England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT
CHANCERY DIVISION
MR JUSTICE RIMER
[2007] EWHC 583 (Ch)

		Royal Courts of Justice Strand, London, WC2A 2LL
		13 February 2008

Lord Justice Moses :

1. Deprived of the opportunity to make a group income election, between 1995 and 31 March 1999, Pirelli UK Plc ("Pirelli UK") and Pirelli General Plc ("Pirelli General") were compelled to pay ACT on payment of dividends to their parents, resident in Italy and the Netherlands. Had such an election been made, the subsidiaries would have been exempt from liability to pay ACT. But on payment of ACT, the parents did receive tax credits pursuant to double taxation agreements ("DTAs") with Italy and the Netherlands.
2. To require the subsidiaries resident in the United Kingdom to pay corporation tax prematurely (in the form of ACT) by depriving them of the opportunity to make a group income election was contrary to article 52 (now 43 of the EC Treaty), Metallgesellscaft/Hoechst case [2001] Ch 620. The subsidiaries sought compensation by requiring the Revenue to return the ACT plus interest, representing the time value of early payment of ACT, in those cases in which ACT could not be utilised against their mainstream corporation tax liability. When it could be so utilised, they sought only interest. They resisted repayment of the tax credits received. In test cases for more than 50 other claims, the House of Lords decided that if the Pirelli subsidiaries had avoided liability to ACT, by choosing, with their parents, to make a group income election, they would not have been entitled to tax credits under the relevant DTAs (see Pirelli Cable Holding NV and Others v IRC [2006] UKHL 4; [2006] 1 WLR 400).
3. In the light of their decision, the House of Lords made the following order of remittal to the Chancery Division :

"That the case be remitted back to Mr Justice Park in the High Court of Justice Chancery Division to decide the unresolved factual question of whether, had group income election been available to the Pirelli group, the group would have elected to have the United Kingdom subsidiaries pay the dividends in question free of ACT or, instead, would have chosen that the United Kingdom subsidiaries should pay the dividends outside group income elections, thus enabling the overseas parents to receive convention tax credits and so that in assessing the amount of compensation payable to the 4^th and 5^th claimants [Pirelli General and Pirelli UK] the amount of the tax credit paid to their parents should be brought into account, and to order repayment of any sums already paid by the appellants to the 4^th and 5^th claimants …."

4. A tyro to the world of fiscal litigation might have expected that the only question remaining to be resolved was whether the Pirelli group would have made a group income election. After all, the Order assumes ("so that") that if the court decides that an election would have been made, the parents will have to bring into account the tax credits paid to them under the relevant DTA. But the tyro would not have reckoned with the persistence and sophistication of Mr Graham Aaronson QC, on behalf of the group. He wished to pursue a point of principle, to be decided before the issue of causation identified by the House of Lords was resolved. On persuading Rimer J (Park J having stolen silently away from the sound and fury of the Group Litigation Order of which the actions for compensation formed a part) that it was open to him to advance the point, despite the House of Lords decision and its Order, Mr Aaronson contended that on payment of mainstream corporation tax, the parents were entitled to tax credits and, accordingly, should not be required to bring them into account.
5. Rimer J (as he then was) disagreed. He concluded that had the group made a group income election, the subsidiaries would not have been liable to ACT and on payment by the subsidiaries of mainstream corporation tax, their parents would not have been entitled to tax credits (see paragraph 77). The group appeals; the Revenue does not cross-appeal Rimer J's reluctant indulgence in permitting the point to be pursued.

The Framework of the Statutory Regime and the DTAs

6. New readers should begin with the full and unchallenged exegesis of the context of the argument given by Rimer J (paragraphs 1-24). Old readers may begin later (at paragraph 17). The issue requires the court to hypothesise that a group income election had been made. Were it not so, everyone agrees that the UK resident subsidiaries would, on payment of a dividend, have been liable to pay ACT and the non-resident parents would have been entitled to a tax credit under the relevant DTA. The obligation to pay ACT arose under Section 14(1) of the Income and Corporation Taxes Act 1988 (ICTA) :

"14.-(1) Subject to section 247, where a company resident in the United Kingdom makes a qualifying distribution it shall be liable to pay an amount of corporation tax ('advance corporation tax') in accordance with subsection (3) below."

7. The dividends paid by the UK resident subsidiaries were qualifying distributions (s.14(2)). Had the parents been UK residents they would have been entitled to tax credits : Section 231(1) provides :

"231.-(1) Subject to sections 95(1)(b), 247 and 441A(b), where a company resident in the United Kingdom makes a qualifying distribution and the person receiving the distribution is another such company…….., the recipient of the distribution shall be entitled to a tax credit equal to such proportion of the amount or value of the distribution as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made."

8. A UK resident parent is not, on receipt of a dividend from its subsidiary, liable to corporation tax (section 208). The credit associated with the dividend is available to frank its own liability to ACT on any distribution it makes (sections 238 and 241). To the extent that the dividend and tax credit exceed the value of qualifying distributions made by the parent, the surplus may be carried forward (section 241) or set off against losses (sections 242 and 243).
9. Since the parents were non-resident, they were entitled to a tax credit under the relevant DTA. They were not liable to corporation tax (under section 208 and, in any event as non-residents). There is no relevant distinction between the agreement with the Netherlands and with Italy, so I shall refer only to the Double Taxation Relief (Taxes on Income) (Italy) Order 1990, SI 1990/2590. The DTA allocates the right to levy tax on the dividend between the High Contracting Parties. Dividends paid by a UK subsidiary to a parent resident in Italy may be taxed in Italy (Article 10(1)). But in such a case Article 10(3) has a dual function, as part of the process of allocation. Under Article 10(3)(c) the recipient parent company, resident in Italy shall:

"… be entitled to a tax credit equal to one half of the tax credit to which an individual resident in the United Kingdom would have been entitled had he received those dividends, and to the payment of any excess of that tax credit over its liability to tax in the United Kingdom."

10. Tax is charged by the UK on the aggregate of the value of the dividend and the tax credit at the rate of 5% (Article 10(3)(a)(ii)). As Park J explained (at paragraph 24, [2003] EWHC 32 (Ch) [2003] STC 250 cited by Rimer J at paragraph 18), the value of the tax credit, after payment of UK income tax is 6.875% of the amount of the dividend.
11. Tax credit is not defined in the DTA. Accordingly it has the meaning defined in ICTA (Article 3(2)). Under ICTA, except in so far as the context otherwise requires, tax credit means a tax credit under section 231 (section 832(1)).
12. The DTA has effect in UK domestic law by virtue of section 788(3)(d) , which provides that, notwithstanding anything in any enactment, DTAs have effect in relation to income tax and corporation tax in so far as they provide :

"(a) for relief from income tax, or from corporation tax in respect of income or chargeable gains; or …

(d) for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident."

13. Although the DTA makes no reference to ACT, a silence, which speaks volumes if one listens to Mr Aaronson, payment of ACT by a subsidiary, resident in the UK, triggers a liability to UK tax imposed on its Italian parent and a limited tax credit under the DTA. If the parent were resident in the UK , the parent would receive a tax credit, available to set against its own liability to ACT (section 241) or to carry forward. But there will be circumstances, typically when it incurs no liability to ACT, in which the UK parent will not be able to use its tax credit. Unlike the foreign parent, it will, in such circumstances, not receive any payment of a tax credit.
14. The Order of the House of Lords assumed the consequences, if a group income election had been available and had been made. The assumption arose by virtue of section 247. Where a subsidiary and parent (as identified in section 247(1)) jointly elect that the dividends received shall be "election dividends" :

"(2) So long as an election under subsection (1) above is in force the election dividends shall be excluded from sections 14(1) and 231 and are accordingly not included in references to franked payments made by the paying company or the franked investment income of the receiving company but are in the Corporation Tax Acts referred to as 'group income' of the receiving company."

15. If a UK resident subsidiary and its resident parent make a group income election, then the subsidiary is not liable to pay ACT on payment of an election dividend to the parent (section 14(1) does not apply). The election dividend is, however, a "qualifying distribution" within the meaning of section 14(2). The parent is not entitled to a tax credit (section 231 does not apply). The dividend is not "franked investment income" (sections 238(1) and 247(2)).
16. Equally, if a UK resident subsidiary and a non-resident parent make a group income election (post-Hoechst), payment of the dividend to a non-resident parent triggers no liability to ACT. It was on the hypothesis that the Pirelli subsidiaries and parents had made a group income election and that, accordingly, the subsidiaries were not liable to pay ACT that the House of Lords ruled that the non-resident parent was not entitled to a tax credit under the DTA, because a tax credit under the DTA, by virtue of Article 3(2) and section 788(3)(d), means a tax credit under section 231 (see e.g. Lord Scott at paragraph 67). Nor is the parent liable to UK income tax (under section 233(1), liability to income tax on a dividend is predicated on it being a distribution in respect of which the recipient, being a non-resident company, is entitled to a tax credit).

Right to a Tax Credit on Payment of Mainstream Corporation Tax: the submission.

17. The decision of the House of Lords precludes any argument that the non-resident parents are entitled to a tax credit on the resident subsidiaries paying an election dividend: no ACT, no tax credit. So their Lordships' Order was confined to the question whether a group income election would have been made: if such an election would have been made, then it necessarily followed from their decision that, on payment of the election dividend, the parents would not have been entitled to a tax credit and, in the calculation of compensation, any tax credit paid would have to be returned.
18. And yet, and yet,……the Pirelli Group now argues that there is nothing in their Lordships' decision which prevents their essential claim to entitlement to a tax credit on payment by the UK subsidiaries of mainstream corporation tax on their underlying profits out of which the dividends had earlier been paid.
19. They found this submission on what they identify as the rationale of the decision in the House of Lords. Entitlement to a tax credit depends on three pre-conditions. Firstly, the explicit requirement under Article 10(3) that the Italian parent should receive a dividend from a UK subsidiary. Secondly, the implicit requirement that tax has been paid by the subsidiary so as to fund payment of the tax credit to the parent. Thirdly, payment of the tax creates the potential for cross-border economic double taxation. In other words, once the subsidiary has paid tax on its underlying profits, out of which the dividend has been paid, there is a potential for tax to be levied on the same distribution in the hands of the recipient or in the hands of any subsequent shareholder to whom the dividend is passed.
20. It is not disputed that the tax credit is designed to avoid what is described in the jurisprudence of the ECJ as "a series of charges to tax on distributed profits", or as "economic double taxation" in the hands of the ultimate shareholder. (see e.g. Test Claimants in the FII Group Litigation v. Commissioners of Inland Revenue(Case C-524/04) [2007] STC 326 at paragraphs 85-90). I shall refer to both as "double taxation". That purpose was recognised in the House of Lords by Lord Nicholls (at paragraph 1) and by Lord Walker (105). The claimants failed in the House of Lords because, on a group income election, on payment of the dividend, no ACT would be levied; thus the claimed tax credit would not have been funded and the potential for double taxation on the same distribution of profits would not yet have arisen.
21. Contrast the position now, says Mr Aaronson. Now that the subsidiary has paid mainstream corporation tax on the underlying profits, after payment of the dividend, the tax credit claimed has been funded and the potential for economic double taxation on that distribution in the hands of the recipient parent has arisen. The pre-conditions are now satisfied; the risk of double taxation needs to be alleviated.

The Requirements of Community Law in relation to Economic Double Taxation of the Dividends

22. But the questions then arise as to whether there is any responsibility to avoid economic double taxation under Community law and if there is, on which member state that responsibility lies. Community law is concerned to remove discrimination which restricts freedom of establishment contrary to Article 43 EC. The decision in Test Claimants in Class IV of the ACT Group Litigation v. Commissioners of Inland Revenue (Case-C-304/04) demonstrates how the obligation to avoid such restrictions operates in the context of cross-border distribution of profits. Where a Member State alleviates economic double taxation on dividends paid to residents by resident companies, Community law requires it to treat dividends paid to residents by non-resident companies in the same way (paragraph 55). But Community law does not require the Member State in which the company making the distribution is resident to alleviate economic double taxation on a distribution to a non-resident shareholder (paragraph 59). The responsibility for alleviating economic double taxation rests, "usually" on the Member State in which the recipient shareholder resides (paragraph 59). That qualification ("usually") is necessary because such a responsibility may be triggered if a Member state exercises its taxing powers in respect of a dividend paid to a non-resident company. It must, in such circumstances, afford the same relief against double taxation to the non-resident recipient as to a resident (paragraph 70).
23. The ECJ applied those principles in Kerckhaert and Morres v. Belgische Stat (Case C-513/04). Belgian residents received dividends from a company resident in France. Income tax was levied at the same rate as if the dividends were received from a Belgian resident company. The recipients complained that they had been subjected to tax at source in France and thus had been taxed twice. The ECJ ruled that that double taxation was the consequence of the exercise of fiscal sovereignty by the two Member states. There are no uniform or harmonised measures for the elimination of double taxation within Community law ( paragraph 22). Member States may apportion fiscal sovereignty between themselves and thereby avoid double taxation by means of DTAs ( paragraph 23). But Community law imposes no obligation to do so, absent discrimination.
24. Mr Aaronson acknowledges those principles. But he contends that since the United Kingdom and Italy have sought to allocate the right to tax dividends received by a parent resident in Italy from a UK subsidiary and thus mitigate the effect of double taxation by means of a DTA, the United Kingdom has assumed responsibility for eliminating double taxation, whether the risk of double taxation arises on payment of ACT or mainstream corporation tax.
25. I do not accept that by virtue of the agreement, set out in Article 10 of the DTA, reached between Italy and the United Kingdom, after the hard bargaining to which Lord Walker refers (at paragraph 97), it follows that under Community law the United Kingdom is under any obligation to eliminate the economic double taxation which might arise on receipt of the dividend by a parent resident in Italy. As the House of Lords recognised, the payment of the tax credit under Article 10(3)(c) depended on payment of ACT. Indeed, the quantification of the credit at 6.875% assumed ACT at a rate of 25% (Park J paragraph 24 and Lord Walker at paragraph 97). Although the DTA makes no reference to ACT, there is no basis for assuming that the parties intended to allocate the right to tax a dividend received by a parent resident in Italy, absent payment of ACT by the UK resident subsidiary. Such an assumption ignores Article 3(2), section 788(3)(d) and the decision of the House of Lords.
26. Since the High Contracting Parties reached no agreement as to the payment of a tax credit in the circumstances of a group income election, there is no foundation for concluding that the United Kingdom has assumed responsibility for eliminating double taxation on the dividend received by the parent resident in Italy. The United Kingdom imposes no tax on receipt of that dividend, whether the recipient parent is resident in the United Kingdom or in another Member State. So it cannot be said to discriminate against the parent resident in Italy. Accordingly, Community law imposes no requirement on the United Kingdom to eliminate double taxation. That is a matter for Italy in the exercise of its fiscal sovereignty in respect of the dividend received by a resident in that Member State.
27. The Order was triggered by legislation which was unlawful in that it discriminated against the Pirelli Group by requiring premature payment of corporation tax (ACT) since a group income election was not available. Accordingly, Mr Aaronson invoked the principle that statutory requirements must be disapplied or moulded to achieve consistency with Community law (Autologic Holdings plc v IRC [2005]UKHL 54 [2006]1 AC 118 ). The parent resident in Italy should be afforded a tax credit, on the subsidiary's payment of mainstream corporation tax either by regarding that payment as a delayed payment of ACT (surely a fiscal oxymoron) or by amendment of sections 247 and 231. But the sculptural proposals of Mr Aaronson depend on establishing that without their adoption, the result will be inconsistent with Community law. Consistency with Community law is achieved by affording the Pirelli group the same opportunity to make a group income election as that afforded to a group resident in the United Kingdom. In circumstances in which the United Kingdom levies no tax on the dividend received by the parent resident in Italy, no obligation to eliminate any subsequent double taxation is imposed on the United Kingdom under Community law.
28. For that reason I would dismiss this appeal. Had it not been for the refinement of Mr Aaronson's arguments in oral submission, I would have written but one line, expressing my agreement with the reasons and conclusion of Rimer J.

Lord Justice Jacob:

29. I agree.

Lord Justice Rix:

30. I also agree.