Test Claimants In the Franked Investment Income Group Litigation v Inland Revenue & Anor

On 2 October 2013 I heard argument for half a day on an application by the defendants (“HMRC”) to make certain re-amendments to their defence to which the claimants have not consented.

The immediate procedural background to the application is briefly as follows. At a case management conference held on 14 May 2013, I gave directions intended to lead to the determination of all remaining issues of liability and quantification in the FII Group Litigation (apart from a few issues on which applications for permission to appeal to the Supreme Court remain outstanding) in a four week trial which has subsequently been fixed to begin on 29 April 2014.

In relation to the pleadings, I set a timetable for sequential amendments to the statements of case in their then current form, with an opportunity for each side to consent to the amendments proposed by the other, coupled with a direction that permission should be sought for any amendments to which consent was not forthcoming.

I also gave directions providing that:

The parties have substantially adhered to this timetable, and I was informed at the hearing on 2 October that worked examples had been duly exchanged, the claimants had served a detailed schedule of quantum together with an extensive explanatory narrative explaining their methodology, and work was well advanced on the agreement of a list of issues. The amendments to the particulars of claim proposed by the claimants were either agreed by HMRC or withdrawn in the light of HMRC’s objections, with the result that the claimants’ case is now set out in the thirteenth amended particulars of claim dated 14 May 2013 (“the particulars of claim”). HMRC’s proposed amendments to their existing amended defence dated 21 December 2007 (“the defence”) were served on 24 June 2013. In a letter dated 26 June 2013, the claimants’ solicitors, Hage Aaronson Limited (now Joseph Hage Aaronson LLP), consented to certain of the amendments, but objected to others. It proved impossible to reach agreement on the disputed amendments, so on 10 July HMRC issued the application for permission to make them which is now before me.

The main objections to the proposed amendments fell under two broad headings. First, it was said that some of the amendments involved the withdrawal of previous admissions, which could not be done without the consent of the court: see CPR Rule 14.1(5) and PD 14 paragraphs 7.1 and 7.2. Secondly, other amendments were alleged to be an abuse of process, because they sought to reopen matters which had already been conclusively determined against HMRC. In their application notice, HMRC set out their general position on these points as follows:

I will not attempt in this judgment to set out the broader background to the FII Group Litigation. It is of enormous complexity, and has already been described in a number of judgments. In the unlikely event that this judgment is read by anybody not already familiar with the litigation, a good starting point would be the judgment of Lord Hope in FII (Supreme Court) [2012] UKSC 19, [2012] 2 AC 337, especially at paragraphs [1] to [8]. A brief summary of some of the main points decided by the Supreme Court, and of developments since that date, including the third reference to the ECJ, may be found in the judgment which I handed down on 24 October 2013 in The Prudential Assurance Co Ltd and another v HMRC [2013] EWHC 3249 (Ch) (“Portfolio Dividends (No. 2)”) at paragraphs [7] and [34] to [37]. In referring to earlier judgments, both domestic and European, I will use the same nomenclature as I did in that judgment.

I heard submissions on 2 October from Mr Ewart QC on behalf of HMRC, and from Mr Aaronson QC and Mr Beazley QC on behalf of the claimants. The claimants produced a helpful document setting out the disputed amendments in the form of a spreadsheet or schedule with four columns, the first showing the relevant allegations in the particulars of claim, the second showing the relevant paragraphs of the defence with the text that HMRC now wish to delete printed in red, the third showing the proposed draft re-amendments, with new material in blue ink, and the fourth containing comments by the claimants. Both sides argued the case by reference to this document, which ran to six double pages. I will refer to it as “the claimants’ schedule”.

CPR Rule 14.1(5) provides that:

In Kojima v HSBC Bank Plc [2011] EWHC 611 (Ch), [2011] 3 All ER 359, Briggs J (as he then was) said at [19] that paragraph 7.2 of PD 14 “contains a useful and uncontentious distillation of earlier authority as to the discretion to permit withdrawal of admissions”.

The only other point to note is that the admissions in question in the present case are all admissions of law. It must be remembered in this context that parties are not obliged to plead points of law on which their case is based: see PD 16 paragraph 13.3, which says in permissive language that

The first group of disputed amendments concerns the alleged unlawfulness of the UK taxation regime relating to advance corporation tax (“ACT”) between 1973 and its abolition in 1999. The respects in which the ACT provisions were said to infringe the freedoms of establishment and movement of capital under the EU Treaty (“the Treaty Provisions”) were pleaded by the claimants in paragraph 11A of the particulars of claim, leading to the following allegations of unlawfulness and breach:

HMRC’s proposed amended response to those paragraphs, all of which is new, reads as follows:

Of those proposed re-amendments, only paragraph 14 is in issue. The claimants have consented to the new paragraphs 11, 12 and 13. The new paragraph 12 is important, because it sets out (at least in part) HMRC’s case about the extent of the illegality under EU law of the ACT provisions, in terms which directly track paragraph 72 of the judgment of the ECJ in FII (ECJ) II:

It should be noted that in that paragraph the ECJ dealt only with nominal rates of tax. Earlier in its judgment, however, when dealing with the lawfulness of the charge to corporation tax under Case V of Schedule D, the Court had cited established authority to the effect that a member state could only validly adopt a dual exemption/imputation system for domestic and foreign dividends if it granted a tax credit at least equal to the amount paid in the state of the company making the distribution, up to the limit of the tax charged in the home state of the recipient: see in particular paragraph 39, referring inter alia to FII (ECJ) I at paragraphs 48 and 57.

That part of the ECJ’s reasoning appears to be reflected in a further admission contained in paragraph 10 of the re-amended defence, pleading to paragraph 11A of the particulars of claim, as follows:

Mr Ewart accepted in the course of argument that the words which I have italicised in the above quotation should be added to paragraph 10(a), to allow for part of the decision of the ECJ on the “corporate tree” issues. Even with that addition, however, the paragraph does not make any admission in relation to foreign corporation tax paid by companies further down the corporate “roots” than the waterside company which paid the dividend, although that issue too was conclusively determined against HMRC in FII (ECJ) II.

Before coming to the admissions which HMRC now wish to withdraw, there are a number of matters to deal with concerning the case now pleaded by HMRC in paragraphs 10 to 14 of the draft re-amended defence.

The first point is the one I have just mentioned, namely the fact that the admission in paragraph 10(a) does not extend to corporation tax paid further down the corporate “roots”. I appreciate that this omission may be readily explicable on the basis that paragraph 11A(a) of the particulars of claim refers only to cases “where tax was paid in the other State on the profits from which the dividend was paid (or those profits were subject to tax in that jurisdiction)”. Nevertheless, since the point has been conclusively determined against HMRC by the ECJ, I think it is desirable that the admission should be expanded so as to provide an accurate reflection of the decision of the ECJ on the corporate tree issues on both sides of the water’s edge. It should be possible to achieve this by the addition of a few words similar to those proposed by Mr Ewart to cater for the position on the UK side of the water.

Secondly, and more importantly, paragraph 12 is open to the objection that it may set out only part of HMRC’s case about the unlawfulness of the ACT provisions. In my judgment it leaves the claimants and the court in real doubt:

In relation to point (a), it is wholly unclear to me how HMRC say that paragraphs 10(a) and 12 are to be reconciled. Is it now their case (as I held in Portfolio Dividends (No. 2)) that the requirement to grant a credit by reference to nominal rates of tax is additional to the requirement to grant a credit for underlying tax actually paid in the source state? Or is it their case that the first of these requirements has somehow displaced the second? As to point (b), I do not understand HMRC to dispute that, as a matter of English law, a credit must be allowed for the foreign withholding tax. Furthermore, the ECJ has held that the grant of such a credit is not a requirement of EU law: see Portfolio Dividends (No. 2) at paragraph [54]. It seems likely, therefore, that there will be no issue between the parties about those principles, and the question of withholding tax in relation to non-portfolio dividends is in any event relevant only to years before 1990 when the Parent-Subsidiary Directive came into force.

Nevertheless, it is in my view desirable that HMRC’s position in relation to withholding tax should be clarified and positively pleaded. In a case of this magnitude and complexity, it is more important than ever that the scope for possible misunderstandings should be minimised and that the issues should be defined by the pleadings as precisely as possible. It is true, as I have observed, that there is no positive obligation on a party to plead contentions of law. In a case of the present type, however, where the law is complex, evolving and largely derived from decisions of the ECJ, I think it will greatly assist the preparation for next year’s trial if the parties’ cases on the relevant law are fully pleaded. In particular, where (as with HMRC’s existing paragraph 12) contentions of law may be only half-pleaded, the scope for confusion and misunderstanding is obvious.

Nor is it a satisfactory answer, in my judgment, to say that the real areas of disagreement between the parties will be made apparent by the worked examples. It is certainly true that worked examples are an invaluable aid to exposition, and can often flush out issues which would otherwise have remained undetected. But the general principle still holds good that the issues between the parties should, as far as possible, be both defined and confined by the pleadings. The problem with paragraph 12 in its present form is that it only partially explains HMRC’s case on the critical issue of the unlawfulness of the ACT provisions, at a time when there is a pressing need for them to articulate their case with complete clarity.

Thirdly, the points which I have just made apply with equal force to paragraph 14. In my view it is essential for HMRC to clarify precisely to what extent, and in what way, they admit that the ACT provisions were contrary to the Treaty Provisions.

The final point is a relatively minor one. It concerns paragraph 10(b), which as it stands contains a non-admission of paragraph 11A of the particulars of claim, subject to the admission contained in paragraph 10(a). Under the CPR, a defendant is required to plead any positive case on which he relies, and a non-admission should in general be reserved only for matters of which he has no knowledge, explaining (where it is not obvious) why that is the case and requiring the claimant to prove the allegation: see generally CPR Rule 16.5 and PD 16 paragraph 10. Mr Ewart did not dispute the validity of these propositions, and made it clear that the non-admission in paragraph 10(b) was in truth directed only at the allegations in paragraph 11A(b) of the particulars of claim to the effect that UK holding companies were obliged to bear ACT “as, effectively, an absolute and permanent cost” where the profits of the group were largely earned by foreign subsidiaries and those profits were distributed to the UK parent. In my view it would not be objectionable if the non-admission were confined to that aspect of paragraph 11A(b), because HMRC cannot reasonably be expected either to admit or to deny that, in the general circumstances posited, the ACT had in practice to be borne by the UK holding company as an absolute and permanent cost. As it stands, however, the non-admission is much too wide, and is on any view inappropriate as a substitute for a full pleading of HMRC’s case on the unlawfulness of the ACT provisions.

I now turn to the admissions which HMRC seek permission to withdraw. The first, contained in paragraph 11(c) of the defence, reads as follows:

The other admissions which HMRC seek to delete are contained in paragraph 13 of the defence, as follows:

It can be seen that the admission in paragraph 13(a) appears to follow on from the admission in paragraph 10(a), and to reflect the clear case law of the ECJ before FII (ECJ) II. In my judgment its proposed deletion reinforces the concerns which I have already expressed about the precise nature of the case now advanced by HMRC in relation to the unlawfulness of the ACT provisions, and HMRC should only be permitted to withdraw the admission if and when their new case, including any fallback contentions, has been fully pleaded. Furthermore, it seems to me at the moment that the existing admission, suitably amended to allow for the determination of the corporate tree issues and the point that deduction of withholding tax is a requirement of UK rather than EU law, should in substance be retained as part of HMRC’s alternative case, assuming that their primary contention will be that the only credit required by EU law is one based on nominal rates of tax. I am therefore not prepared at this stage to give permission for the admission in paragraph 13(a) to be withdrawn; and, because of its consequential nature, the same applies to the admission in sub-paragraph (d). The question will have to be revisited when HMRC have properly and fully formulated their positive case.

Substantially similar issues arise in relation to HMRC’s case on the foreign income dividend (“FID”) regime, where HMRC seek permission to withdraw an admission that ACT levied in connection with FIDs was unlawful, in terms materially identical to the admission in paragraph 13(a) discussed above, and to replace it with an admission “that some ACT levied in connection with FIDs was unlawful and unduly levied”. The details are set out on page 4 of the claimants’ schedule. For the reasons which I have already given, I consider that the proposed new admission is both vague and embarrassing, because it leaves the claimants and the court in the dark about the precise nature of HMRC’s case. As before, I consider it essential that HMRC should spell out their case, including any fallback contentions, with clarity and precision. They should not be permitted to withdraw their existing admission unless and until they have done so.

The second group of disputed amendments concerns alleged attempts by HMRC to re-litigate issues which have already been conclusively determined against them.

This question was considered by the ECJ in FII (ECJ) I and remitted to the national court for determination in the light of the guidance given by the Court. I dealt with it in FII (High Court) at paragraphs [180] to [191], concluding as follows:

My conclusion on this point was appealed by HMRC to the Court of Appeal. The parties agreed a list of the issues on the appeal. Issues 9 and 10 were worded as follows:

By paragraph 7 of its order of 19 March 2010, the Court ordered that:

In the particulars of claim, it is alleged: in paragraph 12E, that the FID regime introduced a new regime for the taxation of foreign sourced dividends with effect from 1 July 1994; in paragraph 12F, that this new regime entailed new restrictions on the free movement of capital in the form of (i) the requirement to pay ACT and then claim it back, and (ii) the refusal of a repayable tax credit to exempt shareholders receiving dividends, and that these restrictions did not fall within the scope of Article 57(1) EC; and in paragraph 12G, that in the premises, where foreign profits were distributed as FIDs, HMRC were prohibited by EC law from levying ACT and required by EC law to grant a tax credit. In the defence, which of course predated the decisions in FII (High Court) and FII (CA), these allegations were denied, and it was averred that the FID regime fell within the standstill provision in Article 57(1).

HMRC’s proposed re-amendments on this point are in substance mainly new, and read as follows:

In their skeleton argument, counsel for HMRC argue that these proposed amendments are merely consequential on the decision of the Court of Appeal that the introduction of the FID regime gave rise to a new restriction for the purposes of Article 57(1). They accept that it is not open to HMRC, in the light of the Court of Appeal’s judgment, to contend that the absence of a tax credit for the shareholder did not amount to a new restriction. They contend, however, that HMRC are entitled to maintain their position that the requirement for the company to pay ACT and then claim it back did not amount to a new restriction.

I agree with the claimants that it is not open to HMRC to adopt this position. The issue which has been conclusively determined against them is not merely the question whether the absence of a tax credit amounted to a new restriction, but the issue whether HMRC are entitled to rely on the standstill provision at all. The Court of Appeal, affirming my decision, has held that they are not. This gives rise to an issue estoppel between the parties, which precludes HMRC from attempting to argue the contrary in either the same or subsequent proceedings between the same parties. Furthermore, I do not accept that the reasoning of the Court of Appeal was confined to the question of the absence of a tax credit. It seems clear to me that they considered the FID regime as a whole, and concluded that it could not benefit from the standstill provision. Accordingly, paragraph 16 of the order of the Court, based on paragraph 1 of my order with immaterial variations, read as follows:

I should add, for completeness, that there is an exception to issue estoppel in special circumstances where its application would work injustice: see Arnold v NatWest Bank Plc [1991] 2 AC 93 at 109A-C per Lord Keith of Kinkel, with whose speech the other members of the House agreed. There is, however, no suggestion in the proposed re-amendments that HMRC might even arguably be able to rely on this exception, which as formulated applies only where:

In the circumstances, I consider that the proposed re-amendments to paragraph 19 of the defence must be disallowed, because the contentions advanced have no reasonable prospect of success. The options available to HMRC, as it seems to me, are either to leave their existing defence on this point un-amended, in which case it will be rejected at trial because the point has already been conclusively determined against them, or (in my view preferably) simply to admit paragraphs 12E to 12G of the particulars of claim.

Paragraph 18C of the particulars of claim reads as follows:

In FII (Supreme Court), the Supreme Court has now unanimously held that section 107 cannot be relied on by HMRC as a defence to claims founded on EU law, because it breaches the EU law principle of protection of legitimate expectations. This conclusion is, of course, binding on the parties as a matter of law, and it is not open to HMRC to question it in the present proceedings. HMRC clearly recognise this fact of forensic life, because their proposed re-amendments include the deletion of paragraphs 69 to 74 of the defence containing arguments which the Supreme Court has now rejected. Nevertheless, paragraph 66 of the proposed re-amended defence still reads:

In my view HMRC are technically entitled to maintain their denial, although it is obvious that they are bound by the decision of the Supreme Court on the issue and it will not be open to them to contend the contrary at trial. It would, however, be preferable in my judgment if they were to bow to the inevitable and admit paragraph 18C of the particulars of claim, coupled if necessary with a qualification to the effect that the interpretation and application of the Supreme Court’s decision on the issue are matters for legal argument.

There is one further disputed amendment which I have not yet mentioned. It concerns the claims for restitution of surplus ACT, or the time value of utilised ACT, on the ground of mistake of law, as pleaded in paragraph 15C of the particulars of claim. In the defence, these claims are denied, but in the alternative it is said that any such restitution should be confined to:

It can be seen that this proposed amendment raises essentially the same issues as those which I have already discussed in relation to unlawful ACT. In my view the proposed wording is acceptable, but only on the understanding that HMRC’s detailed case on the unlawfulness of the ACT provisions will have been fully set out earlier in the re-amended defence.

The claimants sought to buttress their case by reference to the strict approach which the court adopts to late amendments. I was referred to well-known authorities such as Swain-Mason v Mills & Reeve [2011] EWCA Civ 14, [2011] 1 WLR 2735 (CA). I do not find those principles of assistance in the present context. HMRC’s proposed amendments were formulated pursuant to a timetable laid down at the CMC in May of this year, and the trial is not due to begin until the end of April 2014. Although the proceedings have a very long history, that is due to their great legal complexity and the need to make no fewer than three references to the ECJ. I also accept that the decision of the ECJ on the second reference, which was delivered on 13 November 2012, will have required very careful analysis and consideration by HMRC’s legal team. I consider that HMRC acted with reasonable expedition in all the circumstances by submitting their proposed re-amendments on 24 June 2013, and they cannot be blamed for the fact that it proved impossible to arrange the present hearing before the Long Vacation.

It is, however, now necessary for HMRC to produce a revised draft of their re-amended defence as a matter of considerable urgency, if the orderly preparation of this case for trial is to proceed smoothly. I will hear submissions on the appropriate period to allow for this purpose when I hand down this judgment, but my provisional inclination is to allow no more than a further 21 days.