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

Factual and Procedural Background

This judgment concerns an appeal from the decision of Judge Henderson dated 27 November 2008 in a lead case under a group litigation order involving the compatibility of United Kingdom corporation tax legislation with principles of Community law derived from the EC Treaty. The case involves significant sums potentially up to £5 billion and affects other pending proceedings. The core contested rule is that UK-resident companies are exempt from corporation tax on dividends received from other UK-resident companies but are subject to corporation tax on dividends from non-UK-resident companies with a credit for foreign tax paid. The historical context includes the abolition of Advance Corporation Tax ("ACT") in 1999 and subsequent legislative changes affecting dividend taxation.

The claimants, mostly members of the British American Tobacco group ("BAT"), challenged this dual exemption/credit system. Procedurally, the case involved a reference to the Court of Justice of the European Communities ("ECJ") on numerous questions relating to the compatibility of the UK tax regime with Community law, including issues on ACT, foreign income dividends ("FIDs"), and remedies for overpaid tax. The Chancery Division approved the reference questions but did not give an opinion on them. The current court addresses the appeal and cross-appeals, focusing on the interpretation and application of the ECJ judgment and related domestic law.

Legal Issues Presented

1. Whether the provisions of Case V Schedule D infringe Article 43 of the EC Treaty (Freedom of Establishment).
2. Whether the provisions of Case V Schedule D infringe Article 56 of the EC Treaty (Free Movement of Capital) in relation to dividends from Third Countries.
3. Whether any infringement of Article 56 is permitted by the "standstill" provisions of Article 57(1) in light of the Eligible Unrelieved Foreign Tax ("EUFT") rules.
4. Whether the ACT provisions are compatible with Community law where corporation tax was not paid by the EC water's edge company but borne by subsidiaries.
5. Whether ACT provisions are compatible with Community law where ACT was paid by a parent company up the corporate tree following a group income election.
6. Whether the ACT provisions can be interpreted compatibly with Community law.
7. Whether the ACT provisions as to surrender or equivalent relief are incompatible with Community law.
8. Whether the ECJ's answer on FID regime applies to ACT paid by companies higher or lower in the corporate tree.
9. Whether the FID provisions infringe Article 56.
10. Whether the FID provisions are permitted by the "standstill" provisions of Article 57(1).
11. The extent of remedies required by Community law for unlawfully charged taxes and related reliefs.
12. Whether English law provides sufficient remedies for Community law claims (Woolwich and mistake claims).
13. Whether remedies are required in respect of reliefs utilised consequent to unlawful tax charges.
14. Whether remedies are available for ACT paid by an upstream parent company.
15. Whether the defence of change of position is precluded by the wrongdoer principle.
16. Whether the Revenue has demonstrated a factual change of position.
17. Whether change of position defence is available if mistake remedy is not required by Community law.
18. Whether the judge erred in dismissing claims for damages for breach of Community law.
19. Whether new evidence requires setting aside the judge's decision on damages.
20. Whether the application of sections 320 and 107 of the Finance Acts are precluded by Community law principles of effectiveness, equivalence, legal certainty, and legitimate expectations.
21. Whether sections 320 and 107 apply to all Community law claims.
22. Whether section 32(1)(c) of the Limitation Act 1980 applies to repayment or damages claims.
23. Whether restitution and damages remedies are excluded by section 33 Taxes Management Act.

Arguments of the Parties

The opinion does not contain a detailed account of the parties' legal arguments.

Table of Precedents Cited

Court's Reasoning and Analysis

The Court undertook a detailed analysis of the compatibility of the UK corporation tax regime with Community law freedoms under Articles 43 (freedom of establishment) and 56 (free movement of capital). It considered the ECJ's judgment and the Advocate General's opinion, noting significant differences in approach, particularly on whether effective tax rates or nominal rates govern the non-discrimination principle.

On Issue 1, the Court acknowledged the Advocate General's view that the UK's dual system (exemption for domestic dividends and credit for foreign dividends) infringed Article 43 due to differences in effective tax rates caused by reliefs and allowances not passed on to foreign dividends. The ECJ judgment, however, was interpreted by some members as permitting such a system provided nominal rates were equal and full credit was given, with the ECJ reserving factual issues to the national court.

The Court was divided: two members agreed with the Judge that effective rates matter and that the ECJ misunderstood the UK government's position on exceptional circumstances; two others disagreed, considering the ECJ's judgment clear on nominal rates only. To resolve this, the Court unanimously decided to refer the question back to the ECJ for clarification.

On Issues 2 and 3 concerning dividends from Third Countries and the application of Article 56 and its standstill provision in Article 57(1), the Court agreed with the Judge that Article 56 applies to such dividends unless legislation is primarily aimed at establishment. The standstill provision applies to preserve restrictions existing on 31 December 1993, and the introduction of the EUFT rules did not constitute a new restriction removing this protection.

Issues 4 to 10, dealing with ACT and FID regimes, raised complex questions about whether ACT credits and repayments should be available where tax was paid by subsidiaries or upstream companies, and whether the FID regime infringed Community law. The Court agreed with the Judge that these issues were not sufficiently clear for determination and should be referred to the ECJ.

Issue 6 concerned the conforming interpretation of ICTA section 231 on tax credits for ACT. The Court held that the section can be read compatibly with Community law by extending entitlement to tax credits beyond UK resident companies to persons entitled under Community law, without altering the cardinal features of the legislation.

Issues 11 to 14 addressed remedies. The Court confirmed the requirement under Community law for effective restitutionary remedies (San Giorgio claims) for unlawfully charged taxes and related reliefs such as ACT set-off. However, it distinguished reliefs resulting from discretionary tax planning (e.g., group relief and management expenses) as not recoverable under San Giorgio. The Court held that the Woolwich cause of action provides an effective UK remedy for San Giorgio claims and rejected the Judge's view that a formal demand is required to bring a Woolwich claim, extending it to tax exacted by legislative imposition including self-assessment.

Issues 15 to 17 on the defence of change of position were held not to require determination at this stage, with the principle of effectiveness precluding such a defence for San Giorgio claims.

Issues 18 and 19 concerned damages claims for breach of Community law. The Court accepted the Judge's conclusion that the Claimants had not established a sufficiently serious breach given the complexity and evolving nature of Community law in this area, and that new evidence did not warrant overturning that conclusion.

Issues 20 and 21 addressed the compatibility of sections 320 and 107 of the Finance Acts, which abbreviate limitation periods for mistake-based tax claims. The Court held that these provisions are not precluded by Community law principles because the Woolwich cause of action, which is unaffected by these sections, provides an effective remedy for San Giorgio claims.

Issue 22 on section 32(1)(c) of the Limitation Act 1980 was considered. The Court rejected the Claimants' submission for a broad interpretation extending to all claims causally connected to a mistake, holding instead that the provision applies only where mistake is an essential ingredient of the cause of action, consistent with longstanding authority.

Issue 23 on the applicability of section 33 Taxes Management Act (TMA) was addressed. The Court held that section 33 applies exclusively to claims to which it relates, that subsection (2A)(a) is incompatible with Community law and must be read subject to Community law obligations, and that the section does not go against the grain of the legislation when so interpreted. The Court rejected the Claimants' submissions that section 33 should be disapplied in its entirety.

In conclusion, the Court allowed the appeal on Issues 1, 6, 12, 20, and 23; dismissed the appeals on Issues 2, 3, 4, 5, 7, 8, 9, 10, 11, 13, 14, 18, 19, 21, and 22; and held that Issues 15, 16, and 17 did not arise for decision. The Court also ordered a further reference to the ECJ on the critical Issue 1 concerning effective versus nominal tax rates.

Holding and Implications

The Court’s final disposition is as follows:

• Appeal Allowed: On Issues 1, 6, 12, 20, and 23, including a referral back to the ECJ for clarification on the interpretation of its judgment regarding the application of effective versus nominal tax rates in the UK dual dividend taxation system.
• Appeal Dismissed: On Issues 2, 3, 4, 5, 7, 8, 9, 10, 11, 13, 14, 18, 19, 21, and 22.
• Issues Not Reached: Issues 15, 16, and 17 were held not to arise for decision.

The direct effect of this decision is to clarify that certain parts of the UK corporation tax regime are incompatible with Community law, but that the precise scope of incompatibility, particularly regarding effective tax rates, requires further determination by the ECJ. The ruling confirms the availability of effective remedies under UK law consistent with Community law principles, including the Woolwich cause of action for restitution of unlawfully exacted tax. The Court’s approach preserves the existing statutory limitation framework subject to conforming interpretation and confirms that some legislative provisions must be read down to comply with Community law.

No new precedent is established beyond the interpretation and application of existing ECJ jurisprudence and UK law to the facts of this case. The Court’s decision to refer key questions back to the ECJ underscores ongoing legal uncertainty in this complex area of corporate taxation and Community law compliance.