LORD MANCE, LORD REED AND LORD HODGE: (with whom Lord Sumption and Lord Carnwath agree)
1.
This is a test case brought against the Commissioners for Her Majesty’s
Revenue and Customs (“HMRC”) by the Prudential Assurance Co Ltd (“PAC”). PAC is
a typical United Kingdom-resident recipient of dividends on “portfolio” investments
overseas, representing less (usually much less) than 10% of the relevant
overseas companies’ share capital. The issues originate from two features of
the UK tax position in the period 1990 to 1 July 2009. First, throughout that
period dividend income received from overseas investments was in principle
taxable, subject (as will appear) to certain reliefs. Second, until 6 April
1999 Advance Corporation Tax (“ACT”) was levied on dividends distributed to UK
companies’ shareholders. The scope of the issues arising from these features
and open on this appeal is, as will appear, itself in some dispute, but the
appeal on any view involves a number of conceptually difficult points.
2.
The principal issues on this appeal can be summarised as follows:
I. Does EU law require
a tax credit in respect of overseas dividends to be set by reference to the
overseas tax actually paid, or by reference to the foreign nominal tax rate
(“FNR”)?
II. Is PAC entitled to
compound interest in respect of tax which was levied in breach of EU law, on
the basis that HMRC were unjustly enriched by the opportunity to use the money
in question?
III. Subject to HMRC’s
being granted permission to argue the point, does a claim in restitution lie to
recover lawful ACT which was set against unlawful mainstream corporation tax
(“MCT”)?
IV. If the answer to (I)
is that EU law requires a tax credit to be set by reference to the overseas tax
actually paid, PAC seeks permission to cross-appeal on the following question:
should the charge to corporation tax on the foreign dividend income under Case
V of Schedule D (Income and Corporation Taxes Act 1988 (“ICTA”), section 18)
(“DV tax”) be disapplied, or should PAC be allowed to rely on FNRs, or on consolidated
effective tax rates, as a simplification or proxy for tax actually paid?
V. If HMRC are granted
permission to argue Issue III, PAC seek permission to cross-appeal on the
following questions:
(a) where ACT from a pool
which includes unlawful and lawful ACT is utilised against an unlawful MCT
liability, should the unlawful ACT be treated as a pre-payment of the unlawful
MCT liability, or is the ACT so utilised to be treated as partly lawful and
partly unlawful; and
(b) where domestic franked
investment income (“FII”) was carried back to an earlier quarter, is it to be
treated as having been applied to relieve the lawful and unlawful ACT pro rata,
or only lawful ACT?
Issue I
3.
The first issue - Issue I - arises from the approach adopted by
UK law in order to avoid or mitigate double taxation of dividends. It is now
clear that this was inconsistent with EU law, but in what precise respects and
what is due by way of restitution or compensation are live issues. The
inconsistency with EU law arose as follows. Domestically, dividends received by
one UK-resident company, the source of which was a distribution made by another
UK-resident company, were exempt from tax under section 208 of ICTA. The effect
is that corporation tax was only levied once, on the latter company which made the
profit out of which it distributed the dividend to the former company.
4.
In contrast, dividends received by a UK-resident company, the source of
which was an overseas company, were in principle subject to DV tax. But where
the UK-resident company controlled a certain percentage of the voting power of
the relevant overseas company (typically 10%), certain relief was given for
foreign tax paid on the underlying profits out of which such dividends were
paid. This was done either pursuant to a double taxation treaty or unilaterally
under ICTA, section 790. No relief against DV tax was however afforded in
respect of “portfolio” investments, that is investments involving lesser
percentage holdings.
5.
In Metallgesellschaft Ltd v Inland Revenue Comrs; Hoechst v
Inland Revenue Comrs (Joined Cases C-397/98 and C-410/98) EU:C:2001:134;
[2001] ECR I-1727; [2001] Ch 620, the European Court of Justice (“CJEU”) held
that the unharmonized domestic tax regime fell under the EC Treaty, and could
therefore be challenged if inconsistent with a Treaty provision. Pursuant to a
group litigation order dated 30 July 2003, PAC was on 13 November 2003
appointed to conduct the present test case, in which PAC’s primary contention
has been that the UK tax position is inconsistent with article 63 of the FEU
Treaty.
6.
Article 63FEU (ex article 56 of the EC Treaty) provides:
“1. Within the framework of
the provisions set out in this Chapter, all restrictions on the movement of
capital between member states and between member states and third countries
shall be prohibited.
2. Within the framework of
the provisions set out in this Chapter, all restrictions on payments between
member states and between member states and third countries shall be
prohibited.”
7.
At an early stage in the present case, a reference to the CJEU was found
necessary. But, before that reference was heard, the CJEU determined a separate
UK reference, in Test Claimants in the FII Group Litigation v Inland Revenue
Comrs (Case C-446/04) EU:C:2006:774; [2006] ECR I-11753; [2012] 2 AC 436 (“FII
ECJ I” - “FII” standing for franked investment income). In it, the CJEU
held, at paras 1 and 2 of the operative part:
“1. … where a member state
has a system for preventing or mitigating the imposition of a series of charges
to tax or economic double taxation as regards dividends paid to residents by
resident companies, it must treat dividends paid to residents by non-resident
companies in the same way.
[The Treaty provisions] do not
preclude legislation of a member state which exempts from corporation tax
dividends which a resident company receives from another resident company, when
that state imposes corporation tax on dividends which a resident company
receives from a non-resident company in which the resident company holds at
least 10% of the voting rights, while at the same time granting a tax credit in
the latter case for the tax actually paid by the company making the
distribution in the member state in which it is resident, provided that the
rate of tax applied to foreign-sourced dividends is no higher than the rate of
tax applied to nationally-sourced dividends and that the tax credit is at least
equal to the amount paid in the member state of the company making the
distribution, up to the limit of the amount of the tax charged in the member state
of the company receiving the distribution.
Article [63FEU] precludes
legislation of a member state which exempts from corporation tax dividends
which a resident company receives from another resident company, where that state
levies corporation tax on dividends which a resident company receives from a
non-resident company in which it holds less than 10% of the voting rights,
without granting the company receiving the dividends a tax credit for the tax
actually paid by the company making the distribution in the state in which the
latter is resident.
2. [The Treaty provisions]
preclude legislation of a member state which allows a resident company
receiving dividends from another resident company to deduct from the amount
which the former company is liable to pay by way of advance corporation tax the
amount of that tax paid by the latter company, whereas no such deduction is
permitted in the case of a resident company receiving dividends from a non-resident
company as regards the corresponding tax on distributed profits paid by the
latter company in the state in which it is resident.”
8.
This ruling was re-affirmed in the Reasoned Order by which the CJEU
disposed of the reference made by the High Court in the present case: Test
Claimants in the CFC and Dividend Group Litigation v Inland Revenue Comrs (Case
C-201/05) EU:C:2008:239; [2008] ECR I-2875; [2008] STC 1513. The issue of a
Reasoned Order, without a formal Advocate General’s opinion and with the same
juge rapporteur involved as in FII ECJ I, indicates that the CJEU saw
the position as relatively straightforward.
9.
In the light of these two decisions of the CJEU, it is common ground
that the UK’s treatment of overseas dividends was incompatible with EU law. In
a judgment in the present case, Prudential Assurance Co Ltd v Revenue
and Customs Comrs [2013] EWHC 3249 (Ch); [2014] STC 1236, Henderson J held
(para 148) that the appropriate means of rectifying this was for PAC to be
accorded an appropriate tax credit. (This was on the basis that a complete
exemption from UK corporation tax would go further than the CJEU had stated
that EU law required.) HMRC also accept that PAC is entitled to repayment or
restitution of any corporation tax unlawfully charged as a result of the
incompatibility: Amministrazione delle Finanze dello Stato v SpA San Giorgio
(Case C-199/82) [1983] ECR 3595 (“San Giorgio”). However, the amount to
be awarded depends significantly on issues of EU law and domestic law which are
either open or which HMRC seek to raise on this appeal.
10.
Issue I is whether the credit in respect of overseas dividends should
under EU law be set by reference to the overseas tax actually paid, as HMRC
submit, or by reference to the foreign nominal tax rate (“FNR”), as PAC
submits. HMRC rely in this connection upon the CJEU’s judgments in FII ECJ I
and on its Reasoned Order in the present case, as well as upon a further
judgment of the CJEU in Haribo Lakritzen Hans Riegel BetriebsgmbH v Finanzamt
Linz and Österreichische Salinen AG v Finanzamt Linz (Joined Cases
C-436/08 and C-437/08) EU:C:2011:61; [2011] ECR I-355; [2011] STC 917. In all
three cases, the juge rapporteur was Judge Lenaerts, now the President of the
CJEU. In HMRC’s submission, these cases demonstrate, first, a difference in
principle between portfolio investments, such as PAC held, and non-portfolio
investments, conferring a significant measure of control, and, secondly, that
at any rate in relation to portfolio investments the credit to be imputed to
PAC is in respect of the actual tax incurred overseas.
11.
In response, PAC relies upon a later CJEU decision in the FII litigation,
Test Claimants in the FII Group Litigation v Revenue and Customs Comrs
(formerly Inland Revenue Comrs) (Case C-35/11) EU:C:2012:707; [2013] Ch 431
(“FII ECJ II”). Judge Lenaerts was once again the juge rapporteur. In
this judgment, PAC submits, the CJEU refined its jurisprudence to require the
use of the FNR in respect of all dividends received by PAC from overseas. HMRC
in reply point out that FII ECJ II was concerned essentially with
non-portfolio dividends, and criticise some aspects of its reasoning,
particularly its treatment of Haribo. Finally, HMRC submit that the
European legal position is unclear, and requires a further reference to the
CJEU.
12.
There are further issues which HMRC seek to attach to Issue I. The
first, identified before us as “issue 4 CA”, is whether, when considering the
relevant overseas tax position, attention should focus on the overseas company
directly responsible for the remission of the dividend to the UK (the overseas
“water’s edge” company) or on the overseas company (or companies) responsible
for generating the profits out of which such dividend was paid and on which it
(or they) paid tax overseas. The second issue, which HMRC submit that the
Supreme Court should “take into account”, was identified as “issue 6 CA”, and
is whether any difference has been shown to exist between the effective rate
incurred by domestic companies declaring dividends to PAC and the nominal rate
payable by UK companies. This is relevant, HMRC submit, because the existence
of such a difference was a reason why the CJEU indicated in FII ECJ II
that it was appropriate to give a credit for the FNR, rather than the actual
tax, incurred on an overseas dividend. PAC submits that neither of issues 4 CA
and 6 CA is open in this court. The Court of Appeal refused permission for
either issue to be raised before it, and neither issue is properly part of or
essential to the resolution of Issue I.
13.
The CJEU in FII ECJ I and in its Reasoned Order in the present
case clearly established that the discrimination involved in the UK’s
arrangements for taxation of dividends sourced domestically and from overseas
could be resolved by a mixed system, whereby dividends with a domestic source
remained exempt, while credit was given against DV tax for tax actually
incurred overseas on dividends received from overseas.
14.
HMRC point out that the CJEU in FII ECJ I addressed separately
the position of dividends received from non-portfolio and from portfolio
companies. In relation to the former, the question arose whether a mixed system
of exemption in respect of domestically sourced dividends coupled with a credit
in respect of dividends received from overseas was compatible with EU law. The
CJEU dealt with this at paras 46 to 57. The claimants drew attention to the
situation arising if, under the relevant UK legislation, such an exemption was
granted in respect of a nationally-sourced dividend received from a company which
for some reason had no corporation tax liability or paid corporation tax at a lower
rate than the normal UK rate (para 54). The CJEU understood the UK Government
to explain that this arose only exceptionally (para 55), and on that basis
contented itself with saying (para 56):
“In that respect, it is for the
national court to determine whether the tax rates are indeed the same and
whether different levels of taxation occur only in certain cases by reason of a
change to the tax base as a result of certain exceptional reliefs.”
15.
The inference seems to be that, were a significant difference to exist
between the effective rate of tax paid by the UK source of the dividend (eg
because of some relief or allowance available to the company which was the source
of the dividend) and the nominal rate of tax to which the exemption under
section 208 of ICTA applied, then a system of credit in respect of
overseas-sourced dividends which limited the tax credit to tax actually paid
overseas (ie the effective rate of tax) would not be consistent with EU law -
because the overseas-sourced dividend would remain liable for any DV tax
chargeable after the credit had been taken into account. In other words, the
overseas-sourced dividend would not be enjoying, under the tax credit system,
any relief or allowance which had reduced the tax actually paid on it, whereas
the UK-sourced dividend would enjoy any such relief or allowance.
16.
In respect of portfolio dividends, the CJEU faced a more fundamental
objection. The UK system was inherently discriminatory, because it failed to
give any credit at all for overseas tax paid (paras 61 to 72). The CJEU gave
short shrift to the UK Government’s argument that practical difficulties in
ascertaining the tax actually paid justified a different system for portfolio
dividends.
17.
It does not however follow from the separate treatment of non-portfolio
and portfolio holdings in FII ECJ I that the CJEU saw any significant
difference between them regarding the manner in which the deficiencies in the UK
tax system needed to be addressed. It is true that the judgment in Haribo
in February 2011 concerned portfolio dividends; following FII ECJ I and
the Reasoned Order in the present case, it spoke of the need to credit tax
actually paid. But it was only in FII ECJ II, where the focus was on
non-portfolio holdings, that the CJEU identified the FNR as a more relevant
criterion in any context. That therefore in no way indicates that the FNR is
not also relevant to portfolio investments.
18.
As a matter of logic and principle, there seems no basis in this
connection for any distinction between portfolio and non-portfolio holdings,
when applying the mixed system of domestic exemption coupled with a credit in
respect of overseas-sourced dividends to each. Rather than concentrating on the
practical difficulties advanced before the CJEU in FII ECJ II, HMRC now
suggest that there are important differences in the approaches and expectations
which investors would have with regard to portfolio investments, when compared
with non-portfolio investments. There are of course differences between
holdings giving a degree of control and smaller holdings, but it is not obvious
what relevance they have to the question of central interest on this appeal:
that is, the proper treatment of domestically-sourced and overseas-sourced
dividends so as to avoid unfair discrimination between them.
19.
The CJEU’s change of approach in FII ECJ II arose from correction
of the misunderstanding evidenced in paragraph 54 in FII ECJ I. Far from
being exceptional, it had been established conclusively that it was commonly
the position in the UK that a company’s effective rate of tax was (due for
example to group relief, or the carry forward of trading losses or other
reasons) less than the nominal tax rate, and on that basis it was held that the
UK tax system infringed what is now article 63: Test Claimants in the FII
Group Litigation v Revenue and Customs Comrs [2008] EWHC 2893 (Ch); [2009] STC 254 (“FII High Court I”), affirmed [2010] EWCA Civ 103; [2010] STC 1251 (“FII CA”).
20.
Pursuant to an order for a further reference made by Henderson J on 20
December 2010, it became necessary for the CJEU to address the implications.
The European Commission in written submissions in FII ECJ II said (para
28) that in circumstances where the effective rate borne by the company making
the profits from which the dividend came was lower than the nominal rate:
“28. …
to exempt domestic dividends (which in effect amounts to giving credit for the
full amount of tax at the statutory rate even where this full amount has not
been paid) while giving credit only for the actual amount of tax paid in
respect of the profits giving rise to foreign dividends results in more
favourable treatment for domestic dividends.”
21.
The Commission drew from this (para 29) that:
“29. … It can no longer be
said that the credit method is equivalent to exemption, because foreign
dividends receive less favourable treatment than domestic dividends. To
understand why, let us imagine identical resident and non-resident companies
which each have revenues of 100 and have, say, a loss carry-forward of 50. The
tax rate is 30% in both the source and residence states. A company which is a
shareholder in the resident company and receives a dividend from it will have
no further tax obligation, even though that company has paid only 15 in tax
(that is, has an effective rate of 15%). A shareholder in the non-resident
company will receive a credit equivalent to only 15% and will have to pay an additional
15%. The same result will ensue where both states grant, for example, an
identical research and development incentive. That is not equal treatment, and
it constitutes a serious obstacle to outward investment.”
22.
The Commission then discussed how the problem might be addressed (paras
31-34):
“31. In such circumstances
there seem to the Commission to be two ways of ensuring equal treatment. One is
to exempt both domestic and foreign dividends. That solution has the drawback,
as outlined above, that it may permit excessively favourable treatment of
foreign dividends where the tax rate in the source state is lower than in the
United Kingdom. The other, which is wholly consistent with the court’s
reasoning in Case C-446/04 [‘FII ECJ I’], is to have regard solely to
the nominal rate of tax in calculating the tax credit on foreign dividends.
32. That is to say,
recipients of such dividends should receive a tax credit representing the
amount which would flow from the application of the nominal rate of tax in the
source state to the accounting profits of the distributing company. Such a
measure would correspond more truly to the exemption of domestic dividends,
since the latter amounts in effect to the grant of a credit for tax at the
nominal rate. The court has seen and approved a measure of this kind in Joined
Cases C-436/08 and C-437/08 Haribo, judgment of 10 February 2011 … see
point 99 of the judgment. It would no doubt be desirable for a member state
applying such a measure to insert a safeguard clause limiting its scope to
dividends distributed by a company which is subject to the normal system of
taxation in the source state.
33. It should be noted that
such a measure would also alleviate to a very large extent the administrative
burden faced by taxpayers in relation to foreign dividends, especially
taxpayers with small shareholdings.
34. Such a solution does not
ensure substantive equal treatment in all cases. In particular, where the tax
system in the source state is a simple one in which the effective rate is
systematically the same as the nominal rate (because the tax base is constituted
by accounting profits, with no modifications), foreign dividends will treated
less favourably than domestic dividends, since the latter will benefit from any
tax advantages enjoyed by the distributing company. However, to ensure full substantive
equal treatment would require systematic re-calculation of the tax position of
the foreign company - essentially a simulation of the tax which it would have
paid were it resident in the United Kingdom. Such an approach seems impractical.
The solution advocated by the Commission ensures formal equality of treatment,
is easy to apply and achieves a fair result.”
It is worth noting in passing para 33. The Commission
evidently had no doubt about the relevance of its proposed solution to overseas
portfolio holdings.
23.
It was a neat solution which evidently appealed to the juge rapporteur,
who (according to the informal transcript with which the Supreme Court has been
supplied) put to counsel for the UK a series of points, starting with this “very
simple” question:
“… does such an exemption system
not in fact come down to as Mr Lyal said, ‘tantamount
to’ a credit system applied at the normal rate of tax applicable to the taxing
of those dividends with the shareholding company?”
Judge Lenaerts went on to put that an
exemption system does more than a system crediting tax actually paid, because
“It gives more relief than the tax
actually paid by the distributing company and … when you say that you have an
exemption system, in fact, you exonerate from any tax liability, you exempt
from any tax liability, the shareholding companies at the rate applicable to
the taxing of dividends with that shareholding company.”
The reasoning was the same as the Commission’s.
24.
Subsequently various questions were put by Advocate General Jääskinen to
Mr Lyal for the Commission. The Advocate General expressed some doubt whether
the Commission’s proposed solution was really consistent with the CJEU’s
previous judgment. He suggested that it would seem to work if there was
equivalence of both the domestic and the overseas nominal and effective tax
rates, but pointed to a risk of distortion if the nominal and effective tax
rates were similar in one state, but diverged significantly in the other. Mr
Lyal’s response was:
“Yes, my Lord, that’s quite right.
That’s a danger. It is a danger that can be minimised, if what I said a moment
ago about recognizing only the type of tax benefits or discounts or manners of
calculation that are recognized in the state of residence of the parent. The
practical likelihood of the problem is to some extent limited to the extent
that there is something of a correlation between higher taxes, higher company
tax rates and lots of discounts, and equally a correlation between lower
company tax rates and broad tax bases. So, if there is a source company in
Slovakia, say, which has set their tax at, whatever their rate now is, 17%,
perhaps, one can be pretty sure that it’s 17% on accounting profits. And
thirdly, this is after all said to be a rough equivalent because the only other
practical option that I can see for a rough equivalent of the domestic exemption
is exemption for foreign-source dividends as well which would compound the
problem that your Lordship refers to. That is to say you would not only have
the freedom from taxation represented by the difference between the lower rate,
the lower effective rate and [?in] the source state, but also the difference
between the statutory rate in the UK and the lower statutory rate. So, again,
the problem that your Lordship advances is certainly a correct one, but in
circumstances in which the resident state applies an exemption system, we need
to find something that gives substantive equivalent taxation for inbound
dividends, a measure of which focuses on the actual tax, the effective rate of
tax borne by inbound dividends simply is not equivalent.”
25.
Against this background, the CJEU in FII ECJ II addressed the
problem as follows. First, it pointed out (paras 43 to 48) that the tax rate
applied to foreign-sourced dividends would be higher than that applied to
domestic-sourced dividends, and their equivalence compromised, if the resident
company generating the dividends was subject to either a nominal or an
effective rate of tax below that to which the resident company receiving the
dividends was subject, since in a case where an overseas company generating
dividends was subject to an effective tax rate lower than the UK nominal rate,
the difference would be chargeable to DV tax. On this basis, it explained that
in its judgment in FII ECJ I, para 56, the reference to the “tax rates”
related to the nominal rate of tax while the reference to the “different levels
of taxation … by reason of a change to the tax base” related to the effective
levels of taxation.
26.
The CJEU in FII ECJ II, after stating why such discrimination
could not be justified under EU law as necessary to preserve the cohesion of
the domestic tax system, then adopted use of the FNR as an acceptable solution
in the following paragraphs:
“61. The tax exemption to
which a resident company receiving nationally-sourced dividends is entitled is
granted irrespective of the effective level of taxation to which the profits out
of which the dividends have been paid were subject. That exemption, in so far
as it is intended to avoid economic double taxation of distributed profits, is
thus based on the assumption that those profits were taxed at the nominal rate
of tax in the hands of the company paying dividends. It thus resembles grant of
a tax credit calculated by reference to that nominal rate of tax.
62. For the purpose of
ensuring the cohesion of the tax system in question, national rules which took
account in particular, also under the imputation method, of the nominal rate of
tax to which the profits underlying the dividends paid have been subject would
be appropriate for preventing the economic double taxation of the distributed
profits and for ensuring the internal cohesion of the tax system while being
less prejudicial to freedom of establishment and the free movement of capital.
63. It is to be observed in
this connection that in the Haribo case [2011] ECR I-305, para 99, the court,
after pointing out that the member states are, in principle, allowed to prevent
the imposition of a series of charges to tax on dividends received by a
resident company by applying the exemption method to nationally-sourced
dividends and the imputation method to foreign-sourced dividends, noted that
the national rules in question took account, for the purpose of calculating the
amount of the tax credit under the imputation method, of the nominal rate of
tax applicable in the state where the company paying dividends was established.
64. It is true that
calculation, when applying the imputation method, of a tax credit on the basis
of the nominal rate of tax to which the profits underlying the dividends paid
have been subject may still lead to a less favourable tax treatment of
foreign-sourced dividends, as a result in particular of the existence in the
member states of different rules relating to determination of the basis of
assessment for corporation tax. However, it must be held that, when
unfavourable treatment of that kind arises, it results from the exercise in
parallel by different member states of their fiscal sovereignty, which is
compatible with the Treaty …
65. In light of the
foregoing, the answer to the first question is that articles 49FEU and 63FEU
must be interpreted as precluding legislation of a member state which applies
the exemption method to nationally-sourced dividends and the imputation method
to foreign-sourced dividends if it is established, first, that the tax credit
to which the company receiving the dividends is entitled under the imputation
method is equivalent to the amount of tax actually paid on the profits
underlying the distributed dividends and, second, that the effective level of
taxation of company profits in the member state concerned is generally lower
than the prescribed nominal rate of tax.”
27.
These paragraphs are generally stated, and there is no reason why they
should not be as applicable to portfolio holdings as they are to non-portfolio
holdings. There is no hint of any distinction between portfolio and non-portfolio
holdings. If any had been intended, one would have expected it to be mentioned,
particularly when the same juge rapporteur was active in all four of the key
decisions, covering between them both types of holding. Instead, in para 63 of FII
ECJ II, quoted above, reliance is actually placed on Haribo, a case
of portfolio holdings, in support of the use of the FNR. The reliance may, as
Mr David Ewart QC for HMRC submitted, be misplaced, achieving a coherence in
the development of the jurisprudence that is more apparent than real - because
the reference to FNR in Haribo was in the context of a simplified method
permitted by the Austrian tax authorities to show the tax actually paid. But
that is presently irrelevant. What matters is that the CJEU in FII ECJ II
presented its development of the law in the context of non-portfolio holdings
as being in line with, and supported by, its previous jurisprudence in the
context of portfolio holdings. It is inconceivable that it contemplated any
material distinction in the principles applicable to both. It follows that,
subject to one reservation, the CJEU’s jurisprudence establishes clearly that
the credit for foreign dividends in the present case should be by reference to
the FNR, rather than by reference to the actual or effective tax incurred
overseas.
28.
The one reservation arises from the assumption made throughout the
discussion in FII ECJ II, that, in the Commission’s words (para 20
above): “to exempt domestic dividends … in effect amounts to giving credit for
the full amount of tax at the statutory rate even where this full amount has
not been paid;” or in Judge Lenaerts’ words (para 23 above) that “an exemption
system does more than a system crediting tax actually paid by the distributing
company”.
29.
This assumption is readily understandable, if one also assumes that the
domestic company which is the source of and distributes the dividend has an
effective tax rate less than the nominal tax rate, while the receiving company which
is exempted from tax would, but for the exemption, pay tax at the full nominal
rate. There is then a benefit from the exemption, which would have no parallel
if the credit in respect of overseas-sourced dividends was by reference only to
the actual tax incurred overseas. However, in the UK domestic context, there
appears to be no reason to think that companies receiving domestically-sourced
dividends are any less able to reduce the effective tax rate they would have
borne on such dividends than are the companies from which the dividend is
sourced. In other words, the evidence appears to have been that all UK
companies are generally taxed at an effective level below the nominal rate.
That being so, the domestic exemption does not confer a benefit at the nominal
rate, but at their effective rate.
30.
It follows that to give a credit for overseas dividends at the FNR may
confer a benefit on overseas dividends, compared with domestic dividends. By
way of example, given by HMRC, one can suppose an overseas water’s edge company
with a nominal tax rate of 20% and an effective rate of 10%, which makes a
profit after tax of 100 and distributes a dividend of 100. The UK recipient
company has a nominal rate of 30%, but an effective tax rate of 20%. One would
expect the UK company to bear a 10% charge on the dividend to reflect the
higher tax rate charged in the UK (and that is so, whether one is looking at
and comparing the nominal or the effective tax rate in this connection). But a
tax credit can necessarily only reduce the tax which would actually otherwise
be charged. Here, since the UK company’s effective tax rate is only 20%, the
effect of giving credit to the UK company for the FNR of 20% is in fact to
eliminate any UK tax charge.
31.
Does this reservation about the rationale and solution adopted by the
CJEU mean that we should once again refer the case back to the CJEU, for it to
reconsider once again whether its approach is appropriate? In our opinion, it
does not. It is clear that the CJEU was well aware that the adoption of the FNR
would not eliminate all inequities or incongruities: see the Commission’s
written observations, para 34, cited in para 22 above, the Advocate General’s
question put to Mr Lyal and Mr Lyal’s answer cited in para 24 above and the
CJEU’s own judgment, para 64, cited in para 26 above. There could, depending on
the incidence of nominal and effective tax rates, be swings and roundabouts in
the equivalence achieved by a mixed system of domestic exemption combined with
overseas credits. But the “ideal” alternative of a comparison between two tax
systems to ensure equivalence (subject only to each state’s right to set its
own nominal tax levels) was consciously rejected as wholly impractical. In
these circumstances, such inequity as may arise from the reservation discussed
in the previous three paragraphs is not in our view a reason for referring the
matter yet again to the CJEU. The prospect that the CJEU would, at this stage
in history, contemplate revising yet again its jurisprudence appears to us
negligible to the point where it can be discarded.
32.
We turn finally to the two further issues which HMRC suggest should be
taken into account, and should lead to or encourage the making of a reference.
The short answer in relation to each is that permission to raise it before the
Court of Appeal was specifically refused by that court: [2016] EWCA Civ 376;
[2016] STC 1798. In these circumstances, there is no constitutional basis for
consideration of either before the Supreme Court: Access to Justice Act 1999,
section 54(4), Supreme Court Practice Direction No 1 para 1.2.5. Issue I at
first instance might have been wide enough to embrace one or both of issues 4
CA and 6 CA, since it asked inter alia what the appropriate amount of any tax
credit required was, but in fact neither issue was raised at the trial before
Henderson J. Issue 6 CA was first raised six weeks after the trial by
letter to the judge, who refused permission to appeal on it. Issue 4 CA only
emerged as ground 2 in HMRC’s Grounds of Appeal to the Court of Appeal. The
Court of Appeal expressly refused permission to appeal to it on Issues 4 and 6
CA, and the declaration it made read simply that (para 99):
“… the effect of the rulings of
the CJEU is that the foreign dividend should be afforded equivalent treatment,
taking the form of the imputation method according to which credit should be
given for the relevant foreign tax at the effective rate [ie the actual tax
paid] or the nominal rate (whichever is the higher), subject to a cap at the
rate of the UK’s nominal rate of ACT [ie the corporation tax rate or the rate
of ACT as applicable].”
This declaration does not address or require the Supreme
Court to address either of Issues 4 and 6 CA. (In the event, the Supreme Court
has not even been asked to address the question whether the Court of Appeal was
right to declare that credit required to be given for the higher of the
effective and nominal foreign rate, that issue being we were told of no present
relevance, but reserved for a further instalment of the FII litigation.)
Issue IV
33.
It is however appropriate at this point to deal with Issue IV which
is before the Supreme Court. That is whether, if PAC had no entitlement under
EU law to a credit by reference to the FNR, effect should, in the light of what
is said to be the impossibility of showing the tax actually borne by its
portfolio holdings, be given to the CJEU’s judgments either: (a) by disapplying
the DV charge; or (b) by allowing PAC to rely on FNRs (or consolidated
effective tax rates) as a simplification or proxy for tax actually paid. The
short answer to this issue is that it does not arise or need answering, having
regard to our conclusion that PAC is entitled to credit in respect of
overseas-sourced dividends by reference to the FNR.
Issue II: Introduction
34.
PAC seeks restitution, on the ground of unjust enrichment, of an amount
calculated on the basis of compound interest, in respect of each category of claim
which has succeeded. The amounts on which interest is sought, and the periods
over which it is submitted that interest should be compounded, are as follows:
(a) unlawfully levied
ACT which was subsequently set off against lawfully levied MCT, from the date
of payment by PAC to the date of set-off;
(b) all other unlawfully
levied tax (including unlawfully levied ACT which was never set off against
lawful MCT, and unlawfully levied ACT which was set off against unlawfully
levied MCT), from the date of payment by PAC to the date of repayment by HMRC;
and
(c) the time value of utilised
ACT (resulting from (a) above), from the date of set-off to the date of payment
by HMRC.
PAC submits that the interest should be compounded at
conventional rates calculated by reference to the rates of interest, and rests,
applicable to borrowings by the Government in the market during the relevant
period, that being the approach favoured by a majority of the House of Lords in
Sempra Metals Ltd v Inland Revenue Comrs (formerly Metallgesellschaft
Ltd) [2007] UKHL 34; [2008] 1 AC 561.
35.
HMRC have accepted that compound interest is payable in respect of the
utilised ACT falling within category (a) above, since that is what the House of
Lords decided in Sempra Metals. PAC submits that the principles set out
in Sempra Metals entail that the same approach should also apply to the
amounts falling within categories (b) and (c) above. HMRC, on the other hand,
submit that only simple interest should be awarded, in accordance with section
35A of the Senior Courts Act 1981 (“the 1981 Act”), inserted by the
Administration of Justice Act 1982, section 15(1) and Schedule 1, Part I. An
award of interest on that basis would, they argue, be compatible with the
requirement under EU law that PAC should receive an “adequate indemnity”, in
accordance with the decision of this court in Littlewoods Ltd v Revenue and
Customs Comrs [2017] UKSC 70; [2017] 3 WLR 1401.
36.
Although the difference between simple and compound interest is modest
in the present case, the point also arises in other cases which are pending
against HMRC, and the total amount at stake, on HMRC’s estimate, is of the
order of £4-5 billion. The point is also one of considerable importance from a
legal perspective, since it raises some fundamental issues in the law of unjust
enrichment.
The approach of the courts below
37.
In a careful judgment, Henderson J held that compound interest should be
awarded in respect of all three categories of claim, on the basis that,
applying the reasoning of the majority in Sempra Metals, PAC was
entitled on the ground of unjust enrichment to compound interest on all its
claims: [2013] EWHC 3249 (Ch); [2014] STC 1236, paras 242-246. His Lordship
subsequently followed that decision in other proceedings, concerned with the
recovery of VAT paid under a mistake: Littlewoods Retail Ltd v Revenue and
Customs Comrs [2014] EWHC 868 (Ch); [2014] STC 1761, para 417. That
paragraph was then expressly approved by the Court of Appeal in the Littlewoods
proceedings: Littlewoods Ltd v Revenue and Customs Comrs [2015] EWCA Civ 515; [2016] Ch 373; [2015] STC 2014, paras 203-204. When the present case
reached the Court of Appeal, it dismissed the appeal on this issue on the basis
that it was bound by its previous decision in the Littlewoods case. So
the only detailed consideration of this issue, in the context of the present
case, has been that of Henderson J.
38.
It is only necessary to add that, following the decision of this court
in the Littlewoods proceedings (Littlewoods Ltd v Revenue and Customs
Comrs [2017] UKSC 70; [2017] 3 WLR 1401), which reversed the decision of
the Court of Appeal, it is no longer argued that there is a right to compound
interest under EU law.
A preliminary point
39.
As a preliminary point, PAC submits that HMRC should not be permitted to
advance an argument to the effect that the opportunity to use money mistakenly
paid is not a benefit obtained at the expense of the person who made the
mistaken payment. They point out that HMRC did not advance any argument
along these lines at the trial before Henderson J in 2013. On the contrary, it
was conceded in advance of the trial that PAC was entitled to compound interest
in respect of the claims in category (a), following Sempra Metals, and
that position was maintained in the agreed Statement of Facts and Issues.
Although HMRC do not seek to withdraw that concession, PAC submits that the
proposed argument challenges the reasoning in Sempra Metals, and
therefore the basis on which the concession was made. Against this background,
it is submitted that HMRC should not be permitted to advance this argument for
the first time in this court.
40.
In so far as HMRC wish to advance submissions questioning the soundness
of the reasoning in Sempra Metals, the court is not inclined to prevent
them from doing so, in the particular circumstances of this case. As will be
explained, there have been some significant developments in the law of unjust
enrichment since the trial before Henderson J, and indeed since the present
appeal was brought. In particular, the concept of a benefit being obtained at
the expense of the claimant, and the related concept of a transfer of value,
were considered by this court only relatively recently. In this appeal, PAC
invites the court to extend the reasoning in Sempra Metals beyond the
scope of that decision itself, albeit PAC submits that the extension is the
logical consequence of that decision. The appeal therefore involves analysing
the reasoning in Sempra Metals, and unavoidably requires the court to
consider whether that reasoning is consistent with the approach which it has
more recently adopted, so as to form part of a coherent body of law. As we
explain later, there is indeed a difficulty involved in reconciling Sempra
Metals with this court’s more recent case law. Accordingly, even if HMRC
had not wished to subject the decision in Sempra Metals to critical
analysis, that is an exercise which this court could not have avoided. In
addition, it is important to bear in mind that this appeal has to be decided in
the context of a group litigation order, and also that the point of law which
HMRC wish to argue is undoubtedly one of general public importance.
41.
We do not consider that allowing these matters of law to be argued
involves unfairness to PAC. The essence of HMRC’s argument was set out in the
written case which they submitted in advance of the hearing of the appeal,
although, as often happens, the argument was refined during the hearing.
What did Sempra Metals decide?
42.
The issue in Sempra Metals was how effect should be given in
domestic law to the judgment of the CJEU in the Metallgesellschaft case (Metallgesellschaft
Ltd v Inland Revenue Comrs (Joined Cases C-397/98 and C-410/98)
EU:C:2001:134; [2001] Ch 620; [2001] ECR I-1727) (Sempra Metals Ltd being the
same company, under a new name, as Metallgesellschaft Ltd). The case concerned
claims for compound interest in respect of unlawfully levied ACT which had been
set off against lawful MCT: in other words, claims falling within category (a)
above. The CJEU made it clear that it was for domestic law to determine the
juridical basis of the claims: in particular, whether they lay in restitution
or in damages. On the hypothesis that, under domestic law, the appropriate
basis was restitution, the CJEU stated:
“87 … In such circumstances,
where the breach of Community law arises, not from the payment of the tax
itself but from its being levied prematurely, the award of interest represents
the ‘reimbursement’ of that which was improperly paid and would appear to be
essential in restoring the equal treatment guaranteed by article 52 of the [EC]
Treaty.
88. The national court has
said that it is in dispute whether English law provides for restitution in
respect of damage arising from loss of the use of sums of money where no
principal sum is due. It must be stressed that in an action for restitution the
principal sum due is none other than the amount of interest which would have been
generated by the sum, use of which was lost as a result of the premature levy of
the tax.”
Equally, on the hypothesis that the claim properly lay in
damages, the argument that the claimants could not be awarded interest could
not be accepted.
43.
Giving effect to the judgment of the CJEU, the lower courts held that
the claimants were entitled to recover compound interest on the ACT in respect
of the period between the date of payment and the date of set-off. They also
expressed the view, obiter, that the same principles should apply to claims in
respect of unutilised ACT, falling within category (b) above.
44.
HMRC’s appeal to the House of Lords was dismissed ([2008] AC 561). For
varying reasons, the House held, by a majority, that a claim would lie in
unjust enrichment for restitution of compound interest on money which had been paid
prematurely as the consequence of a mistake, and that the appropriate measure
of restitution in the instant case was compound interest calculated on a
conventional basis applicable to government borrowing. The House also held that
compound interest was available as damages, where it was the measure of the
loss foreseeably suffered by the claimant from the loss of the use of his
funds. That aspect of the decision is not in issue in the present case and need
not be considered.
45.
Lord Nicholls of Birkenhead and Lord Hope of Craighead, who were in the
majority on the question of unjust enrichment, emphasised that the interest was
not ancillary to a claim for the recovery of a principal sum: rather, the
interest was itself the principal sum, claimed as restitution of the time value
of money. They interpreted the CJEU’s judgment in Metallgesellschaft as
meaning that EU law required, as Lord Hope put it at para 9, that “the
companies must be provided with a remedy in domestic law which will enable them
to recover a sum equal to the interest which would have been generated by the
advance payments from the date of the payment of the ACT until the date on
which the MCT became chargeable”: see also, to the same effect, the speech of
Lord Nicholls at para 60. In that regard, both Lord Hope and Lord Nicholls
referred to para 88 of the judgment of the CJEU, cited above. Lord Nicholls
identified the crux of the dispute, at paras 71-73, as being whether the
provision English law made for the payment of interest satisfied the EU
principle of effectiveness.
46.
Lord Hope and Lord Nicholls adopted similar analyses of the basis of the
claim in unjust enrichment, at paras 33 and 102 respectively. Lord Hope
described the Revenue’s enrichment at para 33 as “the opportunity to turn the
money to account during the period of the enrichment”. Lord Nicholls analysed
the issue in terms of Professor Birks’s theory of unjust enrichment by
subtraction (that is, at the expense of the claimant), and stated at para 102:
“The
benefits transferred by Sempra to the Inland Revenue comprised, in short, (1)
the amounts of tax paid to the Inland Revenue and, consequentially, (2) the
opportunity for the Inland Revenue, or the Government of which the Inland
Revenue is a department, to use this money for the period of prematurity. The
Inland Revenue was enriched by the latter head in addition to the former. The payment
of ACT was the equivalent of a massive interest free loan. Restitution, if it
is to be complete, must encompass both heads. Restitution by the Revenue
requires (1) repayment of the amounts of tax paid prematurely (this claim became
spent once set off occurred) and (2) payment for having the use of the money for
the period of prematurity.”
47.
Since the enrichment which had to be undone was the opportunity to turn
the money to account during the period before it was lawfully due, it followed
that the measure of the enrichment did not depend on what HMRC actually did
with the money during that period (Lord Hope at para 33, Lord Nicholls at para
117). In that connection, Lord Nicholls drew an analogy at para 116 with the
award of “user damages”, although such awards are based on wrongdoing and are
designed to compensate for loss: One Step (Support) Ltd v Morris-Garner [2018] UKSC 20; [2018] 2 WLR 1353, para 30. In the ordinary course, the market value
of the benefit arising from having the use of money was said to be the cost the
defendant would have incurred in borrowing the amount in question for the
relevant period: a sum which, like all borrowings, would inevitably be
calculated in terms of compound interest (Lord Nicholls at para 103). The court
could however depart from the market value approach if it were established that
it would produce an unjust outcome (Lord Hope at para 48, Lord Nicholls at para
119).
48.
Lord Hope and Lord Nicholls proceeded on the basis of a presumption that
the innocent recipient of a mistaken payment has benefited from the use of the
money, the value of the benefit being the market cost of borrowing the money
over the relevant period. The onus is on the defendant to displace that presumption.
The innocent recipient, rather than the mistaken payer, is thus exposed to the
risks of litigation.
49.
Lord Nicholls acknowledged at para 125 that the decision might have
serious consequences for public finances, because of the extended limitation
period available in cases of mistake, but considered that the issue had been
addressed by legislation:
“The seriously untoward
consequences this may have for the Inland Revenue flow from the open-ended
character of the extended limitation period prescribed by section 32(1)(c) of
the Limitation Act 1980. Parliament has now recognised this extended period
should not apply to payments of tax made by mistake: see section 320 of the
Finance Act 2004.”
50.
Lord Walker of Gestingthorpe stated that he was essentially in agreement
with Lord Hope and Lord Nicholls (para 154), and that he too would dismiss the
appeal, “largely for the reasons which they give”. He also observed that the
“crucial insight” in their speeches was the recognition that income benefits
were more accurately characterised as an integral part of the overall benefit
obtained by a defendant who is unjustly enriched (para 178). He went on,
however, to state that he must confess that his own inclination would be to
extend the equitable jurisdiction to award compound interest, rather than to
recognise a restitutionary remedy available as of right at common law (para
184). He added that he “felt some apprehension” about the suggested conclusion
that compound interest should be available as of right, subject only to an
exception for “subjective devaluation”.
51.
The other members of the Appellate Committee disagreed with the
majority. Lord Scott of Foscote rejected the view that “the mere possession of
mistakenly paid money - and accordingly the ability to use it if minded to do
so - is sufficient to justify not simply a restitutionary remedy for recovery
of the money, but a remedy also for recovery of the wholly conceptual benefit
of an ability to use the money” (para 145). A restitutionary remedy could not
in his view encompass the recovery of anything other than the money which the
defendant had actually received. In reality, in his view, Sempra was asserting
a claim for compensation for its loss of the use of the money, dressed up as a
claim in restitution in order to take advantage of the more generous limitation
period allowed by section 32(1)(c) of the Limitation Act 1980 (“the 1980 Act”).
52.
Lord Mance also noted the practical context of the issue. The basis on
which Sempra principally put their claim was that they had paid the ACT under a
mistake of law. On that basis, section 32(1)(c) of the 1980 Act would postpone
the commencement of the limitation period until the time when Sempra discovered
or could with reasonable diligence have discovered that the ACT was not due: a
time which they identified with the date in 2001 when the CJEU issued its
judgment in the Metallgesellschaft case. Lord Mance commented (para 200)
that the appropriateness of an extended time limit in this context was
questionable. As he noted, Lord Hoffmann had recognised in the Kleinwort
Benson case (Kleinwort Benson Ltd v Lincoln City Council [1999] 2 AC 349, 401) that “‘allowing recovery for mistake of law without qualification,
even taking into account the defence of change of position, may be thought to
tilt the balance too far against the public interest in the security of
transactions’, adding that ‘the most obvious problem is the Limitation Act,
which as presently drafted is inadequate to deal with the problem of
retrospective changes in law by judicial decision’”. Like Lord Nicholls, Lord
Mance noted that, as regards the future (although not as regards the instant
case), section 320 of the Finance Act 2004 meant that section 32(1)(c) of the
1980 Act would no longer apply to mistakes of law relating to a taxation matter
under the care and management of HMRC.
53.
Like Lord Walker, Lord Mance cautioned against a radical reshaping of
the law, observing at para 205 that “we must navigate using the reference
points of precedent, Parliamentary intervention and analogy, and we should bear
in mind the limitations of judicial knowledge and the assistance offered by a
series of Law Commission reports”. European law left it, in his view, to
national law to provide an effective remedy and did not prescribe that this
should be by way of compound, rather than simple, interest (paras 201-204). The
common law had recognised a claim for money had and received, but not a claim
for the use of money had and received. A claim of the latter kind faced a long
line of authority over a period of nearly 200 years, including the recent
decision of the House in Westdeutsche Landesbank Girozentrale v Islington
London Borough Council [1996] AC 669 (paras 203-220). The common law rule
had been recognised and effectively endorsed by the Law Revision Committee,
whose recommendations on interest in their Second Interim Report, 1934 (Cmd
4546) were implemented by provisions of the Law Reform (Miscellaneous
Provisions) Act 1934 (later replaced by section 35A of the 1981 Act) (paras 211-212),
by the Law Commission in all its reports on the subject (paras 222-224), and
most importantly by Parliament, which had legislated in recent times for the
payment of interest, but invariably on a simple basis (paras 212 and 221).
There were in addition policy reasons making it unwise to introduce an absolute
right to compound interest in restitution. As the Law Commission had noted,
compound interest evoked deep-seated fears, because it increased in an
exponential rather than a linear way, especially during periods of high
inflation (para 222). In the light of such concerns, the Law Commission had
made a number of recommendations relating to the introduction of a right to
compound interest on a restricted basis. Those recommendations had not been
acted on (para 224).
54.
The decision of the House on the issues relevant to the present appeal
can therefore be summarised as follows:
(1) By a majority
consisting of Lord Hope, Lord Nicholls and Lord Walker, the House held that the
court had jurisdiction at common law (Lord Hope and Lord Nicholls) or at least
in equity (Lord Walker) to make an award on the ground of unjust enrichment in
respect of the time value of money which was paid prematurely as the
consequence of a mistake. The basis of the award was that the benefit by which
the recipient of the money was enriched was the time value of the money. The
benefit was presumptively quantified as the market value of the use of the
money during the period before it was lawfully due, that is, the cost of
borrowing an equivalent amount in the market.
(2) The same majority
held that:
(a) in the instant case,
the presumption that the Government had benefited from the premature payment of
the tax had not been displaced; but
(b) the Government was
in a different position from ordinary commercial borrowers, in that it could
borrow at more favourable rates; and accordingly
(c) the claims should be
quantified on a conventional basis applicable to Government borrowing.
Legal developments since Sempra Metals
55.
A number of relevant developments in the law have occurred since Sempra
Metals. First, the jurisprudence of the CJEU has developed since its Metallgesellschaft
judgment. As was noted above, that judgment described the sum due under EU law,
where tax was paid prematurely, and on the hypothesis that the appropriate
remedy in domestic law lay in restitution, as “the amount of interest which
would have been generated by the sum, use of which was lost as a result of the
premature levy of the tax” (para 88). More recent judgments have provided
greater clarity.
56.
For example, in Littlewoods Retail Ltd v Revenue and Customs Comrs (Case
C-591/10) EU:C:2012:478; [2012] STC 1714, the CJEU stated at para 27 that “it
is for the internal legal order of each member state to lay down the conditions
in which such interest [that is, interest on amounts levied in breach of EU
law] must be paid, particularly the rate of that interest and its method of
calculation (simple or ‘compound’ interest)”. The CJEU also made it clear, in
relation to the principle of effectiveness, that national rules in relation to
the calculation of interest “should not lead to depriving the taxpayer of an
adequate indemnity for the loss occasioned” (para 29). In Littlewoods Ltd v
Revenue and Customs Comrs [2017] 3 WLR 1401, this court held that an
award of simple interest was sufficient to comply with that requirement, and
that an award of compound interest on overpaid tax was therefore not required
by the EU law principle of effectiveness. Recognition that an award of compound
interest is not necessary in order to comply with the EU principle of
effectiveness affects the context in which these issues have to be considered.
57.
Secondly, the Littlewoods case also revealed a conflict between
the decision in Sempra Metals and prior legislation. Long before Sempra
Metals was decided, Parliament had created a scheme for the repayment of
overpaid VAT, currently set out in section 80 of the Value Added Tax Act 1994
(“the 1994 Act”), with provision for the payment of simple interest in section
78. That section requires HMRC to pay interest on the repaid tax “if and to the
extent that they would not be liable to do so apart from this section”.
Entitlement to interest under section 78 is subject to limitations which would
be defeated if it were possible for taxpayers to bring a common law claim for
interest on mistaken payments.
58.
Until Sempra Metals, it had been settled law for about 200 years
that no such claim could be brought. In enacting section 78, Parliament
legislated on that basis. In deciding Sempra Metals as it did, however,
the House of Lords failed to have regard to the scheme which Parliament had
established. Nor did it take account of section 826 of ICTA, which also
provides for the payment of simple interest on overpaid tax, and covers a range
of direct taxes, including ACT and MCT. These provisions are matched by
corresponding provisions limiting the liability of taxpayers towards HMRC to
simple interest on underpaid tax: see section 74 of the 1994 Act and section
826 of ICTA.
59.
The persuasiveness of the majority’s approach in Sempra Metals is
diminished by their failure to have regard to these provisions. As Lord
Hoffmann observed in Johnson v Unisys Ltd [2001] UKHL 13; [2003] 1 AC 518, para 37:
“… judges, in developing the law,
must have regard to the policies expressed by Parliament in legislation ... The
development of the common law by the judges plays a subsidiary role. Their
traditional function is to adapt and modernise the common law. But such
developments must be consistent with legislative policy as expressed in
statutes. The courts may proceed in harmony with Parliament but there should be
no discord.”
60.
Against the background of the 1994 Act, in particular, the effect of Sempra
Metals, was to create discord of a serious character: it rendered section
78 a dead letter, if that provision were given its natural construction. This
court therefore decided in Littlewoods that, in order for section 78 to
have the effect which Parliament had intended, it was necessary to depart from
its natural construction. Thus the
approach of the majority in Sempra Metals led, as Lord Mance had predicted, to a dislocation
in a related area of the law which the Appellate Committee had not considered.
61.
Thirdly, in Kleinwort Benson [1999] 2 AC 349 it was
realised that allowing recovery of payments made under a mistake of law could
create problems as the law of limitation then stood, since section 32(1)(c) of
the 1980 Act would enable claims to be brought within six years of the mistake
being discovered, no matter how long in the past the payment had been made. For
that reason, Lord Browne-Wilkinson considered that “the correct course would be
for the House to indicate that an alteration in the law is desirable but leave
it to the Law Commission and Parliament to produce a satisfactory statutory
change in the law which, at one and the same time, both introduces the new
cause of action and also properly regulates the limitation period” (p 364). The
majority, however, were unpersuaded that reform of the law of restitution
should be delayed, and assumed that legislation could be enacted if Parliament
considered it desirable to address the limitation question (see, for example,
Lord Hoffmann at p 401). Parliament duly enacted such legislation. By the time
of the decision in Sempra Metals, the majority therefore considered
that the “seriously untoward consequences” for HMRC (as Lord Nicholls described
them at para 125) of claims arising from mistaken payments of tax in the
distant past were guarded against by section 320 of the Finance Act 2004, which
provided that section 32(1)(c) of the 1980 Act should not apply in relation to
a mistake of law relating to a taxation matter under the care and management of
the Commissioners of Inland Revenue.
62.
What has become apparent since Sempra Metals, however, is
that the problems in relation to limitation which arise from the retrospective
effect of that decision, and the decision in Kleinwort Benson, are
incapable of being fully addressed by legislation. Repeated attempts by
Parliament to address the retrospective impact of those decisions by
introducing a limitation period with retrospective effect have been held to be
incompatible with EU law: section 80 of the Value Added Tax Act 1994, as
originally enacted, in Fleming (trading as Bodycraft) v Revenue and Customs
Comrs [2008] UKHL 2; [2008] 1 WLR 195; section 320 of the Finance Act 2004
in Test Claimants in the FII Group Litigation v Revenue and Customs Comrs (Case
C-362/12) EU:C:2013:834; [2014] AC 1161; and section 107 of the Finance Act
2007 in Test Claimants in the FII Group Litigation v Revenue and Customs
Comrs [2012] UKSC 19; [2012] 2 AC 337.
63.
This problem, of which the House of Lords was unaware at the time when Kleinwort
Benson and Sempra Metals were decided, illustrates the risks of
effecting major changes to the law of restitution by judicial decision. By applying
the declaratory theory of adjudication, the law as altered by the decisions was
deemed always to have applied, and the previously settled understanding of the
law was treated as a mistake for the purposes of limitation. Consistently with
that theory, in Kleinwort Benson the House of Lords held that a right of
action had arisen when payments were made under a mistake of law,
notwithstanding that no such right of action was recognised by the courts at
that time. Similarly in Sempra Metals, the right of action in unjust
enrichment arose when the defendant obtained the opportunity to use the money
mistakenly paid, notwithstanding that no such right was understood to exist at
that time. The tension inherent in the decisions is that the House adhered to
the declaratory theory for the purpose of finding that a cause of action based
on unjust enrichment had accrued in the past, based on a mistake of law capable
of invoking section 32(1)(c) of the 1980 Act, while straining the premise of
the theory, namely the need for judicial development of the law to be justifiable
by reference to existing legal principles.
64.
The consequence was that the rights established by those decisions were
deemed to have vested in the claimants before the decisions were reached, with
the result that, under EU law, they could not be taken away by retrospective
legislation excluding or restricting the operation of section 32(1)(c) without
a reasonable transitional period during which claims could be made. The position
would have been different if the changes had been effected by legislation,
since legislation can, and normally does, take effect prospectively.
65.
Fourthly, decisions subsequent to Sempra Metals have demonstrated
the degree of disruption to public finances which the decision in that case,
taken together with Kleinwort Benson, is capable of causing. The
decision in Kleinwort Benson enabled claims to be brought for the
repayment of tax which had been paid in ignorance of the fact that the UK law
under which it was levied was incompatible with EU law. Since the limitation
period did not begin to run until the mistake was or could reasonably have been
discovered, such claims could in principle be backdated to the UK’s entry into
the EU in 1973. Not only could the principal amounts go back, in principle, for
a period of several decades, but they had earned interest over that period. If,
following Sempra Metals, the interest was compounded over that period,
the resultant claims were potentially enormous.
66.
The Littlewoods case, for example, concerned overpaid VAT on
goods supplied to agents employed to make catalogue sales, as a form of
commission paid in kind. Like the present appeal, it was a test case. The
amount turning on the outcome of that appeal was estimated by HMRC at £17
billion. That was not the amount of the overpaid tax, or even the amount of the
interest on the overpaid tax. It was the difference between compound interest
and simple interest. In the present case, as we have explained, the total amount
turning on the outcome is estimated by HMRC at £4-5 billion. Even in the context
of public finances, these are very large sums.
67.
Fifthly, the law of unjust enrichment has developed since Sempra
Metals in ways which cannot easily be reconciled with the reasoning of the
majority in that case. The development of greatest significance has been a more
detailed analysis of the “at the expense of” question, in Investment Trust
Companies v Revenue and Customs Comrs [2017] UKSC 29; [2018] AC 275. It is
necessary next to consider that issue.
“At the expense of”
68.
Assuming for the present that an enrichment arises from having the
opportunity to use money mistakenly paid, the question whether it is obtained
“at the expense of” the claimant can best be answered by reference to the
analysis of that question in the Investment Trust case. Lord Reed
explained at para 42 that
“the law of unjust enrichment … is
designed to correct normatively defective transfers of value, usually by
restoring the parties to their pre-transfer positions.”
He went on at para 44 to endorse Lord Clyde’s dictum in Banque
Financière de la Cité v Parc (Battersea) Ltd [1999] 1 AC 221, 237 that the
principle of unjust enrichment:
“… requires at least that the
plaintiff should have sustained a loss through the provision of something for
the benefit of some other person with no intention of making a gift, that the
defendant should have received some form of enrichment, and that the enrichment
has come about because of the loss.”
Lord Reed also explained at para 50 that, as a general
rule, a cause of action based on unjust enrichment is only available in respect
of a benefit which the claimant has provided directly to the defendant (the
only true exception identified being subrogation following the discharge of a
debt, which is arguably based on a different principle). A causal connection
between the claimant’s incurring a loss (in the relevant sense) and the
defendant’s receiving a benefit was not enough to establish a transfer of
value.
69.
When money is paid by mistake, the claimant normally provides a benefit
directly to the defendant: he pays him the money. He normally does so at his
own expense: he is less wealthy by virtue of the payment. The transaction is
normatively defective: the benefit is provided as the result of a mistake. In
those circumstances, an obligation arises immediately under the law of unjust
enrichment to reverse the enrichment by repaying the money (or an equivalent
amount). The cause of action accrues when the money is mistakenly paid.
70.
The majority in Sempra Metals considered that there was also an
additional and simultaneous transfer of value, comprising the opportunity to
use the money, which also gave rise to a cause of action based on unjust
enrichment. That enrichment had to be reversed by the payment of compound
interest.
71.
This analysis has a number of questionable features, which can be
illustrated by an example. If on 1 April the claimant mistakenly pays the
defendant £1,000, with the result that the defendant is on that date obliged to
repay the claimant £1,000, the defendant’s repayment of £1,000 on that date
will effect complete restitution. Restitution of the amount mistakenly paid in
itself restores to the claimant the opportunity to use the money: there is no
additional amount due in restitution. That is because there has been only one
direct transfer of value, namely the payment of the £1,000. The opportunity to
use the money mistakenly paid can arise as a consequence of that transfer, but
a causal link is not sufficient to constitute a further, independent, transfer
of value. Contrary to the analysis of Lord Nicholls in Sempra Metals (at
para 102), the recipient’s possession of the money mistakenly paid to him, and
his consequent opportunity to use it, is not a distinct and additional transfer
of value.
72.
The position is essentially the same if the £1,000 is repaid not on 1
April but on 1 May. There has been no transfer of value subsequent to 1 April,
when the mistaken payment was made. The only transfer of value needing to be
reversed remains the payment of the £1,000. The claimant can however be
awarded, in addition to the £1,000, simple interest on that amount under
section 35A of the 1981 Act. That is because the obligation which arose under
the law of unjust enrichment on 1 April, upon the making of the mistaken
payment, created a debt. Interest can normally be awarded on a debt under
section 35A of the 1981 Act.
73.
That interest is intended to compensate the claimant for the loss of the
use of the money to which he became entitled to restitution on 1 April. There
is no right to interest on the basis of unjust enrichment: failure to pay a sum
which is legally due is not a transfer of value, and does not give rise to an
additional cause of action based on unjust enrichment. If there was no distinct
cause of action for restitution of the opportunity to use the money on the date
of the mistaken payment (as explained above), a cause of action based on unjust
enrichment cannot have subsequently accrued, since no further defective
transfer of value has taken place.
74.
The point can also be illustrated by an example used by HMRC. If D owes
C £1,000 under a contract, a claim also lies against D for interest under
section 35A, from the date when the contractual payment became due. There is no
claim against D for interest on the ground of unjust enrichment (even if an
unjust factor is present). That is because any benefit obtained by D from his
failure to pay the debt on time is not obtained at the expense of C in the
relevant sense. There has been no transfer of value from C to D. The latter’s
opportunity to use the money which remains in his possession is the result of
his failure to pay the contractual debt. The same analysis applies where the
debt is imposed by the law of unjust enrichment, for example as the result of a
mistaken payment of £1,000. Any benefit obtained by D as a consequence of his
possession of the £1,000 is derived from his failure to pay that debt. It
cannot be said to have been transferred from C to D.
75.
All this is consistent with a long-established understanding of,
first, the nature of the cause of action based on a mistaken payment, and
secondly, the basis on which interest is payable. As to the first of these, Lord
Mansfield stated in the classic case of Moses v Macferlan (1760) 2 Burr
1005, 1010, that the defendant in an action for money had and received “can be liable no further than the money
he has received”. That approach was followed in many later authorities, until Sempra
Metals: see, to give only a few examples, Walker v Constable (1798)
1 Bos & P 306, 307 (“The court were of opinion, on the authority of Moses
v Macferlan, 2 Burr 1005, that in an action for money had
and received the plaintiff could recover nothing but the net sum received
without interest”), Depcke v Munn (1828) 3 C & P 112 per Lord Tenterden
CJ (“… the courts have held again and again that interest cannot be recovered
in an action for money had and received … This has been decided so often, that
I cannot now venture to allow the question to be agitated.”), Johnson v The
King [1904] AC 817 and the Westdeutsche case [1996] AC 669.
76.
As to the basis on which
interest is payable, a clear explanation was provided by Lord Wright, a
judge who was well aware of unjust enrichment (see, for example, Fibrosa
Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32), and had
also had to consider interest as a member of the Law Revision Committee which
reported in 1934, mentioned earlier. In Riches v Westminster Bank Ltd [1947] AC 390, 400, he stated:
“… the essence of interest is that
it is a payment which becomes due because the creditor has not had his money at
the due date. It may be regarded either as representing the profit he might
have made if he had had the use of the money, or conversely the loss he
suffered because he had not that use. The general idea is that he is entitled
to compensation for the deprivation.”
77.
Once it is understood that the claim to interest is not truly based on
unjust enrichment but on the failure to pay a debt on the due date, the
conclusion inevitably follows that interest can be awarded on the claims within
categories (b) and (c) under section 35A of the 1981 Act: see BP Exploration
Co (Libya) Ltd v Hunt (No 2) [1979] 1 WLR 783, and Sempra Metals at
paras 104 (Lord Nicholls) and 175 (Lord Walker).
78.
On a literal reading of section 35A, no such interest could have been
awarded on the claims under category (a). That is because section 35A applies
only where there are proceedings for the recovery of a debt (or damages), and
therefore does not apply where the defendant has repaid the debt (or has set it
off) before the creditor has commenced proceedings for its recovery. An award
of interest is nevertheless required in such circumstances by EU law, if an
effective restitutionary remedy is to be available under English law in respect
of San Giorgio claims: that was the point decided in Metallgesellschaft.
It is unnecessary to decide in this appeal how an award of interest should
be made available in those circumstances (and the court has heard no argument
on the point). But there are a number of potential solutions.
79.
For the foregoing reasons, we therefore depart from the reasoning in Sempra
Metals so far as it concerns the award of interest in the exercise of the
court’s jurisdiction to reverse unjust enrichment. As mentioned earlier, it is
unnecessary for us to consider the reasoning in that case so far as it concerns
the award of interest as damages, and nothing in this judgment is intended to
question that aspect of the decision. Since the award of compound interest to
PAC by the courts below was based on the application of the reasoning in Sempra
Metals which we have disapproved, it follows that HMRC succeed on Issue II,
and PAC’s claims to compound interest under categories (b) and (c) must be
rejected. PAC’s claim to compound interest under category (a) would also have
been rejected, if it had not been accepted by HMRC.
79.
Finally, in relation to this aspect of the appeal, it is worth
adding that the view of the majority in Sempra Metals that the
opportunity to use money mistakenly paid should be regarded as an enrichment
also raises a number of questions, particularly in relation to the method by
which, and the date or dates as at which, the enrichment is to be measured. In addition, if one stands back and
considers the realism, and also the fairness, of the approach to enrichment
adopted by the majority in Sempra Metals, the results which it produces
are concerning. As Professor Burrows has written, in relation to the decision
of Henderson J in the Littlewoods case, in his contribution to Commercial
Remedies: Resolving Controversies, eds Virgo and Worthington (2017), p 266:
“…
if one were to step back from the complex detail, the result of Henderson
J applying compound interest on all the mistaken payments from the date of
receipt appears to be tantamount to saying that, had the Revenue not been paid those
sums, it would have borrowed the same sums at a compound interest rate for five
decades. Surely that cannot be right.”
These issues were not, however, discussed in argument in
the present appeal, and in the circumstances it is inappropriate to consider
them further.
The remaining issues
81.
There remain two issues which are relevant to the computation of the
amounts which EU law requires HMRC to repay. In order to understand those
issues it is necessary to recollect how, under the legislation which was in
force in the relevant years, ACT was charged on distributions by a UK-resident
company and was set against the paying company’s subsequent liability to MCT. Under
section 14 of ICTA, ACT was charged when a UK-resident company paid a
“qualifying distribution”, which included the payment of a dividend (section
209).
82.
Under section 231 of ICTA, when a UK-resident company made a qualifying
distribution, the recipient of the distribution was entitled to a tax credit
equal to the proportion of the amount of the distribution which corresponded to
the rate of ACT in force when the distribution was made. Under section 238,
when a UK-resident company made a qualifying distribution, the sum of the
amount of that distribution together with the proportion of that amount which
corresponded to the rate of ACT in force when the distribution was made was
known as a “franked payment” (“FP”). Section 238 also provided that when a
UK-resident company received a distribution, in respect of which it was
entitled to receive a tax credit, the aggregate of the distribution and the
amount of the tax credit was “franked investment income” (“FII”). When the recipient
company itself made a qualifying distribution in the same accounting period as
it received FII, it paid ACT only on the excess of FP over FII (section 241).
83.
The UK-resident company (“company A”) had to make a return and account
to HMRC for the ACT quarterly by disclosing the FPs which it made and the FII
which it received, foreign income dividends paid and received, and the ACT
payable on the FPs and the foreign income dividends: paragraphs 1 and 3(1) of
Schedule 13 to ICTA. The ACT which company A paid during an accounting period
was then set against its liability (if any) to MCT on its profits in the
accounting period by the operation of section 239 of ICTA, which we discuss
below.
84.
Thus, if company A received a distribution from another UK-resident
company (company B) it would not be liable to pay MCT on that distribution
(section 208). If company A, having received a distribution from company B,
itself made a distribution, it would be liable to pay ACT on the excess of its
FP over its FII. When company A came to pay MCT on its profits in the same
accounting period it would have been entitled to set off the ACT which it had
paid (section 239).
85.
The illegality under EU law, which was caused by the UK’s failure to
match the exemption conferred on dividends received from UK-resident companies
by an equivalent credit in respect of overseas-sourced dividends, is to be
remedied by a credit for foreign dividends by reference to the FNR, as we have
held under Issue I above. Applying the example above but with the receipt by
company A of overseas-sourced dividends in place of UK-sourced dividends, under
EU law the FNR credit would fall to be applied to its payment of MCT. Thus the
MCT which company A paid was unlawful to the extent that the credit had not
been given. If company A had itself paid a dividend, the FNR credit should have
been applied to reduce the ACT which it had paid.
86.
With that introduction we turn to Issue III.
Issue III
87.
Issue III, on which HMRC seek permission to appeal, is whether a claim
for restitution lies to recover “lawful ACT”, which has been set against “unlawful
MCT”. By the expression “lawful ACT” we refer to the element within an
undifferentiated ACT charge which did not represent unduly levied tax on overseas-sourced
dividends. Lawful ACT on the (UK-resident) Company A’s distribution refers to
such ACT as is due after giving effect to (i) the exemption given to income from
dividends of UK-resident companies and (ii) (in light of our answer to Issue I)
the tax credit which EU law requires to be given to income from dividends from
overseas companies. “Unlawful MCT” in this context refers to such part of the
charge to MCT as is attributable to the failure to give the overseas-sourced
dividends, which company A received, a tax credit at the FNR to achieve
equivalence to the exemption which section 208 gave to dividends received from
UK-resident companies.
88.
This issue was not argued in the courts below because Henderson J and
the Court of Appeal, when considering this case, were bound by the Court of
Appeal’s earlier decision in Test Claimants in the FII Group Litigation v
Revenue and Customs Comrs [2010] EWCA Civ 103; [2010] STC 1251 (“FII CA”).
In that judgment the Court of Appeal held that a taxpayer was entitled to reimbursement
of lawful ACT, which HMRC had retained because it had been set against an
unlawful MCT charge. The court held that such ACT related directly to the
unlawful MCT because the CJEU treated ACT as an advance payment of MCT: FII
CA paras 148-151.
89.
The statutory provisions governing the set-off of ACT against MCT were
as follows.
90.
Section 239(1) of ICTA provided for the automatic set-off of ACT against
MCT, thereby reducing company A’s liability to pay MCT. It provided:
“… advance corporation tax paid by
a company (and not repaid) in respect of any distribution made by it in an
accounting period shall be set against its liability to corporation tax on any
profits charged to tax for that accounting period and shall accordingly
discharge a corresponding amount of that liability.”
91.
Where the tax-paying company did not have a sufficient liability to MCT
on its profits to use up the ACT by way of set-off in the same accounting
period, the unused ACT could be carried back under section 239(3) which
provided:
“Where in the case of any
accounting period of a company there is an amount of surplus advance
corporation tax, the company may, within two years after the end of that
period, claim to have the whole or any part of that amount treated for the
purposes of this section (but not of any further application of this
subsection) as if it were advance corporation tax paid in respect of
distributions made by the company in any of its accounting periods beginning in
the six years preceding that period … and corporation tax shall, so far as may
be required, be repaid accordingly.
In this subsection ‘surplus
advance corporation tax’ in relation to any accounting period of a company,
means advance corporation tax which cannot be set against the company’s liability
to corporation tax for that period because the company has no profits charged
to corporation tax for that period …”
92.
The surplus ACT could also be carried forward automatically under
section 239(4) which provided:
“Where in the case of any
accounting period of a company there is an amount of surplus advance
corporation tax which has not been dealt with under subsection (3) above, that
amount shall be treated for the purposes of this section (including any further
application of this subsection) as if it were advance corporation tax paid in
respect of distributions made by the company in the next accounting period.”
93.
Section 239(5) explained how the set-off operated under both subsections
(1) and (4). It provided:
“Effect shall be given to
subsections (1) and (4) above as if on a claim in that behalf by the company
and, for that purpose, a return made by the company under section 11 of the
Management Act containing particulars of advance corporation tax or surplus
advance corporation tax which falls to be dealt with under those subsections
shall be treated as a claim.”
Company A could also surrender its ACT to its subsidiary
in accordance with section 240, with the result that the ACT would be treated
as ACT paid by the subsidiary and set against the subsidiary’s liability to pay
MCT.
94.
HMRC’s case is simple. They argue that if a taxpaying company included
relevant details of ACT paid in its tax return, sections 239(1) and (5)
mandated an automatic set-off of the ACT against the company’s liability for
MCT. If, on a proper understanding of the law, the company did not owe
sufficient MCT in the relevant accounting period, the ACT remained surplus and
available to be set off in the next accounting period under section 239(4). In
other words, HMRC argue that the law treats an unlawful MCT charge as a
nullity, with the result that there is no set off under section 239(1) and no
enrichment of HMRC by the payment of the ACT, which remained available to
offset the taxpaying company’s lawful MCT in other accounting periods.
95.
PAC opposes the grant of permission to HMRC on this issue and submits
that it is a detailed issue of computation which is likely only to affect the
appeal in PAC’s case if PAC’s approach to Issue V is correct. If this court
were to give permission to appeal, PAC advances three arguments. First, it
submits that the court’s approach should be governed by the principle that the
taxpayer should be entitled to recover unduly levied tax. Secondly, it argues
that, because the CJEU has characterised ACT as “nothing more than a payment of
corporation tax in advance” (eg FII ECJ I para 88), ACT could only
lawfully be charged where it is itself a pre-payment of a lawful charge to MCT.
As a result, it contends that the correct analysis is that a payment of ACT,
which is subsequently set against an excessive liability to MCT, is an advance
payment of an excessive tax liability and is itself the payment of an excessive
tax liability. As such, it is liable to be recovered in a claim in restitution.
Alternatively, PAC contends that the payment of the ACT relates directly to the
unlawfully levied MCT and so is recoverable in a claim in restitution. In
support of those contentions PAC relies on dicta of the CJEU in FII ECJ I and
FII ECJ II. PAC’s third argument is that, if it had been aware that it
did not have any liability for a substantial part of the MCT, it would have not
have paid the ACT. PAC was a subsidiary of Prudential plc and it had no
subsidiaries of its own which generated profits giving rise to a liability to
corporation tax against which PAC’s ACT could have been used. It would
therefore have paid dividends to its parent company within a group income
election so that the ACT was paid at the level of the parent company and would
have been available for set-off against the MCT of other subsidiary companies
within the group. This, it submits, would have been the only sensible course to
avoid the ACT being stranded in PAC’s accounts.
Analysis
96.
In our view it is appropriate to give HMRC permission to raise this
issue as it is a point of law of general public importance in an appeal to this
court in the context of a group litigation order. While PAC submits that it
alone is likely to be affected by the determination of this issue, the court is
not in a position to assess whether or not that is so. The matter also arises
in the FII litigation. HMRC had applied for permission to appeal the Court of
Appeal’s ruling on this issue in FII CA but the determination of that
application was postponed by this court by orders dated 8 November 2010 and 9
May 2017. The issue, which will be of relevance to the final determination of
the FII litigation, therefore comes to this court in this appeal before this
court has addressed the application to appeal in that litigation.
97.
In addressing this issue, the starting point is to recall that an
entitlement to repayment or restitution in this context requires that there has
been an unlawful charge to tax as a result of incompatibility with EU law: San
Giorgio. The question we are asked to consider is in substance: have HMRC
unlawfully levied ACT by setting it against MCT which has been unlawfully
charged? But there is a logically prior question, which is whether there has been
any set-off.
98.
Company A may have received income which has funded its distribution
from UK-resident companies and also from companies resident elsewhere in the
EU. In this computational issue the court is not concerned with “unlawful” ACT,
which has been charged on a distribution by company A derived from income which
it has received from an overseas-resident company in the absence of sufficient
credit for foreign tax on the latter company’s distributions. We are concerned
with ACT which is unquestionably lawful but which has purportedly been set
against an unlawful MCT charge on company A.
99.
PAC relies on dicta in FII ECJ I and FII ECJ II to argue
that this prima facie lawful charge on company A’s dividend is tainted by its
being merely an advance payment of an unlawful MCT charge. But the CJEU, when
it characterised ACT as constituting “a form of advance payment of corporation
tax” (FII ECJ I para 88 and FII ECJ II paras 68 and 110), was
well aware of the provisions of ICTA which allowed the taxpaying company to
utilise the ACT which it had paid in different ways. Thus, in FII ECJ II
at para 6, the CJEU stated:
“A company had the right to set
the ACT paid in respect of a distribution made during a particular accounting
period against the amount of mainstream corporation tax for which it was liable
in respect of that accounting period, subject to certain restrictions. If the
liability of a company for corporation tax was insufficient to allow the ACT to
be set off in full, the surplus ACT could be carried back to a previous
accounting period or carried forward to a later one, or surrendered to
subsidiaries of that company, which could set it off against the amount for
which they themselves were liable in respect of corporation tax.”
(The reference to the surrender of ACT to a subsidiary is
a reference to section 240 of ICTA.)
100.
As we have shown, section 239 of ITCA did not confine the MCT, against
which the ACT could be set, to MCT due for the same accounting period as that
in which the ACT was paid (“the same accounting period”). If there was
insufficient MCT due in the same accounting period, the surplus ACT was carried
forward automatically to the next accounting period, unless company A elected
to use it otherwise, such as by carry back under section 239(3). If the company
did not so elect, and if in the same accounting period and subsequent
accounting periods company A did not have sufficient MCT to use up the ACT
which it had paid, or if Company A did not surrender the ACT under section 240,
the ACT was, in PAC’s words, “stranded”. But that stranding of the ACT, were it
to have occurred, would not affect the lawfulness of the ACT charge.
101.
In our view, HMRC are correct in their submission that, if an apparent
charge to MCT was unlawful, that charge was a nullity. The ACT could not have
been set against a nullity but remained available to be carried back if a claim
were made under section 239(3) or for automatic set-off against lawful MCT in a
subsequent accounting period under section 239(4) or otherwise to be utilised. Being
so available, the lawful ACT did not directly relate to the unlawful MCT in the
same accounting period in the sense that penalties and interest may relate to
an unlawfully levied tax. Accordingly, HMRC in receiving payment of the lawful
ACT did not receive unlawfully levied tax which gave rise to a San Giorgio claim.
102.
Further, PAC was obliged by ICTA to pay the lawful ACT. The payment of
the ACT did not entail a defective transfer of value which falls to be
corrected: the ACT was due when it was paid, and was available to PAC to utilise
thereafter. PAC’s loss in the context of Issue III (ie in relation to lawful
ACT) is the result of the levying of unlawful MCT, and, through the
misunderstanding of the law which it shared with HMRC, of its not having been
able to set the unutilised ACT against its liability for lawful MCT in the same
or other accounting periods or otherwise to utilise the ACT to reduce its
liability to tax. Its loss in that sense does not support a claim in
restitution: Investment Trust Companies v Revenue and Customs Comrs,
especially paras 41-45 per Lord Reed.
103.
We are informed that PAC’s corporation tax liabilities in its accounting
periods from 1994 to 1998 are not finalised as PAC’s returns in those years are
still open and that therefore it may be possible for PAC to carry forward
unutilised ACT to set against its MCT liabilities in those periods. But,
whether or not that is the case, in agreement with Henderson J in FII High
Court 1 ([2008] EWHC 2893) we consider that an enquiry into whether, and if
so how, surplus ACT would otherwise have been used within a group of companies
cannot give rise to a claim in restitution but would form part of a claim for
damages if the criteria for such a claim were met.
104.
We therefore, in agreement with Henderson J in the FII litigation,
answer the question raised in Issue III (“Does a claim in restitution lie to
recover lawful ACT set against unlawful corporation tax?”) in the negative.
Issue V
105.
PAC seeks permission to cross-appeal if (as we have done) we grant HMRC
permission to appeal on Issue III. Again, the issue arises in the context of a
GLO and we are unable to assess its significance in other cases within the GLO.
But it is closely connected with Issue III and has significant consequences for
PAC’s claim for interest. It is appropriate that we address it in the context
of this appeal. We therefore grant permission for the issue to be raised.
106.
Issue V comprises two related questions concerning the utilisation of
ACT on a hypothesis that an undifferentiated fund of lawful and unlawful ACT
was purportedly set off against an amount of MCT which was in part lawful and
in part unlawful. The first question (Issue V(a)) which the parties have raised
is:
“Where ACT from a pool which
includes unlawful and lawful ACT is utilised against an unlawful corporation
tax liability, is the unlawful ACT regarded as a pre-payment of the unlawful
corporation tax liability or is the ACT so utilised regarded as partly lawful
and unlawful pro rata?”
107.
PAC contends that the unlawful ACT which company A has paid is to be
regarded as utilised first against the unlawful MCT. HMRC have argued for a pro
rata approach by which the unlawful MCT is regarded as having been met by the
utilisation of lawful and unlawful ACT in the same proportion as the unlawful
MCT bears to the overall MCT charge. The background is that in so far as
unlawful ACT has been utilised against lawful MCT, HMRC have conceded that the
time value of the prematurely-paid ACT is recoverable in compound interest, as
explained earlier in the discussion of Issue II. In so far as the unlawful ACT
has purportedly been utilised against unlawful MCT, the unlawful ACT which the
taxpaying company has paid is recoverable together with interest under section
35A of the 1981 Act, as explained in relation to Issue II, as both the ACT
charge and the MCT charge were nullities.
108.
Henderson J in his second judgment in this case ([2015] EWHC 118 (Ch);
[2015] STC 1119) addressed this issue at paras 34-37. He expressed an initial inclination
to adopt the pro rata approach as everyone at the time had assumed that the
whole of both the ACT and the MCT had been lawfully charged. He decided however
that PAC’s approach was correct because, if the unlawful ACT was regarded as a
prepayment of the unlawful MCT, the end result reflected precisely the credit
for foreign tax which EU law required, whereas on HMRC’s approach company A
would have an additional and unnecessary claim to recover the element of lawful
ACT which had been utilised against the unlawful MCT. His ruling was made
expressly on the basis that he was bound by the Court of Appeal’s ruling on
Issue III above, a ruling which we have now overturned.
109.
The Court of Appeal (paras 113-127) disagreed with Henderson J’s
approach. It stated that the issue was how to determine the extent of the
benefit for HMRC in money terms from the payment or bringing into account of an
unlawful MCT charge for the purpose of determining the extent of HMRC’s unjust
enrichment. The court looked for a fair way of determining that enrichment in a
situation where an undifferentiated fund of lawful and unlawful ACT had
purportedly been set against an apparent liability to MCT, which in fact
comprised both lawful and unlawful MCT. The court attached weight to the fact
that both PAC and HMRC were unaware of the meaning and effect of the relevant
EU law at the time; neither was to blame for the situation; both were disabled
by their ignorance of the true state of affairs from applying their minds at
the time to the allocation of lawful and unlawful ACT as between the lawful and
unlawful elements of MCT. As a result, the court sought to strike a fair
balance between their interests by adopting an objective standard. That
standard was the pro-rating approach which Henderson J had earlier favoured in
his judgment in Test Claimants in the FII Group Litigation v Revenue and
Customs Comrs [2014] EWHC 4302 (Ch); [2015] STC 1471 (“FII (High Court)
Quantification”), para 205.
110.
We are not able to reconcile the Court of Appeal’s ruling with our
decision on HMRC’s appeal on Issue III, which is inconsistent with the ruling
in FII CA by which the Court of Appeal in this case was bound. As HMRC
have submitted and we have held under that issue, section 239 has the effect
that lawful ACT is not set against unlawful MCT, which is a nullity. The pro
rata method, which involves unlawful MCT being met in part by unlawful ACT and
in part by lawful ACT, cannot therefore work. Instead, lawful ACT, which was
not utilised against lawful MCT, remained available to be claimed against
lawful MCT in the same or other accounting periods. The unlawful ACT, which
company A paid, was not set against the unlawful MCT charge in a given
accounting period because both the unlawful ACT charge and the unlawful MCT
charge are nullities. The principled answer is therefore that the unlawful ACT,
which company A has paid, must be treated as having been utilised first against
the unlawful MCT charge. Where there is no unlawful MCT against which to set
the unlawful ACT which has been paid, the residual unlawful ACT is to be
treated as utilised against lawful MCT. Because both of the unlawful charges
are nullities, the unlawful ACT is itself recoverable, unless it has been set
against a lawful MCT charge. When unlawful ACT has been set against lawful MCT,
company A has a claim for interest on the ACT so used, as stated in para 78
above.
111.
The second question under Issue V relates to the carry back to an
earlier quarter of domestic FII received in a later quarter in the same
accounting period. To address this, it is necessary to explain the operation of
paragraph 4 of Schedule 13 to ICTA. Rather than set out the provision we
gratefully adopt the explanation of its effect which Henderson J gave in FII
(High Court) Quantification at para 209:
“The effect of these rather
densely worded provisions may be summarised by saying that FII received in a
later quarterly return period must first be applied in franking any dividends
paid by the company in that period, but that any surplus may then be carried
back to frank unrelieved dividends paid in an earlier quarter, thus generating
a repayment of ACT. If there has been a change of ACT rates in the meantime,
the repayment is not to exceed the amount of the tax credit comprised in the FII
which is carried back.”
If the excess FII was not so used in repayment of ACT
paid in the earlier quarter, it was carried forward into the next annual
accounting period to set against FPs in the same way (section 241(3)).
112.
Issue V(b) asks:
“Where domestic FII was carried
back to an earlier quarter is it to be regarded as having been applied to
relieve lawful and unlawful ACT pro rata or only lawful ACT?”
113.
Henderson J in his second judgment in this case discussed the issue
briefly in paras 40-43 after hearing full argument on the point. He decided,
with considerable hesitation, that the FII was to be regarded as having been
applied to relieve only lawful ACT in the earlier quarter because otherwise FII
from UK-sourced dividends, which was entirely lawful, would be used to cancel
out part of the credit which EU law requires on foreign income. In reaching
this conclusion he departed from the view which he had reached on essentially
the same issue in FII (High Court) Quantification at paras 207-211.
114.
The Court of Appeal disagreed and (paras 128-133) adopted an approach
similar to that which it took on Issue V(a). Again, the court laid stress on
the fact that at the time nobody appreciated that the ACT against which the FII
was carried back might comprise both lawful and unlawful elements and no-one
was to blame. The fair course therefore was to adopt the pro rata approach
which the court had taken in relation to Issue V(a). The effect of that
approach would be that “the primary period of unjust enrichment of HMRC”
through receipt of the unlawful ACT would be brought to an end and HMRC’s
enrichment would be measured by the time value of the ACT payment. The court
did not see this as cancelling out any part of the credit which EU law required
on overseas-sourced dividends.
115.
In this appeal PAC renews the arguments which Henderson J favoured. The
UK tax system was unlawful because credits were not given under section 231 for
tax on overseas-sourced dividends in order to relieve an ACT liability. The use
of carried-back FII to relieve unlawful ACT deprived company A of the credits
which it should have had for the overseas-sourced dividends. The carried-back
FII should therefore be regarded as having been applied to relieve only lawful
ACT.
116.
HMRC’s answer in their written case is that EU law does not mandate a
form of credit for overseas-sourced dividends. They quote the statement of the
CJEU in para 72 of FII ECJ II:
“As is clear from para 62 [of the
present judgment], the obligation presently imposed on the resident company by
national rules, such as those at issue in the main proceedings, to pay ACT when
profits from foreign-sourced dividends are distributed is, in fact, justified
only in so far as that advanced tax corresponds to the amount designed to make
up the lower nominal rate of tax to which the profits underlying the
foreign-sourced dividends had been subject compared with the nominal rate tax
applicable to the profits of the resident company.”
HMRC, unexceptionably, interpret this statement as meaning
that it is lawful to charge ACT on a dividend paid by company A only to the
extent that it was lawful to charge MCT on the profits out of which that
dividend was paid. But HMRC go on to say that the relief required was not in
the form of a credit which was the equivalent of further FII.
117.
We do not accept HMRC’s submission on Issue V(b) for the following three
reasons.
118.
First, it follows from the answer which we have given on Issue I that we
reject the contention that no particular form of credit is mandated by EU law. What
the CJEU said in para 72 of FII ECJ II must be construed in the light of
what it said in paras 61-65 which we have quoted in para 26 above. That in turn
falls to be understood against the earlier ruling of the CJEU in FII ECJ I,
which we have quoted in para 7 above. In other words, EU law requires a tax
credit by reference to the FNR to which the profits of the overseas company
have been subject. As a result, the UK can charge ACT in relation to company
A’s dividends so far as they comprise profits from overseas-sourced dividends
only to the extent that there is tax due in respect of those dividends after it
has given company A that tax credit.
119.
Secondly, the consequence of this is that PAC is correct in its
contention that HMRC’s approach would result in depriving company A of the tax
credits on overseas-sourced dividends which EU law mandates. Using the example
which PAC gave in its written case, suppose that company A paid ACT of £100 in
the first quarter when it had received overseas-sourced dividends which (if EU
law had been applied correctly) would have entitled it to a credit of £25. If
EU law had been applied correctly in that quarter, the ACT paid would have been
£75. Suppose then that in the third quarter company A received FII for
UK-sourced dividends which carried credits of £75 which it carried back to the
first quarter. On PAC’s approach, the carried back FII would result in the
repayment of all the ACT which had properly been paid. If, as on HMRC’s
approach, the £75 of FII, which is carried back from the third quarter, were
utilised pro rata between the lawful and unlawful ACT which comprised the £100
paid in the first quarter, £18.75 (1/4 of the £75) would be attributed to the
unlawful ACT, thereby cancelling to that extent the credit to which company A
was entitled in EU law.
120.
Thirdly, we are not persuaded by the arguments as to fairness which
influenced the Court of Appeal in relation to both of Issues V(a) and V(b). As
unlawful ACT is a nullity, the principled answer is that domestic FII carried
back to an earlier quarter is to be regarded as having been applied to relieve
only lawful ACT so that any excess FII remained available for carry forward
under section 241(3).
121.
We therefore answer Issue V(b) by holding that domestic FII which is
carried back to an earlier quarter under paragraph 4 of Schedule 13 of ICTA is
to be regarded as having been applied to relieve only lawful ACT.
122.
In further written submissions HMRC and PAC disagree on factual matters
which may affect the working out of the rulings which we have made. This court
is not in a position to resolve these matters. We will invite submissions in
response to our judgment as to how our rulings may be applied.
Conclusions
123.
For the foregoing reasons, we allow HMRC’s appeal on Issues II and III,
and dismiss it on Issue I. PAC’s proposed cross-appeal on Issue IV does not
arise, as a result of its success on Issue I, and it also succeeds in its
cross-appeal on Issue V(a). In relation to Issue V(b), the court holds that FII
carried back to an earlier quarter is to be treated as having been applied to
relieve only lawful ACT.
