ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
The Hon Mr Justice Henderson
Case Nos HC05C00732 and HC01C02533
Royal Courts of Justice
Strand, London, WC2A 2LL
Before:
THE MASTER OF THE ROLLS
LORD JUSTICE PATTEN
and
LADY JUSTICE BLACK
Between:
(1) TEST CLAIMANTS IN THE ACT GROUP LITIGATION (CLASS 4) (2) TEST CLAIMANTS IN THE ACT GROUP LITIGATION (CLASS 2) | Appellant |
- and - | |
THE COMMISSIONERS OF HER MAJESTY’S REVENUE & CUSTOMS | Respondents |
Mr Graham Aaronson QC (instructed by Dorsey & Whitney (Europe) LLP) for the Appellant Claimants
Mr Ian Glick QC and Mr James Rivett (instructed by the Solicitor for HMRC) for the Respondent Defendants
Hearing dates: 9th and 10th November 2010
Judgment
The Master of the Rolls:
This is an appeal from the decision of Henderson J, dismissing claims brought by a number of companies (“the claimants”) in three separate multinational groups, Pirelli, Huhtamaki, and Volvo, against Her Majesty’s Commissioners for Revenue and Customs (“HMRC”). Each of the claimant groups had the distinguishing feature of having a parent company resident in an EU member state other than the UK - either Italy (Pirelli) or the Netherlands (Huhtamaki and Volvo) - which had received from a UK-resident subsidiary company a dividend, in respect of which Advance Corporation Tax (“ACT”) had been paid. The claims all arise from the decision of the Court of Justice of the European Communities (“the ECJ”) in Metallgesellschaft & others and Hoechst AG & Hoechst UK Limited v Commissioners of Inland Revenue and HM Attorney General [2001] ECR 1-1727 (“Hoechst”), which was to the effect that the statutory ACT regime offended what was Article 52, then became Article 43, of the EC Treaty, and is now Article 49 of the Treaty on the Functioning of the European Union (“Article 49”), which protects freedom of establishment.
The case has an unusually complex history, having been the subject of no less than three judgments of the High Court, two of the Court of Appeal, and one decision of the House of Lords. In order to put this appeal in its proper context, it is necessary not only to explain that history, but also to say something about the domestic corporation tax and ACT regimes and relevant Double Taxation Conventions (“DTC”s), the ECJ decision in Hoechst, and a subsequent decision of the ECJ. Because the issues raised on this appeal follow on from a number of well expressed domestic judgments, I propose, unusually, to incorporate a great deal of material virtually verbatim from some of those judgments.
The domestic legislative background
The law relating to corporation tax, ACT and Double Taxation Conventions (“DTC”s) was explained in the judgment of Rimer J in what I shall call “Pirelli II”, Pirelli Cable Holdings NV v Commissioners for HM Revenue and Customs [2007] EWHC 583 (Ch), [2008] STC 144, paragraphs 7 to 21:
The Finance Act 1965 introduced the UK system of company taxation under which corporation tax became charged on the total profits of companies, including income and chargeable gains, earned in an accounting period. The end date of the accounting period is usually chosen by the company and an accounting period typically lasts 12 months. For all periods relevant to this litigation, the general rule was that corporation tax became payable nine months after the end of the accounting period. The applicable law became consolidated in the Income and Corporation Taxes Act 1988 (‘ICTA’). …. . .
Under the corporation tax system in force between 1965 and 1973, company profits were taxed separately from company distributions. In effect, the profits were taxed twice - once in the hands of the company and then again (by the deduction of income tax under Schedule F) when the profits were distributed to shareholders by way of dividend. This was known as ‘economic double taxation’, meaning the double taxation of the same funds, and became regarded as undesirable by corporation tax systems. The problem became addressed by the introduction of so-called ‘imputation’ and ‘partial imputation’ systems, which are shorthand concepts for systems under which the tax on profits borne by the corporation is either wholly or partially ‘imputed’ to its shareholders. Each shareholder was itself taxable in respect of the company's dividends (i.e. the company's distributable profits paid to it) but such systems recognised the company as pre-paying the whole or part of the shareholder's own tax liability in respect of the dividend.
The UK's chosen method was a partial imputation system, which it introduced by the Finance Act 1972, the material provisions of which became incorporated into ICTA and remained in force until 6 April 1999. Under that system, the company continued to pay corporation tax on all its profits, whether or not distributed, but a new system of taxation was introduced as regards any so-called ‘qualifying distribution’ (as defined in section 14(2), and it included dividends) that the company made. A company resident in the UK that made a ‘qualifying distribution’ was no longer required to deduct income tax from the distribution but was instead required to pay ACT on a sum equal to the amount or value of the distribution; and the shareholder received a tax credit corresponding to the ACT so paid. Section 14 was the main charging provision and Schedule 13 governed the collection of ACT. Section 14(1) provided:
‘Subject to section 247, where a company resident in the United Kingdom makes a qualifying distribution it shall be liable to pay an amount of corporation tax (“advance corporation tax”) in accordance with subsection (3) below.’
ACT was payable two weeks after the end of the quarter during which the dividend was paid and so it fell due for payment before (and often well before) the time that the company had to pay its corporation tax due in respect of the total profits of its accounting period during which the quarter fell. That tax on profits became known as ‘mainstream’ corporation tax (‘MCT’), although that was not a statutory term of art. The rate of ACT during the relevant period was 25%. If a company declared a dividend of £100, it would pay £100 to its shareholders and £25 ACT to the Revenue. The 25% ACT rate was lower than the MCT rate during the relevant period …. . It was this differential that made the system a ‘partial’ imputation system: as the amount of the credit was fixed at a level which was lower than the MCT rate, the company would pay a residual amount of MCT that would not be capable of being credited against the shareholder's own tax liability.
ACT paid by the company was set off against its MCT liability for the annual accounting period in which it was paid: section 239(1) [of ICTA]. If no MCT was payable for that accounting period (because, for example, the company had no taxable profits), the ACT could be carried back and set off against the company's MCT for a prior period, so entitling the company to a repayment of corporation tax: section 239(3). Any ACT not so carried back could be carried forward and set off against MCT payable for the next accounting period: section 239(4). The company could also surrender any surplus ACT to a subsidiary company: section 240. ACT that was set off against the MCT of the paying company or that of its UK resident subsidiary became known as ‘utilised’ ACT. ACT which had not been and could not be so set off was known as surplus or ‘unutilised’ ACT.
The ACT system can be perceived as yielding an apparent financial benefit to the Revenue and as imposing an apparent disadvantage upon the paying company. As for the Revenue, it received the ACT ahead of the time at which, but for the payment of the dividend, the company would pay the entirety of its MCT on its profits for the accounting period. As for the company, it was disadvantaged between those two payment dates by the loss of the use of the money it had so paid in ACT. As regards any ACT that became unutilised, the company's position was even starker: such ACT amounted, in effect, to an additional irrecoverable cost over and above the company's MCT for the accounting period in which the dividend was paid.
So far I have considered the position from the viewpoint of the company paying the dividends. As for the recipients, section 231(1) [of ICTA] conferred a tax credit for the ACT that had been paid: it was conferred both on UK resident companies and UK resident individuals which or who received a qualifying distribution – including a dividend – from a UK resident payer. The amount of the credit was equivalent to the amount of ACT payable on the dividend. Section 231(1) provided:
‘Subject to section … 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.’
Different regimes applied according to whether the recipient of the credit was an individual or a company. A UK resident individual continued to be chargeable to income tax under Schedule F on the aggregate of the dividend and the tax credit, but he could set the tax credit against his income tax liability for the year or, if the credit exceeded that liability, could claim a repayment from the Revenue: section 231(3) [of ICTA]. By contrast, where the recipient shareholder was a UK resident company subject to corporation tax the company was exempt from corporation tax on the dividend (section 208) but was not generally able to claim a repayment of the tax credit. In its case, the dividend payment plus the associated tax credit was known as ‘franked investment income’ and the tax credit could be used to cover - or ‘frank’ - any onward payment of a dividend that it made in respect of which it would otherwise itself be accountable for ACT: section 238 [of ICTA]. For example, if A Ltd paid a dividend of £100 to its parent, B Ltd, it would be accountable for ACT of £25 and B Ltd would be entitled to a tax credit of £25. If B Ltd then paid a dividend of £100 to its own parent, its tax credit would ‘frank’ the obligation that it would otherwise have to pay ACT in respect of that dividend. If it paid an onward dividend of £150, the tax credit would frank £25 of the ACT, and it would have to pay ACT of £12.50. If it did not pay an onward dividend, it could not normally use its tax credit save by carrying forward its surplus franked investment income for use against its ACT liability on future dividends.
I turn to the position of companies that were not resident in the UK and did not trade there through a branch or agency. They were not subject to corporation tax in the UK. Nor, as section 233(1) [of ICTA] provided, were they liable to income tax in the UK in respect of dividends paid to them by their UK subsidiaries unless those dividends also entitled them to a tax credit. It is central to this case that - as section 231(1) made explicit - the conferring of tax credits under section 231 only applied to qualifying distributions made or paid by UK resident companies to UK resident companies or to UK resident individuals: in particular, it did not apply to such distributions made or paid to companies not so resident, and so section 231 did not, by itself, entitle any such non-resident parent company to a tax credit in respect of a dividend paid to it by its UK subsidiary.
It is, however, equally central that the entitlement to such a tax credit could be extended to non-UK resident recipients by virtue of treaty credits granted under double taxation [conventions (‘DTC’s)] between the UK and the country of the recipient's residence. Where the parent company was entitled to such a credit under a [DTC] concluded between the UK and its state of residence, it was subject to UK income tax under Schedule F on dividends paid to it by its UK subsidiary (see again section 233(1)). In short, from the parent's perspective, if it did not have the benefit of any treaty tax credit in respect of the dividend paid to it by its UK subsidiary, it was not liable to UK income tax. It was only so liable if had the benefit of such a credit. It could then set the credit against the income tax for which it was liable in the UK and, where the credit exceeded the tax liability, it could recover the excess.
[DTCs] have been entered between the UK and various overseas states. When ratified by the contracting parties they become binding in international law. As section 788(1) explained, subject to an appropriate declaration by Order in Council, they have domestic effect for UK tax purposes in accordance with section 788(3). Such agreements have the purpose and effect of preventing double taxation by determining which state may exercise taxing powers in respect of a particular type of income or activity; and/or by providing that one state should allow a credit against its own tax charge for taxes paid in respect of the same income or activity in the other state. Where, as commonly occurs, the effect of a provision in a [DTC] differed from the position which would obtain in the UK as a matter of domestic law, section 788(3) provided that the provisions of the [DTCs] shall prevail ‘notwithstanding anything in any enactment’ in so far as they relate to matters specified in the four sub-paragraphs following. Section 788(3)(a) and (d) provided that such agreements shall have effect in relation to income and corporation tax in so far as they provide:
‘(a) for relief from income tax, or from corporation tax in respect of income or chargeable gains; or …
‘(d) for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident.’
In several such [DTCs], the UK has agreed that non-UK resident shareholders in UK companies should be entitled to a tax credit in respect of dividends paid to them by a UK resident company. Pirelli’s claims in this litigation mainly concern dividends paid by Pirelli UK (a UK company) to its non-resident parents, Pirelli Netherlands/Italy. The UK entered into a [DTC] with each of the Netherlands and Italy (see the Double Taxation Relief (Taxes on Income) (Netherlands) Order 1980, SI 1980/1961; and the Double Taxation Relief (Taxes on Income) (Italy) Order 1990, SI 1990/2590). Article 10(3)(c) of each [DTC] provided that the recipient company shall:
‘… be entitled to a tax credit equal to one half of the tax credit to which an individual resident in the United Kingdom would have been entitled had he received those dividends, and to the payment of any excess of that tax credit over its liability to tax in the United Kingdom.’
Article 10[(3)(a) of] each [DTC] also empowered the UK to charge tax on the aggregate of the dividend and the tax credit at the rate of 5%. As a matter of arithmetic this meant that Pirelli Netherlands/Italy were entitled in the relevant years to a tax credit having a net value (after the imposition of UK income tax at 5%) of 6.875% of the amount of the dividend….. It is to be noted that Article 10 fixes the level of credit by reference to a proportion of the tax credit that an individual resident in the UK would have been entitled had the dividend been paid to him.
Section 247 – the provision primarily responsible for the Hoechst litigation - provided that, in a case in which a 51% (or more) UK subsidiary company paid a dividend to its UK parent, the two companies could jointly elect that section 247(1) should apply to the dividend so paid. Such an election became known as a [group income election (a ‘GIE’)]; and dividends covered by it were known as ‘election dividends’ (section 247(1)). The effect of such an election was provided for by section 247(2), which reads:
‘(2) So long as an election under subsection (1) above is in force the election dividends shall be excluded from sections 14(1) and 231 and are accordingly not included in references to franked payments made by the paying company or the franked investment income of the receiving company but are in the Corporation Tax Acts referred to as 'group income' of the receiving company.’
The effect of that was, therefore, that the election dividends remained ‘qualifying’ distributions - which were defined in section 14(2) - but that the subsidiary became exempt from liability under section 14(1) to pay ACT upon their payment. For reasons given, the making of a group income election could achieve a financial advantage for the subsidiary. Even if any ACT that might otherwise be paid could in due course be utilised in full against the subsidiary's (or its subsidiaries') MCT, there would be a cash flow penalty resulting from its payment, since it was payable no later than two weeks after the end of the quarter in which the dividend was paid whereas the MCT would not be due until nine months after the end of the accounting period; and if the ACT could not be utilised either at all or in full at that payment date, the or any surplus ACT could remain unutilised for years or even indefinitely. The corollary of the exercise of a group income election was, however, that the recipient parent would not obtain a tax credit under section 231 either upon the payment of the dividend or upon the subsequent payment by the subsidiary of its MCT, so that the dividend was not franked investment income in the parent's hands. If, therefore, the parent decided to pay the dividend onward to its own shareholders, it would have to pay ACT (unless it and its parent could and did exercise a group income election).
Crucially, however, section 247(1) applied only to the case in which both subsidiary and parent were resident in the UK. If a 51% (or more) subsidiary paid a dividend to its resident parent outside the UK (for example, in another EU member state), it had no choice but to pay ACT on the distribution, since section 247 afforded no option to the two companies to make a group income election. It was this discriminatory element that was held to be unlawful in the Hoechst decision. It was the very large amount of unutilised ACT paid, in particular, by groups with multinational operations that became the main driver behind the Community law challenge to the ACT system leading to that decision. In such cases the claimants have sought compensation from the Commissioners for (a) having to pay their unutilised ACT at all, and (b) having to pay their utilised ACT earlier than the MCT payment date. Their case was that, if section 247(1) had not unlawfully discriminated against them by depriving them of the right to exercise a group income election to pay dividends to non-resident parents free of ACT, they would not have had to pay it at all. In the present case, when Pirelli UK paid dividends to Pirelli Netherlands/Italy, the group had no choice but to suffer the payment by Pirelli UK of ACT in respect of those dividends.”
Hoechst and a summary of these proceedings
The effect of the ECJ’s decision in Hoechst was graphically described by Lord Walker of Gestingthorpe, in what I shall describe as “Pirelli I”, as “a thunderbolt from Luxembourg”, whose effect is that “under EU law the statutory scheme [relating to ACT] was flawed and has been flawed since its inception in 1973” – Pirelli Cable Holdings NV v Inland Revenue Commissioners [2006] UKHL 4, [2006] 1 WLR 400, para 104.
The basis for the ECJ’s decision in Hoechst was that, if a UK-resident subsidiary had had a UK-resident parent to which it paid a dividend, it could have made a GIE, which would have meant that ACT was not payable on the dividend, whereas that opportunity was not afforded to a UK-resident with a parent resident elsewhere in the EU. Accordingly, ACT would be automatically payable in respect of a dividend paid by a UK-resident subsidiary to such a foreign-resident parent, whereas, where the two companies were UK-resident, they could have made a GIE, thereby avoiding having to pay ACT. The ECJ decided that it was unlawful for the United Kingdom to allow a UK-resident subsidiary to pay a dividend to its parent company under a GIE, and thus avoid having to pay ACT, where the parent company was also UK-resident, while denying that opportunity where a UK-resident subsidiary paid a dividend to an (EU non-UK)-resident parent company.
As Henderson J said, the essence of the decision in Hoechst may be found in paragraph 96 of the judgment of the ECJ, which was to this effect:
“The answer to the second question referred must therefore be: where a subsidiary resident in one member state has been obliged to pay [ACT] in respect of dividends paid to its parent company having its seat in another member state even though, in similar circumstances, the subsidiaries of parent companies resident in the first member state were entitled to opt for a taxation regime that allowed them to avoid that obligation, [Article 49] requires that resident subsidiaries and their non-resident parent companies should have an effective legal remedy in order to obtain reimbursement or reparation of the financial loss which they have sustained and from which the authorities of the member state concerned have benefited as a result of the advance payment of tax by the subsidiaries. The mere fact that the sole object of such an action is the payment of interest equivalent to the financial loss suffered as a result of the loss of use of the sums paid prematurely does not constitute a ground for dismissing such an action. While, in the absence of Community rules, it is for the domestic legal system of the member state concerned to lay down the detailed procedural rules governing such actions, including ancillary questions such as the payment of interest, those rules must not render practically impossible or excessively difficult the exercise of rights conferred by Community law.”
In Deutsche Morgan Grenfell Group PLC v Inland Revenue Commissioners [2006] UKHL 49, paragraph 2, Lord Hoffmann referred to the “forensic fall-out” of the ECJ decision in Hoechst, and the progress of the instant litigation shows how accurate that description was.
The decision of Henderson J, which is being appealed to us, may be seen as being (subject to this, and any subsequent, appeal, or any reference to the ECJ) the culmination of the first round, and the entirety of the third round, of the instant domestic litigation following Hoechst.
The first round, “Pirelli I”, started with a decision of Park J ([2003] EWHC 32 (Ch), [2003] STC 250), which was upheld by the Court of Appeal ([2003] EWCA Civ 1849, [2004] STC 130), but was ultimately reversed by the House of Lords ([2006] UKHL 4, [2006] 1 WLR 400). The second round, “Pirelli II”, involved the decision of Rimer J to which I have referred ([2008] STC 144), which was upheld by the Court of Appeal ([2008] EWCA Civ 70, [2008] STC 508). The third round, which I shall refer to as “Pirelli III”, was decided by Henderson J in the judgment currently under appeal, in which he also dealt with an outstanding point under Pirelli I, which had been referred back to the High Court by the House of Lords for determination ([2007] EWHC 583 (Ch), [2010] STC 1078).
These proceedings: Pirelli I
The claims in Pirelli I were brought by the Pirelli group claimants only. As Henderson J said at [2010] STC 1068, paragraph 8, the claims “were essentially similar to those upon which the ECJ had ruled in Hoechst, but with the difference that the parent companies were entitled to payment of partial tax credits” (as the United Kingdom’s DTC with Germany had, at least at the relevant time, no provision for a tax credit). However, as he immediately went on to point out,
“A further difference, to which Park J drew attention in paragraph 26 of his judgment, was that some of the ACT payments made by one of the UK subsidiaries (Pirelli UK) had not been set off against MCT. In relation to that amount, Pirelli UK claimed repayment of the full amount and interest in the meantime. With regard to the ACT which had been set off against MCT, the same relief was claimed as in Hoechst.”
The course of Pirelli I up to the time of the formulation of the outstanding point by the House of Lords was well described by Henderson J in the judgment below at [2010] STC 1078, paragraphs 9 to 14:
Three main issues were raised in Pirelli I, but for present purposes only two of them matter:
if the dividends in question had been paid under a GIE (assuming such an election to have been available, and to have been exercised), with the result that no ACT would have been payable in respect of those dividends, would the parent company still have been entitled to receive the DTC tax credits? And if not,
should the net tax credits actually received by the parent companies be brought into account in calculating the restitution or compensation for the breach of Article [49], even though it was the subsidiary which paid the ACT and the parent which received the credit?
Park J answered both questions in favour of the Pirelli claimants, that is to say he held (on the first issue) that even if the dividends had been paid under a GIE, the parent would still have been entitled to receive the partial tax credits payable under the DTC, and (on the second issue) that the tax credits should not be brought into account, because the separate corporate identities of the parent and the subsidiary could not be disregarded, nor could they be treated as some form of joint entity. The judgment of Park J was unanimously upheld by the Court of Appeal (Peter Gibson and Laws LJJ and Sir Martin Nourse), for essentially the same reasons. However, the House of Lords unanimously reversed the decisions below and decided both questions in favour of the Revenue. The reasoning of all five of their Lordships was broadly similar, and in bare summary was to the following effect.
On the first issue, the starting point is that there was an implicit and indissoluble linkage in the UK legislation between liability to pay ACT and the grant of a tax credit under section 231. Put simply: no ACT, no tax credit. Against this statutory background, when Article 10 of the relevant DTC comes to be applied in the context of a notional GIE (something which the draftsman could never have expressly contemplated), it should be construed so as to deny any entitlement to a tax credit, because the whole purpose of the notional GIE would have been to ensure that no ACT was payable: see paragraphs 7 to 16, 31 to 39, 60 to 72, 103 to 107 and 108.
On the second issue, the House held that since a GIE had to be made by both the parent and the subsidiary jointly, and as the benefit to the subsidiary of not paying ACT was matched by a corresponding disadvantage to the parent (namely non-receipt of a tax credit), it would be artificial to assess the loss sustained by the subsidiary in isolation, and it was therefore necessary to take into account any countervailing fiscal benefit received by the parent which would not have been available if a GIE had been made: see paragraphs 17 to 26, 40 to 44, 73 to 82, 107 and 108.
In the light of this decision, the House of Lords remitted the case to the Chancery Division to deal with the unresolved factual question whether GIEs would in fact have been made within the Pirelli group had the facility to make them been available, and to assess the amount of compensation payable. The relevant part of the Order of the House of Lords dated 8 February 2006 reads as follows:
‘That the case be remitted back to … the High Court of Justice Chancery Division to decide the unresolved factual question whether, had group income election been available to the Pirelli group, the group would have elected to have the United Kingdom subsidiaries pay the dividends in question free of ACT or, instead, would have chosen that the United Kingdom subsidiaries should pay the dividends outside group income elections, thus enabling the overseas parents to receive convention tax credits and so that in assessing the amount of compensation payable to the 4th and 5th claimants the amount of the tax credit paid to their parents should be brought into account, and to order repayment of any sums already paid by the appellants to the 4th and 5th claimants.’
The reason for the outstanding factual enquiry is, of course, that if the parties would have chosen not to make a GIE, even if one was available, and if they would have preferred the parent companies to receive convention tax credits after deduction of income tax at the specified rate, the group would have suffered no loss in respect of those dividends as a result of the denial of the opportunity to make the election. In such circumstances, therefore, the ACT in question would have been lawfully levied. Conversely, in cases where an election would have been made, the ACT on the dividends would have been unlawfully levied, and the subsidiaries would be entitled to compensation accordingly, although (following the decision of the House of Lords) subject to a reduction for the net tax credits actually received by their parents.”
The decision of the ECJ in ACT Class IV
Before turning to the ensuing stages of the present litigation, it is convenient to refer to a judgment of the ECJ, given after Pirelli I was decided by the House of Lords, but before the case came back before the High Court. The ECJ judgment is in Test Claimants in Class IV of the ACT Group Litigation v IRC ([2006] ECR I-11673, [2007] STC 404 (‘ACT Class IV’).
The effect of the ECJ’s judgment in ACT Class IV was described by Henderson J in his judgment in a passage which I do not understand to be challenged, at [2010] STC 1078, paragraphs 37-43:
…. [T]he reference [to the ECJ] in ACT Class IV was concerned only with cases where no tax credit was payable to the relevant EU parent, either because the DTCs between the UK and the recipient's home state (such as Germany, or Italy before 1991) did not provide for any credit to be payable, or because the DTC did normally provide for a partial credit, but excluded that entitlement where the recipient was itself owned by a company resident in a third state where there was no such entitlement. Accordingly, the precise question that arises under the first issue [which is also the first issue I consider – see paragraphs 21ff below] was not put to the ECJ. Nevertheless, despite this factual lacuna in the questions which were referred to the Court, the Advocate General, in his full and impressively reasoned opinion, and the Court itself, in its somewhat shorter but entirely consonant analysis, were at pains to review the whole question of the cross-border taxation of dividends within the EU on a principled and logical basis. As part of that review, they had well in mind, and explicitly referred to, cases where a partial tax credit was in fact granted.
The first question that is relevant for present purposes is question 1(a), which the ECJ reformulated in paragraph 30 of its judgment as follows:
‘30. By Question 1(a), the national court essentially asks whether [Article] 49 … preclude[s] a rule of a Member State … which, on a payment of dividends by a resident company, grants a full tax credit to the ultimate shareholders receiving the dividends who are resident in that Member State or in another State with which the first Member State has concluded a DTC providing for such a tax credit, but does not grant a full or partial tax credit to companies receiving such dividends which are resident in certain other Member States.’
In other words, the question was whether it was open to the UK, compatibly with Community law, to pay full tax credits to domestic corporate shareholders, but to pay no tax credits at all to shareholders resident in certain other member states.
The Court's answer to this question, in paragraph 74, was that it was open to the UK to do this, subject to the one qualification which I have already mentioned:
‘74. The answer to Question 1(a) must therefore be that [Article 49 does] not prevent a Member State, on a distribution of dividends by a company resident in that state, from granting companies receiving those dividends which are also resident in that state a tax credit equal to the fraction of the corporation tax paid on the distributed profits by the company making the distribution, when it does not grant such a tax credit to companies receiving such dividends which are resident in another Member State and are not subject to tax on dividends in the first State.’
The qualification is to be found in the concluding words ‘and are not subject to tax on dividends in the first State’.
The main steps which led the Court to this conclusion were as follows:
In paragraph 32 the Court expressly recognised that a non-resident company receiving dividends from a resident company was entitled to a full or partial tax credit only where such entitlement was conferred by a DTC concluded between the UK and the recipient company's state of residence.
Paragraph 35 recorded the claimants’ submission that, in order to enable non-resident companies receiving dividends from a resident company to place their shareholders on the same footing as shareholders of resident companies receiving such dividends, the UK should grant a tax credit to non-resident companies.
With regard to Article [49], the Court recorded in paragraph 41 the claimants’ submission that the UK legislation infringed the freedom of establishment of non-resident parent companies because it granted no tax credit either to the parent company or to its ultimate shareholders:
‘By comparison with resident companies receiving dividends from a resident company, a non-resident company is in an unfavourable position, in that, since its shareholders are not entitled to a tax credit, that company must increase the amount of its dividends in order for its shareholders to receive a sum equivalent to that which they would receive if they were shareholders in a resident company.’
Paragraph 46 recited the familiar jurisprudence of the Court that, in order to determine whether a difference in tax treatment is discriminatory, it is necessary to consider whether the companies concerned are ‘in an objectively comparable situation’. The Court noted that ‘discrimination is defined as treating differently situations which are identical, or treating in the same way situations which are different’.
Paragraph 47 recorded the submission of the UK, German, French, Irish and Italian governments, and the European Commission, that the situation of resident and non-resident shareholders in the present context is not identical, ‘in that a non-resident company is not liable to tax in the United Kingdom on those dividends’. Similarly, a non-resident company is not liable to ACT when it distributes profits to its own shareholders.
Conversely, the claimants contended (see paragraph 48) that both resident and non-resident companies in receipt of dividends from a resident company were in an identical situation. Although a non-resident company receiving such dividends was not liable to income tax in the UK (or was, by virtue of a DTC, taxable in the UK but entitled to a tax credit for tax paid by the company making the distribution), a resident company in receipt of such dividends was also exempt from corporation tax in the UK on those dividends.
The Court then noted in paragraph 49 that dividends paid by a company to its shareholders may be subject both to a series of charges to tax and also to economic double taxation:
‘It should be noted in that regard that dividends paid by a company to its shareholders may be subject both to a series of charges to tax, since they are taxed, first, at distributing company level, as realised profits, and are then subject to corporation tax at parent company level, and to economic double taxation, since they are taxed, first, at the level of the company making the distribution and are then subject to income tax at ultimate shareholder level.’
The Court then observed that it is for each member state to organise its system of taxation of distributed profits in accordance with Community law, and to define the tax base and tax rates which apply to the distributing company and/or the recipient shareholder, in so far as they are liable to tax in that state (paragraph 50). No unifying or harmonising measure for the elimination of double taxation has yet been adopted at Community level (paragraph 51), and in the absence of such a measure ‘Member States retain the power to define, by treaty or unilaterally, the criteria for allocating their powers of taxation, particularly with a view to eliminating double taxation’ (paragraph 52, citing case-law to that effect).
However, member states are not entitled to impose measures which contravene the Treaty freedoms of movement (paragraph 54). This principle is illustrated by the treatment of dividends paid to residents by non-resident companies, where the situation of the recipient shareholder is truly comparable with the receipt of dividends from a national source (paragraphs 55 and 56).
However, the same is not necessarily true in relation to the taxation of outgoing dividends (paragraph 57). The source state ‘is not in the same position, as regards the prevention or mitigation of a series of charges to tax and of economic double taxation, as the Member State in which the shareholder receiving the distribution is resident’ (paragraph 58). To require the source state to ensure that dividends received by a non-resident shareholder were not liable to a series of charges to tax or to economic double taxation, whether by exempting the distributed profits from tax or by granting the shareholder a tax credit equal to the tax on the distributed profits, would in practice oblige the source state ‘to abandon its right to tax a profit generated through an economic activity undertaken on its territory’ (paragraph 59). Furthermore, it is usually the home state of the shareholder which is best placed to determine the shareholder's ability to pay tax (paragraph 60).
UK domestic law does not tax dividends paid to another company at all, wherever the recipient shareholder is resident. There is therefore no difference in treatment in this respect (paragraphs 61 and 62).
However, only resident shareholders are entitled to a tax credit, and in this respect there is a difference of treatment between resident and non-resident shareholders (paragraph 63). But it is only in its capacity as the home state of the recipient shareholder that the UK grants the credit (paragraph 64). The position is therefore not comparable with the payment of dividends to a non-resident shareholder, which in turn distributes them to its ultimate shareholders (paragraph 65).
Pausing at this point, the main conclusion clearly follows: so long as the source state does not itself tax a dividend paid to a non-resident shareholder, there is no breach of Article [49] if the source state confines the grant of tax credits exclusively to resident shareholders. The reason for this is that the resident and non-resident shareholders are not in a comparable position, and the tax credit is granted by the source state solely in its capacity as the home state of the recipient.
Furthermore, the same reasoning would in my judgment clearly apply if the source state entered into a DTC with the home state of a non-resident shareholder under which a partial tax credit was conferred on the shareholder, but the source state still did not attempt to tax the dividend. The position then would be that the source state had voluntarily agreed to give a measure of relief from economic double taxation to residents of the treaty state, presumably in return for similar benefits of a reciprocal nature; but none of this would detract from the fact that the grant of a full credit to resident shareholders was something that the source state did exclusively in its home state capacity. The situations of resident and non-resident shareholders would still not be comparable, and Article [49] would not be engaged.”
These proceedings: Pirelli II
The outstanding issue in Pirelli I, as remitted by the House of Lords, was due to be heard by Rimer J, but, when the remitted case came on before him, a new argument was taken by the claimants. Rather than deciding the issue remitted by the House of Lords, Rimer J proceeded to deal with the new argument. Hence Pirelli II, which Henderson J explained below at [2010] STC 1078, paragraphs 15 to 22, in a passage which I do not believe is contentious:
The [claimants’ new] argument was nothing if not ingenious, and I cannot do better than repeat the summary of it given by Rimer J in paragraph 32 of his judgment [in Pirelli II] at 158):
‘The true analysis, say Pirelli, is (i) that if a group income election had been open to and exercised by it, the dividends paid to Pirelli Netherlands/Italy would have been paid free of ACT; (ii) that admittedly (as the House of Lords has decided) at that point no [DTC] credit could or would have been payable or paid to Pirelli Netherlands/Italy; but (iii) that when Pirelli UK subsequently paid its MCT on its profits for the accounting period in which the dividends were paid, a [DTC] credit would then have been payable and paid to Pirelli Netherlands/Italy by way of compensation for the MCT so paid by their subsidiary; (iv) moreover, that credit ought to have been a larger credit than that which had been wrongly paid earlier, because it should have been equal to the full tax credit that the UK resident shareholder would have received under the UK's dividend taxation rules rather than the half-rate credit payable under the [DTCs]; therefore (v) the most that HMRC can say on this enquiry as to compensation is that Pirelli Netherlands/Italy received early a smaller credit than the larger one they would have been entitled to later. Pirelli asserts that this analysis of the position is of fundamental significance to the calculation of the group's loss at least in respect of its claim in respect of utilised ACT.’
Rimer J went on (in paragraph 33 of his judgment) to describe the argument as:
‘a brand new point, at least as far as the issues argued before the Court of Appeal and the House of Lords were concerned, although it is not new as far as Pirelli’s advisers have been concerned, and they argued it (or at least raised it) before Park J.’
The questions on which Rimer J heard full argument, and on which he ruled, were:
whether it was still open to Pirelli to take the new point … ; and
if the point was still open to Pirelli, whether it was in principle well-founded.
After reviewing the history of the litigation, and analysing the decision of the House of Lords in Pirelli I, Rimer J dealt with these two questions in turn. He found the first question ‘not … to be a straightforward one’ (paragraph 61), but decided it in Pirelli’s favour …..
On the second question, Rimer J recorded (in paragraph 62) Pirelli’s acceptance that UK domestic legislation only conferred the entitlement to a tax credit upon the payment of ACT, and he then proceeded to examine the submissions advanced by Mr Graham Aaronson QC (appearing, as in the present case, for the claimants) that as a matter of Community law the parent companies became entitled to a treaty tax credit equal to the full domestic tax credit upon payment by the UK subsidiary of MCT. Mr Aaronson's principal justification for this submission was the proposition that the function of treaty credits was to prevent economic double taxation, on the footing (which the Revenue did not dispute: see paragraph 63) that ACT was to be regarded as merely corporation tax paid in advance. In support of this submission, Mr Aaronson relied on the judgments of the ECJ in two other cases referred for preliminary rulings by the English High Court within the ACT and FII group litigation. Judgment in both cases had been given on the same day (12 December 2006) by similarly-constituted Grand Chambers of the Court, with the same Rapporteur (Judge Lenaerts) and the same Advocate General (Geelhoed). The cases were Test Claimants in the FII Group Litigation v IRC … [2006] ECR I-11753 ….and [ACT Class IV].
From ACT Class IV Rimer J derived two propositions … . The first proposition is that ‘it is not the job of the state of residence of the dividend-paying company to prevent double taxation falling on shareholders in some other State’ (paragraph 71 of his judgment). The second proposition, by way of exception to the first, is that where a member state, whether unilaterally or by means of a DTC, imposes a charge to income tax not only on resident shareholders but also on non-resident shareholders in respect of dividends which they receive from a resident company, the position of non-resident shareholders becomes comparable to that of resident shareholders, and the member state comes under an obligation to provide them with equivalent relief from double taxation to that which it affords to resident shareholders (paragraphs 72 to 75 of his judgment). The second proposition was, of course, potentially applicable to the UK in cases where, as in Pirelli II, the relevant DTC provided for payment of a partial tax credit and for income tax to be charged at a reduced rate on the aggregate of the dividend and the credit.
Having thus set the scene, Rimer J trenchantly disposed of Pirelli’s new argument in a passage which I should quote in full:
‘77. The starting point is that it is clear, as a matter of domestic law, that in the case of a group income election as between exclusively UK resident companies, the UK parent would not be entitled to a tax credit either when the dividend was paid or when its UK subsidiary later paid its MCT. It would, therefore, be odd if, in the case of a like election between a UK subsidiary and its foreign parent, the latter were to be entitled to a tax credit in circumstances in which a UK parent would not. Why should Community law be thought to intend such discriminatory treatment in favour of a foreign parent? I cannot see that [ACT Class IV] provides any support for the thought that it does or might. What it does show is (i) that Community law requires the UK to relieve economic double taxation suffered by a group in respect of a dividend paid by a UK subsidiary to a foreign parent in cases in which (a) the UK itself imposes economic double taxation by exercising taxing rights over the dividend and (b) where the UK relieves such economic double taxation in the case of a UK parent; but (ii) that the UK is not responsible for relieving economic double taxation caused by the tax regime in the home State of the parent company.
In the circumstances of the present case, there can be no question of the UK being under an obligation to relieve Pirelli Netherlands/Italy from any suggested economic double taxation suffered in respect of the relevant dividends. The House of Lords has decided, in a decision binding on Pirelli, that, as Lord Scott put it [in Pirelli I]:
“the only tax credit available, at least in this area of tax law, is a tax credit under section 231. There is no such thing as an article 10(3)(c) tax credit that is not a "tax credit under section 231.”
All their Lordships agreed with Lord Scott's speech, and there can now be no doubt, that a section 231 tax credit is exclusively linked to the payment of ACT under section 14(1). So, as a matter of domestic law, it is plain that upon the hypothetical exercise of a group income election Pirelli Netherlands/Italy would not, upon the subsequent payment by Pirelli UK of its MCT, have become entitled to any tax credit at all. As no credit would have been payable, no UK tax would have been payable on the dividend paid to Pirelli Netherlands/Italy, since such tax is only payable in circumstances in which the foreign parent does receive a tax credit (section 233(1)). The result of all that is: no tax credit, therefore no tax on the dividend, therefore no economic double taxation imposed by UK law, therefore no “risk of a series of charges to tax”, therefore no duty to relieve against it, therefore no entitlement to a tax credit. Community law only requires the UK to provide a credit by way of such relief in circumstances in which it has itself imposed a liability to tax on the dividend – and therefore an exposure by such liability to economic double taxation – but under UK law there was no such liability unless Pirelli has first become entitled to a credit. Pirelli’s problem in this litigation is that it appears reluctant to accept that the House of Lords has decided that it is not entitled to one. As Mr Glick [QC for HMRC] put it, Mr Aaronson's argument amounted to no more than the assertion that Pirelli must be entitled to the claimed credit because it must be entitled to it.
As it appears to me, there is no more to Pirelli’s case than that.’
Pirelli’s subsequent appeal to the Court of Appeal was unanimously dismissed by Rix, Jacob and Moses LJJ ….. The Revenue did not cross-appeal on what Moses LJ (delivering the only reasoned judgment) termed Rimer J’s ‘reluctant indulgence in permitting the point to be pursued’ (paragraph 5). On the substantive issue, the Court upheld the reasoning and conclusion of Rimer J: see paragraphs 25 to 28. The critical point was that, in circumstances where a GIE would have been made (and thus loss might in principle be established), no treaty tax credit would have been payable (because the House of Lords has said so), so there would have been no charge to UK income tax on the dividend, and therefore no economic double taxation which Community law might require the UK (as the state of residence of the dividend paying company) to remedy. It is essential to remember at this point that, although the Dutch and Italian DTCs provide for UK income tax to be levied, they do so only where there is entitlement to a partial tax credit. Absent that entitlement, the foundation of the charge to income tax disappears, and with it the possibility of economic double taxation for which the UK could be held responsible.”
In the course of his pithily expressed reasons, Moses LJ summarised the position at [2008] STC 508, paragraph 27, as being that “consistency with Community law [was] achieved by affording the Pirelli group the same opportunity to make a [GIE] as that afforded to a group resident in the United Kingdom.”
These proceedings: Pirelli III and the remitted issue in Pirelli I
The claimants’ new point having failed in Pirelli II, the case came back before Henderson J for the determination of the outstanding point in Pirelli I, as remitted by the House of Lords. By this time, the Pirelli group of companies had been joined as claimants by the Huhtamaki and the Volvo groups of companies.
Having heard evidence and argument on the remitted point, the Judge decided that, had a GIE been available to the Pirelli group, the group would not have elected to have the United Kingdom subsidiaries pay the dividends in question free of ACT, but would have chosen that the United Kingdom subsidiaries should pay the dividends outside a GIE. Thus, subject to the instant appeal on the point, the effect of the House of Lords’ decision and the decision of Henderson J was that the claims in Pirelli I have failed.
However, Henderson J was also called upon to consider three new arguments raised by the claimants – hence my description of that part of his decision as Pirelli III. Like Rimer J in Pirelli II, Henderson J was unhappy about considering yet more new points raised by the claimants, but he decided to permit the claimants to raise them. However, he found against the claimants on all three arguments. Only two of those arguments are still maintained before us, and they are as follows:
It was inappropriate under Community law to have granted the claimant groups of companies only a partial tax credit, notwithstanding that ACT was paid in full;
The 5% income tax charge should be refunded under the principles established in the ECJ’s judgment in ACT Class IV.
In the course of his clear and careful judgment, Henderson J also dealt with other points, which are not pursued in this court, but, for present purposes, it is right to mention that he disposed of these two arguments in Pirelli III first, and then turned to the remitted issue in Pirelli I. I will take the same course.
Before doing so, it may assist if I repeat a simple example (reflected in Rimer J’s judgment quoted above in Pirelli II, and indeed in Park J’s judgment in Pirelli I at [2003] STC 250, paragraph 24). Assume a UK-resident subsidiary paid a dividend of £1,000 to its parent. ACT would be levied on such a dividend (unless the group can and does make a GIE) in the sum of, say, £250, i.e. 25%. If the parent company is UK-resident, it would receive a tax credit of £250. However, if the parent was (Italy or Netherlands)-resident, the DTC would apply, and the parent would receive a net tax credit of £68.75, or 6.875%, which is arrived at in the following way: £125, or 12.5%, half the domestic credit by virtue of Article 10(3)(c), less £56.25, or 5.625%, under Article 10(3)(a) (this latter figure being 5% of £1,125, a sum which is the aggregate of the gross dividend of £1,000 and the half tax credit of £125).
Pirelli III: can the claimants recover the ACT net of the tax credit?
The claimants’ first point in Pirelli III is based on the proposition that, where a dividend was paid by a UK-resident subsidiary to an (Italy or Netherlands)-resident parent, the group of companies (so-called “Class 2 claimants”, such as the claimants in this appeal) should have been in the same position as a group where the parent was Germany-resident (i.e the position of the so-called “Class 1 claimants”). In the case of the latter type of group, where the DTC (as between the United Kingdom and Germany) has no provision for a tax credit such as is found in Article 10(3) of the DTCs with Italy and the Netherlands, the effect of the ECJ’s decision in Hoechst is that the ACT deducted from the dividend (and not set off against MCT) should be repayable in full. Accordingly, runs the claimants’ argument, in a case where the DTC has provision for a tax credit which mitigates the ACT liability, as where the parent company is (Italy or Netherlands)-resident, the logic of the decision in Hoechst is that the ACT (not set off against MCT) should be repayable less the tax credit.
Mr Aaronson contended that Henderson J’s decision in this case results in an unacceptable anomaly in the position of Class 2 claimants compared with that of Class 1 claimants following the decision in Hoechst, and he put his point most graphically in figures. The effect of Hoechst is that, where a UK-resident subsidiary had paid a Germany-resident parent a dividend of £1,000, from which £250 ACT was deducted, there being no provision in the relevant DTC for a tax credit, the group could recover the full £250. On the other hand, where the parent company is (Italy or Netherlands)-resident, the Judge decided that, simply because the relevant DTC entitled the parent to receive a net tax credit of £68.75, the group had no right to recover anything. The logic of this decision is that, if the relevant DTC entitles the (EU non-UK)-based parent to receive any tax credit, however small, such as £68.75, the group is out of pocket to the extent of the ACT of £250 less the credit, say £181.25, whereas if the relevant DTC provides for no tax credit, the group is not out of pocket at all, as it can recover the whole £250.
Before considering Henderson J’s reasons for concluding that the Class 2 claimants could not recover anything despite this alleged anomaly, it is right to point out that (a) Mr Aaronson’s point is rather overstated as a matter of fact, and (b) at least as a matter of principle, there is no inconsistency between the way in which the Class 1 claimants, i.e. groups with Germany-resident parents, and the Class 2 claimants, i.e. groups with (Italy and Netherlands)-resident parents, are treated as a result of Hoechst and Pirelli I respectively. So far as point (a) is concerned, Class 2 claimants may end up with the same compensation as Class 1 claimants: it depends on whether the Class 2 claimant group in question would have made a GIE if they had been entitled to do so: that was the very question remitted by the House of Lords and decided by Henderson J in Pirelli I.
This ties in with point (b), namely that there is really no inconsistency of treatment between the two classes of claimant. First, the effect of each of those decisions is that the claimant groups have been the subject of unlawful discrimination under Article 49, as against a group with a UK-resident parent. Secondly, the effect of each of those decisions is that the claimant groups were not accorded the opportunity to make a GIE. Thirdly, the effect of each of those decisions is that the claimant groups are entitled to compensation based on what would have happened if they had been given that opportunity.
It is only at the next, fourth, stage that there is a divergence in the effect of the two decisions. In relation to the Class 1 claimants, it is obvious what groups with a Germany-resident parent would have done if they had been accorded the right to make a GIE: they would have made the election. That is because there was no downside in making a GIE where a UK-resident subsidiary paid a dividend to as Germany-resident parent. However, in relation to Class 2 claimants, the position was less clear, as there was the benefit of an Article 10(3)(c) tax credit in relation to a dividend paid to an (Italy or Netherlands)-parent, if no election was made and ACT was paid; this would not, of course, apply to Class 1 claimants, as the DTC with Germany has no equivalent of Article 10(3)(c). That is why the House of Lords decided that it was necessary to resolve the issue ultimately determined by Henderson J in Pirelli I in relation to the Class 2 claimants, and why no such issue had to be determined in relation to the Class 1 claimants in Hoechst.
However, based on the financial differences between the outcome of Hoechst and the outcome of Pirelli I, Mr Aaronson has now reformulated the claimants’ contention as being that, in the case of Class 2 claimants such as the claimants in this case, a UK-resident subsidiary should have been entitled to pay ACT at a rate equivalent to the tax credit afforded to its (Italy or Netherlands)-resident parent, namely 6.875% (or, perhaps, 12.5%), but otherwise free of ACT. There was some argument as to whether this contention involves alleging that ACT was an unlawful tax, but that may be an arid debate, given that the reformulated contention was not raised in Hoechst. Having said that, it is clear that the ECJ in Hoechst did not conclude that ACT was an unlawful tax (as was pointed out by Lord Scott in Pirelli I at [2006] 1 WLR 400, paragraph 81), and (as explained by Moses LJ in Pirelli II), what the ECJ decided was simply that it was unlawful for the United Kingdom to accord a GIE to groups with UK-resident parents and not to groups with (EU non-UK)-resident parents.
Henderson J rejected the claimants’ reformulated contention essentially on the basis of the reasoning of the ECJ in ACT Class IV, for reasons which he gave at [2010] STC 1078, paragraphs 43-51 of his judgment. Having explained what the ECJ had decided in ACT Class IV in the passage I have quoted in extenso in paragraph 13 above, he went on to explain his reasoning as follows:
“43. But what if the source state decides to impose a charge to tax on dividends which are paid to non-resident shareholders? That is the question which the Court went on to consider in paragraphs 68 to 71:
‘68. However, once a Member State, unilaterally or by a convention, imposes a charge to income tax not only on resident shareholders but also on non-resident shareholders in respect of dividends which they receive from a resident company, the position of those non-resident shareholders becomes comparable to that of resident shareholders.
As regards the national measures at issue in the main proceedings, that is the case when, as is mentioned in paragraph 15 of this judgment, a DTC concluded by the United Kingdom provides that a shareholder company which is resident in the other contracting Member State is entitled to a full or partial tax credit for dividends which it receives from a company resident in the United Kingdom.
If the Member State of residence of the company making distributable profits decides to exercise its taxing powers not only in relation to profits made in that State but also in relation to income arising in that State and paid to non-resident companies receiving dividends, it is solely because of the exercise by that state of its taxing powers that, irrespective of any taxation in another Member State, a risk of a series of charges to tax may arise. In such a case, in order for non-resident companies receiving dividends not to be subject to a restriction on freedom of establishment prohibited, in principle, by Article [49] …, the State in which the company making the distribution is resident is obliged to ensure that, under the procedures laid down by its national law in order to prevent or mitigate a series of liabilities to tax, non-resident shareholder companies are subject to the same treatment as resident shareholder companies.
It is for the national court to determine, in each case, whether that obligation has been complied with, taking account, where necessary, of the provisions of the DTC that that Member State has concluded with the State in which the shareholder company is resident (see, to that effect, … Bouanich [2006] ECR I-923, paragraphs 51 to 55).’
It is, of course, precisely this type of case which I now have to consider, because of the charge to income tax (at a maximum rate of 5%) which the UK imposes on dividends paid to parent companies resident in the Netherlands and Italy under the relevant DTCs. It follows, by virtue of paragraph 68, that the position of the recipient shareholder is now comparable to that of resident shareholders. The reason why their positions are now comparable is, it would seem, that the UK levies income tax not only on ultimate shareholders resident in the UK but also on the non-resident parent company. The relevant comparison must be with the ultimate UK-resident shareholders, and not with a UK-resident parent company, because a UK parent company was not liable to either income tax or corporation tax on dividends received from a UK subsidiary. Thus the imposition by the UK of a charge to income tax on resident and non-resident shareholders, although at different levels in the distribution chain, is still enough to engage Article [49].
Paragraph 70 then states the consequences. Because the UK has chosen (through the relevant DTCs, and their incorporation into domestic law by section 788 of ICTA 1988) to tax the outgoing dividends, ‘a risk of a series of charges to tax may arise’. In order to avoid infringing the Article [49] rights of the recipient parent companies, the UK is obliged to ensure that, to repeat the critical words,
‘under the procedures laid down by its national law in order to prevent or mitigate a series of liabilities to tax, non-resident shareholder companies are subject to the same treatment as resident shareholder companies.’
Paragraph 71 then says that it is for the national court to determine whether that obligation has been complied with.
It is noteworthy, I think, that in both paragraphs 70 and 71 the risk which has to be prevented or mitigated is said to be the risk of ‘a series of charges to tax’. That phrase is not coupled, as it is (for example) in paragraphs 55, 56, 58, 59 and 65, with a reference to the prevention or mitigation of economic double taxation. The two concepts clearly overlap, but they are not co-extensive. A series of charges to tax may or may not involve economic double taxation, depending on whether the same economic subject matter is in substance taxed more than once in the hands of different taxpayers. This distinction is drawn by the Court, albeit rather obliquely, in paragraph 49 (and see too the fuller discussion in paragraphs 4 to 7 of the Advocate General's opinion). Conversely, a series of charges to tax may involve, not merely economic, but juridical double taxation, if the same subject matter is taxed twice over in the hands of the same taxpayer (for example by means of a withholding tax on a cross-border dividend in state A, and income tax imposed on the same dividend in the home state of the shareholder, state B). The focus in paragraphs 70 and 71 is on a series of charges to tax, it seems to me, for two main reasons. First, it is the imposition of the tax on the outgoing dividend by the source state which gives rise to the problem which has to be remedied; and prima facie the obvious way to solve the problem is to ensure that this charge to tax is not replicated at any subsequent stage in the chain of distribution. Secondly, the prevention or mitigation of economic double taxation is, as the Court has already explained, generally a matter for the home state to deal with (typically by the grant of a tax credit). In the absence of a unified system of corporate taxation, it is normally not a matter with which the source state needs to concern itself.
With these considerations in mind, I ask myself whether the UK has succeeded in neutralising the risk of a series of charges to tax brought about by its imposition of the 5% charge to income tax on the dividends. In my judgment it plainly has. In a purely domestic context, the mechanism of the full tax credit given to individual shareholders, and the exemption from corporation tax of dividends received by corporate shareholders, together ensured that the charge to ACT when the dividend was first paid (and which, it must always be remembered, Community law regards as no more than corporation tax paid in advance), was not replicated by any subsequent charge in the chain of distribution. An individual ultimate shareholder might be liable to higher rate income tax on the dividend, but that would merely reflect the fact that the UK system was only a partial imputation system. The important point is that the full tax credit under section 231 was equal in amount to the ACT originally charged on the dividend.
In the cross-border context, the charge to tax which must not be replicated is the 5% withholding tax, and this was achieved by the grant of the one half tax credit, the first charge on which was satisfaction of the income tax liability. As a matter of mechanics, this was provided for by Article 10(3)(c) of the relevant DTC, which provided that:
‘In these circumstances a company which is a resident of [the Netherlands] and receives dividends from a company which is a resident of the United Kingdom shall, … provided it is the beneficial owner of the dividends, be entitled to a tax credit equal to one half of the tax credit to which an individual resident in the United Kingdom would have been entitled had he received those dividends, and to the payment of any excess of that tax credit over its liability to tax in the United Kingdom.’
Hence the net payment of 6.875% of the amount of the dividend which was in practice received by the Pirelli parent companies in the Netherlands and Italy.
This, in my judgment, is all that the UK was obliged to do in order to secure compliance with Article [49]. In particular, it cannot be right, in my judgment, to say that the UK was also obliged to pay a full tax credit which matched the amount of the ACT on the dividend, or (alternatively) to tailor the ACT charge to the size of the net tax credit. As I have already explained, the ECJ has clearly held that, in the absence of the 5% income tax charge, no possible objection could be taken on Community law grounds to the imposition of ACT at the full domestic UK rate without the grant of any tax credit to the recipient shareholder, and the same must also apply to the grant of a partial tax credit. It is only the introduction of the income tax charge which gave rise to the problem, and it follows, in my opinion, that it was only the income tax charge which had to be neutralised in order to restore compliance with Community law. I will discuss this point in more detail when I come on to issue 2 below, and for now I will merely say that it would in my judgment be wrong to read paragraph 70 of the ECJ judgment, in the context of the reasoning which leads up to it, as obliging the UK to provide equivalent relief from economic double taxation for non-resident shareholders to that which it provides for resident shareholders, merely because it has been unwise enough to negotiate a DTC which charges income tax at 5% on outgoing dividends and then provides a partial tax credit which is amply sufficient to discharge that liability.
The second question in ACT Class IV upon which Mr Glick placed reliance was question 1(c), which asked (in short) whether it was compatible with Article [49] for the UK to deny a partial tax credit to a parent company resident in the Netherlands or Italy where the company in question was controlled by a company resident in a state such as Germany where there was no entitlement to any tax credit. This question, too, was answered in the UK's favour: see paragraph 94 of the judgment of the Court. The Court in fact considered question 1(c) in conjunction with two other related questions: see paragraphs 73 to 93. The Court's discussion of these issues reinforces the points:
that the grant of a tax credit under a DTC cannot be divorced from the other provisions of the DTC in question (see paragraph 88); and
that a company resident in a member state whose treaty with the UK does not provide for a tax credit is not in an objectively comparable situation with a company resident in a member state whose treaty does so provide (see paragraph 91).
To conclude, I regard it as clear that Community law has no objection to the requirement for ACT to be paid in a greater amount than the tax credit available under the DTCs with the Netherlands and Italy. The test claimants therefore have no rights under Community law which could require the UK to adopt the ‘tailored’ solution for which they contend, and which would in one way or another match the amount of lawfully chargeable ACT to the net amount of the partial tax credit. Mr Aaronson invited me to refer the question to the ECJ if I felt any doubt about the answer, and helpfully suggested a form of words for such a reference. However, I do not consider that there is sufficient doubt about the matter to justify a further reference, assuming in the claimants' favour that the argument is one which it is still open to them to advance.”
Like Moses LJ, at [2008] STC 508, paragraph 28, when considering Rimer J’s judgment in Pirelli II, I am tempted simply to affirm Henderson J’s analysis and conclusion. Not only do I agree with the judgment, and consider it to be well reasoned and expressed, but, as I have already mentioned, a remarkable amount of court sitting time and a remarkable amount of judgment-writing time has already been given over to claims in relation to ACT payments by the Pirelli group. Out of deference to Mr Aaronson’s arguments, however, I shall express my conclusions in my own words, but relatively briefly.
It is clear from the ECJ’s reasoning in ACT Class IV, that if the United Kingdom had levied no income tax charge on the dividend, as permitted by Article 10(3)(a) of the DTCs with Italy and the Netherlands, then there would be no basis for the claimants’ reformulated claims in Pirelli III, irrespective of whether or not there was provision for a tax credit as provided for in Article 10(3)(c). While I consider that Mr Aaronson’s alleged anomaly summarised in paragraph 22 above, is not, on analysis, an anomaly, for the reasons given in paragraphs 23 to 25, it seems to me that, if his reformulated point is correct, there would be an anomaly, because, where a tax credit is accorded, Mr Aaronson’s analysis (as described in paragraph 25 above) would apply if income tax, in however small a figure, was charged in accordance with a provision such as Article 10(3)(a), but the analysis could not apply if no income tax was charged.
In this difficult area, it is probably impossible to arrive at a conclusion or analysis which will not produce results in individual cases which can at least be said to give rise to anomalies. Further, it is important to hold to the fundamental principles, as they are developed by the ECJ. I have already expressed a view as to the consistency of principle between the reasoning in Hoechst and the House of Lords’ conclusion in Pirelli I in paragraphs 23 and 24 above. Quite apart from this, on the basis of the reasoning and conclusions in the judgments of the ECJ in Hoechst and ACT Class IV, it seems to me far more logical and consistent with principle to say that, where the source country (i.e. the United Kingdom) chooses to charge a tax on a dividend paid by a UK-resident subsidiary to an (EU non-UK)-resident parent, it is that tax which the United Kingdom must mitigate in order to ensure that groups with (Italy and Germany)-resident parents are treated the same way as those with UK-resident parents. To hold otherwise, as I see it, would be attributing to the ECJ a capricious view of the law in its discussion in paragraphs 68-71 in ACT Class IV, as analysed and explained by Henderson J in the passage I have quoted in extenso from his judgment in paragraph 26 above.
It is instructive to apply paragraph 70 of the ECJ’s judgment ACT Class IV to the facts of the instant claims. The paragraph is concerned with a case where the United Kingdom “decides to exercise its taxing powers not only in relation to profits made in that State but also in relation to income arising in that State and paid to non-resident companies receiving dividends”. In the current context, that must be a reference to the 5% tax authorised by Article 10(3)(a) of the relevant DTC. In such a case, “it is solely because of the exercise by that state of its taxing powers that, irrespective of any taxation in another Member State, a risk of a series of charges to tax may arise.” That risk arises from the 5% charge. Accordingly, “in order for non-resident companies receiving dividends not to be subject to a restriction on freedom of establishment prohibited, in principle, by Article [49]”, the United Kingdom was “obliged to ensure that, under the procedures laid down by its national law in order to prevent or mitigate a series of liabilities to tax, non-resident shareholder companies are subject to the same treatment as resident shareholder companies.” That was achieved by the tax credit under Article 10(3)(c), which more than compensated for the 5% tax charge.
The claimants alternatively suggested that this issue was one which should be referred to the ECJ. I do not consider that course to be appropriate. In my view, the point is acte clair. In any event, in ACT Class IV, paragraphs 70 and 71, after referring to the obligation to ensure that non-resident shareholder companies are subject to the same treatment as resident shareholder companies, the ECJ said that it was “for the national court to determine, in each case, whether that obligation has been complied with”. The ECJ made a similar point in Amurta SGPS v Inspecteur van de Belastingdienst/Amsterdam [2007] ECR 1-9569, paragraph 83.
Accordingly, I agree with Henderson J that this reformulated contention as to how the claimants’ inability to make a GIE should be remedied, should be rejected on the ground that it is inconsistent with the reasoning of the ECJ in ACT Class IV, quite apart from the fact that the contention sits uncomfortably with the conclusions reached by the ECJ in Hoechst and by the House of Lords in Pirelli I.
Pirelli III: Can the claimants reclaim the 5% tax that has been paid on dividends?
The 5% (or 5.625%) tax levied pursuant to Article 10(3)(a) of the DTC is a tax deducted from a dividend paid to EU-based parent companies which would not be deducted from a dividend paid to a UK-resident parent company. It is common ground, at least for present purposes, that the effect of the ECJ’s judgment in ACT Class IV is that, if the United Kingdom imposes such a tax on dividends paid to an (Italy or Netherlands)-resident parent, which it does not impose on dividends paid to a UK-resident parent, it must, to use Mr Aaronson’s expression, “alleviate the double taxation of those distributed profits”. (Indeed, that is reflected in HMRC’s stance on the point just discussed).
HMRC’s contention, which was accepted by the Judge, was that the requirement identified in ACT Class IV was plainly satisfied in this case, because the 5% income tax (which grosses up to 5.625% once one takes into account the half credit) is indeed neutralised by part of the 12.5% tax credit. At any rate at first sight, it seems hard to quarrel with this contention, but the claimants’ response was that the purpose of the 12.5% credit was not to neutralise the 5% income tax, but to ameliorate the underlying double taxation. To put the point another way, the tax credit was in respect of the corporation tax which had been paid, whereas the 5% tax was paid in respect of the dividend.
Unless it is apparent from the terms of the relevant legislation or of the DTC that the tax credit is somehow inexorably and solely linked to some liability payment other than the 5% tax charge, I would find it very difficult to accept this argument. On the face of it, there is a tax charged on a dividend, and a tax credit in a higher amount, which can be claimed in respect of the dividend. If a dividend is payable from a UK-resident subsidiary to an (Italy or Netherlands)-resident parent, the United Kingdom has the right to tax it at a rate of up to 5%, and the taxpayer is entitled to a tax credit in excess of that sum, so it would seem that the tax is neutralised. It might be different if it was plain from the terms or operation of the DTC or from the legislation that the tax credit had a different purpose, but it does not seem to me that it is.
For HMRC, Mr Glick contended that, if anything, the indications in the DTC and in ICTA to support the proposition that part of the purpose of the tax credit in the DTC was to mitigate the extent of liability to tax: compare the language of section 231(3) of ICTA (and the comment of Lord Scott in Pirelli I as quoted in paragraph 78 of Rimer J’s judgment in Pirelli II, set out in paragraph 21 of Henderson J’s judgment, which is in paragraph 14 above), and the reference to “the payment of any excess of that tax credit over its liability to tax in the United Kingdom” at the end of Article 10(3)(a)(ii) of the DTC. That may be right, but it appears to me that it is unnecessary to go that far. The fact that the 12.5% tax credit may perform more than one function does not seem to me to present any problem, either in practice or in theory.
In their written argument, the claimants also suggested that their case on this point was supported by the proposition that it would otherwise be “nonsensical” for the DTC to grant a credit with one hand and take much of it away with another. However, as Mr Glick said, the answer to this point lies in the next paragraph of the written argument, namely that the purpose of the DTC arrangements “was to impose upon the dividend a UK tax charge which would be recognised as such … by the tax authorities of the state of residence of the shareholders”.
Mr Aaronson referred to a United States Treasury Department Technical Explanation dated 19 July 1997 which explained that the 5% tax and the tax credit should be treated separately for US taxation purposes. With all respect, that cannot have any bearing on the question how, for the purposes of Community and English law, the tax liability and tax credit should be treated.
On this point too, the claimants’ fallback position was that there should be a reference to the ECJ. For the reasons given in paragraph 31 above, I do not consider that course to be appropriate.
Accordingly, I agree with Henderson J that the second point raised by the claimants in Pirelli III should be rejected.
The outstanding point in Pirelli I: would the claimants have elected?
As explained above, the House of Lords concluded that the claimants’ success in Pirelli I hinged on the issue of whether, if they had been entitled to do so, the claimants would have made a GIE in the years 1995 to 1999. In that connection, the claimant groups would have had to balance the advantage of (a) making an election, paying no ACT, and consequently having no concern as to the future set-off of ACT against MCT, as against (b) making no election, paying ACT, and consequently taking the benefit of the tax credit under Article 10(3) of the relevant DTC.
On the assumption that a GIE had been available to the claimant groups, the approach which the Judge adopted, and which seems to have been common ground, subject to the first of the claimants’ two grounds of appeal on this aspect of the decision, was as follows:
If the claimant group would have expected to be able to set off ACT against MCT reasonably soon, and if the cost of funding the ACT in the meantime would have been likely to be less than the net amount of the tax credit, then a GIE would probably not have been made
If the prospects of setting off ACT against MCT in the short term would have been poor, and the funding cost of the ACT would have been likely to exceed the net amount of the tax credit, the advantage of not having to pay ACT would have outweighed the disadvantage of losing the credit, and a GIE could have been expected to be made.
Having read the witness statements of, and heard oral evidence from, Robert Stone, Pirelli’s UK group tax manager and chief financial officer, at the relevant time, and having heard argument on the issue, Henderson J meticulously analysed the evidence and arguments at [2010] STC 1078, paragraphs 103 to 119, and concluded at paragraph 120, that “none of the disputed dividends [i.e. the 19 dividends paid in the relevant period by Pirelli UK to its Italy-domiciled Pirelli parent] would have been paid under a GIE”. Accordingly, he held, “it follows that the ACT levied on the dividends was entirely lawful”, so the claim in Pirelli I failed. As he went on to explain in the next and final paragraph of his judgment, the other groups of claimants in Pirelli I (the Huhtamaki group and the Volvo group), effectively agreed to be bound by this outcome.
On behalf of the claimants, Mr Aaronson attacks this conclusion on two grounds. The first is that it was wrong in principle for Henderson J to have approached the issue as he did. The second ground is that, even if Henderson J was right to approach the issue as he did, his conclusion was against the weight of the evidence.
The first ground is based on the proposition that Henderson J was wrong to carry out an enquiry into whether, on the balance of probabilities, the claimant groups of companies would have made a GIE in respect of each of the 19 dividends. What he should have done, according to this argument, was to assume that the claimant groups would have made a GIE.
On the face of it, this is a surprising submission. The essence of the case of each group of claimant companies in Pirelli I is that, as the group had an (Italy or Netherlands)-resident parent, it should have been accorded the same right, namely to make a GIE, as a group with a UK-resident parent. On that basis, it is well established in domestic law that, in order to make out a claim for damages, a claimant group would have to show, on the balance of probabilities, that, had it had the right to do so, it would have made a GIE: see Allied Maples Group v Simmons & Simmons [1995] 1 WLR 1602, 1610D-1611A.
Further, the notion that Henderson J approached the issue in the wrong way is rather difficult to reconcile with the fact that his approach was precisely that which had been directed by the House of Lords, as set out by the Judge in paragraph 13 of his judgment, which is quoted verbatim in paragraph 11 above. I have some difficulty with the notion that it would have been open to Henderson J, let alone required of him, to proceed in a way different from that ordered by the House of Lords in these very proceedings.
Mr Aaronson suggested, however, that any reliance on the terms on which the House of Lords remitted the case in these proceedings has been overtaken by the reasoning in the opinions of Lord Walker and myself in Fleming v Revenue and Customs Commissioners [2008] UKHL 2, [2008] 1 WLR 195, paragraphs 64-5 and 97. In that case, HMRC did not afford, but, under Community law, should have afforded, taxpayers a transitional period to make a certain type of claim, after introducing a time limit which had retrospective effect in relation to the making of such claims. The House of Lords rejected the contention that the taxpayer could only recover if he could show that he would have claimed if HMRC had afforded taxpayers a transitional period when the retrospective time limit was introduced. Instead the House looked to see whether a transitional period had been granted, on the basis that, if it had not, it should be granted.
Fleming [2008] 1 WLR 195 was concerned with the Community principle of effectiveness, which, as the House of Lords said, on the basis of ECJ jurisprudence, is a matter for the national court – see the opening parts of paragraphs 54 and 62, per Lord Walker. Indeed, that point had been made in the House by Lord Nicholls of Birkenhead in Pirelli I itself – see [2006] 1 WLR 400, paragraph 25. A number of ECJ judgments were cited and relied on in Fleming [2008] 1 WLR 195 – see paragraphs 54 to 58; they were all concerned with limitation periods or retroactivity.
The House of Lords’ decision in Pirelli I to remit the issue ultimately decided by Henderson J was expressly based on effectiveness, and it was a national court’s decision as to the appropriate remedy, against which no objection was taken at the time. The breach of Community law arising from the ACT legislation was not concerned with a time limit or retroactivity. The essence of the reasoning in Hoechst was that groups with (Italy or Netherlands)-resident parents should be placed in the same position as a group with a UK-resident parent. If the former groups are given retrospective right to make a GIE, they will be better off than the latter groups: as the evidence before Henderson J established, it was often hard to know whether to make a GIE within the time available: there would be no such difficulty retrospectively. The position is not the same as with a time limit for making a claim which involves no difficult decision-making. No doubt because they were thought to be irrelevant, none of the cases relied on in Fleming [2008] 1 WLR 195, paragraphs 54 to 58, were cited in Pirelli I, even though they had been decided.
A closely connected argument, which can fairly be treated as subsumed in this first ground, was that the basis upon which the House of Lords remitted the case to the High Court in Pirelli I impermissibly rendered it “in practice impossible or excessively difficult” (to quote from Advocate-General Jacobs in Weber's Wine World Handels-GmbH v Abgabenberufungskommission Wien [2003] ECR I-11365, paragraph 72) for the claimants to seek compensation. Henderson J rejected that contention, and, as he actually assessed the claim for compensation, nobody could have been in a better position to determine that issue.
I turn to Mr Aaronson’s second ground for challenging the Judge’s conclusion on the remitted issue in Pirelli I. He contends that the Judge went wrong in finding that no GIE would have been made by the Pirelli group of companies even if they had had the right to make such an election. At least on the face of it, this contention is a difficult one to maintain, as it involves seeking to challenge a factual inference made in a fully and carefully reasoned judgement by a judge who heard oral evidence directed to the issue. Having said that, it is, of course, open to this court to overturn a judge’s finding in such circumstances, and it will do so if satisfied that the finding cannot fairly be supported by the evidence.
One of Mr Aaronson’s arguments was that Mr Stone’s evidence was an insufficient or inappropriate basis upon which to rest his ultimate conclusion. In so far as that is based on the proposition that Mr Stone was an inappropriate witness, it is rather quaint, as he was, of course, the Pirelli group’s witness. However, reading the transcript of Mr Stone’s cross-examination suggests to me that he was a very relevant witness. True it is that the ultimate decisions about dividends and the like were taken by the group’s senior management in Milan (as the Judge himself said at [2010] STC 1078, paragraph 113), but they were concerned with the likelihood of surplus ACT building up, which was a matter on which Mr Stone advised, and he obviously would have been the person whose opinion would have been sought as to whether or not to make a GIE.
Secondly, Mr Aaronson said that the Judge placed too much weight on internal management reports and forecasts, which were not likely to be an accurate reflection of the accounts on which a decision whether to make a GIE would have been based. That point is not borne out by the evidence, which shows that the reports and forecasts were often prepared during the relevant year, and, in the event, were pretty accurate.
Thirdly, Mr Aaronson relied on the fact that Mr Stone said that, if the opportunity to make a GIE had existed, he would have required and obtained more information than he had had at the time. That is an unimpressive point: when cross-examined, Mr Stone said that he would have spoken to the finance directors and he would have found out about overseas tax liabilities. The finance directors would have told him no more than was in the management reports, and he admitted that he could not have got information about overseas tax liabilities in sufficient time to influence any GIE.
In the light of the argument that the Judge should not have reached the conclusion that he did on this third issue, we were asked by both parties to read the transcript of Mr Stone’s cross-examination and re-examination. Having done so, I am quite satisfied that the Judge was, to put it at its lowest, entitled to reach the conclusion that he did. Inevitably, there were passages in Mr Stone’s evidence which assisted the claimants, as well as passages which assisted the Revenue, but, to my mind, the overall effect of his evidence was, or, at the very least, could properly have been understood to be, in accordance with the Judge’s conclusion.
Accordingly, I would reject this ground of appeal, relating to the outstanding point in Pirelli III, as well.
Disposition
In the light of these conclusions, I would dismiss this appeal and uphold the decision of Henderson J in its entirety.
Patten LJ:
I agree.
Black LJ:
I also agree.