Factual and Procedural Background
This opinion concerns a Group Litigation Order ("GLO") established in 2003 relating to the Franked Investment Income ("FII") group litigation. The claimants are UK-resident parent companies with foreign subsidiaries in EU member states and third countries. The litigation addresses the taxation treatment of dividends received by UK-resident companies from non-resident subsidiaries compared with dividends paid and received within wholly UK-resident groups. The claimants allege breaches of Articles 43 and 56 of the EC Treaty due to discriminatory tax treatment, causing losses dating back to the UK's accession to the EU and the introduction of the advance corporation tax ("ACT") regime in 1973.
The trial began in 2004 but was adjourned for a preliminary reference to the European Court of Justice ("ECJ") given the complexity of Community law issues. The ECJ delivered its judgment in 2006, partly accepting the claimants' complaints and partly the Revenue's arguments, leaving some issues for determination by the English court, including factual questions and remedies.
Subsequent case management directed that liability issues be tried first, deferring causation and quantification. The pleadings define the issues but recede in importance at trial, with the court focusing on legal principles and necessary factual findings as the trial progresses.
The legal issues raised are grouped under four broad headings: the lawfulness of UK corporation tax rules on dividends from EU and third country subsidiaries; the lawfulness of the ACT charge on onward distributions by UK companies; the lawfulness of the foreign income dividend ("FID") regime introduced in 1994; and the remedies available to claimants including restitution, damages, defenses, and limitation issues.
The factual background centers on the BAT multinational group, whose UK-resident parent and intermediate companies received dividends from numerous foreign subsidiaries. The BAT group’s structure, dividend flows, and tax payments over relevant periods are detailed, including witness evidence from senior company tax and financial officers and legal representatives. The group faced a growing problem of surplus ACT, a tax burden that could not be fully offset against mainstream corporation tax liabilities, effectively becoming a permanent additional tax cost related to foreign dividend income.
Legal Issues Presented
- Whether the charge to corporation tax under Case V of Schedule D on dividends received by UK companies from subsidiaries resident in other EU member states and third countries is compatible with Articles 43 and 56 EC.
- Whether the UK ACT regime, which imposes ACT on dividends paid by UK companies to shareholders but only allows relief for dividends received from UK resident subsidiaries, discriminates contrary to Articles 43 and 56 EC.
- Whether the UK FID regime, which allows UK companies to elect to treat dividends as foreign income dividends with delayed ACT repayment and no tax credit for shareholders, complies with Articles 43 and 56 EC.
- What remedies are available to claimants for breaches of Community law, including classification of claims, availability of restitution and damages, defenses such as change of position, sufficiently serious breach, and limitation periods.
Arguments of the Parties
The opinion does not contain a detailed account of the parties' legal arguments.
Table of Precedents Cited
| Precedent |
Rule or Principle Cited For |
Application by the Court |
| Metallgesellschaft Ltd v IRC, Hoechst AG v IRC (Joined Cases C-397/98 and C-410/98), [2001] ECR I-1727 |
Principles on corporation tax and advance corporation tax ("ACT") regimes in relation to EU law. |
Used as background and comparative authority on taxation of dividends and ACT. |
| Deutsche Morgan Grenfell Group Plc v IRC [2006] UKHL 4 |
Recognition of mistake-based restitution claims for wrongly paid tax under Community law. |
Applied to support availability of restitution for tax unlawfully paid. |
| Sempra Metals Ltd v IRC [2007] UKHL 34 |
Confirmed entitlement to compound interest on restitutionary tax claims and principles on recovery of unlawfully levied tax. |
Applied in assessing remedies and interest. |
| Test Claimants in the FII Group Litigation v CIR (Case C-446/04) [2006] ECR I-11753 |
Interpretation of Articles 43 and 56 EC regarding discriminatory tax treatment of dividends from foreign subsidiaries. |
Central authority resolving compatibility of UK tax rules with Community law; formed basis for national court's analysis. |
| Staatssecretaris van Financien v B.G.M. Verkooijen (Case 35/98) [2000] ECR I-4071 |
Established principles on restrictions on freedom of establishment and discrimination under Article 43 EC. |
Used to assess whether UK tax rules unlawfully discriminate against foreign dividends. |
| Manninen (Case C-319/02) [2004] ECR I-7477 |
Clarified application of free movement of capital and freedom of establishment to tax measures. |
Guided court on interpretation of Articles 43 and 56 in dividend taxation context. |
| Holboeck v Finanzamt Salzburg-Land (Case C-157/05) [2008] STC 92 |
Confirmed that Article 56 EC may apply to dividends from third country subsidiaries even where shareholding confers control. |
Supported claimants' position that Article 56 applies to third country dividends in this case. |
| Finanzamt Hamburg-Am Tierpark v Burda GmbH (Case C-284/06) |
Confirmed priority of Article 43 over Article 56 in intra-Community group company situations. |
Distinguished from Holboeck; limited Article 56 applicability where Article 43 applies. |
| Amministrazione delle Finanze dello Stato v Simmenthal S.p.A (Case C-106/77) [1978] ECR 629 |
Established principle of disapplication of national law conflicting with directly effective Community law. |
Applied to explain remedy of disapplying incompatible UK tax provisions. |
| Woolwich Equitable Building Society v IRC [1993] AC 70 |
Foundation of restitutionary claim for recovery of unlawfully levied tax. |
Applied in assessing claimants' entitlement to recover unlawfully paid tax. |
| Factortame Ltd v Secretary of State for Transport (No. 5) [2000] 1 AC 524 |
Conditions for state liability for damages for breach of Community law including sufficiently serious breach. |
Used to assess whether UK breach of Community law was sufficiently serious to warrant damages. |
| Marks and Spencer Plc v Commissioners of Customs and Excise (Case C-62/00) [2003] QB 866 |
Principles on limitation periods and protection of legitimate expectations in Community law claims. |
Applied to assess validity of UK limitation legislation curtailing claims for tax repayments. |
| NEC Semi-Conductors Ltd v IRC [2006] EWCA Civ 25 |
Clarified scope of Woolwich claims and lawfulness of ACT demands. |
Considered in relation to claimants' restitution claims and limitation defenses. |
| Barclays Bank Ltd v W J Simms Son & Cooke (Southern) Ltd [1980] QB 677 |
Test of causation in claims for recovery of money paid under mistake of fact. |
Applied in discussion of causation for mistake-based restitution claims. |
| Lipkin Gorman v Karpnale Ltd [1991] 2 AC 548 |
Recognition and principles of the defence of change of position in English law of restitution. |
Guided analysis of whether Revenue could rely on change of position defense. |
| Scottish Equitable Plc v Derby [2001] EWCA Civ 369 |
Application of change of position defense and causation standards. |
Discussed in context of Revenue’s pleaded change of position defense. |
| Dextra Bank & Trust Co Ltd v Bank of Jamaica [2002] 1 All ER (Comm) 193 |
Rejected relevance of fault and emphasized good faith in change of position defense. |
Supported analysis of change of position defense. |
| Niru Battery Manufacturing Co v Milestone Trading Ltd [2003] EWCA Civ 1446 |
Clarified equitable considerations in change of position defense. |
Considered in relation to Revenue’s defense. |
| Amministrazione delle Finanze dello Stato v SpA San Giorgio (Case 199/82) [1983] ECR 3595 |
San Giorgio principle requiring repayment of charges levied in breach of Community law. |
Central to assessment of remedies available to claimants. |
| Fantask A/S and others v Industriministeriet (Erhvervsministeriet) (Case C-188/95) [1997] ECR I-6783 |
National law cannot bar recovery of charges levied in breach of Community law by settled law defenses. |
Applied to reject defenses limiting recovery of unlawfully levied tax. |
| Konle (Case C-302/97) [1999] ECR I-3099 |
Interpretation of 'existing legislation' for purposes of derogations under Article 57(1) EC. |
Applied to assess continuity of restrictions for third country dividends. |
| Statteverket v A (Case C-101/05) [2007] ECR I-xxxx |
Clarified application of Article 57(1) EC to restrictions repealed and reintroduced. |
Applied to conclude continuous operation of restriction on third country dividends. |
Court's Reasoning and Analysis
The court undertook a detailed analysis of the compatibility of the UK corporation tax system on foreign dividends with Articles 43 and 56 EC, focusing on the distinction between domestic exemption and foreign credit systems. It found that the ECJ and Advocate General accepted that member states may choose different systems, but the UK system infringed Article 43 because it "topped up" foreign corporation tax to the standard UK rate, denying parent companies the benefit of lower effective foreign tax rates, resulting in less favorable treatment of foreign-source dividends.
Regarding dividends from third countries, the court held that although Article 56 applies, the standstill provision of Article 57(1) disapplies it for restrictions existing at 31 December 1993, including the Case V charge and its associated reliefs. Changes such as the EUFT regime did not constitute a new restriction removing this protection.
In relation to the ACT regime, the court accepted the ECJ's finding that the UK unlawfully discriminated by allowing ACT relief only for dividends received from UK resident companies. However, the court found it necessary to refer further questions ("corporate tree points") to the ECJ concerning whether relief should be available where foreign tax is paid further down the corporate chain or where group income elections defer ACT payment within the UK group.
The court held that the appropriate remedy for breaches of Article 43 is to treat foreign dividends as carrying a tax credit, generating franked investment income ("FII") in the hands of the UK recipient company. It rejected arguments that relief should be limited only to actual foreign tax paid by the immediate foreign subsidiary.
On the FID regime, the court found it incompatible with Articles 43 and 56, due to delayed ACT repayment and the absence of tax credits for shareholders, which caused cash-flow disadvantages and required dividend enhancements. It held that the standstill provision did not protect the FID regime from challenge.
The court analyzed the claimants' restitution and compensation claims, concluding that only claims for repayment of unlawfully levied tax and associated interest and loss of use sound in restitution and fall under the San Giorgio principle. Other claims, including those based on use of surplus ACT, disclaimed capital allowances, and dividend enhancements, sound in damages and require proof of sufficiently serious breach.
Regarding defences, the court held that the Revenue could not rely on change of position against San Giorgio claims but could do so against mistake-based restitution claims beyond San Giorgio. It found the Revenue's pleaded change of position defence likely to succeed on the facts, as the tax revenues had been irretrievably spent in good faith and it would be inequitable to require repayment.
On sufficiently serious breach, the court held that the UK had not manifestly and gravely disregarded the limits on its discretion given the complexity and evolving nature of Community law in this area, the absence of clear guidance until around 2000, and the lack of formal legal advice or deliberate risk-taking by the UK government. Accordingly, claims for damages under Factortame principles must fail.
On limitation, the court held that UK legislation (Finance Act 2004 section 320 and Finance Act 2007 section 107) curtailing the limitation period for mistake-based claims without transitional provisions breaches Community law principles of effectiveness and legitimate expectations. These provisions must be disapplied in restitution claims based on mistake of law necessary to provide an effective remedy under the San Giorgio principle.
Finally, the court held that statutory provisions for repayment of tax paid under mistake or error (TMA 1970 section 33) do not exclude other domestic remedies where they do not apply and must yield to Community law principles requiring effective remedies for San Giorgio claims.
Holding and Implications
DISPOSED OF
The court held that the UK taxation system on foreign dividends, including the Case V charge, ACT regime, and FID regime, infringed Articles 43 and 56 EC in various respects. The UK is obliged to provide effective remedies, including restitution for unlawfully levied tax and associated interest, under the San Giorgio principle. However, claims for damages require establishing sufficiently serious breach, which the court found not established here. The Revenue's change of position defence is available against mistake-based restitution claims beyond San Giorgio claims and is likely to succeed on the facts. The UK limitation statutes curtailing mistake-based claims without transitional provisions breach Community law and must be disapplied.
The court referred certain complex issues, including the corporate tree points and the question of whether limitation statutes were enacted with the intention of limiting ECJ judgment consequences, to the ECJ for further guidance. No new precedent was established beyond the application of existing Community law principles to the facts of this case. The decision directly affects the parties' rights and liabilities in the ongoing group litigation.