directly associated benefits to the Revenue which can reasonably be seen as arising from the mistaken payment”. Mr Cavender submitted that what should be reversed are the benefits to the Revenue reasonably arising from the mistake, rather than from “the mistaken payment”. He submitted that the proper approach would be to reverse all the direct consequences of the unlawful tax. When pressed to identify, by reference to the Statements of Case, the precise way in which the claims in respect of the reliefs are made, he produced the following four “constructs”:

“First Construct:

Mistake in year 1 that Case V tax valid and reliefs required to offset that unlawful tax. Benefit of reliefs actually transferred in year 1. Valuation of that benefit transferred calculated by reference to lawful tax paid in subsequent years which would otherwise have been set off by such reliefs.

Second Construct

As in (1) – but benefit transferred in year 2 (or subsequently) when more lawful tax paid than would otherwise have been paid but for the mistake in thinking the Case V charge was valid.

Third Construct

Mistake in year 2 (or subsequently) that reliefs had been validly used in year 1 when in fact due to the unlawfulness of the Case V charge such use was only purported. By reason of that mistake a benefit was transferred in year 2 (or subsequent years) when more lawful tax was paid than would have been the case but for such mistake.

In relation to this construct Test Claimants seek, in the alternative, a declaration in aid of the restitutionary cause of action.

Fourth construct

Whether or not there is a restitutionary remedy under (1) to (3) Test Claimants entitled to a declaration that:

(a)

the Case V charge to tax was unlawful.

(b)

In consequence the use of reliefs against such unlawful tax was purported.

(c)

In consequence such reliefs are available for use or to be carried forward.”

In our judgment, the only relief capable of being restored as an unjust enrichment is the application of ACT against the Case V charge. That is, for the reasons we have given, a San Giorgio claim, and is to be regarded as an advance payment of MCT. Utilisation of the other reliefs may have been a detriment to the Claimants, but did not represent a gain to the Revenue for the purpose of a restitutionary cause of action. The speeches in Sempra Metals emphasised that, for restitutionary remedies, it is the gain which is required to be measured, not the loss to the claimant: paragraphs [28] and [31] (Lord Hope), [119] (Lord Nicholls), [231] (Lord Mance). In Sempra Metals the benefit received by the Revenue was the time value of tax unlawfully exacted prematurely, that is to say the payment of the ACT was the equivalent of a massive interest free loan: paragraph [102] (Lord Nicholls).

Looking at the Claimants’ first construct, the effect of the reliefs in the present case was that the payment of less tax to the Revenue in year 1 than would otherwise have been the case. Plainly that was not a benefit to the Revenue in that year. Indeed, Mr Cavender was compelled to accept that, even on the Claimants’ case, there could have been no completed cause of action for unjust enrichment in year 1 because it would have been impossible to say at that point of time if, when and how much more tax would be paid in future years, if the reliefs had not been applied in year 1. That would depend on a number of variables, including what profits were made, when they were made and by which companies and how the Claimants would then be likely to apply reliefs in their tax planning arrangements and commercial objectives.

As to the second construct, the enrichment is said to have been the greater amount of lawful tax paid in year 2 or subsequent years than would have been paid but for the mistake in thinking that the Case V charge in year 1 was valid and the use of reliefs in year 1 for that reason. This cannot, in our judgment, found a claim in restitution. The short answer to the claim is that the tax paid in year 2 or subsequent years was lawfully due and so cannot be the subject of recovery under Woolwich or as a payment under a mistake: see Kleinwort Benson v Lincoln City Council [1998] UKHL 38, [1999] 2 AC 349 at 408B (Lord Hope).

Furthermore, the unjust enrichment alleged under this construct is too remote from the operative mistake. That was the mistake in year 1 that the Case V charge was valid and the reliefs were required to off-set that tax. The test of causation for unjust enrichment is the “but for” test: Kleinwort Benson at page 399D (Lord Hoffmann); DMG at paragraph [143] (Lord Walker). In applying the “but for” test, it is important to identify the operative mistake and to limit recoverable loss to what is directly caused by it. In Dextra Bank & Trust Co Ltd v The Bank of Jamaica [2001] UKPC 50, [2002] All ER (Comm) 193 at [30], the Privy Council recognised that the mistake was causative according to the “but for” test of causation, but considered that it was too remote from the relevant payment of the money to the defendants. The need for a close connection between the mistake and the enrichment is appropriate in the case of restitutionary relief for unjust enrichment since the cause of action is concerned with the restitution of an identified gain and not compensation for a fault-based tort. In relation to the Claimants’ second construct, there was no mistake by the Claimants about the lawfulness of the tax paid in year 2. It was lawfully due. The mistake was in year 1 in relation to the tax due in that year and the need for the set off of reliefs to reduce it. The connection between the payment of tax lawfully due in year 2 and the mistake in year 1 is not sufficiently direct to satisfy the requirements of causation in restitution. The loss is too remote.

Similar reasoning precludes recovery under the Claimants’ third construct. That construct differs in form from the second construct because the allegation is that the Claimants were mistaken in year 2 that reliefs had been validly used in year 1 when in fact, due to the unlawfulness of the Case V charge, the purported use of such reliefs was a nullity. Woolwich does not apply because the tax was lawfully due; and for the same reason the alleged over-payments are not recoverable as payments under a mistake. In any event, as Mr Ewart observed, it is unclear whether the reliefs purportedly utilised in year 1 remained available in year 2. That is a matter to be ascertained in the light of all the factual circumstances and the provisions of the tax legislation. Furthermore, although presented as a mistake in year 2 as to the continued availability of reliefs, the truly operative mistake was actually in year 1, as we have described above. The mistake as to the availability of the reliefs in year 2 was merely consequential upon and reflective of that earlier mistake. For that reason, the alleged enrichment, that is to say the loss, is too remote.

As to the Claimants’ fourth construct, the claim is not restitutionary, but rather for a declaration that the use of the reliefs in year 1 was a nullity and the reliefs are still available for use or to be carried forward. In our judgment, the question whether or not reliefs are still available for use falls properly within the exclusive jurisdiction of the Tax Chamber of the First-tier Tribunal (which has taken over the former jurisdiction of the Special Commissioners): Autologic Holdings plc v Inland Revenue Commissioners [2005] UKHL 54, [2006] 1 AC 118. The availability of reliefs depends on the precise facts at the time they are sought to be utilised and the general provisions of tax legislation. The current availability of the reliefs is to be distinguished from what were described in Autologic as “satellite claims”, such as whether any remedy is available to the Claimants if the reliefs are not still available.

The parties have made rival submissions as to whether there can be relief in circumstances where (1) a United Kingdom water’s edge company received a dividend from a foreign subsidiary; (2) in breach of Article 43, English law did not provide for the United Kingdom water’s edge company to receive a tax credit on such dividends which could be used to eliminate or reduce the ACT payable on distributions made to its shareholders; (3) in the event, by virtue of the use of group income election, ACT was not paid by the water’s edge company; but (4) ACT was paid by an ultimate parent company at the top of the corporate group when it made a distribution to its shareholders. This scenario was mentioned by the Judge in paragraph [139] of his judgment in the context of the “corporate tree” claims. He considered that it should be referred to the ECJ as part of those claims: paragraph [241].

Mr Ewart submitted that it is clear that no relief should be available in the circumstances postulated since there was no inevitability that ACT would be paid in the circumstances. The ultimate parent company might have decided to invest its profit rather than distribute it to shareholders. The scenario fell, he submitted, within paragraph [207] of the ECJ’s judgment rather than paragraph [205] since it was not “an inevitable consequence” of the breach of Article 43 that a dividend would be paid by the ultimate parent company with an accompanying liability to pay ACT.

Mr Aaronson and Mr Cavender submitted, on the other hand, that the group income election procedure under ICTA section 247 was purely “machinery” forming part of the unlawful system of tax. Their submission was that the unwavering practice was to have a group income election in place and for it to remain in place indefinitely. They said that the natural order of things would be for ACT to be paid at the higher levels of the corporate structure since ACT surplus could be surrendered down a group, but could not be surrendered up a group. In short, they submitted, the system did not work without utilising the group income election, and it would be absurd if there was no remedy for breach of Article 43 in those circumstances.

We agree with the Judge’s decision that this Issue is sufficiently uncertain that it ought to be referred to the ECJ as part of the corporate tree claims. Our observation in the penultimate sentence of paragraph [95] applies here also.

The Judge held that a defence of change of position is “in principle” available to the Revenue in respect of any mistake-based restitutionary claims which go beyond San Giorgio claims, and that, where the defence is available, it is likely to succeed on the facts: paragraph [445]. Paragraph [14] of the declaratory part of his Order said:

“[14] The Defendants are entitled to maintain a change of position defence in respect of any mistake-based restitutionary claims which go beyond San Giorgio claims.”

It is common ground that, notwithstanding the apparently absolute terms of that paragraph [14], the Judge was not making a final determination in respect of the change of position defence, but rather was acknowledging that, on the facts available at this stage, there is nothing to preclude the Revenue from raising the defence at trial. Notwithstanding the limited ambit of the Judge’s order in this respect, the Claimants have appealed his judgment on the Issue. The only proper basis for an appeal against that part of the Order would be that the Judge should have ordered at this stage that, by the date of the trial, there would be no proper basis for the successful invocation of the defence at trial. We did not, however, understand Mr Cavender to be taking such an extreme position. Rather, the complaint of the Claimants appears to be that the Judge misstated the applicable law and should not have formed a preliminary view that the defence was likely to succeed. In the absence of any direction for the determination of a preliminary issue on the defence of change of position, that does not appear to us to be a sound basis for an appeal in the light of the Judge’s order.

In any event, on our analysis and decisions, the defence of change of position does not call for consideration. It is common ground that the Community law principle of effectiveness precludes the application of any change of position defence to San Giorgio claims. For the reasons we have given, all the San Giorgio claims fall within the Woolwich cause of action. Claims for restitutionary relief based on mistake are, for the reasons we give, subject to the limitations imposed by section 33 of the Taxes Management Act 1970, the Finance Act 2004 section 320 and the Finance Act 2007 section 107 (see below). We did not understand the Revenue to be arguing for a change of position defence in relation to claims within those statutory provisions since, constrained by those limitations, they would mirror the San Giorgio claims enforceable under Woolwich.

In those circumstances it is not necessary to consider the submissions made by each side as to the proper legal tests and approach on change of position and as to the Judge’s analysis of the defence. The defence is highly fact-sensitive, and anything we were to say about it would be obiter. The submissions and the Judge’s analysis raise important and difficult questions of law and policy: see generally the discussion by Professor Elise Bant in Restitution from the Revenue and Change of Position [2009] LMCLQ 166. In all those circumstances we do not consider it appropriate to comment further on the defence.

Accordingly, on this Issue, we conclude for the reasons given above that the defence of change of position does not call for consideration.

As explained under Issue 15, this point does not arise. In any event, we do not consider that the Judge’s order determined the issues of fact which would arise at trial.

As explained above under Issue 15, this point does not arise.

It is common ground that the Claimants have no claim for damages for breach of their Community rights unless they can establish a sufficiently serious breach by the United Kingdom. Mr Aaronson prefaced his submissions on the Claimants’ case under this head by heavily criticising the United Kingdom Government’s legislation of sections 107 Finance Act 2007 and 320 Finance Act 2004 in defiance, as he submitted, of the principles of Community law as to the abbreviation of limitation periods so clearly set out in Case C-62/00 Marks & Spencer plc v Commissioners of Customs & Exciser [2002] ECR I-6325 ([2003] QB 866). However, the question under this head is not whether that legislation constituted a sufficiently serious breach of the Claimants’ rights, but whether the maintenance in force of the corporate tax provisions which they contend are unlawful under Community law constituted a sufficiently serious breach.

The Judge discussed the allegation, made by the Claimants, of a sufficiently serious breach at paragraphs [353] to [404] of his judgment. He did so on the basis that, as he held, the ECJ had decided that the United Kingdom corporation tax rules were unlawful. He held that the Claimants had not established a sufficiently serious breach. The Claimants have taken issue with his conclusion, and in addition have sought to adduce documentary evidence that was not available before him.

As we have already stated under Issue 1, we would make a further reference to the ECJ. Accordingly we approach this Issue on the hypothesis, which is yet to be established, that the United Kingdom corporation tax rules were indeed contrary to Community law.

Just how high a hurdle is the requirement of a sufficiently serious breach appears from both the opinion of the Advocate General and the judgment of the ECJ in the present case. The Advocate General said (with footnotes omitted):

“[135] In the present case, for example, I am not convinced that the Brasserie du Pêcheur conditions would be satisfied for all the aspects of the UK system raised in the present reference that, in my opinion, breach Community law. Clearly, the first condition (breach of a rule of law intended to confer rights on individuals) is fulfilled, as each of the Community law provisions raised is directly effective. The same would seem true by and large for the third condition (existence of a direct causal link between the breach of an obligation resting on the State and damage sustained by injured parties), with the potential exception of the claim outlined in Question 6(ix) for the reasons I have mentioned above.

[136] However, I have considerable doubts whether the second condition – the existence of a ‘sufficiently serious’ breach of Community law – is fulfilled for all aspects of the system which, in my view, breach Community law. As observed by the Court in Brasserie du Pêcheur,

‘… the decisive test for finding that a breach of Community law is sufficiently serious is whether the member state or the Community institution concerned manifestly and gravely disregarded the limits on its discretion.

The factors which the competent court may take into consideration include the clarity and precision of the rule breached, the measure of discretion left by that rule to the national or Community authorities, whether the infringement and the damage caused was intentional or involuntary, whether any error of law was excusable or inexcusable, the fact that the position taken by a Community institution may have contributed towards the omission, and the adoption or retention of national measures or practices contrary to Community law.

On any view, a breach of Community law will clearly be sufficiently serious if it has persisted despite a judgment finding the infringement in question to be established, or a preliminary ruling or settled case-law of the Court on the matter from which it is clear that the conduct in question constituted an infringement.’

[137] In Metallgesellschaft, the Court, as I observed above, did not consider this matter, nor was the question raised by the national court in that case. Advocate General Fennelly, who as I have noted was of the opinion that the plaintiffs remedy in that case was restitutionary in nature, none the less made some comments in the alternative on the question of whether the Brasserie du Pêcheur conditions were satisfied. He remarked that, ‘The issue is whether the clarity and precision of Article 43 of the EC Treaty were such that the breach may be regarded as sufficiently serious. This has to be viewed in the light of the widespread use of residence as a criterion for direct taxation purposes coupled with the state of development of the relevant case-law at the material time. This will concern the limits which affect the use by member states of that criterion where it is detrimental to the interests of residents from other member states. In short, was the refusal to allow the group income election, viewed objectively, excusable or inexcusable?’ He went on to opine that, as what was in issue was indirect discrimination, this, ‘should, in general, be considered sufficiently serious … To classify a breach of Article 52 of the Treaty such as that involved in the present case as excusable, the national court must be satisfied not only that the UK authorities genuinely believed that refusing to extend the benefit of the group exemption in question to groups whose parent company was non-resident was strictly necessary, but also, viewed objectively in the light of Bachmann and the principle of strict interpretation of exceptions to fundamental Treaty rules like the freedom of establishment, that this belief was reasonable.’

[138] I agree with Advocate General Fennelly that the crucial question in deciding whether a breach such as the UK’s in that case is sufficiently serious is the question whether the error of law was, viewed objectively, excusable or inexcusable. I would also agree that, in most areas of Community law, indirect discrimination is likely to satisfy this test. However, as I have observed in my Opinion in Test Claimants in the ACT Group Litigation, certain of the Court’s case-law setting out the boundaries of the application of the Treaty free movement provisions in the field of direct taxation is extremely complex and, in parts, in the process of development. For example, it was not in my opinion wholly clear until the recent Verkooijen and Manninen judgments that member states acting in a home State capacity are obliged by Articles 43 and 56 EC to grant equivalent relief from double economic taxation to resident shareholders receiving foreign-source income as for resident shareholders receiving domestic-source income. Such areas may be contrasted, however, with obligations that clearly follow from secondary legislation such as the Parent-Subsidiary Directive, or that follow clearly from jurisprudence of the Court which existed at the time that the relevant measures were in force. In sum, it follows in my view that breaches occurring at what were at that time the boundaries of the development of the Court’s case-law in this field should not be considered as a manifest and grave disregard of the limits or a member state’s discretion within the meaning of the Court’s case-law. It is for the national court to make the final assessment of this issue on the facts of the present case.

In its judgment, the Court adopted the opinion of the Advocate General on this issue:

[212] …, it should be pointed out, first, that a breach of Community law will be sufficiently serious where, in the exercise of its legislative power, a member state has manifestly and gravely disregarded the limits on its discretion (see Brasserie du Pêcheur and Factortame, paragraph 55; British Telecommunications, paragraph 42; and Case C-424/97 Haim [2000] ECR I-5123, paragraph 38). Secondly, where, at the time when it committed the infringement, the member state in question had only considerably reduced, or even no, discretion, the mere infringement of Community law may be sufficient to establish the existence of a sufficiently serious breach (Case C-5/94 Hedley Lomas [1996] ECR I-2553, paragraph 28, and Haim, paragraph 38).

[213] In order to determine whether a breach of Community law is sufficiently serious, it is necessary to take account of all the factors which characterise the situation brought before the national court. Those factors include, in particular, the clarity and precision of the rule infringed, whether the infringement and the damage caused were intentional or involuntary, whether any error of law was excusable or inexcusable, and the fact that the position taken by a Community institution may have contributed towards the adoption or maintenance of national measures or practices contrary to Community law (Brasserie du Pêcheur and Factortame, paragraph 56, and Haim, paragraphs 42 and 43).

[214] On any view, a breach of Community law will clearly be sufficiently serious if it has persisted despite a judgment finding the infringement in question to be established, or a preliminary ruling or settled case-law of the Court on the matter from which it is clear that the conduct in question constituted an infringement (Brasserie du Pêcheur and Factortame, paragraph 57).

[215] In the present case, in order to determine whether a breach of Article 43 EC committed by the member state concerned was sufficiently serious, the national court must take into account the fact that, in a field such as direct taxation, the consequences arising from the freedoms of movement guaranteed by the Treaty have been only gradually made clear, in particular by the principles identified by the Court since delivering judgment in Case 270/83 Commission v France. Moreover, as regards the taxation of dividends received by resident companies from non-resident companies, it was only in Verkooijen, Lenz and Manninen that the Court had the opportunity to clarify the requirements arising from the freedoms of movement, in particular as regards the free movement of capital.

[216]  Apart from cases to which Directive 90/435 applied, Community law gave no precise definition of the duty of a member state to ensure that, as regards mechanisms for the prevention or mitigation of the imposition of a series of charges to tax or economic double taxation, dividends paid to residents by resident companies and those paid by non-resident companies were treated in the same way. It follows that, until delivery of the judgments in Verkooijen, Lenz and Manninen, the issue raised by the order for reference in the present case had not yet been addressed as such in the case-law of the Court.

[217] It is in the light of those considerations that the national court should assess the matters referred to in paragraph 213 of this judgment, in particular the clarity and precision of the rules infringed and whether any errors of law were excusable or inexcusable.

Paragraphs [215] to [217] of the judgment give the national court clear guidance that the lack of clarity of Community law during the period in question is inconsistent with the United Kingdom having committed a sufficiently serious breach. Given the legal uncertainty, which in our judgment continues, it is very difficult indeed, if not impossible, to see how the United Kingdom can be said to have “manifestly and gravely disregarded the limits on its discretion”. The making of the reference to the ECJ in the present case is itself inconsistent with the contention that the effect of Community law on corporation tax rules has for some time been clear. If the legal position were so clear, it is difficult, if not impossible, to see how the Revenue’s submissions before us could have been made in good faith.

In paragraphs [353] to [404] of his judgment, the Judge carefully summarised and analysed the evidence relied upon by the Claimants in support of their case that they had established a sufficiently serious breach. He concluded that they had not. In paragraph [401], he said:

“… If, with the benefit of competent legal advice, the government could reasonably have decided to leave the existing legislation unchanged, and to introduce the FID regime in exactly the same form as they actually did, I think it would be unrealistic to regard their failure to take legal advice as a decisive factor in the balancing exercise which I have to perform. It is not alleged that the Revenue or the government acted in bad faith, and although their conduct is open to criticism, it cannot in my view be said that they “manifestly and gravely disregarded the limits on [their] discretion”. It would also seem paradoxical to find that a sufficiently serious breach was established, in circumstances where the claimants themselves, who had the resources and the motivation to investigate the question in depth, took the view until at least June 2000 that the legislation in question was not open to challenge.”

Mr Aaronson submitted that we should reverse the Judge’s finding on the ground that he had focused “almost exclusively, if not exclusively” on the lack of clarity of Community law, and ignored the fact that there had been a grave and manifest disregard of the limit of the state’s discretion.

We cannot accept this criticism. As the opinion of the Advocate General and the judgment of the ECJ demonstrated, the lack of clarity of the applicable Community rules was a most important consideration in deciding whether or not there had been a sufficiently serious breach. It is difficult to see how a Member State can be said to have gravely and manifestly disregarded the limit of its discretion when it is not clear what that limit is. The Judge did not focus exclusively on the lack of clarity of Community rules: he gave that factor the weight it required. We entirely agree with and endorse the Judge’s analysis and conclusion on this Issue, and do not find it necessary to add to them.

The matters relied upon by the Claimants in their Eleventh Amended Particulars of Claim in support of the allegation of sufficiently serious breach are unimpressive, and impossible to reconcile with the comments of the Advocate General and the Court. It is perhaps significant that before us Mr Aaronson was unable to specify when the United Kingdom’s breach became sufficiently serious breach other than to say that it was “in the mid-90s” after the decision in Case C-1/93 Halliburton Services BV v Staatssecretaris van Financiën [1994] ECR I-1137 in 1994. This is in contrast with the Claimants’ first skeleton argument, which at paragraph [242] contends that “even if the sufficiently serious breach requirement was not met prior to the ECJ Judgment in Verkooijen, it was surely met from the date of that judgment, namely 6 June 2000”. It was not until 2002 that a claim was first made to the Revenue that the corporation tax and ACT rules were incompatible with the Treaty. It is significant that there was no warning from the Commission, at any time, that the United Kingdom corporation and ACT rules were unlawful. To the contrary, and this is significant, the position of the Commission on the reference in the present case was, initially, that the United Kingdom’s dual system of exemption and credit complied with Community rules: see paragraph [48] of the Advocate General’s opinion. Lastly, the Claimants’ claim for repayment of tax paid under a mistake as to the compatibility of United Kingdom corporation tax and ACT rules with Community law implies that a large international corporation, with access to the very best legal advice, did not question their compatibility. It may be that the plea of sufficiently serious breach implies that the Revenue had access to more prescient legal advice than the Claimants. We do not find that self-evident.

Accordingly, on this Issue, we conclude that if the United Kingdom corporation tax rules are in breach of Community law then that breach will not be sufficiently serious so as to entitle the Claimants to damages.

We do, nonetheless, have to consider whether the new documents sought to be relied upon by the Claimants might arguably require a different conclusion. This material consists of documents that were disclosed by the Revenue in the Thin Cap litigation after the Judge had given judgment in the present case; and documents that are the subject of legal professional privilege, disclosure of which the Claimants now seek.

It is convenient first to mention the Claimants’ application for disclosure of privileged documents. They submit that domestic law legal professional privilege is inapplicable in domestic litigation in which it is sought to enforce Community rights. They submit that at the least the Court should draw adverse inferences from the Revenue’s claim for privilege. The Revenue submit that their privilege is equally applicable in proceedings such as the present as in purely domestic claims.

In the end, Mr Aaronson did not press his submission on privilege, on the basis of his contention that if the documents now relied upon demonstrate that the Judge’s conclusion, arrived at without the benefit of those documents, may have been wrong, the issue of sufficiently serious breach should be remitted to the Judge for him to reconsider in the light of the new documents and such oral evidence as the parties may wish to call.

It follows that the essential question for us is whether the new documents, which it is accepted were not available to the Claimants to deploy at the trial before the Judge, could reasonably lead to a different finding on the issue of sufficiently serious breach. We admit them in evidence on this appeal.

The first document on which Mr Aaronson relies is an advice dated 12 July 1994 of Mr Durrans, of the Solicitor’s Office of the Inland Revenue Commissioners on the decision of the ECJ in Halliburton. He regarded it as startling that a breach of Article 52 had been found in circumstances in which the taxpayer had not been the subject of discrimination and the situation was internal to the Netherlands, so that the Dutch Government’s contention that the matter was internal and not a matter of Community law was “unimpeachable”. He stated that the decision of the Court “evidently provides support for the current claims that the group and consortium relief provisions are discriminatory”. But he ended “on a slightly more optimistic note”, stating that “where the transaction is a cross-border transaction it may still be possible to argue that the different treatment is justified by the need to ensure the cohesion of the United Kingdom tax system”.

Soon afterwards, on 26 July 1994, Mr Michael of the International Division circulated a minute on policy. Its recipients included the Chancellor of the Exchequer. The advice warned of “problems ahead with the ECJ applying the principles of the Treaty to national tax provisions”. The action recommended was to note that “we are experiencing difficulty in an increasing number of instances in fending off arguments of Community law in the direct tax field (including in some of the more sensitive parts of the system)”, and to await further advice on the prospects of amending the Treaty of Rome and on domestic legislative changes in the meantime. The advice stated that there was “a growing risk of a major setback in Exchequer and political terms”. Much depended on future developments, including the expected judgment in Case C-279/93 Finanzamt Köln-Altstadt v. Schumacker [1995] ECR I-225. Schumacker was a case about personal, not corporate, taxation that was held to be discriminatory. It was not universally regarded as having clarified Community law, in view of the different result in Case C-336/96 Gilly and another v. Directeur des Services Fiscaux du Bas-Rhin [1998] ECR I-2793: see [1999] BTR 11. The concerns expressed in the advice were said to be shared by senior officials in France and Germany, and they had agreed to meet to discuss the issues. The advice recommended that the United Kingdom should make full use of its right to make observations to the Court in individual cases, and should encourage other Member States to do likewise. This recommendation was, of course, inconsistent with the view that the ECJ would undoubtedly hold that the United Kingdom tax system was incompatible with the Treaty. In addition, it recommended the United Kingdom should ensure that new provisions did not have obvious vulnerabilities and should use legislative opportunities to revisit existing legislation. The author stated that “we anticipate, and have been told to expect, further challenges elsewhere: we have no shortage of vulnerabilities”.

Mr Michael followed his minute with a further minute dated 1 August 1994, which referred to a list of United Kingdom vulnerabilities that had been drawn up. We were told that the list has not been found. This minute was concerned with anti-avoidance legislation, which is not relevant to the present case unless it be suggested that it demonstrates that the Government was concerned to flout all Community rules. It does not: to the contrary, it evinces the view that there is plenty of scope for argument. The minute of 19 October 1994 advised a low-key presentation of thin-cap and other vulnerabilities at Budget time and afterwards.

An interesting minute dated 1 November 1994 from the Financial Secretary to the Chancellor stated that it had become clear that the United Kingdom might be facing widespread challenge to its direct tax system, by reason of the differential treatment of residents as against non-residents. As a result the United Kingdom, and the rest of the EU, were facing widespread forced tax changes which threatened to undermine fundamental features of the direct tax system. While stating that "Virtually no part of the United Kingdom direct tax system is immune from challenge", it asserted that "in some areas, the risk is more theoretical than real, and not all of our vulnerabilities may be challenged". It advised that the only long-term solution was Treaty revision, which was already being discussed with the Germans and the French. It recommended that the seriousness of the issue should be played down, that cases in the courts should be strongly resisted, and that where necessary "Europroofing legislation" should be introduced to remove discrepancies between residents and non-residents.

It is understandable that these and other documents should have been disclosed by the Revenue in the Thin Cap proceedings but not in the present proceedings, in which their relevance is tangential. The use of the word “vulnerability” in these documents does not indicate an intention to breach Community law, but rather a concern as to the possibility that thin-cap and other unspecified United Kingdom tax rules might be held to be in breach. The advice that the Government should not highlight its concerns again does not demonstrate an intention to flout Community rules, but rather a desire not to provoke challenges that might be avoidable. In our judgment, they do not justify re-consideration of the Judge’s finding on sufficiently serious breach.

The appeal on the basis of fresh evidence against the Judge’s dismissal of the Claimants’ claim for damages for breach of Community law will also be dismissed.