The UK chancellor's Pre-Budget Report (PBR) has reversed some of the implications of Deutsche Morgan Grenfell's (DMG) victory against the UK authorities, which entitled companies to compensation for corporation tax overpayment.

Gordon Brown, the chancellor of the exchequer, said that claims for a refund of direct tax because of a mistake of law brought before September 8 2003 would only be credited if the claim was made no later than six years from the date the tax was paid.

In contrast, the House of Lords, the UK's highest court, ruled in November that DMG, a now defunct subsidiary of the German investment house Deutsche Bank, should receive compensation for overpayment of advance corporation tax (ACT) throughout the 1990s, because DMG made its claim within six years from the date it discovered it was paying too much.

Out of time

Claims made after September 8 2003 were already disqualified from benefiting from DMG's result by Section 320 of the 2004 Finance Act.

"I think quite a few companies not part of the group litigation order (for the DMG case) will have filed complaints and will be really quite cross about this," said Guy Brannan, global head of tax at Linklaters. "People who have filed claims are usually excluded from the effect of retrospective legislation. It's quite a draconian action."

Opposition

It is expected that the PBR measure will be disputed.

Sarah Lee:"It wouldn't surprise me if there is a challenge (to the PBR measure)"

"It wouldn't surprise me if there is a challenge on the basis that it seeks to deprive claimants of rights that the House of Lords had confirmed they had," said Sarah Lee, a dispute resolution partner at Slaughter and May who represented DMG.

The ACT challenge was the first group litigation order and the decisions arising from that challenge establish very important issues and principles that are applicable to many other companies with European operations,"

The decision to disqualify claims made after September 2003 is already being fought as part of the FII group litigation. The challenge is on the basis that the 2004 Finance Act does not have a transition period for people to claim.

The ECJ ruled in the Marks & Spencer VAT case of 2002 that a limitation period could be reduced but that a transitional period was required.

"This new six year provision impacts adversely on a claim validly made over three years ago in accordance with the time limits for making claims and which is pending before the Courts," said Liesl Fichardt, partner elect at Dorsey & Whitney who is representing the taxpayers in the FII group litigation. "It seeks to render it invalid for most of the time period it covers."

The ECJ announced its verdict in both the FII Group litigation and the ACT group litigation on December 12, six days after the PBR.

HMRC or the Treasury declined to comment on the PBR measure or the DMG case. In a statement, the Treasury said: "For most direct tax provisions, there is already a six-year limitation period which balances the legitimate interests of claimants and the government. This measure will ensure that this six-year period applies to all direct tax claims."

Previous decision

The DMG group litigation followed the Metallgesellschaft/Hoechst case against the UK tax authorities.

The ECJ ruled in Metallgesellschaft/Hoechst in March 2001 that the ACT regime that existed in the UK from 1973 until 1999 contravened freedom of establishment rules n the EC Treaty.

Under the ACT regime foreign subsidiaries had to pay tax on dividends to their parent company while UK subsidiaries were exempt. Following the advocate general's opinion on Metallgesellschaft/Hoechst in September 12 2000, DMG, the test claimant, commenced its action on October 18 2000.

The UK authorities argued that some of DMG's ACT payments were made more than six years before October 18 2000 and so should not be refunded.

But the bank argued that it was not aware of any malpractice on the part of the Inland Revenue, HMRC's predecessor, until the advocate general's opinion and its claim was made less than a month after.

The case went to the High Court, who ruled in favour of the bank. But an appeal court verdict went in favour of the Inland Revenue.

Considered Kleinwort Benson

Lee said: "What the Court of Appeal did was to look very, very closely at the earlier House of Lords decision given in the Kleinwort Benson case – we thought too closely and therefore out of context. But it was on that basis that the Court of Appeal had reached its decision."

The verdict in Kleinwort Benson v City of Glasgow suggested that a mistake in law couldn't be claimed for.

Most companies involved in the group litigation had already settled with HMRC before the DMG verdict.

Companies involved in the group litigation that are yet to settle are protected from the PBR ruling by the DMG decision.

Some, including car manufacturer Daimler Chrysler, are waiting for the outcome of Sempra's (Metallgesellschaft's new name) claim for a compound interest refund rather than a simple interest one – as Deutsche Bank received. Sempra is not affected by the PBR ruling.

Compound interest is calculated on both the initial principal and the accumulated interest.

A win for Sempra, which Slaughter and May is also acting for, could prove a financial nightmare for HMRC.

Lee said: "If Sempra succeed on the compound interest question, compound interest over a long period of time can obviously equate to very significant amounts of compensation."

HMRC declined to comment on the DMG case. CJ