Test Claimants In the Act Group Litigation (Classes 4 & 2) v Revenue and Customs

On 8 March 2001 the Court of Justice of the European Communities (“the ECJ”) delivered its landmark judgment in the Hoechst case: joined cases C-397 and 410/98 Metallgesellschaft Ltd and others and Hoechst AG and Hoechst (UK) Ltd v Commissioners of Inland Revenue and HM Attorney General, [2001] ECR I-1727, [2001] Ch 620. The ECJ held that it was contrary to Article 52 (later Article 43) of the EC Treaty, which protects freedom of establishment, for the UK to allow a UK-resident subsidiary to pay a dividend to its parent company under a group income election (“GIE”), and thus to avoid having to pay advance corporation tax (“ACT”), in circumstances where the parent company was also resident in the UK, but to deny that opportunity to a UK-resident subsidiary when its parent company was resident in another member state.

In paragraph 96 of its judgment the ECJ answered the second question referred to it by the English High Court (concerning remedies) in the following terms:

“96.

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 52 of the Treaty 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.”

Two points may be noted at this stage. First, the ECJ did not hold ACT to be an unlawful tax. The unlawfulness identified by the Court lay in the restriction of the right of establishment of non-UK resident parent companies by denying them and their UK-resident subsidiaries the opportunity to make GIEs. It was only where ACT was paid in such circumstances, and where (in addition) the parties would have made a GIE had it been open to them to do so, that the ACT in question was unlawfully levied and the UK was obliged to provide an effective remedy by way of reimbursement or reparation of financial loss. The second point is that, on the facts of the cases considered by the ECJ, the ACT paid by the UK subsidiaries had all subsequently been set off against mainstream corporation tax (“MCT”) for which they became liable. Accordingly the only remedy which was required was compensation for the premature levy of the ACT, which in the eyes of the ECJ was not a separate tax but merely an advance payment of corporation tax: see, for example, paragraph 6 of the judgment. Although loosely and conveniently described as claims for interest on the prematurely paid tax, the claims could more accurately be characterised as restitutionary claims relating to the loss of use of the money paid as ACT between the date of payment and the date of set off against MCT.

Until the abolition of ACT with effect from 6 April 1999, a United Kingdom company which received a dividend in respect of which ACT had been paid was entitled to a tax credit equal to the amount of the ACT. This was the result of section 231(1) of the Income and Corporation Taxes Act 1988 (“ICTA 1988”), which provided as follows:

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

The aggregate amount of the dividend and the tax credit constituted franked investment income (“FII”), which the recipient company could use to frank the ACT payable on its own distributions. Where, however, a GIE was made, the corollary of the avoidance of liability to ACT was that there was no entitlement to a tax credit while the election remained in force, and dividends which were paid under the election (“election dividends”) were excluded from the parent company’s FII: see section 247(2) of ICTA 1988, which provided that while a GIE was 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.”

As a matter of UK domestic law, a parent company resident outside the UK could not be entitled to a tax credit on dividends which it received from a UK subsidiary, because section 231(1) expressly confined such entitlement to UK resident companies. However, double taxation conventions (“DTCs”) entered into between the UK and foreign states often conferred entitlement to a UK tax credit on dividends received from UK subsidiaries, and where they did so the credit would typically be one half of the credit which would have been available to an individual shareholder resident in the UK under section 231. By virtue of section 788(1) and (3)(d) of ICTA 1988, such arrangements in a DTC were given effect in UK domestic law and prevailed over any provisions of domestic law which were inconsistent with them. The relevant wording in section 788(3) was as follows:

“(3)

Subject to the provisions of this Part, the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide –

…

(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.”

It so happens that the DTC between the UK and the Federal Republic of Germany which was in force at the relevant times did not grant a right to a tax credit to companies resident in Germany which held shares in and received dividends from companies resident in the UK. All of the parent companies involved in the Hoechst litigation were resident in Germany, so although ACT was paid on the dividends which they received from their UK subsidiaries, they had no right to a tax credit, either directly under section 231 or by virtue of a DTC and section 788.

In many cases, however, DTCs between the UK and other member states did grant partial tax credits to parent companies in receipt of dividends from UK subsidiaries. Examples were the DTC between the UK and the Netherlands of 7 November 1980 and the DTC between the UK and Italy of 21 October 1988 (although it should be noted that until April 1991 the DTC with Italy did not so provide). For example, Article 10(3)(c) of the Netherlands convention entitled a company resident in the Netherlands which received dividends from a company resident in the UK 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.”

By virtue of Article 3(2), “tax credit” here has the same meaning as in ICTA 1988. By virtue of Article 10(3)(a)(ii), a convention tax credit was liable to UK income tax at a rate not exceeding 5% on the total amount of the dividend and the tax credit. The relevant provisions of the Italian convention were materially identical. Thus a parent company resident in either of those member states which received a dividend from a UK subsidiary was entitled to payment of the partial tax credit after deduction of UK income tax at a rate not exceeding 5% on the aggregate of the dividend and the credit.

In cases of this nature, it was clearly necessary to decide whether, and if so how, receipt of such partial tax credits affected the reimbursement or reparation recoverable from the UK for its breach of Article 43 in not permitting a GIE to be made. These questions were duly raised in the context of the ACT group litigation, and were considered by Park J, the Court of Appeal and the House of Lords in Pirelli Cable Holding NV and others v IRC (“Pirelli I”). The judgment of the House of Lords is reported at [2006] 1 WLR 400, [2006] UKHL 4; that of the Court of Appeal at [2004] STC 130, [2003] EWCA Civ 1849; and that of Park J at [2003] STC 250, [2003] EWHC 32 (Ch). Pirelli I concerned dividends paid between 1995 and 1999 by UK-resident subsidiaries in the Pirelli group to parent companies resident in the Netherlands and Italy. 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 in the way I have explained. 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.

Three main issues were raised in Pirelli I, but for present purposes only two of them matter:

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 4^th and 5^th 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 4^th and 5^th 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 first hearing of the remitted case took place before Rimer J (as he then was) in February 2007. One might have supposed that the hearing would have been devoted to the consequential issues identified in the House of Lords’ order, but in fact the Pirelli claimants advanced an anterior argument of principle which, had it been accepted, would have made the exercise directed by the House unnecessary, or at least would have had a very significant impact on how the compensation was to be calculated. The 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 (see Pirelli Cable Holding NV and others v Revenue and Customs Commissioners (No. 2) [2007] EWHC 583 (Ch), [2008] STC 144 (“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:

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 for the reasons which he went on to give in that paragraph:

“I have made clear that I consider that Pirelli should have raised their new point as part of their argument in the House of Lords. I have, however, also observed that I cannot be certain as to whether the House would in fact have entertained it. Since that observation reflects the possibility that the House would not have entertained it, I consider that it follows that it would be a harsh judgment on Pirelli to decide the abuse of process issue on the basis that their last chance of raising the point, and of having it conclusively decided, was when the matter was before the House of Lords. That consideration indicates to me that the just disposal of the abuse of process issue requires the benefit of any doubt on the matter to be given to Pirelli. I find further support for that conclusion from the facts that (a) the point is not a new one as far as HMRC are concerned, and they have known since the hearing before Park J that it was waiting in the wings; (b) the point is a short one (the whole hearing before me occupied less than two days); (c) it is one that is of importance not just to Pirelli, but to more than 50 other litigants who are in a like interest, a consideration which Mr Glick accepted was a relevant factor; and (d) Mr Glick in fact chose to argue the merits of the point before arguing that I should not entertain any argument on it at all, which struck me as illogical; the whole point of HMRC’s assertion that the new point amounted to an abuse of the process was, in theory, to relieve them from the burden of having to argue it. Collectively, those considerations have satisfied me that I should not regard the raising of the point as amounting to an abuse of the process, and I hold that it is not.”

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 (Case C-446/04 [2006] ECR I-11753, [2007] STC 326 (“FII”) and Test Claimants in Class IV of the ACT Group Litigation v IRC (Case C-374/04 [2006] ECR I-11673, [2007] STC 404 (“ACT Class IV”).

From ACT Class IV Rimer J derived two propositions, each of which I will need to examine in more detail later in this judgment. 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 the [ACT Class IV] case 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.

78.

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 … :

“71.

… 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 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.

79.

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: Pirelli II at [2008] EWCA Civ 70, [2008] STC 508. 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.

I have set out this background material at some length, because it is needed in order to place the issues which were argued before me in context. A fuller, and very helpful, description of most of the relevant factual and legal background may also be found in paragraphs 1 to 24 of Rimer J’s judgment in Pirelli II, upon which I have gratefully drawn, and which Moses LJ endorsed in paragraph 6 of his judgment as giving a “full and unchallenged exegesis of the context of the argument” in that case. I should also acknowledge the assistance that I have gained from the introductory section of the skeleton argument of counsel for HMRC in the present case (Mr Ian Glick QC, Mr David Ewart QC and Mr Ian Hutton).

Despite their comprehensive defeats in Pirelli I and Pirelli II, the claimants in the ACT group litigation returned to the fray undaunted, and in July 2009 a fresh group of common issues of law was added by amendment to section (iv) (Treaty Credits) of the EU issues in the now much-amended group litigation order originally made by Chief Master Winegarten on 26 November 2001. The substantive issues thus added were the following:

“(C)

Is the non-UK resident parent of a Class 2 Group, in respect of dividends received by it from its UK subsidiary, entitled to:

(i)

a payment of a sum equal to the tax credit which would have been available had that non-UK resident company been resident in the UK for dividends received before 5 April 1999; or

(ii)

restitution and/or damages for any UK income tax incurred by the non-UK resident company pursuant to either section 20 Schedule F of ICTA for dividends received in accounting periods ending on or before 5 April 2005 or under sections 383, 384, 385 and 398 of the Income Tax (Trading and Other Income) Act 2005 thereafter; or

(iii)

both (i) and (ii); or

(iv)

no more than the abated partial tax credit provided for in the relevant double tax convention?

(D)

From what date does the limitation period commence?

(E)

Are claimants within a Class 2 group entitled to bring their claims referred to in (C) as claims in restitution for payments made under a mistake of law?”

It can be seen at once that these are entirely new arguments, which go far beyond the quantification of compensation for the breach of Article 43 upon which the ECJ ruled in Hoechst. A “Class 2 Group” is defined in paragraph (A) of the new issues as (in short) an EU-resident parent company in receipt of dividends from its UK subsidiary and a tax credit under the terms of the relevant DTC. The definition therefore posits the existence of a DTC such as the Dutch and Italian treaties, and it also assumes that no GIE would have been made (because in such a case no tax credit could have been payable). In other words, it posits a situation where it had hitherto been common ground that there was no breach of Article 43, nothing unlawful about the levy of ACT, and no unlawful payment or other loss in respect of which the group concerned might be entitled to recover compensation. What the claimants now wish to argue, and to argue for the first time, is that the arrangements in DTCs which provide for the payment of abated partial tax credits are themselves in breach of Community law. If that proposition is made good, the consequences which are said to follow are put on two broadly alternative (or possibly even cumulative) bases, depending on whether the payment of ACT (which in a Class 2 group there will always have been) is itself attacked.

The first approach is to focus on the payment of ACT, and the fact that the rules required it to be paid in an amount which exceeded the amount of the partial tax credit. On this approach, the levy of the ACT is said to be unlawful to the extent of the excess, and restitution is sought accordingly (either of the excess tax itself, where it was not subsequently set against MCT, or of the time value of the loss of use of the money, where it was).

The second approach accepts that ACT was required to be paid at the full UK domestic rate, and that no part of the ACT itself is recoverable. On this footing, the claimants now say that they should have been granted a full (and not just a partial) tax credit, and that the parent companies are entitled to have the full amount of the credit paid to them. They also say that the levy of UK income tax on the aggregate of the dividend and the credit was, on any view, unlawful, because dividends received by a UK-resident parent from its UK subsidiary are exempt from corporation tax (by virtue of section 208 of ICTA 1988). They therefore seek restitution of the income tax paid by deduction from the partial tax credits, as well as (or in any event as an alternative to) payment of a full tax credit.

These, in outline, are the substantive new arguments that the claimants wish to advance. Unsurprisingly, the Revenue took the view that it would be an abuse of process to permit the claimants this third opportunity to attack the relevant legislation on the grounds of its alleged inconsistency with Community law, in the context of the long-established group litigation and its conduct to date. There is accordingly a procedural issue which I need to address, in much the same way as Rimer J had to in Pirelli II. This procedural question is reflected in paragraphs (A) and (B) of the new issues, which read as follows:

“(A)

Where a parent company resident in another EU/EEA Member State received dividends from its UK subsidiary and a tax credit under the terms of the relevant double tax convention (“a Class 2 Group”), are the parent company and the subsidiary entitled to contend that they need not prove that they would have made a group income election in respect of those dividends to be entitled to restitution and/or damages or is that question res judicata?

(B)

If the answer to (A) is “no” and/or that the question is res judicata, how do Claimants show that they would have elected to pay within a group income election and do the test Claimants meet that test?”

Rather oddly, to my mind, paragraph (A) is framed in terms of whether it is open to a Class 2 group to seek restitution/and or damages, without proving that they would have made a GIE in respect of the relevant dividends. The wording also appears to confine the issue to whether the question is res judicata in the strict sense of that term. It seems to me that the question would more aptly be framed as whether, in all the circumstances of the case, it would now be an abuse of process to permit the test claimants to argue all or any of the substantive issues raised in paragraphs (C) to (E). In any event, the argument before me was in practice addressed to that broader question, and I shall proceed to deal with it accordingly.

Finally, and wrapped up in paragraph (B), one finds an oblique reference to what Moses LJ’s “tyro to the world of fiscal litigation” (Pirelli II at paragraph 4) might reasonably have supposed to be the only live issue left after Pirelli I, namely the question of fact remitted to the High Court by the House of Lords’ order of 8 February 2006. Even here, however, the formulation of the question allows room for argument that the court should carry out an exercise which differs in some unspecified respects from the apparently simple factual enquiry envisaged and directed by their Lordships. It is also clear that, if the claimants are permitted to argue the substantive new points, and if they succeed on some or all of them, there may well be substantial consequential effects on the computation of the compensation recoverable by the claimants for the breach of Community law established in Hoechst, quite apart from any new heads of liability which may be established.

In the event, I heard both argument and oral evidence on the question remitted by the House in Pirelli I, and that is therefore one of the matters that I will need to deal with. I propose, however, to leave it to last, because of the potential impact on the question of the new issues. As to the new issues themselves, it would in many ways be logical to begin with the question of abuse of process, as Rimer J did. Indeed, in paragraph 61 of his judgment (quoted above) he criticised Mr Glick QC for having argued the merits of the new point in that case before arguing that the court should not entertain the point at all. Nevertheless, and with some hesitation, I find it convenient to follow the same illogical order myself. Neither side has asked me to deal with the question of abuse of process as a separate preliminary issue. Furthermore, both sides wish me to state my conclusions on the new substantive issues, even if I consider that the court should not entertain them. In those circumstances, there is in my view much to be said for dealing with the substantive issues first. After all, if I conclude that they are devoid of merit, the question whether the court should entertain them becomes comparatively unimportant. Conversely, if I consider any of them to be well-founded, that may itself be a material consideration for the court to take into account on the question of abuse of process.

For completeness, I should also record at this stage:

In their skeleton argument counsel for the test claimants dealt with this issue first, although in his oral submissions Mr Aaronson QC reversed the order of presentation, and sought rather to portray this issue as the reverse side of the same coin as the second issue. Whatever his tactical reasons may have been for following this course, I prefer to stay with the original order, and to approach this question, at least in the first instance, as a self-contained one. The question, in essence, is whether the UK was in breach of Community law by operating a system of corporate taxation whereby the same full rate of ACT was chargeable on dividends paid by a UK-resident company to its parent, whether the parent was also UK-resident or resident in another member state, but where (in the absence of a GIE) the UK tax credit given to a UK parent was a full credit equal to the amount of ACT, but the credit given to a non-resident parent was (in the cases with which I am now concerned) only a partial one. To put the central question even more simply, is it a requirement of Community law that a UK company with an EU parent should not be obliged to pay more ACT than the amount which is needed to fund the tax credit? Thus, if the argument is sound, in cases where the net credit paid to a Dutch or Italian parent company is equal to 6.875% of the amount of the dividend (for the calculation see paragraph 18 of Rimer J’s judgment in Pirelli II), the UK could validly have required the UK subsidiary to account for ACT of that amount, but no more. With an ACT rate of 25%, the balance of 18.125% would have been unlawful, or at least the group should have been afforded the opportunity to make a partial GIE in respect of the balance.

Mr Aaronson submitted that this was indeed the correct analysis for the following main reasons. First, the House of Lords in Pirelli I has held that there is an inextricable link between the payment of ACT (or, more accurately, the imposition of the charge to ACT) on the dividend, and the grant of a tax credit to the recipient. Secondly, the function of the charge to ACT, in the domestic context, is to fund the grant of the tax credit in a corresponding amount. As Lord Hope put it in Pirelli I at paragraph 36:

“The purpose of section 231 was to provide the receiving company with a tax credit equivalent in amount to the ACT payable on the dividend. The tax credit was designed to avoid tax having to be paid twice on the same dividend when tax was paid on its profits by the parent company.”

Thirdly, a non-resident parent is not in the same position as a UK parent with respect to the tax credit, because it receives only a one half credit less withholding tax (the 6.875% to which I have referred). Fourthly, therefore, the principle that ACT must be paid in order to obtain the credit only explains the need for an ACT payment equivalent to the amount of the net half credit. It does not explain the need for payment of the full amount of the ACT. Fifthly, the UK rules discriminate against foreign-owned groups in cases of this type, because they treat domestic and foreign-owned groups in exactly the same way in relation to the imposition of ACT, although their situations with regard to tax credits are materially different. It is a well-established principle of Community law that discrimination consists in the application of different treatment to comparable situations, or the application of the same treatment to non-comparable situations, unless in either case such treatment is objectively justified: see, for example, Case 106/83 Sermide v Cassa Conguaglio Zucchero [1984] ECR 4209 at paragraph 28. Sixthly, in these circumstances, the requirement to pay the full amount of ACT is disproportionate, and constitutes an unjustified restriction on the claimants’ freedom of establishment contrary to Article 43 EC as interpreted by the ECJ in Hoechst.

In his oral submissions Mr Aaronson frankly conceded that this way of looking at the matter had only recently occurred to the claimants’ legal advisers, but he described the revelation as a “eureka moment” and argued that this solution had the great merit of producing the “right” result. It fully recognises the principle of Pirelli I (that there could be no tax credit without a payment of ACT), and by matching the amount of ACT that could lawfully be charged to the amount of the tax credit actually received, it avoids the unfairness of requiring a foreign-owned group to pay more ACT than the amount needed to fund the credit which it received.

The Revenue’s riposte to these submissions was, in essence, a simple one. The critical point, submits the Revenue, is that no relevant breach of Community law was involved in the UK entering into DTCs such as the Dutch and Italian treaties, whereby receipt of a partial and abated tax credit was made conditional upon the payment of ACT at the full UK rate on the dividend. There is no harmonised system of EU corporate taxation, and subject to one point it is entirely a matter for the source state (here the UK) and the home state of the parent company (here the Netherlands or Italy) to decide, by means of a DTC, which is itself likely to be the product of detailed and hard negotiation, whether a tax credit is to be provided at all on outward dividends, and (if so) in what amount and on what terms. The one qualification which has to be recognised is that, if the home state chooses to tax the dividend, it then has to ensure that equivalent fiscal treatment is accorded to the parent company as is accorded to a domestic shareholder. The nature and ambit of that qualification will have to be considered under the second issue below. But it is irrelevant to the first issue, which turns on the freedom which Community law necessarily recognises (in the absence of a harmonised system of corporate taxation) for member states to make their own decisions about the cross-border taxation of dividends.

Mr Glick QC went on to submit that these propositions are clearly established by the answers which the ECJ gave to two of the questions referred to it in ACT Class IV. Before turning to those questions, I would observe that the reference 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 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 Articles 43 EC and 56 EC preclude a rule of a Member State, such as the rule at issue in the main proceedings, 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 Articles 43 EC and 56 EC do 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:

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 43 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 43 would not be engaged.

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.

69.

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.

70.

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 43 EC, 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.

71.

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, Case C-265/04 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 43.

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 43 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 43. 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 43 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:

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.

It will probably be apparent from what I have already said that I consider these other possible ways of putting the claimants’ new case to be as unfounded as the first way. They depend upon essentially the same interpretation of the ECJ’s judgment in ACT Class IV as before, and in particular on the proposition that when the Court said in paragraph 70 of its judgment that the source state (here the UK) is obliged to ensure that non-resident shareholders are subject to “the same treatment” as resident shareholder companies, this means that the same or equivalent treatment in all respects must be accorded to foreign-parented groups as to UK-parented groups, once the UK has taken the fatal step of charging the dividends to income tax.

If that proposition were correct, it would then be relatively easy to understand how the rest might plausibly be said to follow. The 5% income tax charge would be objectionable, because in a domestic context dividends paid to a corporate shareholder were exempt from corporation tax and were also outside the Schedule F charge to income tax. Similarly, there could be no good reason for confining the tax credit to one half of the amount given to an individual UK shareholder, because equivalent relief from economic double taxation would prima facie require the grant of a full credit. Furthermore, extravagant though it may look at first blush, it is not easy to see why the two remedies should not be cumulative: both would be needed in order to place the non-resident corporate shareholder in substantially the same position as its UK-resident counterpart.

Mr Aaronson submitted with missionary zeal that this was indeed what Article 43 requires. He did not dispute that the result might look disproportionate as a consequence of imposing a 5% tax charge, but submitted that the UK had only itself to blame for not thinking through the Community law consequences of entering into DTCs in this form and maintaining them in force. He emphasised that the Advocate General and the Court had been at pains to review the whole subject of corporate cross-border taxation of dividends in the context of Community law, and to place it on a coherent and logical basis. He also referred me to subsequent case-law which showed, he said, that the views expressed by the Advocate General and the Court in Act Class IV had quickly become firmly established in the jurisprudence of the Court.

I have not so far examined the reasoning of the Advocate General in ACT ClassIV in any detail, but since it underpins the more compressed analysis by the Court itself (which I have already discussed), and since Mr Aaronson places particular reliance upon it, it is appropriate that I should now do so.

In paragraph 55 of his opinion, the Advocate General repeated by way of summary the important distinction which he had previously drawn at greater length, between what he termed “quasi-restrictions”, which do not fall within the scope of Article 43, and “true restrictions” which do. A quasi-restriction is a restriction on freedom of establishment which “results purely from the co-existence of national tax administrations, disparities between national tax systems, or the division of tax jurisdiction between two tax systems”. By contrast, a true restriction goes “beyond those resulting inevitably from the existence of national tax systems”, and is prohibited by Article 43 unless justified. Referring back to his earlier discussion of the elements of cross-border taxation and the absence of any unified Community system of corporate taxation, he went on to say in paragraph 55, again by way of summary:

“In the terminology used above, in order to fall under Article 43 EC, disadvantageous tax treatment should follow from discrimination resulting from the rules of one jurisdiction, not disparity or division of tax jurisdiction between (two or more) Member States’ tax systems.”

He then said in paragraph 57:

“In my view, it follows as a consequence of the method of dividing tax jurisdiction adopted by Member States – that is, the distinction between worldwide (home State) and territorial (source State) tax jurisdiction – that the concept of discrimination applies in different ways to States acting in home State and source State capacity. Quite simply, as the nature of the tax jurisdiction being exercised in each case differs fundamentally, an economic operator subject to home State jurisdiction cannot per se be considered to be in a comparable situation to an economic operator subject to source State jurisdiction, and vice versa. As a result, Article 43 EC imposes two different categories of obligation on a State, depending on the jurisdictional capacity in which it is acting in a particular case.”

The Advocate General proceeded in paragraphs 58 to 65 to discuss the home state obligations imposed by Article 43. The central obligation, he said in paragraph 58, was “in essence, to treat foreign-source income of [the home state’s] residents consistently with the way it has divided its tax base”. If the home state had divided its tax base to include foreign-source income, by treating it as taxable income, it must then not discriminate between foreign-source and domestic income. The Advocate General illustrated this principle by reference to the Court’s case-law (to which FII may now be added).

He then turned to the obligations imposed on the source state by Article 43, and in paragraph 66 identified the guiding principle as follows:

“66.

As source States have tax jurisdiction only over the income that is earned by the non-resident within the source State’s jurisdiction, they are subject to a more limited obligation under Article 43 EC. In essence, this can be expressed as an obligation to treat all non-residents in a comparable way to residents (non-discrimination), in so far as these non-residents fall within their tax jurisdiction – i.e., subject to the difference in the extent of their tax jurisdiction over residents and non-residents.”

He then gave examples of how this principle had been applied in practice by the Court, drawn from both corporate and individual income taxation, before continuing in a paragraph upon which both sides sought to rely:

“69.

A further application of the source State non-discrimination obligation is that, in so far as a source State chooses to relieve domestic economic double taxation for its residents (for example, in taxation of dividends), it must extend this relief to non-residents to the extent that similar domestic double economic taxation results from the exercise of its tax jurisdiction over these non-residents (for example, where the source State subjects company profits first to corporation tax and then to income tax upon distribution). This follows from the principle that tax benefits granted by the source State to non-residents should equal those granted to residents in so far as the source State otherwise exercises equal tax jurisdiction over both groups.”

Mr Aaronson relied on this paragraph as authority for the proposition that, once the UK had decided to impose income tax on the dividends paid to non-resident shareholders, it was then obliged to give those shareholders equivalent relief from economic double taxation to that which it gives to resident shareholders. However, I agree with Mr Glick that the Advocate General chose his language with care to make it clear that the obligation extended only to double taxation which resulted from the exercise of theUK’s tax jurisdiction over the non-residents in question. In the present context, this means that the UK was obliged to grant relief to non-resident parent companies from the double taxation occasioned by the imposition of the 5% income tax charge on the dividends, but no more. The only domestic double economic taxation which resulted from the exercise by the UK of its tax jurisdiction over the dividends was the imposition of both corporation tax (in the form of ACT) and income tax on 5% of the dividends. It is only to that extent that the UK sought to exercise equal tax jurisdiction over non-resident shareholders as compared with resident shareholders, and accordingly it is only to that extent that Article 43 obliged the UK, as the source state, to provide relief from economic double taxation. This was duly achieved by the grant of the partial tax credit.

In a later section of his opinion, the Advocate General dealt expressly with cases where, by virtue of a DTC, the UK subjects dividends to limited UK income tax, and he again expressed himself in very similar terms:

“88.

In this regard, I would repeat that, as I explained above, the nature of the UK’s obligation, acting as source State as regards outgoing dividends, is, in so far as it exercises tax jurisdiction over non-residents’ income, to treat it in a comparable way to residents’ income. In other terms, to the extent that the UK exercises jurisdiction to levy UK income tax on dividends distributed to non-residents, it must ensure that these non-residents receive equivalent treatment – including tax benefits – as residents subject to the same UK income tax jurisdiction would receive. Put otherwise, the extent of the UK’s obligation should respect the division of jurisdiction and tax base arrived at in the applicable bilateral DTC. As held by the Court in Bouanich, it is for the national court to decide, in each case and depending on the terms of the relevant DTC, whether this obligation has been complied with.”

Finally, in paragraph 91 the Advocate General’s proposed answer to question 1(a) mirrors the language of paragraph 69:

“However, to the extent that, pursuant to a DTC, the UK exercises jurisdiction to levy UK income tax on dividends distributed to non-residents, it must ensure that these non-residents receive equivalent treatment – including tax benefits – as residents subject to the same UK income tax jurisdiction would receive.”

With every respect to Mr Aaronson’s forceful submissions, I cannot read these passages, and still less the judgment of the ECJ itself, as requiring the UK to provide for foreign parent companies and their shareholders equivalent treatment in all respects to that which the UK affords to domestic parent companies and their shareholders. Such a conclusion would make no sense, given (a) the very limited nature of the charge to income tax imposed by the UK as source state, (b) the general principle that the relief of economic double taxation is primarily the responsibility of the home state (i.e. in the present context either the Netherlands or Italy), and (c) the acknowledged fact that Article 43 would not be engaged at all in the absence of the 5% income tax charge, even though ACT was imposed at the full UK domestic rate on dividends paid to non-resident parents. (I should add, for completeness, that Article 43 would of course be engaged, and breached, if the case is one where the UK subsidiary and its EU parent would have entered into a GIE had one been available: see Hoechst. But that is a quite separate breach of Article 43 from the one that the claimants are trying to establish in the present proceedings).

I was referred by both sides to subsequent case-law of the ECJ in which the principles laid down in ACT Class IV have been affirmed and applied. The cases are (in chronological order): Case C-170/05 Denkavit Internationaal BV and Denkavit France SARL v Ministre de l’Économie, des Finances et de l’Industrie [2006] ECR I-11949, [2007] STC 452 (“Denkavit”); Case C-379/05 Amurta SGPS v Inspecteur van de Belastingdienst/Amsterdam [2007] ECR I-9569, [2008] STC 2851 (“Amurta”); Case C-194/06 Staatssecretaris van Financiën v Orange European Smallcap Fund NV [2008] ECR I-3747 (“Orange Smallcap”); and Case C-540/07 Commission of the European Communities v Italian Republic (“Commission v Italy”), in which Advocate General Kokott had delivered her opinion on 16 July 2009 but the Court had not yet given judgment at the time of the hearing before me in late October. The Court subsequently delivered its judgment on 19 November 2009, substantially following the Advocate General’s opinion.

Denkavit was a decision of the First Chamber of the ECJ, with the same Rapporteur (Judge Lenaerts) and the same Advocate General (Geelhoed) as in ACT Class IV. Judgment was delivered on 14 December 2006, only two days after the judgments in FII and ACT Class IV. The ECJ held, in brief, that French legislation imposing a liability to withholding tax on dividends paid by a French subsidiary to its Dutch parent company, while it allowed resident parent companies almost full exemption from such tax, infringed Article 43. The DTC between France and the Netherlands reduced the rate of withholding tax applicable to the dividends from the usual domestic rate of 25% to 5%, and also provided that credit should be given in the Netherlands for the French withholding tax up to the amount of the Dutch tax due on the dividends. However, the dividends were in fact exempt from Dutch tax, so the parent company could not avail itself of the treaty credit. It therefore sought repayment of the 5% withholding tax on the ground that the combined effect of the French legislation and the treaty infringed its right of establishment in France.

It should be noted, by way of contrast with the present case, that France did not provide any form of effective tax credit to the Dutch parent, so the 5% French withholding tax remained wholly unrelieved in the parent’s hands.

Unsurprisingly, the ECJ held that these arrangements did indeed infringe Article 43. In paragraph 22 of his opinion, the Advocate General repeated in very similar language the principles which he had stated in paragraphs 69 and 88 of his opinion in ACT Class IV. He went on to reject arguments by the French government based on the principle of territoriality, and on the principle that the relief of double taxation is a matter for the home state of the taxpayer. As he said in paragraph 27, in relation to the latter argument:

“This in no way alters the obligation of a source State to treat non-residents in a comparable manner to residents, in so far as the former fall within their tax jurisdiction.”

To similar effect, the ECJ repeated the principles which it had laid down in paragraphs 57 to 65 and 68 of its judgment in ACT Class IV, and stated its conclusion in paragraph 37 as follows:

“37.

It must be held in that regard that the exemption in respect of dividends received by resident parent companies is designed to avoid the imposition of a series of charges to tax on the profits of subsidiaries which are distributed by way of dividend to the parent companies of those subsidiaries. As the Advocate General stated at point 22 of his Opinion, since the French Republic has chosen to relieve its residents of such a liability to tax, it must extend that relief to non-residents to the extent to which an imposition of that kind on those non-residents results from the exercise of its tax jurisdiction over them (see, to that effect, Test Claimants in Class IV of the ACT Group Litigation, paragraph 70).”

It is abundantly clear, in my judgment, that the Court was here applying precisely the same principle which it had identified in ACT Class IV, and the crucial point was that France, having chosen to tax the outgoing dividends, had not provided any equivalent of the exemption which it afforded to domestic shareholders. I agree with Mr Glick that the words “to the extent” in the last sentence show that the obligation on France as the source state went no further than to grant equivalent relief for the 5% withholding tax which was actually imposed.

In Amurta a similar question arose in relation to Dutch withholding tax on dividends paid to a Portuguese company by a Dutch company. The Portuguese company owned 14% of the shares in the Dutch company, while 66% of the shares were held by another Dutch company. The effect of the relevant Dutch tax legislation was that withholding tax of 25% was charged on the dividends paid to the Portuguese shareholder, but the dividends paid to the Dutch shareholder were exempt. The Court applied its reasoning in ACT Class IV and Denkavit and held that the legislation infringed Article 43. In paragraph 39 of its judgment, the Court referred to paragraph 70 of its judgment in ACT Class IV and described the obligation on the home state as being “to ensure that … non-resident shareholder companies are subject to the same treatment as resident shareholder companies”. The Court continued in paragraph 40:

“Clearly, the economic double taxation, to which dividends distributed to companies not established in the Netherlands are subject, stems solely from the exercise by the Kingdom of the Netherlands of its taxing powers, which subject those dividends to dividend tax, whereas that Member State elected to prevent such economic double taxation in respect of recipient companies with their seat in the Netherlands or having a permanent establishment there which owns the shares in the company making the distribution.”

In agreement with Mr Glick, I consider that this paragraph shows that the focus of the Court was solely on the economic double taxation brought about by the Dutch withholding tax. Had that economic double taxation been neutralised, whether by other Dutch legislation or by an effective provision in the relevant DTC, there would then have been no breach of Article 43. This is clear from paragraph 83 of the judgment, where the Court said:

“83.

It is therefore for the national court to establish whether account should be taken, in the main proceedings, of the DTC, and, if so, to determine whether that convention enables the effects of the restriction of free movement of capital identified in the context of the reply to the first question, in paragraph 28 of this judgment, to be neutralised.”

There is no suggestion that any wider enquiry into the Portuguese tax position of the Portuguese shareholder might be relevant.

Orange Smallcap was a case with rather complicated facts, concerning a Dutch investment fund in receipt of foreign dividend income whose shareholders were partly resident in other member states and third countries. One of the issues in the case concerned a concessionary scheme operated by the Netherlands for granting a measure of double tax relief for foreign taxes paid on dividends received by the fund from abroad. However, there was a restriction on the amount of the concession which reduced it in line with the interest in the capital of the fund of shareholders who were not resident or established in the Netherlands. This restriction fed through into the amount of profits available for distribution to shareholders of the fund, wherever they were resident. The ECJ held that the restriction on the concession constituted a restriction on the free movement of capital under Article 56 EC, and it could not be justified by its avowed purpose of avoiding a reduction in tax revenue. For present purposes, the important point is that in its discussion of this question the Court referred to and relied upon the principles established in Denkavit and ACT Class IV. In paragraph 79 of its judgment, the Court said this:

“79.

Therefore, as the Advocate General noted at point 121 of his Opinion, as soon as the Kingdom of the Netherlands decided to grant fiscal investment enterprises established within its territory a concession for tax deducted abroad and to exercise its fiscal sovereignty over all dividends distributed by such enterprises to their shareholders, whether resident or established in that Member State or in others, it had to extend the benefit of that concession to fiscal investment enterprises which included shareholders not resident or established in that Member State (see, to that effect, Case C-170/05 Denkavit Internationaal and Denkavit France … paragraph 37 and the case-law cited).”

Finally, Commission v Italy concerned infraction proceedings brought by the European Commission against Italy in relation to withholding tax levied by Italy on dividends paid to non-resident shareholders. The details do not matter, and it is enough to note that the relevant Italian legislation subjected dividends distributed to non-resident companies to a higher rate of tax than that imposed on dividends distributed to resident companies: see paragraph 33 of the judgment of the Court. In holding that the infraction proceedings succeeded, the Court rejected a number of defences to the clear prima facie infringement of Article 56, and in paragraphs 51 to 53 it repeated the now familiar principles derived from ACT Class IV, Denkavit and Amurta.

In my judgment none of these cases advance the claimants’ case, although they do undoubtedly show that the principles laid down in ACT Class IV have rapidly become a well-established part of the ECJ’s jurisprudence. One reason why the later cases take the matter no further, as Mr Aaronson pointed out in his submissions in reply, is that none of them had to deal with an imputation (or partial imputation) system of corporate taxation operated by the source state. They therefore throw no further light on the extent of the obligations undertaken by a state (such as the UK) which does operate such a system when it subjects cross-border dividends to a withholding tax. The answer to that question still has to be found in ACT Class IV itself, and for the reasons which I have already given I do not consider that the obligation extends beyond neutralisation of the tax charge in the hands of the recipient company. Since the partial tax credit paid by the UK under the relevant DTCs amply fulfils that objective, there can in my judgment be no question of any breach of Article 43 on this account. I therefore conclude that the claimants’ alternative ways of putting their case under this heading are no more persuasive than their case under the first heading, and they must likewise be dismissed. As before, I do not consider that there is sufficient doubt about the answer to justify a further reference to the ECJ.

If I had decided that there was any merit in the new issues, a number of consequential questions would have arisen about (a) the nature of the remedies that are available under domestic law for the alleged breaches of Community law, (b) mistake and (c) limitation. There appeared to be little, if any, disagreement between the parties about how most of these questions should be answered, if one got to them; and since, on the view which I take of the merits, they do not arise, I prefer to leave them unanswered.

I now turn to the question of abuse of process.

In their skeleton argument, counsel for the Revenue confined their attack on this ground to what they called point (a) and I have termed the first issue or the first way in which the claimants seek to advance their new case, that is to say the argument that any liability on the UK subsidiary to pay ACT in excess of the partial tax credit payable to the parent company under the relevant DTC was an unjustified infringement of Article 43 (see paragraphs 33 to 51 above). Their reason for not extending the attack to the second way in which the claimants advance their new case, or point (b) in their terminology, (see paragraphs 52 to 73 above) was, I think, that ACT Class IV and Denkavit had not yet been decided by the ECJ at the date of the hearing and judgment of the House of Lords in Pirelli I, so the claimants could not reasonably be criticised for their failure to advance in Pirelli I arguments which depended on principles that the ECJ had not yet enunciated. Pirelli I was heard by the House of Lords on 23 and 24 November 2005, and judgment was delivered on 8 February 2006, some two weeks before the date of the Advocate General’s opinion in ACT Class IV (23 February 2006) and some ten months before the ECJ delivered its judgment on 12 December 2006.

In his oral submissions, however, Mr Glick broadened his attack to include the second issue, on the basis that these arguments could have been run in Pirelli II which was heard by Rimer J on 14 and 15 February 2007, and in which he delivered judgment on 23 March 2007. Indeed, at one stage Mr Glick argued that the claimants’ second way of putting their new case was flatly inconsistent with Rimer J’s order and the subsequent order of the Court of Appeal in Pirelli II, with the result that it had to be rejected as an abuse of process for that reason alone. He later modified this submission somewhat, and argued that while those orders were only an absolute bar to the first way of putting the case, nevertheless both ways of putting it amounted to a collateral attack on the orders in Pirelli II and were an abuse of process for that reason.

In evaluating these submissions, it is necessary to begin with the terms of the various orders on which the Revenue relies. I have already quoted the relevant part of the order of the House of Lords dated 8 February 2006 in paragraph 13 above. For present purposes, the crucial words are “and so that in assessing the amount of compensation payable to the 4^th and 5^th claimants the amount of the tax credit paid to their parents should be brought into account”. Mr Glick argued, and I would agree, that these words assume that, if a GIE would have been made and compensation is accordingly recoverable, the amount of such compensation is to be reduced, on a pound for pound basis, by the tax credits paid to the parent companies. As Moses LJ put it in Pirelli II at paragraph 4:

“After all, the order assumes (“so that”) that if the Court decides that an election would have been made, the parents will have to bring into account the tax credits paid to them under the relevant DTA.”

The relevant parts of Rimer J’s order in Pirelli II read as follows:

“IT IS ORDERED that:

1.

There be a declaration that if any of the Claimants had exercised a group income election so that a dividend was paid without the paying company having to account for ACT, the receiving company would not have been entitled to a tax credit when the dividend was paid or at any later time.

IT IS ORDERED BY CONSENT that:

2.

Without prejudice to the Claimants’ right to appeal this Order to the Court of Appeal and to the Defendants’ right to contend that any particular dividend would not have been paid under a group income election, it is declared that, in computing any compensation payable to a Pirelli Subsidiary in respect of a particular dividend, the convention tax credit received by the Pirelli Parent in respect of that dividend or a dividend paid to the Pirelli Parent out of the particular dividend (plus interest on the tax credit at the relevant rate referred to in Schedule 1 hereto from the date on which the credit was received until the date on which the compensation (if any) is payable) is to be deducted pound for pound from the compensation which would otherwise be payable.”

The order of the Court of Appeal in Pirelli II simply dismissed the appeal, and remitted the case to the Chancery Division “to deal with the outstanding matters that arise out of the House of Lords’ order of 8 February 2006”.

Leave to appeal to the House of Lords was refused. An application for permission to appeal was subsequently dismissed by the Appeal Committee (Lord Hope, Lord Scott and Lord Walker) on 17 June 2008. It is of some interest to note the brief reasons which the Committee gave for its decision:

“Permission is refused because the petition does not raise an arguable point of law of general public importance which ought to be considered by the House at this time, bearing in mind that the cause has already been the subject of judicial decision and reviewed on appeal.

In relation to the point of European Community law raised in the application, the application is also refused because the correct application of Community law is so obvious as to leave no scope for any reasonable doubt.

Reason why the Community law issue falls within this category: the principles reflected in the paragraphs 55 – 74 of ACT Class IV, as applied by Rimer [J] in paragraphs 76 – 78 of his opinion.”

I will take first Mr Glick’s submission that the orders in Pirelli I and Pirelli II are an absolute bar to the first way in which the claimants put their new case. In oral argument he characterised this as an issue estoppel point, but did not elaborate the submission. In my judgment the submission goes too far and must be rejected. I have already described the issues which were considered by the Courts in Pirelli I and Pirelli II. They did not include the question whether Community law requires the amount of ACT paid by the subsidiary to match the treaty tax credit paid to the parent, or any other variations on that theme. The Court orders which I have quoted were not directed to that question, for the simple reason that it had not at that stage occurred to anybody that the disparity between the amounts of ACT and the tax credits might offend Community law. As Mr Cavender (who argued this part of the case for the claimants) candidly accepted, everybody assumed throughout the proceedings in Pirelli I and Pirelli II that, in the absence of a GIE, there was nothing unlawful about either the charge to ACT or the amount of the credit. But an issue estoppel cannot be founded upon an untested common assumption, although there may of course be room for an argument that the party who subsequently seeks to go behind the common assumption should not be permitted to do so, because he could and should have raised the point earlier. That is a classic abuse of process argument of the type considered by the House of Lords in Johnson v Gore Wood & Co [2002] 2 AC 1, but it is quite different from an absolute bar to re-litigation of a point which has already been decided between the same parties or their privies.

For similar reasons, it would in my view be wrong to construe the Court orders in Pirelli I and Pirelli II as implicitly directing what was to happen in relation to dividends which would not have been paid under a GIE, or as necessarily precluding any argument that the levy of ACT in an amount exceeding the tax credit was unlawful. The truth is that questions of this nature were not before the court, and court orders, like Acts of Parliament or any other official pronouncements, have to be construed in their context. Furthermore, I do not think that there is any inconsistency between the new arguments on the first issue and the consent order made by Rimer J. The new arguments on this issue do not attack either the existence or the amount of the tax credit paid on non-election dividends, nor do they entail the consequence that the tax credit should not be taken into account as a deduction “from the compensation which would otherwise be payable”. Rather, they go to the question of how that compensation should be calculated, or the further question whether the claimants may have an entirely separate claim for the recovery of unlawfully levied ACT.

I therefore come to what seems to me to be the real question, which is whether to entertain the new arguments on either the first or the second issues would be an abuse of process. There was no discernible difference between the parties about the guiding principles in this area. The key text is the well-known passage from the speech of Lord Bingham in Johnson v Gore Wood & Co (see [2002] 2 AC 1 at 31A-F) which Rimer J cited in Pirelli II, and which I will for convenience repeat:

“But Henderson v Henderson abuse of process, as now understood, although separate and distinct from cause of action estoppel and issue estoppel, has much in common with them. The underlying public interest is the same: that there should be finality in litigation and that a party should not be twice vexed in the same matter. This public interest is reinforced by the current emphasis on efficiency and economy in the conduct of litigation, in the interests of the parties and the public as a whole. The bringing of a claim or the raising of a defence in later proceedings may, without more, amount to abuse if the court is satisfied (the onus being on the party alleging abuse) that the claim or defence should have been raised in the earlier proceedings if it was to be raised at all. I would not accept that it is necessary, before abuse may be found, to identify any additional element such as a collateral attack on a previous decision or some dishonesty, but where those elements are present the later proceedings will be much more obviously abusive, and there will rarely be a finding of abuse unless the later proceeding involves what the court regards as unjust harassment of a party. It is, however, wrong to hold that because the matter could have been raised in earlier proceedings it should have been, so as to render the raising of it in later proceedings necessarily abusive. That is to adopt too dogmatic an approach to what should in my opinion be a broad, merit-based judgment which takes account of the public and private interests involved and also takes account of all the facts of the case, focussing attention on the crucial question whether, in all the circumstances, a party is misusing or abusing the process of the court by seeking to raise before it the issue which could have been raised before. As one cannot comprehensively list all possible forms of abuse, so one cannot formulate any hard and fast rule to determine whether, on given facts, abuse is to be found or not … While the result may often be the same, it is in my view preferable to ask whether in all the circumstances a party’s conduct is an abuse than to ask whether the conduct is an abuse and then, if it is, to ask whether the abuse is excused or justified by special circumstances. Properly applied, and whatever the legitimacy of its descent, the rule has in my view a valuable part to play in protecting the interests of justice.”

It is worth adding to that citation what Rimer J went on to say about it in paragraph 60 of Pirelli II:

“60.

That statement is of course directed to the raising in a second claim of an issue which could have been raised in an earlier claim but its general thrust must be equally applicable to, for example, a case in which there is a split trial on liability and damages. If a claimant succeeds on liability, it is potentially abusive for the defendant to seek to raise on the enquiry as to damages a point which goes to liability and which he could and should have raised at the liability trial. Similarly, if Pirelli could and should have raised their new tax credit point before the Court of Appeal and House of Lords (it being closely related to the points which were there argued and being said to go to the principles by reference to which the computation of loss was to be assessed), it is arguably abusive for Pirelli to seek to raise that point for the first time in the context of an enquiry as to that computation. HMRC are entitled to say that they should not now be subjected to the new point.”

Mr Cavender also referred me to a series of recent cases in which the Court of Appeal has corrected trial judges who were too ready to find that a Henderson v Henderson abuse of process had been established. The cases were: Tannu v Moosajee [2003] EWCA Civ 815, unreported; Aldi Stores Ltd v W S P Group Plc [2007] EWCA Civ 1260, [2008] 1 WLR 748; Stuart v Goldberg Linde [2008] EWCA Civ 2, [2008] 1 WLR 823; and Walbrook Trustees (Jersey) Ltd v Fatal and others [2009] EWCA Civ 297 (an appeal from a decision of my own). Tannu v Moosajee also provides further authority for the proposition that the principle of Henderson v Henderson can apply in relation to separate stages of the same litigation: see paragraphs 31 and 40, per Dyson LJ and Arden LJ respectively.

Like Rimer J in Pirelli II, I have not found this an easy question. My strong initial reaction was to think that at least the new arguments on the first issue were abusive. There is no doubt that they could have been run earlier, and unlike the arguments which Rimer J admitted in Pirelli II they had not formed part of the claimants’ case at any earlier stage in the litigation. The purpose of group litigation is to promote the orderly and efficient resolution of multiple claims which involve common issues of law or fact. It is not intended to provide test claimants with a laboratory in which they can try out one new argument after another, until they finally hit on one which meets with the court’s approval. It is important that the disciplines of ordinary litigation should as far as possible be observed, although with due regard to the special features of group litigation stressed by Lord Woolf in Boake Allen Ltd v Revenue and Customs Commissioners [2007] UKHL 25, [2007] 1 WLR 1386 at paragraphs 30 to 33. Furthermore, the unspoken common assumption throughout both Pirelli I and Pirelli II was that, if no GIE would have been made, the subsidiary would have to pay ACT at the usual domestic rate and the parent would receive only the reduced treaty tax credit. The attack on that orthodoxy is not only a completely new point, it also goes far beyond the natural scope of the computation of compensation for the breach of Community law identified in Hoechst. It looks much more like a separate and freestanding attack on a different aspect of the UK system of taxation of cross-border dividends. As such, it has never been properly pleaded, nor is the issue clearly defined and stated even in the new Treaty Credits paragraphs added to the ACT GLO (see paragraph 24 above).

On the other hand, the new arguments raise questions of law within a relatively narrow compass. As the hearing before me demonstrated, they are capable of resolution on the basis of short and focussed legal submissions, and without any apparent prejudice to the Revenue (apart from the prejudice, if any, in allowing them to be raised at all). Furthermore, if I did not permit them to be raised in the context of the ACT GLO, there must be a risk that the Revenue would anyway have to face them in other proceedings brought by litigants who have chosen not to sign up to the ACT GLO (subject of course to questions of limitation and any other available defences).

In addition, there is force in the point that the new arguments on the second issue could not in practice have been run until after the ECJ had given judgment in ACT Class IV; and although they could in theory have been raised in Pirelli II, it is hardly surprising, and not a matter for criticism, that they did not occur to the claimants’ advisers in the short interval between the judgment of the ECJ in December 2006 and the hearing before Rimer J in February 2007. This suggests to me that at least the arguments on the second issue cannot reasonably be regarded as abusive; and, if that is right, there is then a strong case for allowing the arguments on the first issue to be advanced as well. The arguments on the two issues may not be two sides of the same coin, but they certainly have a close generic similarity, and they are likely to stand or fall together. Considerations of practical convenience therefore favour their being heard and decided together.

The position might be different if the arguments amounted to a clear collateral attack on the court orders in Pirelli I and Pirelli II, but for the same reasons which have led me to reject the Revenue’s issue estoppel argument I do not consider that they do. I can perceive no real inconsistency, or at the highest the inconsistency is only with the common assumptions on which everybody was then proceeding.

As I say, I do not find the question an easy one, but in the end I have concluded that the arguments in favour of permitting the issues to be raised in the present proceedings outweigh the arguments against. I would therefore not accede to the Revenue’s request to dismiss them as an abuse of process.

I come finally to the causation issue remitted to the High Court by the House of Lords in Pirelli I. The “dividends in question” referred to in the order of the House dated 8 February 2006 were set out in schedule 2 to the Statement of Facts and Issues. They comprised 19 dividends paid by Pirelli UK Plc (“Pirelli UK”), the UK holding company, between 5 May 1995 and 31 March 1999, and two dividends paid by Pirelli General Plc (“Pirelli General”), a wholly-owned subsidiary of Pirelli UK, on 2 and 30 May 1997. It was, and is, common ground that the latter dividends were in turn distributed on their receipt by Pirelli UK to its three non-resident parent companies, Pirelli Tyre Holding NV (“Pirelli Tyre”, resident in the Netherlands), Pirelli SpA (the ultimate holding company, resident in Italy) and Pirelli Cable Holding NV (“Pirelli Cable”, also resident in the Netherlands). Each of those companies held one third of the shares in Pirelli UK.

The Pirelli group’s claims therefore relate to dividends paid over a relatively short period of less than four years. There are two reasons why the claims do not go back beyond 1995. The first reason is that until April 1991 the DTC then in force between the UK and Italy did not provide for the payment of any tax credit. The Pirelli group’s pre-1991 claims therefore fell within Class I of the ACT GLO, and were long ago settled in full. The second reason is that Pirelli UK paid no dividends between 1989 and 1995, because the UK group suffered badly from the recession in the late 1980s and the early 1990s. On a consolidated basis, the UK group made pre-tax losses on its ordinary activities in the four accounting periods ending 31 December 1990 to 1993, and it only returned to profit in the following year. During those four years, therefore, the UK group had no profits available for distribution to the three non-resident parent companies. The reason why the claims stop in March 1999 is, of course, that ACT was abolished for dividends paid on or after 5 April 1999.

The schedule of relevant dividends also shows the dates when ACT was paid, the amounts of ACT, the dates when ACT was utilised by set off against MCT, the amount of unutilised surplus ACT, and the amounts of the tax credits. It can be seen that all of the ACT paid on the dividends up to and including May 1998 was set off against MCT within a maximum of two and a half years, but that some of the ACT on the dividends paid in October 1998, and all of the ACT on the March 1999 dividends, remained surplus at the time when the schedule was prepared for the purposes of the House of Lords hearing in Pirelli I. As at 2 July 2009, the date of the main witness statement for Pirelli in the present proceedings, the Pirelli claimants still had surplus ACT of £5,283,000 referable to the dividends paid in October 1998 and March 1999. Accordingly, on the assumption that GIEs would have been made in relation to all of the dividends, the compensation now due to the Pirelli group may be quantified, broadly speaking, as £5.283 million, plus the time value of the utilised ACT between the dates of payment and set off, less the tax credits received (which total approximately £1.4 million).

It is apparent from these figures that, if one disregards the time value claims and interest, the Pirelli claimants are about £3.9 million worse off as a result of having paid the ACT and received the tax credits. Thus with the benefit of hindsight it may seem obvious that they should have made GIEs, thereby avoiding the need to pay ACT altogether at the cost of not receiving the tax credits. However, the question that I now have to consider is one that must be answered without hindsight. The question is what the group would in fact have done, on the hypothesis that the facility to make GIEs was available, when each dividend was declared and paid. In broad terms, one would expect the group to have decided to pay ACT, and take the benefit of the tax credit, if it expected to be able to set off the ACT against MCT in the reasonably near future, and if the funding cost of the ACT in the meantime was likely to be less than the net amount of the tax credit. Conversely, if the prospects of short term set off were poor, and the funding cost of the ACT was likely to exceed the amount of the net credit, the balance would probably tip the other way, and the advantage of not having to pay ACT would prima facie outweigh the disadvantage of losing the credit.

That, as I understand it, is in essence the exercise that I am directed by the House of Lords to perform. Although it requires consideration of what would have happened in a hypothetical situation that nobody could have envisaged at the time, it is an exercise of a kind well known to the law, and in my view it does not involve any major conceptual difficulty. It is closely akin to the kind of question that the court often has to consider in, for example, a professional negligence action, where an issue of causation arises about what the claimant would in fact have done if he had been given competent advice: see Allied Maples Group v Simmons & Simmons [1995] 1 WLR 1602 (CA), especially at 1610 D-H (per Stuart-Smith LJ, with whose analysis of the law both Hobhouse LJ and Millett LJ agreed).

Despite the apparently clear terms of the House of Lords’ order, counsel for the test claimants raised a number of points in their skeleton argument which were designed either to deter me from carrying out the exercise at all, or at least to predispose me to conclude that GIEs would have been made. These points were barely touched upon in oral argument, and since I am satisfied that there is nothing in them I will deal with them briefly.

The first point is that the question has been wrongly labelled as one of causation. It is said that causation does not normally arise as an issue in the law of restitution, and where it does its function is to link the claimant to the payment he is seeking to have returned to him. Properly understood, the issue in the present case is whether the claimants have actually been disadvantaged by the rule denying them the right to make a GIE. If the Revenue are correct in saying that the claimants would not have exercised the election, then the true analysis is not that the breach did not cause the enrichment but that there is no enrichment in the first place. However, had the claimants not paid the ACT and not received the credit, they would have been £3.9 million better off. It is therefore clear that the Revenue has been enriched.

In my view this submission simply begs the question which has to be answered. If the claimants would not in fact have exercised the election, there was nothing unlawful about the charge to ACT and no question of unjust enrichment arises. It cannot be assumed that the Revenue’s enrichment was unjust merely because, with hindsight, it can be seen that it would have been advantageous for the group to make the elections. Whether the question is labelled as one of causation, or simply as a factual question which the court has to determine, is just a matter of terminology. However, it is certainly convenient to refer to it as a causation issue, and I note that it is so described both in the claimants’ witness statements and in the trial bundles prepared by their solicitors.

The second point, following on from the first, is that the Revenue “are seeking to defeat the claimants’ claim by artificially introducing a hypothetical causation issue”. That is said to be wrong in principle, and reliance is placed on the observations of Lord Neuberger in Fleming v Revenue and Customs Commissioners [2008] UKHL 2, [2008] 1 WLR 195, at paragraph 97 where he said that:

“… arguments and evidence as to the hypothetical question of whether a particular claim would have been made during a notional transitional period would very often be expensive and time-consuming and likely to lead to uncertainty.”

However, the context of those observations was very different from the present case, and the hypothetical exercise that I have to embark upon is one that the House of Lords has itself directed.

The third point seeks to pray in aid the Community law principle of effectiveness, and the comments made by Advocate General Jacobs in his opinion in the Weber’s Wine World case (Case C-147/01, [2003] ECR I-11365) at paragraphs 70 to 72. It is suggested that the principle of effectiveness requires me to interpret the question remitted by the House of Lords as an enquiry into whether the election would have been beneficial for claimant taking account of all the facts now at the disposal of the Court. Alternatively, if it is necessary to conduct the hypothetical enquiry, the burden placed on the claimants should be a light one and should take account of the extreme difficulty of retrospectively establishing what they would have done. It should be enough for the claimants to show that there were factors which might well have led them to make an election at the time, a decision which hindsight shows would have been the correct one.

In my judgment the Community law principle of effectiveness is not engaged. Requiring the claimants to establish, on the balance of probabilities, that they would have made a GIE does not in my view make it “in practice impossible or excessively difficult” (Weber’s Wine World at paragraph 72) for them to obtain reimbursement for unlawfully levied ACT. As I have pointed out, the period involved is a relatively short one in the mid-1990s. The basic data concerning the dividends and the payments of ACT are still available, as are the contemporary board papers and minutes. The Pirelli group’s witness is Mr Robert Stone, who was the UK group tax manager and chief financial officer at the time, and within whose responsibilities it would have fallen to decide whether to make a GIE had one been available. In his written evidence he deals fully and carefully with the relevant considerations that would have informed such a decision, and although he naturally stresses the difficulties and uncertainties involved in a hypothetical enquiry of this nature, the case comes nowhere near being one where it is in practice impossible or excessively difficult to establish what would have happened. Nor can I accede to the invitation to apply something other than the normal civil standard of proof on the balance of probabilities, and still less to the invitation to allow my assessment of the probabilities to be influenced by hindsight. Mr Stone’s written evidence was to the effect that the claimants would probably have exercised the election had it been available to them in all of the relevant years apart from 1997. That is the basic proposition which Mr Glick tested in a probing cross-examination of Mr Stone, and now that I have cleared these preliminary points out of the way, that is the question to which I must turn.

In his main witness statement Mr Stone set out a number of assumptions which he made in approaching the causation issue. Those assumptions were, in summary, as follows:

I should say a little more at this point about the structure of the Pirelli group. At the relevant time the group had two main businesses: the manufacture of tyres, and the manufacture of high-technology cables and systems for energy and telecommunications. The latter part of the business was sold in 2005. The ultimate parent company of the group, as I have said, was Pirelli SpA, based in Milan. The UK sub-group consisted of four main companies: Pirelli UK, the holding company; Pirelli General, responsible for the UK cable business; Pirelli UK Tyres Ltd, responsible for the UK tyre business; and Pirelli UK Finance Ltd, the UK treasury company. I have already explained how Pirelli UK was in turn owned equally by Pirelli SpA, Pirelli Tyre and Pirelli Cable. Although the three non-resident parent companies each held one third of the voting shares in Pirelli UK, their rights to receive dividends were not equal. Their entitlement to dividends depended on the source of the UK profits which were being distributed, so that Pirelli Tyre received distributions of the profits of the UK tyre business, Pirelli Cable received the profits from the cable business, and Pirelli SpA received the portion of the distribution attributable to the profits of the treasury company.

There is no dispute, as I understand it, about the part of the claim which relates to utilised ACT, so the causation issue only relates directly to the surplus ACT attributable to the October 1998 and March 1999 dividends. However, in order to answer the question whether elections would have been made in respect of those dividends, it is first necessary to reconstruct what the UK group’s ACT position would have been in October 1998 had the facility to make elections been available from 1995 onwards. Accordingly the causation question has to be addressed in relation to all of the dividends, and that is what Mr Stone proceeded to do in his written evidence. Similarly, Mr Glick’s cross-examination dealt with the matter chronologically.

Mr Stone emphasised that the UK group had always carried surplus ACT throughout the 1990s, and that surplus ACT was a real problem. Although it could be carried forward, it did not attract interest, so the longer it remained unutilised the less its value was in real terms to the group as a tax credit. It was part of his job to take what steps he could to minimise the amount of surplus ACT. He summarised in a helpful table the amounts of surplus ACT carried forward at the end of each accounting period from 1992 to 1999. I reproduce the figures from 1994 onwards:

As the table shows, the group was still carrying surplus ACT of £5.34 million as at 31 December 1995, even though Pirelli UK paid no dividends between 1989 and 1995. The absence of profits from 1990 to 1993 inclusive meant that the group had only low levels of ACT capacity, and therefore limited opportunity to reduce surplus ACT. However, the group returned to profit from 1994 onwards, and in another table Mr Stone sets out the consolidated UK group profits from 1984 until 1999. I reproduce the figures from 1993 onwards:

There was a standing general instruction from Pirelli headquarters in Milan that Pirelli UK should pay dividends equal to its current year profits, subject to consideration of the tax consequences. The underlying policy reason for this directive was to enable Pirelli SpA, which is quoted on the Milan stock exchange, to pay dividends to its shareholders. The UK group therefore resumed the regular payment of dividends once the return to profitability had been established. In broad terms, this had two consequences so far as ACT was concerned. First, payment of the dividends would itself generate further payments of ACT. Secondly, however, the group now had profits which generated MCT, and if the profits were sufficient the MCT could be used to absorb not only the ACT on the current dividends but also surplus ACT which had been carried forward. The ACT table which I have set out above shows that the amount of surplus ACT carried forward at the year end fell sharply to £1.1 million at 31 December 1996, and remained at around that level for the following two years, before rising again to £5.3 million at the end of 1999. The natural conclusion to draw from this is that the substantial group profits recorded from 1994 to 1998 were sufficient, when MCT came to be paid, not only to frank the ACT on the current dividends, but also to reduce the carried forward surplus to a manageable level. By contrast, the group experienced a sudden downturn in profits in 1999 (dropping to £8 million from £36 million in the previous year), and this is reflected in the figure for carried forward ACT which returned to approximately the same level as at the end of 1995.

Mr Stone first joined the group in 1995. As part of his job, he had to prepare six monthly reports for the Board of Pirelli UK on tax issues, usually in March and September. Because of the importance of the surplus ACT issue, Mr Stone would normally prepare ACT utilisation forecasts in each of his two annual reports, and would compare the forecasts with the ACT actually utilised. In making these forecasts, he had to take into account a number of variables, many of which were very difficult to predict. For example, he had to forecast the profits of each company in the UK group for the current year, in order to estimate the tax payable and hence the ACT utilisation capacity. These forecasts would involve taking a view on matters such as fluctuations in exchange rates, interest rates, delays in major contracts, and the prices of raw materials. For the purposes of the March forecast, use was made of the management plans prepared by the individual companies towards the end of the previous year. However, these management plans represented a target, deliberately set at a high level, against which the performance of the subsidiaries was measured. By the time of the September meeting, the position would usually be clearer, because two thirds of the current year would by then have elapsed.

A further particular cause of uncertainty mentioned by Mr Stone is the amount of double tax relief. Pirelli General had a number of overseas branches, and the income generated by those branches was potentially subject to full double tax relief which, if claimed, would have the effect of reducing the group’s taxable profits and therefore its MCT and its ACT capacity. However, the amount of the relevant branch profits, and of the corresponding tax relief, would not be known at the time when Mr Stone was making his ACT forecasts, and might not be finally resolved for some years. While this element of uncertainty was undoubtedly present, the amounts of double tax relief claimed in the years in issue were relatively insignificant, ranging from a low of £139,000 in 1995 to a high of £900,000 in 1997.

As a matter of form, the question whether or not to declare interim and final dividends, and in what amount, was a matter for the board of Pirelli UK to decide. Nowhere in his written evidence did Mr Stone suggest that this was not what in fact occurred. In cross-examination, however, he said that the real decisions were in practice taken in Milan, following discussions with the finance directors of the operating companies. The decisions on dividends would already have been made, at least informally, before the board meetings of Pirelli UK, which he agreed were in effect “just rubber stamping decisions that had already been taken”. The board of Pirelli UK had no more than three or four members, only one of whom, according to Mr Stone, might conceivably have been involved in the real decisions taken in Milan. Mr Stone was not himself a member of the board, although he normally attended the board meetings and presented his tax report. Since the real decisions had already been taken elsewhere, it follows, as he accepted, that his tax reports were not a tool for decision-making, but rather provided information on current tax issues affecting the group. In answer to the question whether the board required his report in order to be able to justify their rubber stamping exercise, Mr Stone replied “No, I don’t think they did, no”.

I now come to the sequence of dividends paid by Pirelli UK, beginning with the final dividend for the year ending 31 December 1994, paid on 5 May 1995. The amount of the dividend was £8.1 million, and as the rate of ACT was at all material times 25% it generated ACT of £2.025 million. In his taxation report for the board meeting of Pirelli UK held on 21 March 1995, Mr Stone said that the ACT on a dividend of this amount would be payable on 14 July 1995, and on the basis of profit forecasts “this ACT should be recoverable against the 1995 corporation tax liability”. At the board meeting on 21 March the 1994 annual report and accounts of Pirelli UK were signed off by the directors. The accounts showed a profit on ordinary activities before tax of £15.677 million. Evidently nothing had happened between 31 December 1994 and the board meeting on 21 March to cause Mr Stone to doubt that substantial profits would also be made in 1995, because his forecast was that the ACT should be recoverable against the 1995 MCT liability. Since, as he accepted, the group set off ACT against MCT on a “first in, first out” basis, it seems that when he made this forecast Mr Stone must have envisaged that all of the group’s surplus ACT would also have been absorbed by MCT on the group’s profits for 1994 and 1995. In fact the forecast turned out to be a little over-optimistic, but the ACT on the dividend was still absorbed in full by 1 October 1997, the date when MCT on the profits for 1996 was payable. Furthermore, the set off which was effected on 1 October 1997 was a set off in cash terms. For accounting purposes, the set off was against the liability to MCT generated by the 1996 profits.

The decision to pay the dividend was one which had already been taken in Milan. The board meeting on 21 March rubber-stamped that decision. Had the option to make a GIE been available, I have little doubt that it would not have been exercised. On the basis of Mr Stone’s forecasts, the ACT would be set off against MCT on the current year’s profits. The recession was over, and the group was again trading profitably, with no reason to suppose that this would not continue. In those circumstances, the funding cost of the ACT until its expected recovery was relatively trivial when compared with the available net tax credit of £556,875. I therefore find on the balance of probabilities that no election would have been made.

The position was essentially similar, and I reach the same conclusion, in relation to the dividends which were then paid in October 1995, May and October 1996, May 1997 and May 1998. Mr Glick went through the dividends in turn with Mr Stone, but it is unnecessary for me to repeat the exercise. Group profits remained at a healthy level of more than £30 million per year, and all of the ACT on the dividends was set off against MCT within one or two years. The obvious decision in each case would have been to pay the ACT and take the benefit of the tax credit. Indeed, when Mr Aaronson came to make his submissions he virtually conceded that, if I found no election would have been made in 1995, the same result would follow for 1996, 1997 and 1998.

I can move on, therefore, to the October 1998 and March 1999 dividends which generated the ACT that still remains surplus. By the time the October 1998 dividend was paid Mr Stone was aware that ACT would be abolished for dividends paid after 5 April 1999, and that with the abolition of ACT the tax credit available to a UK resident individual shareholder would be reduced from 25% to one ninth of the dividend. It followed from this that the net tax credit payable to the Dutch and Italian parent companies under the relevant DTCs would be virtually eliminated. In percentage terms, the net credit would reduce from 6.875% of the dividend to only 0.278%. Furthermore, although ACT would be abolished for dividends paid after 5 April 1999, there would be no acceleration of the opportunity to set surplus ACT against future MCT, because a system of “shadow ACT” was introduced which would in broad terms replicate the existing system for the purpose of calculating when carried forward ACT could be set off under the new regime. With these considerations in mind, it would have been obvious that the opportunity to receive substantial tax credits on dividends paid by Pirelli UK was soon going to be lost, and that the system for set off of ACT against MCT after 5 April 1999 would in practical terms remain much the same as before. There would therefore have been every incentive to pay the largest dividends possible before 5 April 1999, and not to make a GIE, provided only that the UK group’s profits could be expected to remain at roughly the same level as they had been for the past three years.

The October 1998 dividends totalled £10.1 million and generated ACT of £2.525 million. Mr Stone’s report for the September board meeting said that the group’s pre-tax profit for 1998 was forecast to be nearly £42 million, in which case all surplus ACT would have been utilised by the end of the year and there would in fact be unused capacity of £295,000. Against that optimistic background, and with no clouds about the future profitability of the group on the horizon, I can see no reason to doubt that these dividends too would have been paid without an election. It is true that Mr Stone’s utilisation forecast did not take into account any ACT that would be payable in respect of the final dividend for 1998, assuming that such a dividend was paid before 5 April 1999; but any uncertainty on that score would not have provided a good reason for making an election in October. After all, if it turned out that the ACT on the final dividend was likely to cause problems, an election could always be made when it came to be paid; or alternatively, if it was paid at the usual time, in May 1999, ACT would by then in any case have been abolished.

In the event, payment of the final dividend for 1998 was accelerated, and on 31 March 1999 dividends totalling £17.35 million were paid, thereby generating ACT of £4.337 million. The fact that the final dividend was brought forward in this way, so that it could be paid before the 5 April deadline, is in itself a powerful indication that the group wished to receive the tax credits, and was confident that the benefit of receiving them would outweigh the likely funding cost of the ACT under the shadow ACT system. This impression is confirmed by the report which Mr Stone prepared for the Pirelli UK board meeting on 19 March 1999. Under the heading “Shadow ACT” he briefly described how the new system would operate, and said it was expected “that Pirelli will recover all of its surplus ACT in accounting years 1999 and 2000”. Figures in an appendix showed that the expected amount of surplus ACT as at 31 December 1999 was only £207,000. Mr Stone’s forecast therefore was that nearly all of the surplus ACT, including the ACT attributable to the accelerated final dividend, would be absorbed by the group’s ACT capacity for 1999, with only a trivial amount left to be absorbed in 2000.

In fact, as we now know, the ACT attributable to the final dividend was not absorbed and it has remained surplus. However, the reason for this lies in the sudden downturn in profits in 1999: see paragraph 107 above. Mr Stone himself knew nothing about this until the end of June 1999. As he explains in paragraph 65 of his main witness statement:

“The March 1999 report forecast ACT utilisation of £6.8 million. However, by September, this had changed dramatically to a forecast ACT utilisation of about £2.2 million. The profitability of the group started to fall sharply in the spring of 1999. In particular, the Cable business was affected by the high value of sterling and downward pressure on prices. The Cable business also incurred substantial restructuring costs of £3.5 million and during the period went from a significant profit making position (£30.6 million in 1998) to a loss before tax of £2.4 million … It therefore became quickly apparent that there would be nowhere near the ACT capacity that we had initially predicted. In fact such was the concern with the surplus ACT position that in June 1999 an email was sent to both UK and Italian management recommending a reduction in the interim dividend to be paid in October … In the event, the group profits for the year before taxation were just £8 million compared with £36.7 million in the previous period … and the ACT utilised was just £1.8 million.”

Mr Stone sought to suggest that alarm bells must have started to ring within the group over the level of its ACT capacity for 1999 before the board meeting on 21 March, even though he accepted that he personally knew nothing about it and the same was probably true of the board members themselves. He confirmed that he attended the March meeting, and that none of the directors raised any point about the projected profitability figures in his report. This evidence is not necessarily conclusive, given that the real decision to declare the dividend must already have been taken elsewhere. However, it seems to me inconceivable that those who took the real decision would have allowed it to proceed and be implemented if they knew about the impending downturn in profits. After all, the whole purpose of bringing forward the date of payment of the final dividend must have been to ensure that tax credits would still be received, so if anything happened to upset the normal calculation about the funding cost of the ACT one would expect those concerned to have taken immediate steps to review the position. There is no indication that anything of this sort occurred, from which I infer that nobody in the group who was involved in the actual decision to declare and pay the final dividend knew about the downturn in profitability until it was too late to reverse the decision. That being so, there could have been no possible reason to pay the dividend under an election, had it been possible to do so, and I find that no election would have been made.

My conclusion on the causation issue is, accordingly, that none of the disputed dividends would have been paid under a GIE. It follows that the ACT levied on the dividends was entirely lawful and this part of Pirelli’s claim must be dismissed.

I should add, for completeness, that the trial bundle also included evidence filed on behalf of the Huhtamaki and Volvo test claimants. However, none of this was deployed at the hearing, because the parties sensibly agreed that Mr Stone’s evidence could be used to test all the points which the Revenue wished to raise. It is therefore unnecessary for me to make any further findings of fact.