Factual and Procedural Background
In March 2000, Company A, a leading mobile telecommunications group, acquired Company B through its wholly owned subsidiary, Company C, incorporated and resident in The State. For this purpose, Company D, incorporated and resident in Luxembourg, was interposed between Company C and Company B as a wholly owned subsidiary to hold shares in Company B and other European telecommunications companies. During the accounting period ended 31 March 2001, Company D derived substantial income and accounted for it to the Luxembourg tax authorities.
In November 2002, the tax authority (HMRC) notified Company C of its intention to enquire into its tax return for that period, seeking information to assess Company C to UK tax on Company D’s income, giving credit for tax paid in Luxembourg. The statutory basis was the Controlled Foreign Companies ("CFC") legislation under Chapter IV of Part XVII of the Income and Corporation Taxes Act 1988 ("ICTA"). Company C contended the legislation did not apply, arguing that taxing it on Company D’s profits would unlawfully restrict its freedom of establishment under Article 43 EC. Its request for a closure notice was refused, and it appealed to the Special Commissioners.
Meanwhile, a similar issue arose between another company and HMRC, leading the Special Commissioners to refer questions to the European Court of Justice ("ECJ") in 2004. The ECJ’s 2006 judgment in that case rendered a similar reference in Company C’s appeal redundant. The Special Commissioners ultimately considered whether the CFC legislation could be interpreted in a manner consistent with the freedom of establishment as declared by the ECJ. They were divided, with the chair casting the deciding vote in favour of such an interpretation.
Company C appealed to the High Court, where the judge held that it was impossible to interpret the CFC legislation to conform with the freedom of establishment and therefore disapplied the legislation as contrary to Community law. HMRC appealed that order. The court identified two issues: (1) whether the CFC legislation could be interpreted consistently with the freedom of establishment, and if not, (2) to what extent and in what manner it should be disapplied.
Legal Issues Presented
- Is it possible to interpret the Controlled Foreign Companies legislation so as not unlawfully to restrict the appellant’s freedom of establishment under Article 43 EC?
- If not, to what extent and in what manner should the legislation be disapplied to comply with Community law?
Arguments of the Parties
Appellant's Arguments
- The CFC legislation cannot be interpreted compatibly with the freedom of establishment; therefore, it must be disapplied.
- Limiting conforming interpretation to the motive test in section 748(3) of ICTA is appropriate and consistent with ECJ guidance.
- Introducing a geographical distinction in the legislation (i.e., exempting companies established within the European Economic Area) would conflict with precedent and the legislative scheme.
- A conforming interpretation would be retrospective, involve policy decisions, and fail the test of legal certainty.
Respondent's (HMRC) Arguments
- The CFC legislation can be interpreted conformably with Community law by introducing an additional exception for companies genuinely established in another Member State and carrying on genuine economic activities.
- This additional exception could be inserted as a further paragraph within section 748(1) or as an alternative condition in section 748(3).
- The interpretative obligation under section 2(4) of the European Communities Act 1972 is broad and permits such modifications without altering the fundamental thrust of the legislation.
- The proposed interpretation is consistent with ECJ rulings and does not create an impermissible two-tier regime.
- No order of disapplication is necessary if the conforming interpretation is accepted; the enquiry into the appellant’s tax return should continue.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Cadbury Schweppes [2006] ECR I-7995 |
ECJ ruling on the compatibility of CFC legislation with freedom of establishment under Article 43 EC. |
Formed the central legal framework for assessing whether the CFC legislation unlawfully restricts freedom of establishment and the scope for justification. |
| Marks & Spencer [2005] ECR I-10837 |
Justification of restrictive tax measures under EU law. |
Considered by the Advocate-General in assessing whether CFC legislation is suitable and proportionate to counteract tax avoidance. |
| Pfeiffer v Deutsches Rotes Kreuz [2004] ECR I-8835 |
Limits of ECJ jurisdiction in interpreting Member State legislation. |
Supported the principle that national courts must interpret entire national law compatibly with Community rights. |
| Criminal Proceedings against Pupino [2005] ECR I-5285 |
Obligation of national courts to interpret domestic law in conformity with EU law. |
Reinforced the duty of consistent interpretation beyond the wording of legislation. |
| Pickstone v Freemans [1989] AC 66 |
Principles of statutory interpretation to conform with Community law. |
Outlined broad and far-reaching interpretative obligations on courts. |
| Marleasing SA v La Comercial Internacional de Alimentacion SA [1990] ECR I-4135 |
Obligation to interpret national law in conformity with EU directives. |
Supported the interpretative approach required under Community law. |
| Litster v Forth Dry Dock [1990] AC 546 |
Permitting departure from strict literal interpretation to comply with Community law. |
Confirmed courts may imply words to ensure conformity. |
| ICI v Colmer [1999] 1 WLR 2035 |
Limits on creating distinct regimes based on geographic distinctions within tax legislation. |
Considered in assessing whether a conforming interpretation creating two regimes is permissible. |
| Ghaidan v Godin-Mendoza [2004] 2 AC 557 |
Limits on interpretation under Human Rights Act 1998 to avoid altering the substance of legislation. |
Used to assess whether conforming interpretation crosses into impermissible legislation. |
| HMRC v IDT Card Services Ireland Ltd [2006] STC 1252 |
Extension of statutory provisions by interpretation to comply with EU law. |
Supported the permissibility of broad interpretative adjustments to achieve conformity. |
| HMRC v EB Central Services Ltd [2008] EWCA Civ 486 |
Constraints on interpretative obligations. |
Clarified limits on interpretation where courts lack capacity to evaluate practical repercussions. |
| Fleming/Conde Nast v HMRC [2008] 1 WLR 195 |
Interpretation and disapplication of legislation conflicting with Community rights. |
Guided the approach to disapplication and the scope of enforceable Community rights. |
| Autologic Holdings plc v IRC [2005] STC 1357 |
Disapplication of legislation inconsistent with Community law. |
Referenced for principles on identifying persons entitled to protection under disapplication. |
| Centros [1999] ECR I-1459 |
Freedom of establishment and abuse thereof. |
ECJ precedent confirming that establishing a company to benefit from favourable legislation is not in itself abusive. |
| Inspire Art [2003] ECR I-10155 |
Freedom of establishment and abuse of rights. |
Supported the principle that tax-motivated establishment does not necessarily constitute abuse. |
| Emsland-Stärke [2000] ECR I-11569 |
Criteria for abuse of Community law rights. |
Referenced to explain the need for objective evidence of artificial arrangements. |
| Halifax and Others [2006] ECR I-1609 |
Assessment of objective circumstances in abuse cases. |
Used to clarify the requirement for objective factors to establish abuse. |
| Eurofood IFSC [2006] ECR I-3813 |
Definition of wholly artificial arrangements and letterbox companies. |
Illustrated characteristics of artificial subsidiaries lacking genuine economic activity. |
| In re S [2002] 2 AC 291 |
Limits on judicial interpretation crossing into legislation. |
Referenced to delineate boundaries between interpretation and legislation. |
Court's Reasoning and Analysis
The court began by examining the CFC legislation, which imposes UK tax on profits of controlled foreign companies resident in lower-tax jurisdictions, subject to various exceptions. The appellant’s subsidiary, Company D, was undisputedly a controlled foreign company under the legislation.
The court then analyzed the ECJ’s judgment in the analogous Cadbury Schweppes case, which established that the CFC legislation restricts the freedom of establishment under Article 43 EC but may be justified to prevent wholly artificial arrangements intended to circumvent national tax law. The ECJ held that such legislation must be applied only to artificial arrangements and not to companies genuinely established and carrying on genuine economic activities.
The central question was whether the CFC legislation could be interpreted consistently with this freedom of establishment. The Special Commissioners had limited their interpretation to the subjective "motive test" in section 748(3), but the court rejected this narrow approach, holding that the entire CFC legislation must be considered for conforming interpretation.
The court reviewed relevant authorities on the breadth of the interpretative obligation under section 2(4) of the European Communities Act 1972, emphasizing that courts may depart from literal meanings and imply words necessary to comply with Community law, provided the interpretation does not contradict fundamental features of the legislation.
HMRC’s proposed conforming interpretation was to introduce an additional exception to the CFC legislation for companies genuinely established and carrying on genuine economic activities in another Member State. The court found this interpretation permissible, as it aligns with the ECJ’s rationale and does not alter the core scheme of the legislation. The court rejected objections that such an interpretation would create impermissible two-tier regimes or lack legal certainty, noting that the legislation already contains geographical distinctions and that retrospective effect is inherent in conforming interpretations.
The court distinguished the present case from ICI v Colmer, where the House of Lords rejected geographical distinctions that undermined statutory schemes, finding that the CFC legislation’s existing exceptions and regulatory framework accommodate such distinctions without fundamental alteration.
Given that the CFC legislation is susceptible to a conforming interpretation, the court held that disapplication of the legislation was unnecessary. It further noted that a broad order of disapplication, as made by the High Court judge, would be excessive and inconsistent with the ECJ’s decision.
Holding and Implications
ALLOWING the appeal.
The court ruled that the Controlled Foreign Companies legislation is capable of being interpreted in a manner consistent with the appellant’s freedom of establishment under Article 43 EC, specifically by construing the legislation to exclude companies genuinely established in another Member State and carrying on genuine economic activities from its application.
As a result, the previous disapplication order is set aside. The enquiry into the appellant’s tax return may continue consistent with this conforming interpretation. The decision does not establish new precedent beyond applying existing ECJ principles and statutory interpretation obligations but clarifies the scope and manner in which the CFC legislation must be read to comply with Community law.