The Court of Appeal handed down its judgment in The Test Claimants in the FII Group Litigation v HMRC on 24 November 2016, finding largely in favour of the taxpayers. The method of computing double tax relief on EU sourced dividends for the period from 1973 to 1999 therefore remains as established by Henderson J. HMRC again raised its various ‘restitutionary’ defences as to why it should not have to repay the unlawful tax, but these were rejected. The court notably allowed the claimants’ cross-appeal regarding the date of discovery, extending the date from which the six-year limitation period began to run from 2001 to 12 December 2006 and bringing all claims in the GLO within time.
On 24 November 2016, the Court of Appeal delivered its judgment in the franked investment income (FII) group litigation (see Test Claimants in the FII Group Litigation v HMRC [2016] EWCA Civ 1180, reported in Tax Journal, 2 December 2016). This determines HMRC’s appeal and the claimants’ cross-appeal against Henderson J’s judgment of 18 December 2014. It is the latest development in the long-running litigation, which has generated decisions at every level of the UK courts and no fewer than three references to what is now the CJEU.
The background to the case is the hybrid system of taxation operated by the UK until 1999 of exemption for domestic dividends and imputation (granting credits for foreign tax) for foreign dividends. That system required the payment of advance corporation tax (ACT) at the corporate level to be set against corporation tax, with a corresponding credit to the shareholders to be set against income tax.
Prior to the High Court hearing, the claimants had already established that various aspects of this regime were contrary to EU law and that they were entitled in principle to restitution of the unlawfully levied tax. This was true in relation both to corporation tax charged on foreign sourced dividends under Schedule D Case V of ICTA 1988 (DV tax) and to ACT.
Henderson J’s judgment therefore focused on quantifying the claims and the availability of certain defences to HMRC.
The High Court’s judgment took the form of 29 separate issues, 19 of which were appealed to the Court of Appeal. The Court of Appeal determined 17 of the 19 issues in the claimants’ favour, largely for the reasons already given by Henderson J. The claimants’ case had also been strengthened in a number of respects since the High Court’s judgment, as a result of the Court of Appeal’s decision in Prudential Assurance Company Ltd v HMRC [2016] EWCA Civ 376 (Prudential CA), which considered some of the same issues in the context of portfolio holdings.
This Court of Appeal has not merely relied on that earlier judgment, but has actively reconsidered the same points and come to the same decisions. Between them, these judgments now establish the methodology for computing claims for double tax relief and the recovery of ACT for holdings both above and below 10%.
The one adverse change to the High Court’s judgment which has any impact on value is only relevant to the circumstance of a UK company in receipt of EU dividend income, and which then paid ACT on dividends to a foreign parent. In circumstances where the foreign parent was entitled to an abated half tax credit for the ACT paid, the Court of Appeal has held, contrary to Henderson J, that credit must be given against the ACT reclaim for the half credit received. This produces a minor reduction in the value of such ACT claims.
In one significant way, the claimants have substantially improved their position over the High Court judgment. This concerns the time limit for issuing High Court claims. High Court claims must be issued within six years of payment of the tax concerned. For claims in mistake, however, that six year period does not commence until the claimant discovered, or could with reasonable diligence have discovered, that the tax had been paid by mistake (the tax in reality not being due). Henderson J had set that date at 8 March 2001, the date of the Hoechst judgment [2001] Ch 620. This put claims issued after 8 March 2007 out of time, which affected seven of the claims in the GLO.
Following the Supreme Court’s logic in DMG v HMRC [2006] UKHL 49, the Court of Appeal held that, in the case of a point of law being disputed in current litigation, the true state of the law is not ‘discoverable’ until the point has been authoritatively resolved by a final court. For the claimants, this was not until the CJEU’s decision in the first FII reference (Case C-446/04) on 12 December 2006. This had the effect of ensuring that all claims within the GLO were in time.
Having determined the amount of the unlawful tax, the court went on to consider various ‘restitutionary’ defences put forward by HMRC. These were various arguments to the effect that it was not required to repay any (or virtually any) tax, even where it had been unlawfully levied.
Set-off against unlawful tax (issue 17)
This concerned the extent to which HMRC could deduct credits given to shareholders from the amounts of unlawful ACT to be repaid.
The High Court had previously held that this was not allowed because, inter alia, there was insufficient connection between the credits and the unlawful tax, as they were the subject of independent statutory provisions. The Court of Appeal dismissed HMRC’s appeal but disagreed with Henderson J’s reasoning; it was not necessary that HMRC be ‘a mere channel for the transfer of money from companies to their shareholders’. The real issue, it said, was that on a proper construction, the credits were not dependent on payment of the unlawful tax at all.
Change of position (issues 19 and 20)
HMRC argued that it should not have to repay the unlawful tax because it had changed its position by irretrievably spending those receipts.
Whilst this argument was available in principle, HMRC had not successfully proved it on the facts. It had to show that expenditure would not have been incurred had the overpayments not been received; it was, however, ‘miles away from demonstrating that to be the case’. Critically, there was a ‘fatal absence of evidence of how any ACT (utilised or not) was taken into account in government forecasts’. The same was true in relation to the relatively modest overpayments of corporation tax on DV income.
Actual benefit (issues 22 and 23)
HMRC argued that it was only required to repay the unlawful tax to the extent of the ‘actual benefit’ that it received from it. This, it argued, was much less than the objective time value of the cash, because it had been largely spent on current public expenditure (as opposed to reducing borrowing or on capital expenditure), which was of no value.
The Court of Appeal overturned the judge’s conclusion that this defence was not open to HMRC as a matter of English domestic law. However, the court then agreed with the judge that in any case the defence had not been made out on the facts. The government was not to be regarded as an involuntary recipient of the tax. It was well able to choose how to spend the overpayments and whether or not to repay borrowing; as such, it was required to repay the objective use value of the money, accepted to be compound interest at the government borrowing rate.
Remedies under EU law (issues 18, 21 and 24)
Having rejected each of HMRC’s arguments to reduce the amounts repayable as a matter of English law, the court considered that the same arguments were, in any event, precluded as a matter of EU law.
At the time of writing, the Court of Appeal has yet to decide whether to grant HMRC permission to appeal to the Supreme Court. It is likely that it will at least receive permission to appeal the question of whether interest is to be paid on a compound or simple basis, in order to protect its position should the Supreme Court overturn the Court of Appeal’s judgment in Littlewoods Retail Ltd v HMRC [2015] EWCA Civ 515. If the Court of Appeal refuses HMRC’s application, the next stage will likely be for it to seek permission directly from the Supreme Court, with a decision expected usually in about four months from the judgment.
The Court of Appeal’s decision marks a significant step in this mammoth litigation, a major contribution to the English law of restitution and a positive result for the claimants and other multinationals with claims enrolled in the GLO. Whether the end is now in sight or whether there will be a second trip to the Supreme Court, however, still remains to be seen. The table below sets out each of the issues of the FII case and their status.
The author’s firm acted for the claimants in this case.
