The Prudential Assurance Company Ltd v HM Revenue and Customs

The purpose of this judgment is to resolve some outstanding questions of principle which have emerged in the working out of the order dated 28 January 2014 (“the January 2014 Order”) which I made after hearing argument on consequential matters on that date, following the handing down of my judgment in the present case (“the Main Judgment”) on 24 October 2013 after the resumed trial of the action over five days from 15 to 19 July 2013: see Prudential Assurance Co Ltd and Another v HMRC [2013] EWHC 3249 (Ch), [2014] STC 1236.

The present judgment should be read as a sequel to the Main Judgment. I will therefore give no further explanation of the complex subject matter of the case, apart from saying that it concerns issues of liability and quantification arising from the alleged or established invalidity under EU law of various aspects of the UK legislation which governed the taxation of “portfolio dividends” (i.e. dividends derived from holdings of less than 10% of the shares in the companies concerned) paid by companies resident either in the EU, or elsewhere in the world (“third countries”), to corporate shareholders resident in the UK. The issues all arise in the context of the CFC and Dividend Group Litigation. The test claimant is a company in the Prudential Insurance group. The periods in dispute run from 1990 to 2009.

In general, I will use the same definitions and abbreviations in this judgment as I did in the Main Judgment. For the reasons given in the Main Judgment at [2], I there referred to my earlier judgment in the present claims in 2010 as Portfolio Dividends (No.1). For consistency, I have elsewhere referred to the Main Judgment as Portfolio Dividends (No. 2): see, in particular, Littlewoods Retail Ltd and Others v HMRC [2014] EWHC 868 (Ch), [2014] STC 1761, and Test Claimants in the FII Group Litigation v HMRC [2014] EWHC 4302 (Ch), as yet unreported, (“FII (High Court) II”) in which I handed down judgment on 18 December 2014. Adopting the same nomenclature, the present judgment will therefore be Portfolio Dividends (No. 3).

In paragraph 7 of the January 2014 Order, I gave directions for the calculation of the quantum and payment of the successful test claim. Pursuant to those directions, the claimant (“Prudential”) provided its calculations quantifying the claim on 21 February 2014, together with an Explanatory Note explaining the methodology employed. HMRC then made requests for further information and documentation on 21 March 2014, to which Prudential responded on 4 April 2014, enclosing updated calculations. HMRC then provided their calculations on quantification on 2 May 2014, including a document entitled “Skeleton of Recalculation Methodology” which summarised their approach. Thereafter, the parties continued to discuss the issues both in correspondence and at a meeting held on 8 September 2014. A large measure of agreement was reached in relation to the underlying facts and identification of the outstanding issues, and a draft List of Issues was prepared.

Until shortly before the hearing before me, which took place over two days on 20 and 21 October 2014, the issues still potentially in contention were reflected in sets of rival computations filed by Prudential on 6 October 2014 and by HMRC on 26 September 2014 respectively. The areas of dispute appeared to relate to the following questions of principle:

In the light of HMRC’s skeleton argument for the hearing, it was apparent that HMRC had decided to concede at least one of the issues (namely (b) above), and that there might also be no real disagreement in relation to issue (a). Further clarification and agreement was then reached on several other points during the hearing itself, with the result that the number of questions which I now have to resolve has been substantially reduced. I asked the parties to prepare an updated List of Issues accordingly, which was provided to me on 3 November 2014. I will use that document (“the List of Issues”) as the basis for my judgment, and where the parties have been able to agree how a question should be answered, I will record what the agreed answer is.

Prudential was represented at the hearing by junior counsel alone, Mr Jonathan Bremner, who performed his task with conspicuous ability. HMRC were represented by Mr David Ewart QC and Ms Barbara Belgrano. I am grateful to all counsel, and to those instructing them, for the assistance which I was given.

Paragraph 4 of the January 2014 Order states that:

It is now common ground that the answer to this question is Yes. In the Main Judgment, I decided that all of the successful restitution claims for unlawfully levied MCT and ACT carry compound interest as part of the restitution to which the claimant is entitled: see [194] to [247]. This entitlement is one of substantive law, and is unaffected by the procedural question whether the accounting period in which the unlawful tax was paid happens to remain open. The relevance of the latter question goes to a different point, namely whether the High Court should give immediate judgment for the restitution claimed (including the compound interest), or whether equivalent relief should be granted in due course (in respect of the open periods) when the relevant proceedings before the Tax Chamber of the First-tier Tribunal are determined. In other words, the question in relation to the open periods is not whether Prudential is entitled to compound interest as part of its successful restitutionary claims, but rather when, and by which court or tribunal, that entitlement should be translated into an order for payment of the relevant amounts.

Until the hearing, Prudential and its advisers appear to have been under the misapprehension that HMRC were in some way seeking to reopen the substantive question of liability to compound interest in respect of the open periods. I can understand how this impression might have been gained from HMRC’s skeleton argument, which did not state as explicitly as it might have done that no challenge was made (otherwise than by appeal) to my conclusion that all of the restitutionary claims carried compound interest. The misunderstanding was, however, cleared up at an early stage of the hearing, as a result of which it became common ground (as I have already said) that Issue 1 must be answered in the affirmative.

The agreed formulation of this Issue reads as follows:

This is the question which HMRC expressly conceded in their skeleton argument. It is now agreed that the answer to it is that such a claim “is a claim in restitution for the repayment of unlawfully levied tax in the form of ACT”. As such, it is a claim which can only be pursued as a restitution claim in the High Court.

The only live question under this heading is Issue 3(a), which asks whether the claimants are able to prove from the evidence before the court at trial the foreign nominal rates of tax (“FNRs”) applicable during these four accounting periods. Three further questions under Issue 3 were not pursued by Mr Ewart in his oral submissions, and it is now agreed that they do not need to be answered.

In [108] to [111] of the Main Judgment I dealt with the element of the tax credit required by EU law which represents the relevant FNR. I briefly described the work performed by Prudential for this purpose, as set out in the second witness statement of Nicola Hine, who was then a trainee solicitor at Dorsey & Whitney (Europe) LLP, and in the tables appended to her statement. Subject to a few exceptions relating to periods later than those with which I am now concerned, I stated in [109] my understanding that “a nominal rate was … ascertained by her for each relevant country for each relevant year”. Ms Hine was not required to attend for cross-examination, and nobody suggested, either during the trial or after my judgment had been circulated in draft, that my understanding was incorrect.

In [111] I said this:

These conclusions were reflected in the January 2014 Order, where declarations 1(E) and (F) read as follows:

The point now taken by HMRC is that the table contained in exhibit 16 to Ms Hine’s second statement runs chronologically from 1994 to 2007. It contains no entries for 1990 to 1993. In addition, the description of her methodology given by Ms Hine in the body of her statement focuses on the years from 1994 onwards. Presumably by an oversight, or possibly because the earlier years were not then thought to be in issue, she did not deal explicitly with the position in the four previous years. Thus, it is argued, the claimants have failed to provide any evidential basis upon which the relevant FNRs for the years 1990 to 1993 can be ascertained, and the restitutionary claims for those years must therefore be dismissed.

The point could hardly be less meritorious, given that the only relevant rates for those years are the headline rates of corporation tax in force in Member States of the EU. The claims relating to dividends from third countries all relate to 1994 and subsequent years. The relevant rates should therefore be easily ascertainable, and even if they were not formally put in evidence it is hard to imagine that the parties would have any difficulty in agreeing them. If it were necessary to do so, and since the point appears to have been overlooked by all concerned at the trial, I would be inclined to give a direction to that effect, rather than allow the Revenue’s objection to prevail.

In fact, however, there is a much simpler solution to hand. The material exhibited to Ms Hine’s statement includes a table of historic statutory corporation tax rates for a number of countries from 1985 to 2007, including all of the Member States of the EU between 1990 and 1993. Ms Hine described this material as follows, in paragraph 8 of her statement:

The academic credentials of the two authors appear to be unimpeachable, and the table reproduced by Ms Hine provides the necessary information for the years 1990 to 1993. I am therefore satisfied that the evidence already before the court provides an adequate foundation for the claims in respect of those years, even though those years are not included in the main table prepared by Ms Hine. Declaration 1(F) in the January 2014 Order should therefore be read as extending to the rates for 1990 to 1993 derived from the table contained in exhibit “NJH 19”, as well as to the rates set out in exhibit “NJH 16”.

This Issue raises a relatively small point of principle, the answer to which is now agreed. It concerns the question of how the creditable amount of foreign tax should be computed, in the relatively rare cases where the FNR is below the ACT rate (with the consequence that the credit required by section 231 of ICTA 1988, construed conformably with EU law, is limited to the foreign tax).

Issue 4 asks:

Although “tracing” is a convenient shorthand description, this Issue does not concern tracing in any recognised legal or equitable sense of the term. The question is, rather, akin to that raised by the methodology relied upon by HMRC in FII (High Court) II for linking ACT paid by UK companies with EU-source income so as to give effect to the judgments in FII (ECJ) I and FII (ECJ) II. I described this methodology, and gave my reasons for rejecting it in the context of the FII group litigation, in FII (High Court) II at [164] to [171], which need to be read together with [116] to [121] and [141] to [155].

Issue 5 poses the following questions:

The short answer to these questions, in my opinion, is that HMRC are not entitled to raise this contention, because it is inconsistent with the rulings on the nature and quantification of the section 231 credit required by EU law which I have already given in the Main Judgment.

The thinking behind the contention is that an actual charge to ACT arises only when a distribution is made by a UK-resident company, with the consequence (so it is said) that it is necessary to examine the distribution in order to identify how much of it is represented by the EU income which generated the relevant credit. It needs to be remembered, in this context, that the company which received the EU income may well have had other sources of income, such as interest on bank deposits or loans, or profits of a trade carried on in the UK; that the EU income may not be distributed until after the year of receipt, and the company may also have had other sources of income in the year of distribution or any intermediate years; and that if the company forms part of a UK-resident group, some or all of the EU income may have been passed up the group without payment of ACT under group income elections, before it was finally distributed outside the group and ACT became payable.

Under the domestic ACT system, none of these questions arise, because once FII has been generated by payment of a distribution outside a group income election, the whole of that FII is then available in the hands of the recipient company to frank any distribution of equivalent amount made by that company, regardless of any other sources of income which it may have and regardless of the nature of the income comprised in the distribution. It was essentially for these reasons that in FII (High Court) II HMRC were obliged to devise an extremely complex methodology, which had no counterpart in the domestic statutory scheme and involved the making of numerous assumptions of an often arbitrary nature, with a view to identifying the EU-source income supposedly comprised in the distribution which eventually triggers a charge to ACT.

In broad terms, that is the general nature of the exercise which HMRC now wish to carry out in the present case, while making due allowance for the differences between portfolio dividends received by companies which are not themselves members of the same corporate group as the company paying the dividend, on the one hand, and dividends paid by foreign subsidiaries of UK-resident members of a corporate group, on the other hand.

The argument is, however, precluded, in my judgment, by my analysis of issues concerning the ACT charge in [124] to [129] of the Main Judgment, as reflected in declarations 2(A) to (D) and paragraphs 3(d) and (e) of the orders contained in the January 2014 Order. I have already held that section 231 of ICTA 1988 would have been compliant with EU law, in the case of portfolio dividends received from EU-resident companies, had it also provided a “dual” credit of the nature which I described. I have also held that this result can be reached as a matter of conforming interpretation of section 231, and does not require the section to be disapplied. It is implicit in these conclusions, in my view, that if section 231 is thus construed conformably with EU law, the domestic ACT system is thereby rendered compliant with EU law, and the credit for portfolio dividends should then be treated in the same way as domestically generated FII. There is accordingly no room for a further analysis which would cut down the relief so that it applies only to so much of any subsequent distributions as can be identified in some way as comprising the EU income which generated the credit in the first place.

I also consider that it is now too late for HMRC to pursue this argument. The adjourned trial in July 2013 was the trial of the action, including all issues of principle in relation to quantification. Although I am sometimes willing to allow more procedural latitude to the parties to test claims in group litigation than I normally would to parties to purely private proceedings, I think that if HMRC wanted to run an argument of this fundamental significance to the quantification of the claims they should have pleaded it in good time before the hearing, and then adduced calculations and evidence to explain and support their new case. As it is, however, the argument played no part at all in the trial, and it has surfaced for the first time at the stage of working out the January 2014 Order. If I were to accede to HMRC’s request, the result would be to set in motion a third trial at which the issue would have to be properly pleaded from scratch, and then debated and resolved in much the same way as its counterpart was in FII (High Court) II, but with the added advantage for HMRC that they would know my reasons for having rejected the similar methodology advanced by them in the latter case. I do not think it would be fair to Prudential and the other claimants in the Portfolio Dividend GLO to allow this to happen, when the point could and should have been raised, if it was to be run at all, at the trial in July 2013.

Mr Ewart sought to counter this last point by arguing that the claimants had themselves failed to plead any detailed positive case on the methodology by which unlawful ACT should be calculated. He further submitted that the claimants had implicitly endorsed HMRC’s methodology by pleading, in the alternative, that HMRC were not entitled to charge ACT upon the “further distribution” of the relevant dividend income, because the foreign companies which paid the portfolio dividends were liable for tax upon the distributed profits in the jurisdictions where they were earned: see paragraph 34 of the second amended particulars of claim. There could only be a “further distribution” of an EU dividend, said Mr Ewart, if and to the extent that the same income were subsequently distributed by the recipient company.

I find this argument unconvincing. It is true that the claimants’ case on methodology was only pleaded in outline fashion, but by the end of the trial their contentions had been clearly articulated in their skeleton argument and Mr Aaronson’s oral submissions, without any objection from HMRC that they were being taken by surprise. By contrast, there had not been even the faintest hint of the case that HMRC now wish to advance. I am also satisfied that the reference to “further distribution” cannot bear the weight which Mr Ewart would place upon it. Read in its context as an outline contention, it can naturally be understood as referring to the further distribution within the domestic FII system of an amount equivalent to the EU dividend received, without any requirement that the income should remain identifiably the same. This understanding gains added force from the reliance expressly placed in paragraph 34 on the ruling of the ECJ in FII (ECJ) I. As Mr Bremner pointed out, the language used by the Court in paragraph 82 of its judgment shows that it fully understood the contention of the FII test claimants that what mattered was the payment of dividends “of the same amount” by the recipient company to its own shareholders. I would add that it is a natural shorthand description to refer to this process as the onward payment of the original dividend, without thereby implying any identity of the income distributed with the EU income received.

Finally, it will be apparent from what I have already said that, even if it were open to HMRC to run the argument, I would find it no more convincing in the context of portfolio dividends than I found its counterpart in FII (High Court) II, and I would therefore reject it, on the basis of the material now before me, for substantially the same reasons.

The problem addressed by this Issue arises where an undifferentiated fund of lawful and unlawful ACT was utilised by being set off against an amount of MCT which was itself in part lawful and in part unlawful. The question is whether (as Prudential contends) the unlawful ACT should be regarded as having been utilised first against the unlawful MCT, or whether (as HMRC contend) a pro rata approach should be adopted throughout, with the result that the unlawful MCT is treated as having been offset by a mixture of lawful and unlawful ACT in the same proportions as the unlawful MCT bears to the total MCT charge.

In the absence of any special reason to the contrary, my inclination would be to adopt a pro rata approach throughout, as HMRC submit. The question is what factual assumptions it is appropriate to make, in a situation where everybody at the time assumed the whole of both the ACT and the MCT to have been lawfully charged. It therefore seems natural, now that the true position has emerged, to treat the relevant payments of ACT and MCT as composed proportionately of lawful and unlawful tax. I would not be dissuaded from taking this approach by the fact that the ECJ has consistently treated (lawful) ACT as a prepayment of (lawful) MCT, because that seems to me to have nothing to do with the question of attribution of historical payments with which I am now concerned.

The difficulty with this approach, however, in the present context, is that it gives rise to an anomaly, which Prudential skilfully exposed by an example contained in Mr Bremner’s supplementary skeleton argument. It is unnecessary for me to set out the example in full, because Mr Ewart accepted on behalf of HMRC that it is in principle well-founded, and is not invalidated by the fact that it incorporates some empirically unlikely assumptions in order to bring out the underlying point more clearly. The effect of the example may be summarised by saying that (a) if the unlawful ACT is regarded as a prepayment of the unlawful MCT, the end result precisely reflects the credit for foreign tax required by EU law, whereas (b) HMRC’s pro rata approach leaves the claimant UK company with an additional, and apparently unnecessary, claim to recover the element of lawful ACT which has been utilised against the unlawful MCT. The claimant therefore ends up being over-compensated.

Mr Ewart’s answer to this point was to say that the anomaly is caused by the ruling of the Court of Appeal in FII (CA) at [148] that lawful ACT set against unlawful MCT is recoverable under the San Giorgio principle. Mr Ewart suggested that the Court of Appeal was wrong on this point, and said that HMRC would so argue if and when the Supreme Court grants permission to appeal on the question (a decision on which has been stayed since 2010). There can be no doubt, however, that the decision of the Court of Appeal on the point is binding upon me, and represents the law as it now stands. I therefore consider that there is good reason to depart from the pro rata approach which I would otherwise be inclined to adopt, and I conclude that in this particular context Prudential’s approach should be preferred.

I now come to some additional issues which emerged from the revised computations supplied by HMRC on 26 September 2014. The first such issue concerns cases where Prudential has a claim to recover unlawful ACT, and the ACT in question was paid late. Due to the complexities of life insurance taxation, this happened from time to time. There is no suggestion that Prudential was in any way a recalcitrant or careless taxpayer. Under the legislation in force at all material times, interest was due on the late payments of ACT at specified rates: see section 87 of the Taxes Management Act 1970 for accounting periods ending before 30 September 1993, and section 87A for later periods.

The point now taken by HMRC is that Prudential has adduced no evidence that it actually paid the interest which was due when it made late payments of ACT, with the result (it is argued) that Prudential is not entitled to include such interest in its claim for restitution of the overpaid tax. I can see no reason, however, why I should not infer on the balance of probabilities that, when Prudential made a late payment of ACT, it also paid the statutory interest which was due. There is nothing to suggest that Prudential would have failed to comply with its legal obligations to pay such interest, and had it failed to do so one would expect HMRC to have raised assessments on Prudential for the amounts due. There is no evidence that anything of this kind ever happened. I am therefore willing to draw the inference that Prudential complied with its obligations and duly paid the interest which it now seeks to recover.

The agreed formulation of this issue reads as follows:

The relevant statutory provisions which enabled surplus FII to be carried back within the same accounting period (but no further) were contained in paragraph 4 of schedule 13 to ICTA 1988. In FII (High Court) II I set out these provisions at [209], and summarised their general effect in this way:

Issue 12 in FII (High Court) II was, I think, essentially the same as the issue which I now have to consider: see the formulation of Issue 12 in [210]. As I recorded in [207], the question had been barely touched upon in the numerous written submissions presented to me, and had not been mentioned at all in oral argument. I therefore dealt with it very briefly, concluding as follows in [211]:

In the present case, by contrast, I have heard full argument on the question from Mr Bremner and Mr Ewart. With the benefit of their submissions, I now consider (although with considerable hesitation) that Prudential’s case is correct. The central point, if I have correctly understood Mr Bremner’s submissions, is that the FII carried back is by definition entirely lawful, as it was generated exclusively by the receipt of UK-source dividends. Any repayment of ACT paid in an earlier quarter to which the carried back FII gives rise must therefore be treated as far as possible as a repayment of lawful ACT. If that is not done, FII generated by UK income ends up being used so as to cancel out part of the credit which EU law requires on foreign income. By taking me through some sample computations, Mr Bremner was able to persuade me that this would be the result of applying HMRC’s approach, and that any apparent timing anomalies thrown up by Prudential’s approach are appropriately dealt with by interest adjustments.

This issue was not argued before me, either in writing or orally. It reads as follows:

Since I have received no submissions on this question, I take it that the parties are content for me to provide a short answer to it. It seems to me that either solution would be a reasonable one to adopt, and there are no obvious reasons for preferring one to the other. My slight preference, however, is for the former solution, because it better reflects what actually happened, as can now be seen with the benefit of hindsight. I would therefore answer the question accordingly.

One further question was briefly canvassed before me at the hearing, namely the date from which interest should accrue at the rate specified in section 17 of the Judgments Act 1838. The question was whether such interest should run from the date of the Main Judgment (24 October 2013), or from the date when the present judgment is handed down. The parties are now in agreement that the latter date is the correct one, with the consequence that interest will continue to accrue until that date at the rates set out in paragraph 4 of the January 2014 Order (i.e. the conventional government borrowing rate, compounded monthly).