England and Wales Court of Appeal (Civil Division) Decisions

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE, CHANCERY DIVISION
MR JUSTICE HENDERSON
HC03C0223

		Royal Courts of Justice Strand, London, WC2A 2LL
		2nd September 2014

Lady Justice Gloster :

Introduction

1. On 27 March 2014 this court gave permission to the applicants, now The Commissioners for Her Majesty's Revenue and Customs ("HMRC"), to appeal against part of the order of Henderson J made on 29 November 2013 ("the November 2013 Order"), consequent upon his judgment of the same date, [2013] EWHC 3757 (Ch) ("the judgment"), by which the judge declined to allow HMRC to make certain re-amendments to their defence in ongoing litigation with the respondents, who are Test Claimants in the Franked Investment Income ("FII") Group Litigation ("the Claimants"): see paragraphs 31 to 39 of the judgment and paragraph 1 of the November 2013 Order.

2. Having heard full argument on the substantive appeal in the course of HMRC's application for permission, we dismissed the appeal on the same date.

3. This judgment sets out the reasons why I considered it appropriate to dismiss the appeal.

The issue which was the subject of the appeal

4. The decision on the proposed re-amendments, relevant to this appeal, depended on the following issue: namely, whether it was open to HMRC to plead in their defence that they were entitled to rely on the standstill provision in Article 64(1) of The Treaty on the Functioning of the European Union ("TFEU") (formerly Article 57(1) of the EC Treaty) to deny claims by the Claimants for the time value of advance corporation tax ("ACT") on third country foreign income dividends ("FIDs"), to which the Claimants were otherwise entitled by reason of breach of Article 63 of TFEU, pursuant to the European Court of Justice's ("ECJ") decision in C-446/04 Test Claimants in the FII Group Litigation v Commissioners of Inland Revenue [2006] ECR I-11753 ("FII ECJ1").

5. Article 64(1) provides as follows:

"The provisions of Article 63 shall be without prejudice to the application to third countries of any restrictions which exist on 31 December 1993 under national or Union law adopted in respect of the movement of capital to or from third countries involving direct investment — including in real estate — establishment, the provision of financial services or the admission of securities to capital markets. In respect of restrictions existing under national law in Bulgaria, Estonia and Hungary, the relevant date shall be 31 December 1999."

The background to the proceedings and the FID regime

6. The application arises out of the FII Group Litigation which was established by a group litigation order dated 8 October 2003 under CPR 19.10 ("the FII GLO"). The FII GLO concerns the UK's treatment of dividends received by UK-resident companies from group subsidiaries in the EU and third (i.e. non-EU) countries.

7. The Claimants seek restitution and/or damages in respect of overpaid tax and other matters arising out of the incompatibility with EU law of certain aspects of the UK's domestic tax legislation as it applied to foreign dividends. The relevant Treaty freedoms are Article 49 TFEU (ex Article 43 EC) and Article 63 TFEU (ex Article 56 EC) on the free movement of capital.

8. In order to understand the issues in contention on the present appeal it is necessary very briefly to describe the relevant United Kingdom corporation tax landscape.

9. In very short summary, under the United Kingdom corporation tax system at the relevant time (i.e. as at 31 December 1993) a company paying a dividend was liable to pay ACT on the dividend under section 14 of the Income and Corporation Taxes Act 1988 ("ICTA"). ACT was charged at a fixed rate (typically 25% of the dividend). Companies paying ACT were (as its name "advance corporation tax" indicates) in principle entitled to set off the ACT against their mainstream corporation tax liability on their profits; shareholders receiving dividends were granted a tax credit against their own income tax or corporation tax liability equal to the amount of the ACT under section 231(1) ICTA (which was repayable if the shareholder was exempt).

10. The purpose of this system (known as "a partial imputation system") was to reduce the double taxation to which company profits paid out as dividends would otherwise be subject in the hands of companies and their shareholders. This legislative requirement to pay ACT had existed since the imputation system was introduced in 1972 and it was common ground between the parties that these original ACT rules existed at 31 December 1993.

11. However, because the tax liability on foreign sourced profits was largely paid in the source state, UK-resident companies receiving substantial foreign-source dividends found in some cases that they had insufficient UK mainstream corporation tax liabilities, after relief had been given for foreign taxes under the relevant double taxation treaties, to absorb the ACT already paid. This led to an overhang of "surplus" (i.e. unabsorbed) ACT which had to be carried forward indefinitely and which built up over the years.

12. By contrast, a UK-resident company receiving a qualifying distribution (i.e. a dividend on which ACT had been paid) from another UK-resident company was entitled to a tax credit: section 231(1). The total of the distribution and the tax credit was called franked investment income ("FII"): section 238(1). Where a UK-resident company received FII, it was liable to pay ACT in relation to its own dividends only to the extent that those dividends and the ACT referable to them (i.e. its payments) exceeded the FII: section 241.

13. Following pressure from UK-based multinationals, the FID regime introduced new rules, with effect from 1 July 1994, under which a UK-resident company paying a dividend could elect to pay the dividend as a FID, rather than as an ordinary dividend. A company paying a FID still had to pay ACT but, providing that the election complied with those rules, it was subsequently entitled to claim repayment of "surplus" ACT, i.e. the ACT which could not otherwise be offset against corporation tax liabilities. Unlike ordinary dividends, however, FIDs did not carry a tax credit for shareholders, and this was so even if the ACT was not in fact repaid in any given case (whether because the ACT was set off against mainstream corporation tax or because of a failure to comply with the relevant rules).

14. As the judge said in paragraph 7 of his judgment, the broader background to the FII Group Litigation is of considerable complexity, and has already been described in a number of judgments: see for example the judgment of Lord Hope in FII (Supreme Court) [2012] UKSC 19, [2012] 2 AC 337, especially at paragraphs [1] to [8]; and, for a summary of developments since that date, including the third reference to the ECJ, the judgment of Henderson J in The Prudential Assurance Co Ltd and another v HMRC [2013] EWHC 3249 (Ch) ("Portfolio Dividends (No. 2)") at paragraphs [7] and [34] to [37].

15. For present purposes the following brief summary will suffice. At an early stage in the proceedings the High Court referred a number of issues to the ECJ. On 12 December 2006 the ECJ gave its Judgment in FII ECJ1. The matter then came back to the High Court (Henderson J) to decide a number of agreed liability issues arising out of the ECJ's judgment. Henderson J gave his decision on 27 November 2008 in Test Claimants in the FII Group Litigation v R&CC [2008] EWHC 2893 (Ch), [2009] STC 254 ("FII HC").

16. The judge dealt with the issue whether the FID regime could benefit from the standstill protection in Article 57(1) EC (now Article 64(1) TFEU) at paragraphs [180] to [191] of his judgment in FII HC, concluding as follows:

"190. In my judgment Mr Ewart's argument does not meet Mr Aaronson's contention, nor does it answer the question remitted to the national court by the ECJ. A central point of that question, although it is easy to miss it on a superficial reading, is that the FID regime denies any tax credit, even though it does not provide for automatic reimbursement of the ACT which is paid, and instead gives priority to setting off ACT which would otherwise be repayable against any outstanding liability to MCT. In an extreme case, the result could be that no ACT at all was repayable, because the company concerned had a sufficiently large outstanding MCT liability to absorb all of the ACT paid in respect of the FIDS. Mr Ewart had no real answer to this point, and in my view this feature of the FID regime has to be regarded as the introduction of a new restriction which had no precursor in the previous legislation. By introducing this new restriction, I consider that the UK forfeited the protection of art 57(1) EC for the FID regime, even though the general purpose of the FID regime was to mitigate the adverse ACT consequences of the regime otherwise applicable to foreign dividends.

191. For these reasons, I conclude that the FID regime breached art 56 EC in relation to third country FIDs, and that the breach was not negated by art 57(1) EC. It follows that liability in respect of third country FIDs is in principle established." (Emphasis supplied.)

17. Consistently with that decision, paragraph 1(c) of the order which Henderson J made on 12 December 2008 in FII HC provided:

"1. The following claims are successful in relation to the GLO issues determined in the trial: …

(c) claims for the time value of ACT on third country FIDs paid on or after 1 July 1994 and refunded under the FID regime; …" (Emphasis added.)

Likewise consistently with that decision, the order also included declarations in the following terms:

"8.The FID regime is incompatible with Article 56 EC [now article 63 TFEU] in relation to FIDs matched with dividends paid by a company resident in a country other than a Member State ("third country FIDs").

9. The introduction of the FID regime was a new restriction for the purposes of Article 57(1) [now article 64(1) TFEU] so that the application of Article 56 EC is not excluded in relation to third country FIDs."

18. The judge's decision on this point was appealed by HMRC to the Court of Appeal. The parties agreed a list of the issues on the appeal. Issues 9 and 10 were worded as follows:

"9. Do the FID provisions infringe Article 56?

10. If the FID provisions infringe Article 56 in principle, are they permitted by virtue of the "standstill" provisions of Article 57(1)?"

19. The Court of Appeal handed down its judgment on 23 February 2010 in Test Claimants in the FII Group Litigation v Revenue and Customs Commissioners [2010] EWCA Civ 103 ("FII CA"). It upheld the decision of Henderson J in relation to the relevant FID issues identified above and dismissed HMRC's appeal. The Court of Appeal dealt with issue 9 in paragraphs [116] to [119] of its judgment and with issue 10 in paragraphs [120] to [130]. It is enough for present purposes to quote the last three paragraphs of this part of their judgment:

"128. In sum, Mr Aaronson submitted that the removal of the tax credit where a dividend was paid as a FID did not follow the logic of the ACT arrangements. He submitted therefore that the fact that shareholders were not entitled to any tax credit was a new restriction.

129. The question that the ECJ required the national court to consider was whether the FID scheme justified the absence of a tax credit for shareholders. The fact is that a company could fall between two stools. There was nothing which prevented it from electing to make a FID and then finding that it could not in fact obtain repayment of ACT under the restrictions applying to the foreign tax admitted for FID regime purposes. No doubt this would not happen to a company that was well advised, and could be avoided with planning. Nonetheless the circumstances postulated could occur. The company would have paid ACT and not be able to claim repayment of that ACT, and yet the dividend paid by it would carry no tax credit. That was inconsistent with the logic of the legislation as it did not respect the "unspoken" link between the payment of ACT and the entitlement to a tax credit. Thus there was a new approach and new restriction in the FID regime, which meant that art 57(1) EC did not apply to it.

130. We would dismiss the appeal on this point."

20. By its order dated 19 March 2010 giving effect to its judgment in FII CA the Court of Appeal upheld Henderson J's declarations. Paragraph 7 of such order provided:

"7. The Respondents' appeals on Issues 9 and 10 [whether the FID regime offended article 63 or was protected by article 64(1)] are dismissed. Declarations 8 and 9 are affirmed. …

Paragraph 16(b) of the Court of Appeal's order dated 19 March 2010 similarly provided:

"16. Order 1 [the order of Henderson J referred to above] is varied to read:

The following claims are successful in relation to the GLO issues determined in the trial: …

(b) Claims for the time value of ACT on third country FIDs paid on or after 1 July 1994 and refunded under the FID regime in so far as (i) the ACT paid was not due after taking into account the tax credit available under section 231 in respect of those dividends and (ii) the claims are made within the applicable limitation periods; …" (Emphasis added.)

21. HMRC did not seek permission to appeal issue 10 to the Supreme Court, so it has been finally determined in the Claimants' favour since March 2010.

22. Since the decision of the Court of Appeal in FII CA, there has been a further appeal to the Supreme Court and two further references to the ECJ. Those proceedings, however, were not concerned with the issue raised in the present application and do not need to be considered further.

23. The purpose of the first hearing before Henderson J (FII HC) had been (according to the recital to his order dated 12 December 2008) to try:

"all GLO issues raised by the test claims, including liability for restitution, save in so far as those issues concern causation or quantification of the Claimants' claims."

Those issues clearly included whether HMRC was entitled to rely in relation to the FID regime, as a whole, on the standstill provision in Article 57(1). The litigation has now moved to a second stage, which involves an application of those principles, and any other principles and legal points which arise, to the detailed facts which arise from the claims made by the relevant Test Claimants. A hearing before Henderson J was listed for this second stage on 2 May 2014.

The proposed amendments

24. HMRC sought to amend their defence prior to that hearing in order to argue that ACT charged on the payment of certain FIDs was not contrary to Article 56 EC on the basis that the ACT charge was a restriction which existed prior to 31 December 1993; if that was so, the restriction was protected by the "standstill" provisions in Article 57(1) EC/ Article 64(1) TFEU in so far as it applied to dividends sourced from "third countries" (i.e. countries outside the EU/EEA). In paragraphs 34 and 35 of the judgment the judge summarised the Claimants' pleaded case and HMRC's proposed amendments as follows:

"34. In the particulars of claim, it is alleged: in paragraph 12E, that the FID regime introduced a new regime for the taxation of foreign sourced dividends with effect from 1 July 1994; in paragraph 12F, that this new regime entailed new restrictions on the free movement of capital in the form of (i) the requirement to pay ACT and then claim it back, and (ii) the refusal of a repayable tax credit to exempt shareholders receiving dividends, and that these restrictions did not fall within the scope of Article 57(1) EC; and in paragraph 12G, that in the premises, where foreign profits were distributed as FIDs, HMRC were prohibited by EC law from levying ACT and required by EC law to grant a tax credit. In the defence, which of course predated the decisions in FII (High Court) and FII (CA), these allegations were denied, and it was averred that the FID regime fell within the standstill provision in Article 57(1).

35. HMRC's proposed re-amendments on this point are in substance mainly new, and read as follows:

"19(e) As to paragraph 12E, the FID Regime introduced with effect from 1 July 1994 introduced two new elements i.e. the right given to the payer of the FID to automatically recover ACT and the denial of a tax credit to the recipient of the FID. This required new procedures to establish whether a FID could be paid, to what foreign sourced income it related and as to the way in which ACT was to be recovered. Subject to the above, paragraph 12E is not admitted.

(f) As to paragraph 12F, the requirement to pay ACT and claim it back did not amount to a new restriction on the free movement of capital. Subject to the above, paragraph 12F is admitted.

(g) Accordingly, the requirement to pay ACT on a FID is authorised as a restriction which existed on 31 December 1993 for the purposes of Article 57(1) EC. Subject to the above, paragraph 12G is admitted."

25. Before Henderson J the Claimants argued that this issue had been decided against HMRC by the Court of Appeal in FII CA. The judge agreed and disallowed the proposed re-amendments. He held that the proposed re-amendments had no reasonable prospects of success; the issue in question had been conclusively determined against HMRC by the Court of Appeal in FII CA on HMRC's appeal (unsuccessful in this regard) from his order in FII HC, which decisions followed FII ECJ 1. In paragraphs 36-39 of the judgment he said:

"36. In their skeleton argument, counsel for HMRC argue that these proposed amendments are merely consequential on the decision of the Court of Appeal that the introduction of the FID regime gave rise to a new restriction for the purposes of Article 57(1). They accept that it is not open to HMRC, in the light of the Court of Appeal's judgment, to contend that the absence of a tax credit for the shareholder did not amount to a new restriction. They contend, however, that HMRC are entitled to maintain their position that the requirement for the company to pay ACT and then claim it back did not amount to a new restriction.

37. I agree with the claimants that it is not open to HMRC to adopt this position. The issue which has been conclusively determined against them is not merely the question whether the absence of a tax credit amounted to a new restriction, but the issue whether HMRC are entitled to rely on the standstill provision at all. The Court of Appeal, affirming my decision, has held that they are not. This gives rise to an issue estoppel between the parties, which precludes HMRC from attempting to argue the contrary in either the same or subsequent proceedings between the same parties. Furthermore, I do not accept that the reasoning of the Court of Appeal was confined to the question of the absence of a tax credit. It seems clear to me that they considered the FID regime as a whole, and concluded that it could not benefit from the standstill provision. Accordingly, paragraph 16 of the order of the Court, based on paragraph 1 of my order with immaterial variations, read as follows:

"The following claims are successful in relation to the GLO issues determined in the trial:

……………………

(b) claims for the time value of ACT on third country FIDs paid on or after 1 July 1994 and refunded under the FID regime…"

It would not have been possible for the Court of Appeal to make an order in this form if it were still open to HMRC to contend that the requirement to pay ACT and claim it back under the FID regime did not amount to a new restriction on the free movement of capital. Finally, even if it were still open to HMRC to argue the point, I am unable to understand how it would help them to do so. The admitted new restriction relating to the absence of a tax credit would, by itself, be enough to ensure that the standstill provision was inapplicable.

38. I should add, for completeness, that there is an exception to issue estoppel in special circumstances where its application would work injustice: see Arnold v NatWest Bank Plc [1991] 2 AC 93 at 109A-C per Lord Keith of Kinkel, with whose speech the other members of the House agreed. There is, however, no suggestion in the proposed re-amendments that HMRC might even arguably be able to rely on this exception, which as formulated applies only where:

"there has become available to a party further material relevant to the correct determination of a point involved in the earlier proceedings, whether or not that point was specifically raised and decided, being material which could not by reasonable diligence have been adduced in those proceedings."

39. In the circumstances, I consider that the proposed re-amendments to paragraph 19 of the defence must be disallowed, because the contentions advanced have no reasonable prospect of success. The options available to HMRC, as it seems to me, are either to leave their existing defence on this point un-amended, in which case it will be rejected at trial because the point has already been conclusively determined against them, or (in my view preferably) simply to admit paragraphs 12E to 12G of the particulars of claim."

HMRC's arguments

26. On the appeal Mr Rupert Baldry QC and Mr Oliver Conolly, respectively leading and junior counsel appearing on behalf of HMRC, maintained that the relevant issue had not yet been decided and that HMRC could, and should, be allowed to argue the point. In summary they submitted:

i) Dividends sourced from third countries fall outside the scope of Article 43 EC (freedom of establishment), as that freedom only applies within the EU; the Claimants therefore need to rely on Article 56 (free movement of capital) in respect of dividends received from third countries and, if Article 56 does not apply, because of the standstill provisions, their claims on this part of the case must fail.

ii) Article 56 EC provided:

"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." (Emphasis added).

iii) Article 57(1) EC, known as the standstill provision, provided as follows:

"The provisions of Article 56 shall be without prejudice to the application to third countries of any restrictions which exist on 31 December 1993 under national or Community law adopted in respect of the movement of capital to or from third countries involving direct investment – including in real estate – establishment, the provision of financial services or the admission of securities to capital markets. In respect of restrictions existing under national law in Estonia and Hungary, the relevant date shall be 31 December 1999."

iv) It was readily apparent that the application of the standstill provisions in Article 57(1) presupposed the identification of a "restriction" of the freedom of capital under Article 56.

v) It was critical to identify with precision which issue had been decided in relation to the application of the standstill provisions under Article 57(1) EC with respect to dividends from third countries.

vi) There were two issues. The first issue was whether the FID regime itself constituted a new restriction for the purposes of Article 57(1) EC. If so, then it clearly could not itself benefit from the protection afforded by that Article, because it post-dated 31 December 1993. In FII (CA) the Court of Appeal had indeed decided that the FID regime did not benefit from the standstill provisions.

vii) However, the second, and logically distinct, issue was whether the obligation imposed on a UK company to account for ACT on dividends paid by it out of dividends received from third countries – which was itself a "restriction" on the freedom of capital of those companies – was protected by the standstill provisions. That issue had not been determined by the Court of Appeal. It did not follow from the Court of Appeal's determination of the first issue in favour of the Claimants that it had determined the second issue in their favour. Thus a relevant issue to the determination of the Claimants' claims had not in fact been determined in the FII GLO litigation, and accordingly it was still open to HMRC to raise it.

viii) There were thus two distinct restrictions under the UK legislation as it applied to FIDs: (i) the requirement for the FID-paying company to pay ACT; and (ii) the denial of a tax credit to the shareholder receiving the FID. The requirement for the FID-paying company to pay ACT, albeit under the improved FID regime, with the consequential ability on the part of the company to claim repayment of surplus ACT, had to be treated separately from the other element of the FID regime, namely the denial of a tax credit to the shareholder receiving the FID.

ix) The Court of Appeal had decided that the second of those restrictions was a new restriction outside the scope of the standstill provisions. The Court of Appeal had not, however, decided whether the effect of the introduction of the FID regime was to make the first restriction, i.e. the ACT restriction, a new restriction.

x) The requirement for the FID-paying company to pay ACT was not a new restriction; it was an old restriction existing on 31 December 1993 (albeit that it had been ameliorated by the provisions of the new FID regime) and therefore was saved by the standstill provisions of Article 57(1).

xi) Therefore the Claimants could not maintain a claim for interest on the delay in recovering ACT paid under the FID regime, because that element of the restriction was in place as at 31 December 1993 and protected by Article 57(1).

Discussion and determination

27. Largely for the reasons put forward by Mr Graham Aaronson QC, leading counsel on behalf of the Claimants, in his written and oral submissions before this Court, I conclude that Henderson J was correct to decline to allow HMRC to amend its case. In summary, in my judgment HMRC is estopped per rem judicatam, or, put another way, prevented, as a result of the issue already having been decided in the litigation, from raising the issue a second time. I take the view that the contention now being advanced by HMRC is inconsistent with the earlier decision of Henderson J in FII HC as affirmed by the Court of Appeal in FII CA. Further or alternatively, any attempt by HMRC now to litigate the issue as to whether the obligation imposed on a UK company under the FID regime to account for ACT on dividends paid by it out of dividends received from third countries was a separate restriction, protected by the standstill provisions, from that denying a tax credit to the shareholder receiving the FID, would amount to an abuse of process and fall foul of the rule in Henderson v Henderson (1843) 3 Hare 100. That is because the point now sought to be taken by HMRC (namely that the obligation under the FID regime imposed on a UK company to account for ACT on dividends matched with dividends received from third countries was a separate restriction protected by the standstill provisions) is a point that could have been taken, but was not taken, before Henderson J in FII HC and before the Court of Appeal in FII CA. On the contrary, the arguments run by HMRC in those courts (and indeed before the ECJ) was based on the premise that there was one composite FID scheme.

28. My reasons for this conclusion are as follows.

29. The starting point is the decision of the European Court in FII ECJ1. The most relevant paragraphs for present purposes are 188-196:

"188 The United Kingdom Government argues that, should the Court hold that Article 56 EC precludes national legislation governing the taxation of foreign-sourced dividends, such as the legislation at issue in the main proceedings, that would apply not only to the measures covered by Questions 1 to 3, which were adopted prior to 31 December 1993, but also to the FID regime, which came into effect on 1 July 1994, inasmuch as that regime did not introduce any new restrictions vis-à-vis the existing measures but, on the contrary, did no more than abolish a number of the restrictive effects of the existing legislation.

189 It is necessary first of all to clarify the concept of restrictions which exist on 31 December 1993 within the meaning of Article 57(1) EC.

190 As the claimants in the main proceedings, the United Kingdom and the Commission propose, reference should be made to Case C-302/97 Konle [1999] ECR I-3099, in which the Court had to provide an interpretation of the concept of 'existing legislation' contained in a derogating provision in the Act concerning the conditions of accession of the Republic of Austria, the Republic of Finland and the Kingdom of Sweden and the adjustments to the Treaties on which the European Union is founded (OJ 1994 C 241, p. 21, and OJ 1995 L 1, p. 1), allowing the Republic of Austria to maintain its existing legislation governing secondary residences for a limited period.

191 While it is, in principle, for the national court to determine the content of the legislation which existed on a date laid down by a Community measure, the Court held in that case that it is for the Court of Justice to provide guidance on interpreting the Community concept which constitutes the basis of a derogation from Community rules for national legislation 'existing' on a particular date (see, to that effect, Konle, paragraph 27).

192 As the Court stated in Konle, any national measure adopted after a date laid down in that way is not, by that fact alone, automatically excluded from the derogation laid down in the Community measure in question. If the provision is, in substance, identical to the previous legislation or is limited to reducing or eliminating an obstacle to the exercise of Community rights and freedoms in the earlier legislation, it will be covered by the derogation. By contrast, legislation based on an approach which is different from that of the previous law and establishes new procedures cannot be regarded as legislation existing at the date set down by the Community measure in question (see Konle, paragraphs 52 and 53).

193 Next, as regards the relationship between the FID regime and the existing national legislation governing the taxation of foreign-sourced dividends, as described by the national court, it is apparent that the objective of that regime is to limit the restrictive effects arising from the existing legislation for resident companies receiving foreign-sourced dividends, in particular by offering those companies the opportunity to obtain a repayment of the surplus ACT which is due when they pay dividends to their own shareholders.

194 It is, however, for the national court to determine whether the fact that, as the claimants in the main proceedings point out, shareholders receiving a FID are not entitled to a tax credit, must be regarded as a new restriction. While it is true that, in the national system of which the FID regime forms part, the grant of such a tax credit to a shareholder receiving a distribution is the counterpart of the payment by the company making the distribution of the ACT on that distribution, it cannot be inferred from the description of the national tax legislation provided in the order for reference that the fact that a company which has elected to be taxed under the FID regime is entitled to be reimbursed surplus ACT justifies, under the logic governing the legislation which existed on 31 December 1993, its shareholders not being entitled to any tax credit.

195 In any event, contrary to what the United Kingdom Government contends, the FID regime cannot be categorised as an existing restriction merely on the basis that, because it is optional, the companies concerned can always elect to be taxed under the system previously in place, with the restrictive effects to which it gave rise. As mentioned in paragraph 162 of this judgment, a system which restricts the freedoms of movement still remains incompatible with Community law, even though its application may be optional.

196 The answer to Question 5 must therefore be that Article 57(1) EC is to be interpreted as meaning that where, before 31 December 1993, a Member State has adopted legislation which contains restrictions on capital movements to or from non-member countries which are prohibited by Article 56 EC and, after that date, adopts measures which, while also constituting a restriction on such movements, are essentially identical to the previous legislation or do no more than restrict or abolish an obstacle to the exercise of the Community rights and freedoms arising under that previous legislation, Article 56 EC does not preclude the application of those measures to non-member countries when they apply to capital movements involving direct investment, including investment in real estate, establishment, the provision of financial services or the admission of securities to capital markets. Holdings in a company which are not acquired with a view to the establishment or maintenance of lasting and direct economic links between the shareholder and that company and do not allow the shareholder to participate effectively in the management of that company or in its control cannot, in this connection, be regarded as direct investments."

30. In the light of what the ECJ said in these paragraphs, read in the context of the full judgment, I cannot accept Mr Baldry's submission that the only issue which the ECJ was addressing, or remitting to the national court, was the issue whether the denial of a tax credit to the shareholder receiving the FID was a new restriction. As paragraphs 192 to 194 to my mind emphasise, one has to look at the legislative package as a whole in order to ascertain whether the approach reflects a new approach which is different from that of the previous law. Moreover, as Mr Aaronson QC pointed out, the ECJ was well aware that, ultimately, the question to be determined was whether the Claimants could make claims in respect of ACT paid on third country FIDs and that the ACT charge was already in place under the legislation existing at 31 December 1993.

31. When one turns to consider the judgment of Henderson J in FII HC in what was effectively a liability trial, and the orders and declarations made by him to give effect to his judgment, it is plain to me that he decided that the composite FID regime (and not merely that element of it which involved the denial of a tax credit to the shareholder receiving the FID) was incompatible with Community law and a new restriction. I refer to paragraphs 184 -191 of the judgment (paragraphs 190-191 of which I have already quoted above):

"4) Third country FIDs and Article 57(1)

180. I now move on to a more substantial question, which is whether, on the assumption that Article 56 applied and was breached in relation to third country FIDs, the introduction of the FID regime was a new restriction such that the UK could no longer rely upon the standstill provision in Article 57(1). I use the expression "third country FIDs" as a convenient, although slightly inaccurate, shorthand for FIDs which are matched with distributions made by companies resident in third countries.

181. This part of my discussion assumes that the ECJ's conclusion that the FID regime breached Article 56 in relation to third country FIDs is correct, and has not been overtaken by its subsequent decision in Burda. On that aspect of the matter, I have nothing to add to what I have already said in paragraphs 80 to 95 above.

182. I will also not repeat what I have already said in paragraphs 88 to 98 about the jurisprudence of the ECJ in relation to Article 57(1). It will be recollected that where the question is whether new legislation introduced after 31 December 1993 can properly be regarded as a continuation of a restriction which was in existence on the latter date, the relevant test, as laid down in Konle and the judgment of the ECJ in the present case, is whether the new legislation is based on an approach which is different from that of the previous law and which establishes new procedures. If there is such a difference of approach, coupled with the establishment of new procedures, the new legislation cannot be regarded as "in substance identical" to the previous restriction. However, a member state will be able to continue to rely on an existing restriction where the new legislation "is limited to reducing or eliminating an obstacle to the exercise of Community rights and freedoms in the earlier legislation". In other words, a relaxation of an existing restriction will not remove protection from what remains of the restriction. The principles which I have just identified were stated by the ECJ in paragraph 192 of the judgment, in the context of their discussion of Question 5 in the Order for Reference. I have already quoted part of Question 5 in paragraph 89, but for completeness I will now quote it in full:

"5. Where, prior to 31 December 1993, a Member State adopted the measures outlined in Questions 1 and 2 and after that date it adopted the further measures outlined in Question 4, and if the latter measures constitute a restriction prohibited by Article 56 of the EC Treaty, is that restriction to be taken to be a new restriction not already existing on the 31 December 1993?"

183. The ECJ did not answer this question themselves, but remitted it to the national court for determination in the light of the guidance given in the judgment. The only remaining part of the judgment which I need to refer to in this context comes immediately after paragraph 192:

"193. Next, as regards the relationship between the FID regime and the existing national legislation governing the taxation of foreign-sourced dividends, as described by the national court, it is apparent that the objective of that regime is to limit the restrictive effects arising from the existing legislation for resident companies receiving foreign-sourced dividends, in particular by offering those companies the opportunity to obtain a repayment of the surplus ACT which is due when they pay dividends to their own shareholders.

194. It is, however, for the national court to determine whether the fact that, as the claimants in the main proceedings point out, shareholders receiving a FID are not entitled to a tax credit, must be regarded as a new restriction. While it is true that, in the national system of which the FID regime forms part, the grant of such a tax credit to a shareholder receiving a distribution is the counterpart of the payment by the company making the distribution of the ACT on that distribution, it cannot be inferred from the description of the national tax legislation provided in the order for reference that the fact that a company which has elected to be taxed under the FID regime is entitled to be reimbursed surplus ACT justifies, under the logic governing the legislation which existed on 31 December 1993, its shareholders not being entitled to any tax credit."

184. The important points which emerge from paragraphs 193 and 194 are in my judgment as follows. First, the object of the FID regime was to limit the restrictive consequences of the former legislation for UK resident companies in receipt of foreign dividends. If that were all that the FID regime did, there would be no reason why the relaxed restriction should not continue to enjoy the protection of Article 57(1). Secondly, however, shareholders who receive a FID are not entitled to a tax credit, even though the company pays ACT in the usual way after the dividend has been paid. This is prima facie a new restriction, based on an approach which is different from that of the previous law. However, it may be capable of justification on the basis that ACT is reimbursed to the company. Whether it can be so justified will depend on a detailed examination of the relevant legislation, which only the national court can perform. A relevant consideration, highlighted by the ECJ in the final sentence of paragraph 194, is that the company is only entitled to be reimbursed surplus ACT, whereas the shareholders in receipt of FIDs are not entitled to any tax credit.

185. Drawing on this guidance, Mr Aaronson submitted that the FID legislation was clearly based on a new approach, and the denial of any tax credit to recipients of FIDs could not be justified because the company was only entitled to reimbursement of surplus ACT after any remaining liability to MCT had been discharged by set off. He referred in this context to the provisions for repayment and set off of ACT which I have described in paragraphs 171 to 172 above, and submitted that the FID regime could only have continued to enjoy the protection of Article 57(1) if, as a minimum, it provided for the grant of tax credits in respect of any part of the ACT which was not reimbursed.

186. Mr Ewart's riposte to these submissions was to argue that the question remitted to the national court by the ECJ in paragraph 194 of the judgment had been conclusively answered in the Revenue's favour by the decision of the House of Lords in Pirelli Cable Holding NV v IRC http://www.bailii.org/uk/cases/UKHL/2006/4.html[2006] UKHL 4, http://www.bailii.org/cgi-bin/redirect.cgi?path=/uk/cases/UKHL/2006/4.html[2006] 1 WLR 400 ("Pirelli 1"). That case was concerned with the quantification of the compensation payable to certain companies under the ACT GLO, and one of the issues which arose was whether, on the hypothesis that a UK company and its foreign parent were able to make a group income election, and thus to avoid payment of ACT on dividends paid by the former to the latter, the foreign parent would nevertheless still be entitled to receive tax credits under the double taxation agreement entered into between its state of residence and the UK. The House of Lords, differing from Park J and the Court of Appeal, answered this question in the negative. They held, in essence, that there was an inextricable link between payment of ACT and the receipt of a tax credit, and that this principle should inform the construction of the relevant provisions in the double taxation agreement in such a way as to preclude payment of the tax credit in circumstances where ACT was not payable.

187. The link between payment of ACT and the receipt of a tax credit was expressed in varying ways, but to similar effect, by their Lordships. For example, Lord Nicholls said in paragraph 1 at 402G:

"Nowhere did the legislation state that liability to pay ACT was a precondition of entitlement to a tax credit. But this unspoken linkage lay at the heart of the scheme, and the legislation was drawn in a form which achieved this result."

See too the speech of Lord Hope at paragraphs 37 and 39, and the speech of Lord Walker at paragraphs 103 and 105.

188. Accordingly, submitted Mr Ewart, if the original liability to pay ACT under the FID regime was subsequently extinguished by repayment of the ACT, no tax credit could have been payable, and in denying payment of a tax credit to the recipient of a FID the legislation was merely reflecting that basic principle.

189. Mr Ewart sought to derive further support for his submission from the decision of the Court of Appeal in the next instalment of the Pirelli litigation, Pirelli Cable Holding NV v Revenue & Customs Commissioners (No. 2) http://www.bailii.org/ew/cases/EWCA/Civ/2008/70.html[2008] EWCA Civ 70, [2008] STC 508 ("Pirelli 2"). For present purposes, however, I do not think that the judgments of the Court of Appeal in Pirelli 2 add anything to the basic principle of linkage between the payment of ACT and the grant of a tax credit established by Pirelli 1. The focus of Pirelli 2 was on a different point, upon which the claimants had fastened following their defeat in Pirelli 1, namely whether entitlement to a tax credit was also triggered by the payment of MCT by the dividend-paying subsidiaries. That contention was rejected by Rimer J at first instance, and then by the Court of Appeal. I was told that the House of Lords subsequently refused permission to appeal, so that chapter in the litigation is now closed.

190. In my judgment Mr Ewart's argument does not meet Mr Aaronson's contention, nor does it answer the question remitted to the national court by the ECJ. A central point of that question, although it is easy to miss it on a superficial reading, is that the FID regime denies any tax credit, even though it does not provide for automatic reimbursement of the ACT which is paid, and instead gives priority to setting off ACT which would otherwise be repayable against any outstanding liability to MCT. In an extreme case, the result could be that no ACT at all was repayable, because the company concerned had a sufficiently large outstanding MCT liability to absorb all of the ACT paid in respect of the FIDs. Mr Ewart had no real answer to this point, and in my view this feature of the FID regime has to be regarded as the introduction of a new restriction which had no precursor in the previous legislation. By introducing this new restriction, I consider that the UK forfeited the protection of Article 57(1) for the FID regime, even though the general purpose of the FID regime was to mitigate the adverse ACT consequences of the regime otherwise applicable to foreign dividends.

191. For these reasons, I conclude that the FID regime breached Article 56 in relation to third country FIDs, and that the breach was not negated by Article 57(1). It follows that liability in respect of third country FIDs is in principle established."

32. What is clear from this passage (and indeed Mr Baldry QC did not dispute this point) was that, before Henderson J, Mr David Ewart QC, leading counsel on behalf of HMRC, was contending that there was a composite scheme and that the inextricable link between payment of ACT and the receipt of a tax credit demonstrated that the FID regime was indeed protected by the standstill provision of Article 57(1). Basically, Mr Ewart QC was arguing that, although the removal of the tax credit to shareholders was an additional restriction, one had to read it in conjunction with the change to ACT regime, and, viewed as a whole, the legislation adopted the same approach and the same logic as the previous statutory regime, and therefore was protected by the standstill provision of Article 57(1).

33. Against that background, the only possible construction of:

i) paragraph 1(c) of Henderson J's order dated 12 December 2008 in FII HC, namely:

"1. The following claims are successful in relation to the GLO issues determined in the trial: …

(c) claims for the time value of ACT on third country FIDs paid on or after 1 July 1994 and refunded under the FID regime; …" (Emphasis added.);

ii) the declarations at paragraphs 8 and 9 of such order that:

"8.The FID regime is incompatible with Article 56 EC [now article 63 TFEU] in relation to FIDs matched with dividends paid by a company resident in a country other than a Member State ("third country FIDs").

9. The introduction of the FID regime was a new restriction for the purposes of Article 57(1) [now article 64(1) TFEU] so that the application of Article 56 EC is not excluded in relation to third country FIDs."

was that Henderson J concluded that every aspect of the FID regime was not saved by the standstill provisions.

34. Similarly, in my judgment it is impossible to construe the Court of Appeal's judgment and order in FII CA as reaching any different result. The relevant paragraphs are paragraphs 122-130:

"122. The Judge considered that the FID regime created a new restriction because, while it provided a method of reducing ACT surpluses built up by groups in receipt of foreign-source dividends, it did not provide any tax credit. The ACT released had first to be set against the resident company's liability for MCT, and would only then be repaid. The Judge concluded that the FID regime involved a new restriction and that the United Kingdom had forfeited the protection of Article 57(1) by introducing the FID regime, even though that regime was intended to mitigate the ACT consequences of the regime otherwise applicable to foreign dividends (judgment, paragraph [190]).

123. On this appeal the Revenue challenges the Judge's conclusion. Mr Ewart submitted that the question referred to the national court by the ECJ could be answered by reference to the decision in the House of Lords in Pirelli Cable Holding NV v IRC [2006] UKHL 4, [2006] 2 All ER 81. On his submission, that decision showed that there was an inextricable link between the payment of ACT and the receipt of a tax credit. The issue was whether, if it were unlawful for a subsidiary and its non-United Kingdom resident parent company to make a group income election, the tax credits envisaged under the relevant double taxation conventions would not be payable. Lord Nicholls, Lord Hope and Lord Walker each held that there was a link between the tax credit and the payment of ACT. Lord Nicholls said that "this unspoken linkage" lay at the heart of the legislative scheme. Lord Hope also held that the prerequisite for the giving of a tax credit was the making of the qualifying distribution, which was liable to ACT ([39]). He added that "A group income election extinguished that liability and with it the right to the tax credit that was that the counterpart of the liability" ([39]). Lord Walker also held that, if the payment of a dividend was not accompanied by a payment of ACT, the dividend would not give rise to a tax credit ([103]). It followed, on Mr Ewart's submission, that it was consistent with the legislative scheme for ACT to deny a tax credit where ACT was about to be repaid.

124. The Judge distinguished the passages in Pirelli on the basis that the FID regime denied any tax credit to shareholders of the parent company even though it did not provide for the automatic reimbursement of the ACT which was paid, and instead gave priority to the setting off of ACT, which would otherwise be repayable, against any outstanding ability to MCT (judgment, paragraph [190]).

125. Mr Ewart submits that the Judge fundamentally misunderstood the purpose of the FID regime, and the reason why companies chose to pay dividends as FIDs rather than as normal dividends. By using the FID regime, companies could reduce their ACT surplus by allowing the unutilised ACT to be repaid. Companies could, therefore, pay both FIDs (which they would do if they would otherwise have unutilised ACT) and ordinary dividends in the same year. A FID did not carry a tax credit, since it was intended and was the case in practice that a FID was used only in cases where the company calculated that the ACT would not be used and would therefore be repaid in full. If FIDs had always carried a tax credit, the result would have been that all payments of dividends would have been made as FIDs, thus entitling shareholders to tax credits even though most or all of the ACT was subsequently be repaid. This would break the "unspoken linkage" between the payment of ACT and entitlement to a tax credit.

126. Mr Aaronson sought to uphold the Judge's judgment. He submitted that the FID scheme linked the repayment of ACT to distributable profits and that the refusal of a tax credit was not linked to the repayment of ACT. He further submitted that the FID scheme contained restrictions that meant that, if the effective rate of foreign corporation tax were less than the United Kingdom MCT, there would be ACT which would not be eligible for repayment. There was no automatic right to payment of ACT where the FID was paid and the tax credit lost. Mr Thomas David Bilton, who gave evidence on the Claimants' behalf, stated that:

"Under the FID system there was no option but to make an educated guess as to what the underlying rate of exchange was going to be. If we got it wrong and there was insufficient double tax relief to match the foreign sourced income with the FIDs, this would mean that the ACT could not be reclaimed and, to the extent any had been paid, interest (and potentially penalties) would be payable".

127. Mr Bilton's evidence on this point was not contested. The Revenue adduced no evidence and merely contended that it was not relevant that it might not work out in practice that the ACT would not be repaid. That was not what was intended to happen.

128. In sum, Mr Aaronson submitted that the removal of the tax credit where a dividend was paid as a FID did not follow the logic of the ACT arrangements. He submitted therefore that the fact that shareholders were not entitled to any tax credit was a new restriction.

129. The question that the ECJ required the national court to consider was whether the FID scheme justified the absence of a tax credit for shareholders. The fact is that a company could fall between two stools. There was nothing which prevented it from electing to make a FID and then finding that it could not in fact obtain repayment of ACT under the restrictions applying to the foreign tax admitted for FID regime purposes. No doubt this would not happen to a company that was well advised, and could be avoided with planning. Nonetheless the circumstances postulated could occur. The company would have paid ACT and not be able to claim repayment of that ACT, and yet the dividend paid by it would carry no tax credit. That was inconsistent with the logic of the legislation as it did not respect the "unspoken" link between the payment of ACT and the entitlement to a tax credit. Thus there was a new approach and new restriction in the FID regime, which meant that Article 57(1) did not apply to it.

130. We would dismiss the appeal on this point."

35. As quoted above, the declarations which the Court of Appeal made pursuant to its judgment can only be regarded as consistent with the conclusion that the composite FID regime was not saved by the standstill provision. To recapitulate, paragraph 7 of the Court of Appeal's order dated 19 March 2010, giving effect to its judgment in FII CA, provided:

"7. The Respondents' appeals on Issues 9 and 10 [whether the FID regime offended article 63 or was protected by article 64(1)] are dismissed. Declarations 8 and 9 are affirmed. …;

and paragraph 16(b) of the Court of Appeal's order dated 19 March 2010 similarly provided:

"16. Order 1 [the order of Henderson J referred to above] is varied to read:

The following claims are successful in relation to the GLO issues determined in the trial: …

(b) Claims for the time value of ACT on third country FIDs paid on or after 1 July 1994 and refunded under the FID regime in so far as (i) the ACT paid was not due after taking into account the tax credit available under section 231 in respect of those dividends and (ii) the claims are made within the applicable limitation periods; …" (Emphasis added.)

36. In the light of this approach, in my judgment HMRC's current assertion before this court that Henderson J and the Court of Appeal focused solely on the removal of the shareholders' right to a tax credit, and that they had not adjudicated on the Claimant companies' claims in respect of the time value of ACT is simply not sustainable. Such an argument is inconsistent with the orders of both Courts, which dealt expressly with the Claimant companies' claims for the time value of ACT. Moreover, Mr Ewart's submissions before both courts was that the FID regime should be looked at as a whole, and, as the main purpose of the FID regime as a whole was to alleviate the discriminatory restriction on ACT payments, the regime as a whole should be regarded as falling within the "standstill" in Article 57(1). Both Henderson J and the Court of Appeal rejected this argument. In those circumstances it lies ill in HMRC's mouth now to change tactics and put forward a wholly different case.

37. Accordingly, in my judgment, the issue which HMRC wishes to raise has been conclusively determined against it by Henderson J and the Court of Appeal. Therefore HMRC is estopped per rem judicatam, from raising the issue a second time: the contention now being advanced by HMRC is inconsistent with the earlier decision in the same case; see Price v Nunn [2013] EWCA Civ 1002 and the Supreme Court's decision in Virgin Atlantic Airways Limited v Zodiac Seats UK Limited [2013] UKSC 46, [2013] 3 WLR 299. It is thus not open to HMRC now to seek to raise this argument.

38. Alternatively, if I am wrong in my analysis that the issue which HMRC now seeks to raise has been conclusively determined against it by Henderson J and the Court of Appeal, in any event the raising of this argument (namely that one should look at the various elements of the restrictions imposed by the FID regime separately) would be contrary to the public interest and an abuse of process: see Lord Bingham in Johnson v Gore Wood [2002] 2 AC 1, at 31A, where he explains the principle articulated in Henderson v Henderson.

Disposition

39. For the above reasons I concluded that, whilst it was appropriate, in the light of the full arguments which we had heard, to grant permission to appeal, HMRC's appeal should be dismissed.

Lord Justice McFarlane:

40. I agree.

Lord Justice Moore-Bick:

41. My reasons for concurring in the order made on 27^th March 2014 were the same as those given by Gloster L.J.