Pirelli Cable Holding NV & Ors v Commissioners of Inland Revenue

Abbreviations, dramatis personae, glossary.

The ‘Article 52/43 issue’ in this case arises out of one aspect of United Kingdom tax law as it stood from 1973 until 1999, and also out of the decision of the CJEC in Metallgesellschaft/Hoechst. The general rule was that, if a United Kingdom company paid a dividend, it had also to pay ACT to the Revenue: ICTA s.14. The rate of ACT varied over the years. At the times with which this case is concerned it was 25% of the dividend. However, if the dividend-paying company was a subsidiary of a United Kingdom holding company the two companies could make a joint election under section 247, the effect of which was that the paying company did not have to pay ACT after all. If the dividend paying company was a subsidiary of a non-United Kingdom holding company the two companies could not make an election under section 247, so the paying company had to pay ACT in circumstances where a subsidiary of a United Kingdom company, if it and its parent had made an election, did not.

In Metallgesellschaft/Hoechst the CJEC held that, if the non-United Kingdom holding company was established in another Member State (Germany in that particular case), the denial of the right of election to it and its subsidiary was contrary to the freedom of establishment conferred by article 52 (now article 43) of the EC Treaty. Further, the CJEC held that, as respects ACT which had been paid in the past by United Kingdom subsidiaries of parent companies in other Member States, Community law conferred a right of compensation or restitution which the aggrieved companies were entitled to pursue in the United Kingdom courts.

In consequence of the CJEC decision a large number of actions have been commenced in the courts of this country whereby United Kingdom subsidiaries of parents in other Member States are claiming relief by way of damages or restitution for ACT which they paid in the past and which they say they would not have paid if they had been able to join with their parents in making s. 247 elections. The various actions have all been brought within a group litigation order (GLO) regulated by rules 19.11 to 19.15 of the Civil Procedure Rules. Within the ambit of the GLO the actions have been classified into a number of different categories. The two cases to which the Metallgesellschaft/Hoechst decision related are in one category. As I understand it negotiations are in progress which, as respects that category, may result in agreement of how damages or restitution are to be calculated, thus eliminating the need for a trial. The points of principle were all determined by the decision of the CJEC, and only details remain to be resolved.

However, in other categories there are points of principle which have not been resolved, and one such point arises in the Pirelli cases, which have been heard before me and to which this judgment relates. They are the test cases for GLO cases in the same category. Five different Pirelli companies are claimants, and in form there are five separate claims, not one claim by five joint claimants. However, although the three companies which make up Pirelli Italy/Netherlands have brought claims of their own, it was clear in the hearing before me that the effective claims are for compensation or restitution payable to the two United Kingdom companies, Pirelli UK and Pirelli General, which paid ACT in circumstances where they say that, if United Kingdom law had not been contrary to the EC Treaty, they would not have paid the ACT.

The feature which differentiates the claims of the Pirelli companies from the claims of the United Kingdom subsidiaries involved in the Metallgesellschaft/Hoechst cases (and from other cases where the parent companies are in Germany) is that the DTAs between the United Kingdom on the one hand and Italy and the Netherlands on the other contain provisions which have no equivalent in the DTA with Germany. The three dividend recipients which are ‘Pirelli Italy/Netherlands’ are established in Italy and the Netherlands. The DTA provisions had the practical effect that, when Pirelli Italy/Netherlands received dividends from Pirelli UK (being dividends in relation to which Pirelli UK, or in two cases its wholly-owned United Kingdom subsidiary Pirelli General, paid ACT in this country), they (Pirelli Italy/Netherlands) received payments (the ‘Article 10 DTA payments’) from the United Kingdom Revenue equal to 6.875% of the dividends.

The Revenue’s case is that, in a detailed way which I will explain as this judgment progresses, the receipt of the Article 10 DTA payments by Pirelli Italy/Netherlands operates to extinguish or reduce the damages or compensation which the Pirelli subsidiaries in this country have claimed pursuant to the decision of the CJEC. For reasons which I will explain later I do not accept the Revenue’s arguments. In my judgment the damages or restitution to which the United Kingdom subsidiaries are entitled are unaffected by the receipt by their shareholders in Italy and the Netherlands of the Article 10 DTA payments. That will be my decision on the issue which has occupied most of the time in the hearing before me.

There is another issue which has been raised: the ‘Athinaiki issue’. This issue does not arise from the CJEC decision in Metallgesellschaft/Hoechst, but from a more recent CJEC decision in a case which originated in Greece and which concerned the Parent and Subsidiary Directive. The case is Athinaiki Zithopiia v Greek State, Case C-294/99, [2001] ECR I-07697. Article 5 of the Directive prohibits the imposition of withholding taxes on dividends from a subsidiary in one Member State to a parent company in another. The Pirelli claimants say that, from observations in Athinaiki about the scope of Article 5, it follows that the ACT payments which Pirelli UK and Pirelli General made to the Revenue were withholding taxes, and that they should be refunded. The Pirelli claimants also say that, if they are right about this, the Revenue’s arguments about the Article 10 DTA payments, even if correct in the context of the article 52/43 issue, cannot affect their claims for repayment under the Parent and Subsidiary Directive. The Revenue’s main argument on the Athinaiki issue is that, even if ACT might otherwise have been a withholding tax to which Article 5 might have applied, it is expressly prevented from being one by Article 7.

In my view this issue, if it is material, raises a question of Community law which ought to be referred to the CJEC rather than decided by me. I will consider later whether, given my decision on the Article 52/43 issue, I should make or refrain from making a reference of the Athinaiki issue.

The group structure of the Pirelli group, so far as relevant to this case, was as follows. Pirelli General was a United Kingdom company which was wholly owned by Pirelli UK, another United Kingdom company. Pirelli UK was owned by three equal shareholders, one of which(Pirelli SpA) was based in the Italy and the other two in the Netherlands. The two Netherlands companies were wholly owned, directly or indirectly, by Pirelli SpA. The fact that the immediate ownership of the shares in Pirelli UK was split three ways within the group is irrelevant to this case. The issues and arguments would be exactly the same if Pirelli UK was wholly owned by Pirelli SpA or by one of the Netherlands companies. This case is particularly concerned with flows of United Kingdom dividends within the group. Thus Pirelli General paid dividends to Pirelli UK, and Pirelli UK paid dividends to Pirelli Italy/Netherlands.

Under the imputation system of dividend taxation which was introduced in 1973 and was in force during the years relevant to this case the general rule was that a United Kingdom company which paid a dividend (one species of a ‘qualifying distribution’: see ss.14(2), 209(2)(a)), had to pay ACT to the Revenue shortly afterwards. Unlike the Schedule F income tax which had applied from 1965 to 1973, ACT was not deducted from the dividend. If a company declared a dividend of 100 between 1965 and 1973 and the basic rate of income tax was 33% at the time, the company paid 67 to the shareholders and 33 to the Revenue. If a company declared a dividend of 100 in, for example, 1995 (when some of the dividends involved in this case were declared) the ACT rate was 25%. The company did not pay 75 to the shareholders. It paid 100 to them and paid 25 of ACT to the Revenue.

That was the general rule. The exception to it was that, if the payer and recipient of the dividend were both companies resident in the United Kingdom, and if they were both members of the same group (the typical case being subsidiary and 100% parent), they could make a joint election under which (unless they notified the Revenue otherwise for any specific dividend, which sometimes it might have been advantageous to do) the payment of dividends by the subsidiary to the parent did not carry with it an obligation on the subsidiary to pay ACT to the Revenue: s.247. Dividends covered by a group election were called ‘group income.’ I imagine that there was a group income election in force between Pirelli General and Pirelli UK, but, because Pirelli Italy/Netherlands were not United Kingdom resident companies, there was not and could not have been a group income election in force between Pirelli UK and Pirelli Italy/Netherlands. So whenever Pirelli UK paid dividends to Pirelli Italy/Netherlands it was liable to pay, and did pay, ACT to the Revenue.

The pleadings and an Agreed Statement of Facts give particulars of the dividends which the case is about. Between May 1995 and March 1999 Pirelli UK on 19 occasions paid dividends which attracted ACT. On two dates in May 1997 Pirelli General paid dividends which attracted ACT. As respects those two Pirelli General dividends, corresponding dividends were paid on by Pirelli UK to Pirelli Italy/Netherlands. Pirelli UK did not, when it paid on the corresponding dividends, itself have to pay ACT, because those dividend payments by it were covered by ‘franked investment income’ in the form of the dividends received (not as group income) from Pirelli General: see s.241(1) and the definitions of ‘franked investment income’ and ‘franked payment’ in section 238(1). In the present case no distinction is sought to be drawn by the Revenue between Pirelli UK’s claim for compensation or restitution in respect of the ACT paid by it and Pirelli General’s similar claim in respect of the ACT paid by it on the two May 1997 dividends. That is, the Revenue accept that if Pirelli UK’s claim succeeds as respects its payments of ACT, then Pirelli General’s claim should succeed also, and no point is taken on the feature that Pirelli General was a member of a United Kingdom group.

When a company paid ACT it was entitled to set off the amount of the payment against its liability for ‘mainstream’ corporation tax on its profits, and thus to pay a lower amount of corporation tax than it would otherwise have paid on the due date: s.239. Where a company was able to use its ACT in this way the process still yielded a financial benefit to the Revenue and a corresponding disadvantage to the company, because the ACT (as its name implies) was paid in advance of the time at which, if the company had not paid a dividend, it would have had to pay its mainstream corporation tax. So the Revenue got some of the company’s corporation tax bill in earlier. How much earlier varied from company to company, depending on the precise timing of the payment of the dividend, but there was always a timing advantage to the Revenue through a receipt of an ACT payment as opposed to waiting for what would otherwise have been the due date for the company’s mainstream corporation tax to be paid. There was a corresponding timing disadvantage to the company which paid the ACT.

If a company which had paid a dividend and therefore had paid some ACT did not, for whatever reason, have a liability to pay mainstream corporation tax for the current period, there were various other ways in which the company (or subsidiaries of it) might still be able to set off the ACT against some other liability for mainstream corporation tax. But it was far from uncommon for companies to have to pay ACT on dividends which, as a matter of commercial reality, the market constrained them to pay, but not to be able to set the ACT off against any mainstream corporation tax at all. In a case of that sort the companies could not get their ACT back, so that the advantage to the Revenue and the corresponding disadvantage to the companies were more than a timing advantage and disadvantage. The Revenue received payments which were described by the Act as being advance (i.e. early) payments of corporation tax, but in substance the payments were outright additions to the effective tax burden falling on the companies.

In the case of the Pirelli companies the figures were as follows. Pirelli UK, on the 19 dividends which it paid between May 1995 and March 1999, paid a total amount of ACT of £20,220,000. Of that amount £15,180,000 was later set off against mainstream corporation tax either of Pirelli UK itself or of United Kingdom subsidiaries. How much later the set-off was after the payment of the ACT varied. On the dates in the companies’ records for when the ACT was paid (the dates in the Revenue’s records are slightly different) the longest period was 810 days and the shortest 260 days; the commonest period was 444 days. £5,040,000 of ACT paid by Pirelli UK was not set off against mainstream corporation tax, and thus was an absolute additional tax cost to Pirelli UK. Pirelli General, on the two dividends which it paid in July 1997, paid ACT of £2,975,000, the whole of which was set off against mainstream corporation tax on three dates, which fell 352, 444 and 717 days after the payments of the ACT.

The immediately preceding paragraphs have examined some of the consequences of the ACT system to a company which paid a dividend. The system could also have consequences for recipients of dividends. These came through ‘tax credits’, which the legislation conferred on certain recipients but not on others. Section 231(1) enacted a general rule that, if a dividend was received by a person resident in the United Kingdom, the recipient was entitled to a tax credit of an amount which corresponded to the rate of ACT in force at the time. (For completeness I should mention that section 231(1) referred to a ‘qualifying distribution’, but dividends were by far the most important kinds of qualifying distribution, and for simplicity I shall refer only to dividends in the explanation and discussion which follows.) For s. 231(1) to enact that a person was entitled to a tax credit did not prescribe what the recipient could do with the tax credit. That was covered by other provisions, and the permitted uses of tax credits varied according to the nature of the recipient. For example, a resident individual (who would be an income tax payer, not a corporation tax payer) could set his tax credits against his income tax liability on the whole of his income (including the dividend income), and if the tax credits exceeded the income tax liability he would receive a payment of the difference from the Revenue: section: s.231(3).

More relevantly to this case, where the recipient of a dividend was a company resident in the United Kingdom the manner in which it could use its tax credit was described in sections 238 and 239. A recipient corporation tax payer, unlike a recipient income tax payer, was not generally able to claim repayment of the tax credit. Its normal use of the tax credit was via the franked investment income system, which was a system whereby companies could use the tax credits attaching to dividends received by them to ‘frank’ what would otherwise have been their own liability to pay ACT on onward dividends which they paid themselves. Suppose that a resident company received a dividend (not being group income – see the next paragraph) of 100 and the ACT rate was 25%. The company had a tax credit of 25, and its franked investment income was 125. If it wished to pay an onward dividend of 100 itself it would not have to pay the ACT of 25 which the payment of the dividend would normally attract. If it wished to pay an onward dividend of 150 it would have to pay ACT on 50 (i.e. ACT of 12.5). If it did not pay any onward dividend itself it would (normally) not be able to use its tax credit, and it would have a ‘surplus of franked investment income’ to carry forward and use against its liability to pay ACT on dividends paid by it in future years.

There was an important exception to the proposition that, if a resident company received a dividend, the dividend plus the associated tax credit was franked investment income which could be used to frank the company’s own liability for ACT on dividends which it paid itself. The dividend was not franked investment income if it was received as group income from a subsidiary pursuant to a group income election under section 247. Section 247(2) provided:

… the election dividends shall be excluded from .. section 231 and are accordingly not included in references to … the franked investment income of the receiving company …

So far in discussing the receipt of dividends and the availability and uses of tax credits to recipients I have considered only recipients resident in the United Kingdom. The general pattern was that the United Kingdom statute did not confer tax credits on non-residents. There was a limited exception for certain individuals who claimed personal reliefs against United Kingdom tax on their incomes (see s.232(1)), but otherwise the statute did not itself extend tax credits to non-residents. However, when the imputation system was introduced by the Finance Act 1972, to commence on 6 April 1973, it was anticipated that other countries would wish to negotiate DTAs with the United Kingdom which would give some measure of United Kingdom tax credits to their residents who received United Kingdom dividends. Therefore a paragraph was inserted into what is now section 788 of the ICTA. Section 788(3)(d) enacts that provisions in DTAs shall have effect in domestic United Kingdom tax law in so far as they provide–

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.

This is the point at which I can focus on the precise issue which is in dispute, and it is appropriate that I explain about the Italian and Netherlands DTAs under a new sub-heading.

I begin with the general point that, where a DTA is negotiated by the United Kingdom, it does not take effect in our domestic tax law until it has been declared by an Order in Council that it is expedient that it should (s.788(1)), but once that has been done the DTA’s provisions have effect according to their terms ‘notwithstanding anything in any enactment’ (s.788(3)), provided only that the subject matter of the provisions is within the subject matters spelt out in the section. As I have described in the previous paragraph, from 6 April 1973 one of those subject matters has been the conferring of tax credits on non-resident recipients of United Kingdom dividends. The words ‘notwithstanding anything in any enactment’ make it clear that provisions in the operative articles of DTAs override anything in the domestic legislation: see Lord Radcliffe in Ostime v Australian Mutual Provident Society [1960] AC 459 at 476. (The foregoing sentence should be qualified to the extent that it is possible for Parliament to enact some provision which is expressly declared to prevail over DTA provisions. This had been done on one or two occasions, mainly where it was thought that a DTA was being used for unacceptable tax avoidance purposes. There is no such enactment by Parliament relevant to this case.)

The Italian and Netherlands DTAs (unlike the German DTA) post-date the introduction of the imputation system in this country, and also post-date the introduction of what is now s.788(3)(d), which I quoted in paragraph 20 above. Each of the Italian and Netherlands DTAs contains an article, article 10 in each case, which, so far as it deals with United Kingdom dividends, is in a form widely used since the introduction of the imputation system. There is no relevant difference between the two articles. The articles contain some provisions which apply only so long as United Kingdom law gives tax credits to individual United Kingdom residents who receive dividends from United Kingdom companies. The articles contain other provisions which would take effect if United Kingdom law changed in that respect. It is the former provisions which are relevant in the present case. In the account which follows I shall refer to an Italian recipient of a dividend, but what I say would be equally applicable to a Netherlands recipient. The articles prescribe different treatments according to the nature of the holder and the size of the holding in the United Kingdom company on which the dividend is paid. The key distinction is between, on the one hand, holdings of 10% or more (measured by voting power) in United Kingdom companies by Italian corporate shareholders, and, on the other hand, all other holdings in United Kingdom companies by Italian shareholders. The present case is concerned with corporate shareholders with holdings in excess of 10%, so I shall concentrate on the provisions of the Articles which apply to them.

Article 10 deals with: (i) how far an Italian recipient of a United Kingdom dividend (an item of income from a United Kingdom source) is liable to United Kingdom tax on the dividend; (ii) whether and to what extent an Italian recipient is entitled to a United Kingdom tax credit; and (iii) how the Italian recipient can use the tax credit. I think that it is convenient for me to summarise the effect of the article first, and to quote the precise wording after I have done so.

At this point I think that it is helpful to show how the foregoing provisions worked out in figures. Suppose that a United Kingdom company paid a dividend of 100 to an Italian corporate recipient (‘SpA’) which had a holding of at least 10% of the voting power in the paying company, and assume that the United Kingdom ACT rate (from which the amount of the tax credit is ascertained: s.231(1)) was 25%. The tax credit to which a resident individual shareholder would have been entitled would have been 25. SpA was entitled to a tax credit equal to half of that amount; i.e. to a tax credit of 12.5. SpA was liable to United Kingdom income tax at a rate not exceeding 5% on 112.5, being the aggregate of that tax credit and the dividend. 5% of 112.5 is 5.625, so SpA’s liability to United Kingdom tax was 5.625. It was entitled to be paid by the United Kingdom the excess of its tax credit (12.5) over its United Kingdom income tax liability (5.625). That excess is 6.875, so that is the amount which was payable to SpA by the United Kingdom. It was also the payment to which I am referring in this judgment as an Article 10 DTA payment. It may be remembered that, in the Overview at the beginning of this judgment, I said that Pirelli Italy/Netherlands had received Article 10 DTA payments of 6.875% of the dividends which they had received from Pirelli UK. The figures in this paragraph explain the calculation of the percentage.

In Metallgesellschaft/Hoechst the CJEC held that it was contrary to article 52 of the EC Treaty, now renumbered as article 43, for the German parent companies and their United Kingdom subsidiaries not to have been permitted by United Kingdom law to elect for dividends to be paid as group income, whereas United Kingdom parent companies and their United Kingdom subsidiaries were so permitted. The subsidiaries of Metallgesellschaft and of Hoechst had paid ACT when they paid dividends to their parents. In the cases of those companies it appears that all of the ACT was eventually set off against mainstream corporation tax, so the losses sustained in consequence of the breach of Community law were timing losses resulting from the subsidiaries having been required to pay parts of their corporation tax liabilities earlier than would otherwise have been the case. The amounts by way of compensation or restitution to which they were in principle entitled were to be calculated by reference to interest over the periods between the dates when they paid the ACT and the dates when it was set off against mainstream corporation tax.

The present case, viewed from the point of view of Pirelli UK, possesses one feature which was not present in Metallgesellschaft/Hoechst. Some of the ACT payments made by Pirelli UK were not set off against mainstream corporation tax. I have given details of this in paragraph 16 above: Pirelli UK paid a total amount of ACT of £20,220,000, of which £5,040,000 was not set off against mainstream corporation tax. There was nothing equivalent in Metallgesellschaft/Hoechst. As respects the £5,040,000 Pirelli UK claims repayment of the full amount and interest in the meantime. As respects the balance of the ACT paid it claims the same relief as the subsidiaries were held to be entitled to in Metallgesellschaft/Hoechst: compensation or restitution calculated by reference to interest for the period between the payment of the ACT and the dates when it was set off against mainstream corporation tax. Pirelli General claims only the latter form of relief: it set off the whole amount of ACT which it paid (£2,975,000) against mainstream corporation tax, so it is in the same position as the subsidiaries in Metallgesellschaft/Hoechst.

It is implicit in the claims by Pirelli UK and Pirelli General that, if United Kingdom law had permitted group income elections to be made between a United Kingdom subsidiary and a parent company in an EC country, Pirelli UK and Pirelli Italy/Netherlands would have made elections, and the dividends which Pirelli UK in fact paid subject to ACT would have been paid as group income. A detailed point to make here is that, although Pirelli UK was not a 51% subsidiary of any of the three companies which made up Pirelli Italy/Netherlands (because each company owned one-third of the shares in Pirelli UK), the wider group structure, whereby the two Netherlands companies were wholly owned by Pirelli SpA and Pirelli SpA was itself the third of the three owners of Pirelli UK, meant that group income elections could have been made under section 247 but for the requirement that all of the companies concerned had to be resident in the United Kingdom. To put the point another way, if s.247(1), instead of saying ‘both being bodies corporate resident in the United Kingdom’, had said ‘both being bodies corporate resident in the United Kingdom or in another Member State of the European Community’, group income elections could have been made covering all of the dividends which this case is about.

As to whether group income elections would have been made, the case of the Pirelli claimants is that they would. The Revenue reserved their position on this for the purposes of the hearing before me. They may wish to return to the question at a later stage in the progress of the GLO, but it was agreed that, for the purposes of the hearing before me which has led to this judgment, it should be assumed (i) that elections would have been made if they had been permitted, (ii) that Pirelli UK and Pirelli General would have paid the same dividends as they actually paid, but (iii) that they would not have paid ACT.

Making those assumptions the Revenue accept that, but for the arguments which they advance in reliance on the receipt of the Article 10 DTA payments by Pirelli Italy/Netherlands, the Pirelli claimants would in principle be right. In particular they accept that, if there had been no Article 10 DTA payments, Pirelli UK would be entitled to compensation or restitution in an amount equal to the £5,040,000 of ACT which it paid and which it did not set off against mainstream corporation tax. They also accept that Pirelli UK and Pirelli General would have been entitled to compensation or restitution calculated by reference to interest on the ACT which they paid and which was set off against mainstream corporation tax.

The Revenue’s case is that, in determining whether the Pirelli subsidiaries are entitled to any compensation or restitution in respect of the ACT which they paid, it is necessary to take account also of the receipt by Pirelli Italy/Netherlands of the Article 10 DTA payments. The Revenue say that those payments were countervailing advantages, which must operate to reduce or extinguish the Pirelli subsidiaries’ claims.

This argument by the Revenue gives rise to several issues. The foremost one, as it appears to me, is whether the receipt of the Article 10 DTA payments by Pirelli Italy/Netherlands should fairly be regarded as a countervailing advantage at all. In my view that depends on whether, if United Kingdom law had permitted the dividends from Pirelli UK to be paid as group income and they had been so paid, Pirelli Italy/Netherlands would still have been entitled to the Article 10 DTA payments. If they would the receipt of the payments cannot be regarded as an advantage which countervails the disadvantage to Pirelli United Kingdom and Pirelli General of having to pay the ACT: Pirelli Italy/Netherlands would have received the Article 10 DTA payments whether Pirelli United Kingdom and Pirelli General paid ACT on the dividends or not. Suppose, however, that, if Pirelli UK had paid dividends to Pirelli Italy/Netherlands as group income and therefore did not pay ACT (see s.247(2)), Pirelli Italy/Netherlands would not have received the Article 10 DTA payments. On that hypothesis the Article 10 DTA payments which Pirelli Italy/Netherlands in fact received over the years from 1995 to 1999 can be seen as a countervailing advantage to be evaluated against the disadvantage to Pirelli UK of paying the ACT which it did actually pay.

The Revenue submit that, if Pirelli UK could have paid dividends to Pirelli Italy/Netherlands as group income and did pay them in that way, Pirelli Italy/Netherlands would not have been entitled to the Article 10 DTA payments. The Pirelli claimants submit that Pirelli Italy/Netherlands would have been entitled to the Article 10 DTA payments. I agree with the Pirelli claimants, and I analyse the arguments on this issue under the next sub-heading.

If I am wrong there are certain other issues which arise, and which I will consider later. In particular, given that the disadvantage was suffered in the subsidiaries (Pirelli UK and Pirelli General) and that the countervailing advantage (if there was one) was enjoyed in the holding companies (Pirelli Italy/Netherlands), would the countervailing advantage operate to reduce the damages or restitution to which the subsidiaries are entitled? The Revenue submit that it would, relying on a proposition that in this context the subsidiaries and their shareholders must be regarded as a single person. The Pirelli claimants disagree. They say that, if there is a countervailing advantage in the holding companies, that is irrelevant to the amounts recoverable by the subsidiaries. I agree with Pirelli on this issue also, and I shall consider it under a later sub-heading. The Revenue have a different argument that the claim for compensation or restitution is a claim by the Pirelli group as a whole, and that the court must not award relief which would place the group in a better position than a comparable group all the members of which were companies resident in the United Kingdom. I do not accept this argument either. I shall consider it in detail later.

The first step in the Revenue’s argument is that, if s.247 had permitted Pirelli UK to pay dividends to Pirelli Italy/Netherlands as group income, Pirelli UK would not have been liable to pay ACT in consequence of paying the dividends. See the words at the beginning of s.14: ‘Subject to s.247 ..’. See also s.247(2): ‘… the election dividends shall be excluded from section 14(1) …’ Thus far I agree. The next step is that, if a company which paid a dividend was not liable to pay ACT (or did not have franked investment income made up of dividends from lower tier companies which had themselves been liable to pay ACT), the recipient of the dividend could not be entitled to a tax credit in respect of the dividend. I do not agree with this as a mandatory proposition of law, although I accept that, apart from the international element provided by the present case, the proposition would be factually accurate as a description of how the legislation was in fact constructed. The final step in the Revenue’s argument is that article 10 of the Italian and Netherlands DTAs did not entitle Italian or Netherlands holding companies to receive Article 10 DTA payments unless there was a liability to pay ACT in the United Kingdom by reference to the dividends or by reference to underlying dividends lower down the corporate hierarchy. I do not agree with this.

In my opinion the question ultimately turns on the construction of the relevant provisions of article 10 in the two DTAs, but I would like to begin with some more general observations. I accept that in the minds of those who devised the imputation system there was an association between the payment of ACT by the company and the conferring of tax credits on shareholders. The main structure of the legislation first appeared in the 1972 Finance Bill, in connection with which the Government issued a White Paper (Cmnd. 4955) entitled ‘Reform of Corporation Tax’. Paragraph 9 of the White Paper read as follows:

9.

Advance corporation tax and the shareholder’s tax credit form the core of the new system; they are the essential link between the company’s corporation tax and the shareholder’s own tax liability. In this way a single rate of ‘imputation’ can be applied to all distributions regardless of the effective rate at which the company is liable to tax. In its absence there would be difficulties where dividends are paid out of profits which, for one reason or another, have not borne UK corporation tax in full. Clearly it would be wrong in such cases to give the shareholder a credit for tax which has never been paid; and the Select Committee therefore regarded some such preliminary payment as an essential element in an imputation system.

That is an important paragraph, but it must be read subject to two important qualifications.

With those introductory observations I now turn to the wording of the Italian DTA. Article 10, read with s.788(3) (whereby the provisions of the Agreement have effect notwithstanding anything else in any other enactment) lays down the conditions which have to be fulfilled, and also prescribes the consequences which follow where they are fulfilled. I have quoted the provisions and explained their effect in paragraphs 23 and 24 above. So far as concerns shareholders like Pirelli SpA (an Italian company with a holding of 10% plus in Pirelli UK) the conditions and the operation of them was as follows.

In my opinion the sub-paragraphs in the foregoing paragraph set out exhaustively all the relevant contents of the DTA. Pirelli SpA complied with every specific condition, and would have done so whether the Pirelli UK dividends were paid to it as group income or not. There is no provision in the article that the dividends do not qualify the recipient (Pirelli SpA) to obtain Article 10 DTA payments unless ACT was paid or payable by Pirelli UK or by other United Kingdom companies lower down the corporate hierarchy. The only requirement is that ‘a company which is a resident of Italy received dividends from a company which is a resident of the United Kingdom’ (words in the middle of article 10(3)(c)). There is a definition of ‘dividends’ in article 10(6). It indubitably covers the dividends received by Pirelli SpA from Pirelli UK, and it would equally have applied to them if they had been paid as group income. Whether Pirelli UK was liable to pay ACT or not, they were still dividends received from a United Kingdom company.

Mr Glick tries to escape from the foregoing conclusion, but in my judgment he cannot do so. He correctly points out that Article 10(3) refers to Pirelli SpA receiving a ‘tax credit’, and that that term as used in the DTA has the meaning which it bears in domestic United Kingdom tax law: see article 3(2) of the DTA. S.832(1) of ICTA defines ‘tax credit’ as meaning a tax credit under s.231. So Mr Glick takes me to s.231, where I find that subsection (1) begins: ‘Subject to .. section 247 ..’. He then moves to s.247. S.247(2) provides that where a group income election is in force ‘the election dividends shall be excluded from section .. 231 and are accordingly not included in references to .. franked investment income of the receiving company.’

My comment so far as concerns Pirelli UK dividends received by Pirelli SpA and assumed for this purpose to have been received as group income is: So what? Let it be supposed that Pirelli UK dividends received by Pirelli SpA as group income would not be included in a statutory reference to franked investment income of Pirelli SpA. What difference would that make to the operation of article 10 of the DTA? The answer is: none. The article makes no reference to franked investment income, and Pirelli SpA, in order to meet the conditions for it to receive the Article 10 DTA payments in respect of the Pirelli UK dividends, would not have to show that the dividends were ‘franked investment income’ in its hands. So the elaborate route which Mr Glick takes from the words ‘tax credit’ in article 10(3)(c), through article 3(2), section 832(1), and section 231(1), to section 247(2), does not take him to a destination which changes the conclusion apparent from article 10 itself, namely that, if Pirelli SpA had received the 1995 to 1999 dividends from Pirelli UK as group income, it would still have been entitled to receive Article 10 DTA payments equal to 6.875% of them.

Further, quite apart from the route by which Mr Glick takes me to the concept of franked investment income, I cannot see how he can get away from the position that, by virtue of Article 10(3)(c) and notwithstanding anything in any other enactment (such as another enactment about franked investment income), if an Italian company with a 10% plus holding in a United Kingdom company received a dividend, it was entitled to receive from the United Kingdom a payment (the Article 10 DTA payment) calculated as described in the article and working out at 6.875% of the dividend.

What I have written in the foregoing paragraphs about how article 10 of the Italian DTA would have applied if the dividends paid to the Italian company, Pirelli SpA, had been paid as group income applies equally to how article 10 of the Netherlands DTA would have applied if the dividends paid to the two Netherlands holding companies comprised in Pirelli Italy/Netherlands had also been paid as group income.

I can understand in a general way the influences which have led the Revenue to submit that Pirelli Italy/Netherlands would not have been entitled to Article 10 DTA payments in the circumstances which I have postulated. In a case where ACT has not been payable the Revenue perceive the payment of tax credits to a shareholder as inconsistent with the thinking behind the imputation system. They may think (as I am inclined to think) that if, when the DTAs were negotiated with Italy and the Netherlands, section 247 had permitted dividends to be paid as group income from United Kingdom subsidiaries to holding companies resident in those two countries, the United Kingdom negotiators would have strenuously resisted conceding any payments of tax credits to Italian or Netherlands holding companies which received dividends in the form of group income. But the point which has now arisen because of the decision of the CJEC in Metallgesellschaft/Hoechst never occurred to the United Kingdom negotiators of the DTAs. The Agreements are worded as they are, and not as they might have been if the negotiators had had advance warning of the Metallgesellschaft/Hoechst decision. I have to interpret them as they are, and on that basis I conclude that, if the dividends which were paid by Pirelli UK to Pirelli Italy/Netherlands between 1995 and 1999 could have been and were paid as group income without Pirelli UK being liable for ACT, Pirelli Italy/Netherlands would still have been entitled to receive the Article 10 DTA payments from the United Kingdom Revenue.

It appears to me to follow that Pirelli Italy/Netherlands’ actual receipts of the Article 10 DTA payments cannot be regarded as countervailing advantages to be set against the disadvantages to Pirelli UK (and in two cases, Pirelli General) of having to pay ACT in circumstances where it would not have paid ACT if United Kingdom law had taken the form which the CJEC said that it would have had to take in order to comply with Community law. In my view this substantially destroys the Revenue’s arguments against Pirelli UK and Pirelli General in this case. However, in case I am wrong, I will continue and consider other arguments which were debated before me.

Suppose that, contrary to my opinion as explained under the previous sub-heading, Article 10 DTA payments would not have been available to Pirelli Italy/Netherlands if the dividends from Pirelli UK could have been paid as group income and were so paid: in that case the Article 10 DTA payments which Pirelli Italy/Netherlands did receive in consequence of the dividends being paid to them (not as group income) might be regarded as countervailing advantages to the Pirelli group to be balanced against the disadvantage of Pirelli UK (and in two cases Pirelli General) having had to pay ACT soon after they paid the dividends. But the Revenue would still have a problem over arguing that those countervailing advantages could as a matter of law operate to reduce or extinguish the compensation or restitution payable under the decision of the CJEC to redress the infringement of Community law. The problem is that harm suffered in consequence of the breach of Community law was suffered by the United Kingdom subsidiaries (Pirelli UK and Pirelli General), whereas the countervailing advantages were enjoyed by the holding companies (Pirelli Italy/Netherlands).

Mr Glick accepts that the basic position in English law would have been that a court could not reduce the compensation or restitution payable to a subsidiary by the amount of a benefit received, not by the subsidiary itself, but by its shareholder or shareholders. However, he submits that in the context of whether dividends are paid as group income or not the subsidiary and the parent should be regarded as a single person. On the particular facts the submission would appear to be that Pirelli General, Pirelli UK and Pirelli Italy/Netherlands should all be treated as one person. I cannot agree with this. Mr Glick submits that he can maintain his argument on this point consistently with the general principle of separate corporate personality, but in my opinion he cannot. In my view that is particularly the case in the context of dividends, the whole point of which is that a company is a legal person distinct from its shareholders. The company’s profits belong to it, not to its shareholders, and if the shareholders are to enjoy them a resolution by the company to pay a dividend is necessary. The payment of a dividend changes the financial position of both the company and the shareholders. It also has separate tax consequences for the company on the one hand and the shareholders on the other.

Mr Glick points out that, in Adams v Cape Industries [1990] Ch 433 at 536, Slade LJ said that there can be cases ‘where the wording of a particular statute or contract has been held to justify the treatment of parent and subsidiary as one unit, at least for some purposes’. He submits, if I understand him correctly, that this is one of those cases, and that the wording of ICTA makes it appropriate for the subsidiary and the holding company or (as here) the subsidiary and the holding companies to be treated jointly and as a single entity. He bases this submission on the word ‘jointly’ in s.247(1): ‘… the receiving company and the paying company may jointly elect that this subsection shall apply to the dividends …’.

However, that provision is just a part of the mechanics of how the election for dividends to be paid as group income is to be made. It is a machinery provision, not a substantive provision. It is a huge and unjustifiable step to read into it that two companies which can make an election for dividends to be paid between them as group income are for some purposes of substantive law to be treated, not as the two companies which in fact and in law they are, but as some form of joint entity. It is obviously sensible to require both companies to join in a making a group income election, because the tax consequences of an election being made or not made can differ as between parent and subsidiary. In this context it is worth noting that in many cases there are minority shareholders involved, whose interests ought to be considered before a subsidiary joins in an election, and whose interests might be ignored if the election did not have to be a joint one. Further, the section also permits dividends to be paid as group income where the paying company is not controlled by the receiving company, but is controlled by a consortium of other companies. It is unjustified to attach more than procedural significance to the requirement that the election must be joint and cannot be made unilaterally.

In any case, if there was any further significance it would surely only arise in a case where an election has been made, and has been made by the two parties to it ‘jointly’. However, Mr Glick’s argument is directed to a case where no election has been made. He is focusing on what actually happened between 1995 and 1999: there was no group election between Pirelli UK and Pirelli Italy/Netherlands; when Pirelli UK paid dividends it was liable to pay ACT, and did pay it (so did Pirelli General on two occasions); Pirelli Italy/Netherlands was entitled to receive and did receive Article 10 DTA payments. It seems to me quite wrong to say that in that actual situation the statute requires Pirelli UK and Pirelli Italy/Netherlands to be treated as one entity, and that the reason why is because, if the companies had been permitted to make a group election, they would have had to make it jointly. The fact was that, as United Kingdom law stood at the time, the companies were not permitted to make a group election, and the dividends which Pirelli UK in fact paid were wholly unaffected by any election, joint or otherwise.

There is, of course, an element of lifting or piercing the corporate veil in Mr Glick’s argument on this point. In support of his argument he refers to the judgment of Lord Denning MR in DHN v Tower Hamlets London Borough Council [1976] 1 WLR 852. In that case, in the context of statutory compensation for disturbance under the Compulsory Purchase Act 1965, it may be that Lord Denning was prepared to lift the corporate veil: ‘The three companies should, for present purposes, be treated as one …’. However, I do not regard the case as authority for any general proposition that parent companies and subsidiaries should be treated as one, and certainly not that Pirelli UK and Pirelli Italy/Netherlands should be so treated in this case. Further, no other judge has gone as far as Lord Denning went in the DHN case. Lord Keith, in the House of Lords in Woolfson v Strathclyde Regional Council (1978) SLT 159 at 161, expressed major doubts about Lord Denning’s judgment, and as far as I am aware there is no other case in which Lord Denning’s approach has been applied to the facts before the court, although there have been several other cases in which unsuccessful attempts have been made to rely on them. A conspicuous example is Adams v Cape Industries [supra]. As far as I am concerned the present case can be added to the list.

Mr Glick advances another, and slightly different, argument which rests on the feature that all the Pirelli companies involved in this case are members of the same group. The argument which I have considered, and not accepted, in the last few paragraphs seems to me to be presented as an argument of English law: hence the reliance on Slade LJ in Adams v Cape Industries and on Lord Denning MR in the DHN case. The other argument, to which I turn now, appears to me to be put as an argument of Community law. I think that Mr Glick contends that this argument is still available even if, as I have already held, Pirelli Italy/Netherlands would have been entitled to receive Article 10 DTA payments even if the dividends from Pirelli UK had been paid as group income.

I believe that the argument is that compensation or restitution pursuant to the decision of the CJEC in Metallgesellschaft/Hoechst should be ascertained on the footing that (to quote a sub-heading in the skeleton argument of Mr Glick and Ms O’Sullivan) ‘The group is the victim.’ This refines into a submission that compensation or restitution should not place a group consisting of a United Kingdom subsidiary and holding companies in other Member States into a more advantageous position, taken as a group, than a group consisting of a United Kingdom subsidiary and a United Kingdom holding company.

In my judgment, however, this would not be in accordance with the judgment of the CJEC in Metallgesellschaft/Hoechst. As I read the judgment, the Court focused entirely on the subsidiary level. The infringement of Community law was an infringement at that level, not at the holding company level: United Kingdom subsidiaries of Member State parents had no choice but to pay ACT when they paid dividends to their parents, whereas United Kingdom subsidiaries of United Kingdom parents did have a choice. The following extract from the judgment seems to me clearly to demonstrate that the Court was concerned only with how the subsidiaries, as opposed to their parent companies, would be treated in the two situations:

“83 … what is contrary to Community law is … the fact that subsidiaries, resident in the United Kingdom, of parent companies having their seat in another Member State were required to pay that tax in advance whereas resident subsidiaries of resident parent companies were able to avoid that requirement.”

To the same effect are the terms in which the CJEC answered one of the questions referred to it by the High Court:

“It is contrary to Article 52 of the EC Treaty (now, after amendment, Article 43 EC) for the tax legislation of a Member State, such as that in issue in the main proceedings, to afford companies resident in that Member State the possibility of benefiting from a taxation regime allowing them to pay dividends to their parent company without having to pay advance corporation tax where their parent company is also resident in that Member State but to deny them that possibility where their parent company has its seat in another Member State.”

It may be true that the focus on the contrasting treatment of the different subsidiaries in that answer can be explained on the basis that it reflects the terms of the question asked of the CJEC. However, in my view it is clear from the judgment as a whole that the Court was not influenced by arguments that, under United Kingdom tax law, it was an incomplete view to note only that subsidiaries of United Kingdom parents and subsidiaries of non-United Kingdom parents were treated differently: it was said that there were also differences in the treatments of the parents, and that those differences needed to be evaluated before concluding that the differential treatments of the subsidiaries was contrary to Community law. The United Kingdom Revenue (which addressed submissions to the Court in defence of the United Kingdom system) pointed out that, although subsidiaries which had made group income elections with their United Kingdom parents did not have to pay ACT when they paid dividends to their parents, the parent companies, when they paid onward dividends to their general body of shareholders, did. Thus the freedom from ACT in the subsidiary was usually balanced by a liability to ACT in the parent when it paid dividends to its own shareholders. In contrast, if a United Kingdom subsidiary could pay dividends without ACT to a parent in another Member State, there would be no balancing liability to ACT when the parent paid dividends on to its shareholders. There was force in the point, but it did not deflect the CJEC from deciding that the United Kingdom system, because of the differential treatment at the subsidiary level, infringed Community law.

Accordingly, in so far as it is relevant I do not accept Mr Glick’s submission that under Community law the comparison is not one between (i) a United Kingdom subsidiary of a United Kingdom parent and (ii) a United Kingdom subsidiary of another Member State parent, but rather a comparison between (i) a group consisting of United Kingdom subsidiary and United Kingdom parent taken as a group and a (ii) a group consisting of United Kingdom subsidiary and Member State parent taken as a group. It follows that the compensation or restitution payable to the Pirelli subsidiaries is not to be reduced by reference to this argument advanced by the Revenue.

Mr Aaronson presented arguments to the effect that, even if Pirelli Italy/Netherlands, Pirelli UK and Pirelli General were to be treated as one person, Community law would still not allow the alleged countervailing advantage of the Article 10 DTA payments (even if it was an advantage, which in my view it was not) to be taken into account to reduce the compensation or restitution. I have my doubts about those arguments, but in my view they do not arise. The Pirelli claimant companies have succeeded before the case gets to the point where the arguments could realistically be material. I will therefore not go further into that aspect of the case.

There is nothing more that I wish to say on the Article 52/43 issue. I believe that the Pirelli claimants succeed upon it.

The following are among the provisions of the Parent and Subsidiary Directive.

Whereas it is furthermore necessary, in order to ensure fiscal neutrality, that the profits which a subsidiary distributes to its parent company be exempt from withholding tax …

Article 1

Each Member State shall apply this Directive:

…

-

to distributions of profits by companies of that State to companies of other Member States of which they are subsidiaries.

…

Article 5

1.

Profits which a subsidiary distributes to its parent company shall, at least where the latter holds a minimum of 25% of the capital of the subsidiary, be exempt from withholding tax.

…

Article 7

1.

The term ‘withholding tax’ as used in this Directive shall not cover an advance payment or prepayment (précompte) of corporation tax to the Member State of the subsidiary which is made in connection with a distribution of profits to its parent company.

I would not myself regard ACT as being conceptually a withholding tax. If a United Kingdom company declared a dividend of 100 to its shareholders it paid them 100, not 100 less an amount withheld out of it on account of the tax on the dividend. However, Mr Aaronson’s submission is that, by virtue of the Athinaiki decision, ACT falls to be regarded as a withholding tax for the purposes of the Parent and Subsidiary Directive. In Athinaiki the CJEC was concerned with a Greek tax which was not the same as ACT, but the court held that whether a tax was a withholding tax or not was to be determined, not by its classification under national law, but by its objective characteristics. Further, one reading of the judgment is that the court held that a tax is a withholding tax if it has two characteristics: (1) the chargeable event for the tax is the payment of dividends; (2) the amount of tax is directly related to the size of the distribution. ACT possesses those two characteristics. The Revenue concede that, if those two characteristics determine definitively whether a tax is a withholding tax within article 5 of the Directive, ACT would be such a tax.

The Revenue argue, however, that, if ACT would otherwise be a withholding tax within article 5, it is taken out of the article by article 7.1: it is an advance payment of corporation tax to the Member State of the subsidiary (the United Kingdom). They also say that that is entirely clear and that there is no need to refer the question to the CJEC: the matter is ‘acte clair’. Mr Aaronson and his team on behalf of Pirelli disagree. They do not say that it is clear that ACT is not a tax covered by article 7.1, but they do say that it is not clear that it is a tax covered by article 7.1. Their point is that a payment of ACT may or may not operate as a true advance payment of corporation tax: whether it does so operate or not depends on whether the company paying the dividend has sufficient profits liable to corporation tax. Where the company has sufficient such profits, the payment of ACT is in the event an advance payment of corporation tax; but where the company has not sufficient profits liable to corporation tax the payment of ACT is not a true advance payment of corporation tax. Furthermore, this is not an obscure debating point. Over the years while the ACT system was in force it was very common for United Kingdom companies to pay dividends to their shareholders, and therefore to have to pay ACT, in circumstances where they did not have mainstream corporation tax liabilities against which they could set their payments of ACT. Mr Aaronson wishes to argue that a payment of tax which may or may not operate as an advance payment of corporation tax, and in the case of which it is not known at the time when it is paid whether it will operate in that way or not, is not ‘an advance payment of … corporation tax’ within the meaning of article 7.1 of the Directive.

It seems to me that there is a substantial point to be decided in this respect, and that, if it matters, I ought to refer the question to the CJEC. However, I am hesitant about simply going ahead and referring it. If I am right on what I have said about the Article 52/43 issue the question makes no difference to the outcome of the present case. I appreciate that there may be an appeal against my decision on the Article 52/43 issue, and that if the appeal succeeds the Athinaiki issue could become highly material. I am nevertheless doubtful about whether I ought to refer the question of the status of ACT under the Parent and Subsidiary Directive to the CJEC when, as matters now stand, it appears to be of academic importance, and the reference would be made only because it might become of practical importance in future. What I will do is to indicate my concern about this point and to discuss it with counsel at a future hearing.

That is all that I wish to say about the Athinaiki issue in this judgment. There are no other matters which I need to consider, and therefore that is the end of the judgment.