UK Supreme Court judgment extends journey towards FII certainty
On May 23 2012, the Supreme Court in London handed down its lengthy judgment in Test Claimants in the Franked Investment Income Group Litigation v Commissioners for HM Revenue and Customs.
A number of issues were taken in the appeal but of particular interest to readers will be the questions raised as to the lawfulness of legislation introduced by the UK to curtail the mistake of law remedy in tax claims, that is, section 320 of the Finance Act 2004 (section 320) and section 107 of the Finance Act 2007 (section 107). In addition, a number of debates have been resolved on various interesting, if somewhat esoteric, issues concerning the English law of restitution.
As an indication of the importance of this case, the Supreme Court sat as a panel of seven judges rather than the usual five.
The judgment of the Supreme Court is the latest in a series of judicial decisions since the Franked Investment Income Group Litigation Order (GLO) was established in October 2003. The GLO brought together a number of claims issued in the High Court challenging the lawfulness of the tax treatment of dividends received by UK resident companies from their non-UK resident subsidiaries. In particular the claims disputed the way in which the system of advance corporation tax (ACT) in the UK essentially resulted in the profits of foreign subsidiaries of UK companies being taxed twice.
The ACT system required UK public companies to pay ACT upon dividends paid out of the group to its shareholders. The non-corporate shareholder received a credit equal to the amount of ACT paid on the portion of the dividend received by him. A corporate shareholder receiving the dividend from a UK subsidiary, which had paid ACT on the distribution, received it as franked investment income (FII). If that parent company then itself paid a dividend (say, up to the group’s ultimate shareholders), ACT was only payable by the parent company on the amount of its franked payments less its FII. ACT was designed as a temporary tax to be offset against the group’s corporation tax liabilities on its UK profits. Any ACT paid by the parent could thus be used against its own mainstream corporation tax (MCT) liability or surrendered to the subsidiary, which had made the bulk of the profits in the first place.
When a UK public company earned profits through subsidiaries outside the UK, however, the ACT could not in practice be reclaimed and became a permanent tax. In this situation, the income received by the UK parent could not qualify as FII and therefore could not reduce the amount of ACT payable on the parent’s onward distribution. The double tax relief received by the parent reduced its MCT so that there was then a reduced amount of MCT against which to set off the ACT. Much of the ACT paid by public companies with significant overseas trading profits therefore in practice became trapped or “surplus”. The ACT system was abolished in 1999.
On September 8 2003 the Paymaster General (before 2008, a UK Treasury minister) announced that legislation would be introduced, retrospective to the date of the announcement and with no transitional period, to reduce High Court claims, which in some cases dated back to 1973, to a six year period. In practice this allowed claims for only the last three years of the ACT regime. This legislation (which became section 320 of the Finance Act 2004) left claims already made by the date of the announcement intact but caught further claims issued in the GLO after that date (including one issued on the morning of September 8 itself, before the announcement had actually been made). Then, on December 6 2006, six days before the Court of Justice of the European Union (ECJ) was due to release its ruling in this case, HMRC announced further retrospective legislation (which became section 107 of the Finance Act 2007), to cancel all restitution claims in tax matters whenever commenced if they went back further than six years. This legislation therefore cancelled all claims beyond six years of even those made by claimants left unaffected by this earlier 2004 legislation, that is, those issued before September 8 2003. The judgment of the ECJ in the test case, which then followed on December 12 2006, did largely find discrimination and favoured the taxpayers.
The test claimants challenged these UK provisions on the basis that they offended the EU law principles of effectiveness and the protection of legitimate expectations. The Supreme Court unanimously held that by cancelling existing claims section 107 offended EU rights and cannot be applied. This reinstates the claims issued before September 8 2003. A majority of the judges (5 - 2) held that section 320 also failed for the same reasons.
The following discussion will focus on the respective approaches of Lord Walker and Lord Sumption, who gave the leading judgments, to the section 320 question.
Lord Walker, having reviewed the authorities predominantly from the ECJ, considered both principles of effectiveness and legitimate expectations. In relation to the former, he drew particular attention to the decision of the ECJ in 2002 in Marks & Spencer plc v Customs and Excise Comrs (Case C-62/00)  QB 866 (M&S), in which he noted “the [ECJ] spelled out very clearly… the capacity and limits of national legislation in curtailing limitation periods in proceedings for recovery of tax levied in breach of EU law.” He also highlighted the High Court decision in Deutsche Morgan Grenfell Group plc v Inland Revenue Commissioners  1 AC 558 (DMG) on July 18 2003, in which the High Court for the first time upheld a claim for repayment of tax based on a mistake of law (and therefore able to benefit from the extended limitation period under section 32(1)(c) of the Limitation Act 1980).
The announcement in September 2003 of what became section 320 was of course a reaction to Justice Park’s judgment in DMG.
Lord Sumption focused entirely on the principle of legitimate expectations. In his view, no taxpayer could have had any expectation that they had a remedy in mistake until Justice Park’s judgment in July 2003. Even then, however, he considered that with an extant appeal on “serious grounds”, no taxpayer could have had a reasonable and realistic expectation, effectively, that Justice Park’s judgment would be upheld.
Lord Walker did not disagree with that conclusion. Even so, however, he considered that the actions of the UK did infringe the principle of effectiveness, as explained in M&S. That case laid down a clear requirement for transitional provisions, which was derived as much from the principle of effectiveness as it was to protect legitimate expectations. Thus section 320 was unlawful and, for the same reasons, so was section 107.
Though Lord Sumption held that section 320 was lawful, he concluded that section 107 was not. That legislation had been enacted after the House of Lords decision in the DMG case, which reinstated Justice Park’s ruling (the Court of Appeal having found in favour of the Revenue). Despite that, however, Lord Sumption considered that claimants who had brought their claims before September 8 2003 had, by 2006, acquired a legitimate expectation of being able to bring an action to recover on the grounds of mistake, not least because they were excluded from the effect of the earlier legislation in 2004. Accordingly, section 107 was contrary to the principle of the protection of legitimate expectations.
Because EU law requires certainty as to its interpretation by national supreme courts, this dissenting opinion has forced the Supreme Court to refer this question back to the ECJ for clarification.
Woolwich/English domestic law Issues
HMRC’s case was that “mistake claims” could be cancelled retrospectively because the claimants had alternative so-called Woolwich claims which were already limited to six years (that is, a claim for tax paid pursuant to an unlawful demand under the principle established in Woolwich Equitable Building Society v Inland Revenue Comrs  AC 70 (Woolwich)).
A preliminary issue was whether Woolwich claims were indeed limited to six years and did indeed give the claimants an adequate remedy. The claimants raised three arguments :
• A Woolwich remedy required a formal demand, which did not exist for a self assessed tax such as ACT. Thus the Woolwich claim was never available to the claimants. If the only claim available was a mistake claim, then section 320 and section 107 were curtailing the only available remedy and more certainly must have been in breach of EU law.
• The extended limitation period beyond six years from payment of the tax for mistake claims (section 32(1)(c) of the Limitation Act 1980) applied to Woolwich claims because they met the necessary definition as “claims for relief from the consequences of a mistake”. Because Woolwich claims in fact extended beyond six years, then both section 320 and section 107 would more certainly have breached EU law because they would have curtailed all available claims.
• The ECJ in Reemstma Cigarettenfabriken Gmbh v Ministero delle Finanze (Case C-35/05)  ECR I-2425 showed that claims in mistake, not covered by Woolwich, were also EU repayment claims.
The judges unanimously rejected these submissions. They held that Woolwich claims did not benefit from the extended limitation period and were sufficient to give an adequate EU repayment remedy. This meant that the main issues of EU law, already discussed, were therefore engaged.
Section 33 Taxes Management Act 1970
This part of the case related not to ACT but to the taxation of foreign dividends. The claimants argued that, in addition to the discriminatory effects of the ACT regime, while dividends received by UK subsidiaries were exempt from UK tax, the UK taxed dividends received from non-resident subsidiaries (under Schedule D Case V [known as DV] of the Income and Corporation Taxes Act 1988), though giving credit for the tax they paid abroad. The claimants argued that this imposed a higher tax burden on foreign profits than on UK profits.
The Court of Appeal had held that section 33 of the Taxes Management Act 1970 provided the exclusive remedy for recovery of DV tax on foreign dividend income and that it could be interpreted consistently with EU law by simply removing the offending restrictions (including the “practice commonly prevailing” restriction) and HMRC’s discretion. The Supreme Court has strongly rejected this conclusion, Lord Sumption stating that “it seems, with respect, eccentric to imply an ambit for section 33 which is inconsistent with EU law and then to torture the express provisions so as to deal with anomalies that but for the implication would never have arisen.” This means that the claims for restitution based on a mistake of law apply also to the DV claims, giving claimants the potential benefit of the extended limitation period.
There were some 23 issues identified by the Court of Appeal in its judgment. This appeal was about five of those issues. The Court of Appeal referred another set to the ECJ and a judgment is awaited on those. Yet further issues have been reserved for determination after that ECJ judgment and, of course, there is now to be a third reference on the section 320 issue. All in all, therefore, while this was an encouraging result for the claimants, there is still a considerable way to go before all the issues in this case are finally resolved.
Alison Last (email@example.com) is a senior associate at Dorsey & Whitney (Europe).
On behalf of the test claimants, Dorsey & Whitney instructed Graham Aaronson, QC, of Pump Court Tax Chambers, and Laurence Rabinowitz, QC, and David Cavender, QC, both of One Essex Court, in the Supreme Court.
Rupert Baldry, QC, and David Ewart, QC, both of Pump Court Tax Chambers, Andrew Burrows, QC, of Fountain Court, and Kelyn Bacon and Sarah Ford, both of Brick Court Chambers, were instructed by the Solicitor for HM Revenue & Customs.