Strand, London, WC2A 2LL
B e f o r e :
LORD JUSTICE CHRISTOPHER CLARKE
LORD JUSTICE SALES
| The Prudential Assurance Company Limited
|- and -
|Commissioners for Her Majesty's Revenue and Customs
Graham Aaronson QC, Tom Beazley QC and Jonathan Bremner (instructed by Joseph Hage Aaronson LLP) for the Respondent
Hearing dates: 11/03/2016 to 18/03/2016
Crown Copyright ©
Lord Justice Lewison:
"3.4 The trials of all test claims are to be heard together.
3.5 Save for the quantification of the amount of damages and compensation or restitution all issues in the test claims including liability for restitution shall be heard together…. The parties have liberty to apply for directions for the determination of any matters which remain in contention regarding the quantification of the amount of damages and compensation … following the trial of the test claims."
"Is there a restitutionary defence available – e.g. defence of change of position, passing on, "fiscal chaos" and, if so, are the requirements of any such defence fulfilled and to what extent."
"While it is good sense not to be pernickety about pleadings, the basic requirement that material facts should be pleaded is there for a good reason—so that the other side can respond to the pleaded case by way of admission or denial of facts, thereby defining the issues for decision for the benefit of the parties and the court. Proper pleading of the material facts is essential for the orderly progress of the case and for its sound determination. The definition of the issues has an impact on such important matters as disclosure of relevant documents and the relevant oral evidence to be adduced at trial. In my view, the fact that the nature of the grievance may be obvious to the respondent or that the respondent can ask for further information to be supplied by the claimant are not normally valid excuses for a claimant's failure to formulate and serve a properly pleaded case setting out the material facts in support of the cause of action. If the pleading has to be amended, it is reasonable that the party, who has not complied with well-known pleading requirements, should suffer the consequences with regard to such matters as limitation."
"All litigants are entitled to be protected from incurring unnecessary costs. This is the objective of the GLO regime. Primarily, it seeks to achieve its objective, so far as this is possible, by reducing the number of steps litigants, who have a common interest, have to take individually to establish their rights and instead enables them to be taken collectively as part of a GLO Group. This means that irrespective of the number of individuals in the group each procedural step in the actions need only be taken once. This is of benefit not only to members of the group, but also those against whom proceedings are brought."
"In the context of a GLO, a claim form need be no more than the simplest of documents."
"The management court may direct that the GLO claimants serve 'Group Particulars of Claim' which set out the various claims of all the claimants on the Group Register at the time the particulars are filed. Such particulars of claim will usually contain –
(1) general allegations relating to all claims; and
(2) a schedule containing entries relating to each individual claim specifying which of the general allegations are relied on and any specific facts relevant to the claimant."
i) They were wholly new issues;
ii) They were issues which HMRC tried to ventilate before the judge, but he refused on the ground that they were raised too late;
iii) They were issues which would have required further facts to be found;
iv) They were unpleaded issues which ought to have been pleaded.
ACT and corporation tax
The illegality of the UK tax system
" …First, whatever mechanism a member state chooses to adopt in order to prevent or mitigate economic double taxation, the Treaty freedoms of movement prohibit treating foreign-sourced dividends less favourably than nationally sourced dividends, unless the less favourable treatment either (a) concerns situations which are not objectively comparable, or (b) is justified by overriding reasons in the general interest.
 Secondly, there is no reason in principle why a member state should not operate a dual system (of exemption for national dividends and imputation for foreign dividends, as in the UK at the material time), provided that:
(a) the member state does not impose a higher rate of tax on foreign dividends than it does on national dividends; and
(b) it gives a credit for the amount of tax paid by the foreign company, up to (but not in excess of) the amount of tax paid by the national company on the dividends.
 Thirdly, the mere fact that an imputation system imposes additional administrative burdens on taxpayers, when compared with an exemption system, for example requiring evidence of the amount of tax actually paid in the foreign country, does not infringe art 63 TFEU, because such burdens 'are an intrinsic part of the operation of a tax credit system'."
"54. The claimants in the main proceedings none the less point out that when, under the relevant United Kingdom legislation, a nationally-sourced dividend is paid, it is exempt from corporation tax in the hands of the company receiving it, irrespective of the tax paid by the company making the distribution, that is to say, it is also exempt when, by reason of the reliefs available to it, the latter has no liability to tax or pays corporation tax at a rate lower than that which normally applies in the United Kingdom.
55. That point is not contested by the United Kingdom government, which argues, however, that the application to the company making the distribution and to the company receiving it of different levels of taxation occurs only in highly exceptional circumstances, which do not arise in the main proceedings.
56. In that respect, it is for the national court to determine whether the tax rates are indeed the same and whether different levels of taxation occur only in certain cases by reason of a change to the tax base as a result of certain exceptional reliefs." (Emphasis added)
"The answer to Question 1 must therefore be that arts 43 EC and 56 EC must be interpreted as meaning that, where a member state has a system for preventing or mitigating the imposition of a series of charges to tax or economic double taxation as regards dividends paid to residents by resident companies, it must treat dividends paid to residents by non-resident companies in the same way."
Nominal rate or effective rate?
"…..is that a Member State is free to adopt a dual exemption/imputation system for domestic and foreign dividends, and the two methods are in fact equivalent, so long as (a) the tax rate applied to foreign dividends is not higher than the rate applied to domestic dividends, and (b) the tax credit is at least equal to the amount paid in the State of the company making the distribution, up to the limit of the tax charged in the home State of the recipient (paragraph 39, referring to FII (ECJ) I at paragraphs 48 and 57, Haribo at paragraph 86, Accor at paragraph 88, and the reasoned order in the present case at paragraph 39)."
"43. It must in fact be held that the tax rate applied to foreign-sourced dividends will be higher than the rate applied to nationally-sourced dividends within the meaning of the case-law cited in paragraph 39 of the present judgment, and therefore that the equivalence of the exemption and imputation methods will be compromised, in the following circumstances.
44. First, if the resident company which pays dividends is subject to a nominal rate of tax below the nominal rate of tax to which the resident company that receives the dividends is subject, the exemption of the nationally-sourced dividends from tax in the hands of the latter company will give rise to lower taxation of the distributed profits than that which results from application of the imputation method to foreign-sourced dividends received by the same resident company, but this time from a non-resident company also subject to low taxation of its profits, inter alia because of a lower nominal rate of tax.
45. Application of the exemption method will give rise to taxation of the distributed nationally-sourced profits at the lower nominal rate of tax applicable to the company paying dividends, whilst application of the imputation method to foreign-sourced dividends will give rise to taxation of the distributed profits at the higher nominal rate of tax applicable to the company receiving dividends.
46. Second, exemption from tax of dividends paid by a resident company and application to dividends paid by a non-resident company of an imputation method which, like that laid down in the rules at issue in the main proceedings, takes account of the effective level of taxation of the profits in the State of origin also cease to be equivalent if the profits of the resident company which pays dividends are subject in the Member State of residence to an effective level of taxation lower than the nominal rate of tax which is applicable there.
47. The exemption of the nationally-sourced dividends from tax gives rise to no tax liability for the resident company which receives those dividends irrespective of the effective level of taxation to which the profits out of which the dividends have been paid were subject. By contrast, application of the imputation method to foreign-sourced dividends will lead to an additional tax liability so far as concerns the resident company receiving them if the effective level of taxation to which the profits of the company paying the dividends were subject falls short of the nominal rate of tax to which the profits of the resident company receiving the dividends are subject.
48. Unlike the exemption method, the imputation method therefore does not enable the benefit of the corporation tax reductions granted at an earlier stage to the company paying dividends to be passed on to the corporate shareholder.
49. Accordingly, the determination which the referring court was called upon to make by the Court, in paragraph 56 of its judgment in Test Claimants in the FII Group Litigation, relates both to the applicable nominal rates of tax and to the effective levels of taxation. The "tax rates" to which paragraph 56 refers relate to the nominal rate of tax and the "different levels of taxation … by reason of a change to the tax base" relate to the effective levels of taxation. The effective level of taxation may be lower than the nominal rate of tax by reason, in particular, of reliefs reducing the tax base."
"70 ….in paragraphs 44 and 45 the Court is concentrating on nominal rates of tax, and (except at one point) is leaving out of account any possible difference between the nominal rate and the effective rate. The Court begins by hypothesising a situation (probably quite rare in practice) where a resident company paying dividends (which I will call P1) is subject to a lower rate of tax than the recipient resident company (R). Exemption of those dividends in the hands of R means that they are taxed overall at only the lower of the two nominal rates (say 20% instead of 30%). That situation is then contrasted with the receipt by R of dividends from a foreign company (which I will call P2) which are subject to the imputation system. It is again assumed that the nominal rate of tax applicable to the dividends in P2's state of residence is lower than the 30% rate applicable to R (see the concluding words of paragraph 44, although the words "inter alia" suggest that there may also be other reasons for the lower taxation of P2's profits). Let it be assumed, as in the case of P1, that the lower rate is 20%. This time, however, the overall result is that the dividends are taxed in R's hands at the full rate of 30%. The tax credit available to set against the charge on R will be only 20%, and in the absence of any exemption the overall charge to tax on the dividends will be "topped up" to R's nominal rate. The contrast drawn in paragraph 44 is then lucidly summarised in paragraph 45.
71 The Court then considers the position where the lower rate of tax paid by P1 and P2 is not a lower nominal rate, but a lower effective rate. Suppose, for example, that in the states of residence of P1 and P2 the nominal rate applicable to the profits out of which the dividends were paid was 30% (the same as the nominal rate applicable to R), but P1 and P2 in fact paid tax on their profits at an effective rate of only 20%. In these circumstances, too, there is no equivalence between the exemption and the imputation systems, because the former results in an overall charge to tax of 20% whereas the latter results in an overall charge of 30%. As before, the difference is accounted for by the topping-up effect of the imputation system. These are the points which the Court is making in paragraphs 46 to 48."
"60. As to the proportionality of the restriction, whilst application of the imputation method to foreign-sourced dividends and of the exemption method to nationally-sourced dividends may be justified in order to avoid economic double taxation of distributed profits, it is not, however, necessary, in order to maintain the cohesion of the tax system in question, that account be taken, on the one hand, of the effective level of taxation to which the distributed profits have been subject to calculate the tax advantage when applying the imputation method and, on the other, of only the nominal rate of tax chargeable on the distributed profits when applying the exemption method.
61. The tax exemption to which a resident company receiving nationally-sourced dividends is entitled is granted irrespective of the effective level of taxation to which the profits out of which the dividends have been paid were subject. That exemption, in so far as it is intended to avoid economic double taxation of distributed profits, is thus based on the assumption that those profits were taxed at the nominal rate of tax in the hands of the company paying dividends. It thus resembles a grant of a tax credit calculated by reference to that nominal rate of tax.
62. For the purpose of ensuring the cohesion of the tax system in question, national rules which took account in particular, also under the imputation method, of the nominal rate of tax to which the profits underlying the dividends paid have been subject would be appropriate for preventing the economic double taxation of the distributed profits and for ensuring the internal cohesion of the tax system while being less prejudicial to freedom of establishment and the free movement of capital.
63. It is to be observed in this connection that in Haribo …, paragraph 99, the Court, after pointing out that the Member States are, in principle, allowed to prevent the imposition of a series of charges to tax on dividends received by a resident company by applying the exemption method to nationally-sourced dividends and the imputation method to foreign-sourced dividends, noted that the national rules in question took account, for the purpose of calculating the amount of the tax credit under the imputation method, of the nominal rate of tax applicable in the State where the company paying dividends was established.
64. It is true that calculation, when applying the imputation method, of a tax credit on the basis of the nominal rate of tax to which the profits underlying the dividends paid have been subject may still lead to a less favourable tax treatment of foreign-sourced dividends, as a result in particular of the existence in the Member States of different rules relating to determination of the basis of assessment for corporation tax. However, it must be held that, when unfavourable treatment of that kind arises, it results from the exercise in parallel by different Member States of their fiscal sovereignty, which is compatible with the Treaty (see, to this effect, Kerckhaert and Morres, paragraph 20, and Case C-96/08 CIBA  ECR I-2911, paragraph 25).
65. In light of the foregoing, the answer to the first question is that Articles 49 TFEU and 63 TFEU must be interpreted as precluding legislation of a member state which applies the exemption method to nationally-sourced dividends and the imputation method to foreign-sourced dividends if it is established, first, that the tax credit to which the company receiving the dividends is entitled under the imputation method is equivalent to the amount of tax actually paid on the profits underlying the distributed dividends and, second, that the effective level of taxation of company profits in the Member State concerned is generally lower than the prescribed nominal rate of tax."
How to identify the unlawful ACT
"I also consider that it is now too late for HMRC to pursue this argument. The adjourned trial in July 2013 was the trial of the action, including all issues of principle in relation to quantification. Although I am sometimes willing to allow more procedural latitude to the parties to test claims in group litigation than I normally would to parties to purely private proceedings, I think that if HMRC wanted to run an argument of this fundamental significance to the quantification of the claims they should have pleaded it in good time before the hearing, and then adduced calculations and evidence to explain and support their new case. As it is, however, the argument played no part at all in the trial, and it has surfaced for the first time at the stage of working out the January 2014 Order. If I were to accede to HMRC's request, the result would be to set in motion a third trial at which the issue would have to be properly pleaded from scratch, and then debated and resolved in much the same way as its counterpart was in FII (High Court) II [i.e. FII Quantification], but with the added advantage for HMRC that they would know my reasons for having rejected the similar methodology advanced by them in the latter case. I do not think it would be fair to Prudential and the other claimants in the Portfolio Dividend GLO to allow this to happen, when the point could and should have been raised, if it was to be run at all, at the trial in July 2013."
"Had the Portfolio Companies been UK residents then the requirement upon [Prudential] to pay … ACT … would have been reduced because the Dividend Income would have attracted tax credits… and would have amounted to franked investment income."
"Portfolio dividend income received from companies resident beyond the UK should have been treated as FII."
"The Revenue's methodology, by contrast, starts from the proposition that it is only when ACT was actually paid that it is necessary to determine whether any of it was unlawful. It is therefore necessary to begin by identifying the EU source income comprised in the dividends which trigger the actual charge to ACT. Since the charge was usually imposed at the top of the group, after payment up of all or part of the EU income originally received by the water's edge company through one or more intermediate holding companies, and since all the UK companies involved usually had other sources of income, the Revenue have to devise a mechanism for tracing the original EU income as it passed up the group until the stage when ACT became payable. This is an exercise which has no analogue in the UK ACT system, and it involves the making of a number of sometimes arbitrary assumptions, as well as calculations of very considerable complexity."
"… where a company resident in the United Kingdom makes a qualifying distribution and the person receiving the distribution is another such company or a person resident in the United Kingdom, not being a 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."
"(1) In this Chapter –
'franked investment income' means income of a company resident in the United Kingdom which consists of a distribution in respect of which the company is entitled to a tax credit (and which accordingly represents income equal to the aggregate of the amount or value of the distribution and the amount of that credit) …;
'franked payment' means the sum of the amount or value of a qualifying distribution and such proportion of that amount or value as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution was made …
(1A) For the purposes of this Chapter, a company has a surplus of franked investment income in an accounting period if the amount of the franked investment income of the company in that period exceeds the amount of the franked payments made by it in that period."
"(1) Where in any accounting period a company receives franked investment income the company shall not be liable to pay advance corporation tax in respect of qualifying distributions made by it in that period unless the amount of the franked payments made by it in that period exceeds the amount of that income.
(2) If in an accounting period there is such an excess, advance corporation tax shall be payable on an amount which, when the advance corporation tax payable thereon is added to it, is equal to the excess.
(3) Where a company has a surplus of franked investment income for any accounting period, the surplus shall be carried forward to the next accounting period and treated for the purposes of this section … as franked investment income received by the company in that period.
"a conforming interpretation can be achieved simply by reading in words that make it clear that resident companies can claim a credit under section 231 in respect not only of qualifying distributions made by resident companies (domestic-source income) but also distributions made by other companies (foreign-source income) to the extent that Community law requires a tax credit to be given in respect of that income too. The extent of that entitlement can then be investigated when the section falls to be applied. …" ()
"Section 231(1) should be construed in such a way as to grant a limited credit for foreign-sourced portfolio dividends of the amount needed to secure compliance with EU law. No question of disapplication therefore arises."
"Where a corporation tax liability is in part unlawful and against which ACT was utilised which incorporated unlawful ACT, is the unlawful ACT to be regarded as utilised first against the unlawful corporation tax (the Claimant's view) or is the lawful and unlawful corporation tax to be regarded as having been met pro rata by the utilisation of lawful and unlawful ACT?"
"In the absence of any special reason to the contrary, my inclination would be to adopt a pro rata approach throughout, as HMRC submit. The question is what factual assumptions it is appropriate to make, in a situation where everybody at the time assumed the whole of both the ACT and the MCT [Main Corporation Tax] to have been lawfully charged. It therefore seems natural, now that the true position has emerged, to treat the relevant payments of ACT and MCT as composed proportionately of lawful and unlawful tax. I would not be dissuaded from taking this approach by the fact that the ECJ has consistently treated (lawful) ACT as a prepayment of (lawful) MCT, because that seems to me to have nothing to do with the question of attribution of historical payments with which I am now concerned."
"[A pro rata] approach, on the other hand, reflects the indisputable fact that lawful and unlawful ACT were both mingled in a single pot in every accounting period, with no way of distinguishing one component from the other. In those circumstances, I think the only rational solution to the problem is to regard all the payments, surrenders and applications of ACT which actually took place as having been comprised of both lawful and unlawful ACT on a pro rata basis …"
"Where a quarterly return has been made of franked payments and ACT has been paid in respect of those payments and the company receives excess FII after the end of that quarterly return period but before the end of the accounting period, is the resulting repayment of ACT:
(i) attributable to the offsetting of actual FII against franked payments so that unlawful ACT only arises from the offsetting of the section 231 credits which should have accompanied foreign dividend income against the net amount of ACT not repaid (the Claimants' case); or
(ii) a repayment of lawful and unlawful ACT in the proportions in which that ACT payment was made up of lawful and unlawful ACT (HMRC's case)?"
"41. The relevant statutory provisions which enabled surplus FII to be carried back within the same accounting period (but no further) were contained in paragraph 4 of schedule 13 to ICTA 1988. In FII (High Court) II [i.e. FII (Quantification)] I set out these provisions at , and summarised their general effect in this way:
"The effect of these rather densely worded provisions may be summarised by saying that FII received in a later quarterly return period must first be applied in franking any dividends paid by the company in that period, but that any surplus may then be carried back to frank unrelieved dividends paid in an earlier quarter, thus generating a repayment of ACT. If there has been a change of ACT rates in the meantime, the repayment is not to exceed the amount of the tax credit comprised in the FII which is carried back."
42. Issue 12 in FII (High Court) II was, I think, essentially the same as the issue which I now have to consider: see the formulation of Issue 12 in . As I recorded in , the question had been barely touched upon in the numerous written submissions presented to me, and had not been mentioned at all in oral argument. I therefore dealt with it very briefly, concluding as follows in :
"In my judgment the Revenue are correct on this point. Although the repayment is generated in its entirety by the receipt of actual FII, I can see no good reason why that fact should alter the characterisation of the ACT which is repaid, or create an exception to the general pro rata approach to utilisation which I have held to be appropriate."
"… The central point, if I have correctly understood Mr Bremner's submissions, is that the FII carried back is by definition entirely lawful, as it was generated exclusively by the receipt of UK-source dividends. Any repayment of ACT paid in an earlier quarter to which the carried back FII gives rise must therefore be treated as far as possible as a repayment of lawful ACT. If that is not done, FII generated by UK income ends up being used so as to cancel out part of the credit which EU law requires on foreign income. By taking me through some sample computations, Mr Bremner was able to persuade me that this would be the result of applying HMRC's approach, and that any apparent timing anomalies thrown up by Prudential's approach are appropriately dealt with by interest adjustments."
"In the 1993 accounting period franked payments were only made in the second quarter. Excess FII arose in the fourth quarter and the return for that quarter claimed a corresponding repayment of ACT. However the ACT liability in the second quarter was met by a number of ACT payments some made before the fourth quarter and some after it. Is the repayment of ACT arising from the fourth quarter return to be regarded:
(i) as a repayment of each of those payments made towards the second quarter liability on a pro rata basis whether those payments were made before the fourth quarter or not (the Claimant's case); or
(ii) a repayment of only those payments of the second quarter liability which had been made before the fourth quarter on a pro rata basis (HMRC's view)."
"Since I have received no submissions on this question, I take it that the parties are content for me to provide a short answer to it. It seems to me that either solution would be a reasonable one to adopt, and there are no obvious reasons for preferring one to the other. My slight preference, however, is for the former solution, because it better reflects what actually happened, as can now be seen with the benefit of hindsight. I would therefore answer the question accordingly."
The change of position defence
"… [HMRC] have changed their position in consequence of the payments made by the Claimants… such that it would be inequitable and/or unconscionable to require [HMRC] to make restitution of those sums. The sums in question formed part of the United Kingdom's tax revenue for the relevant years in which they were paid. Those sums have been irretrievably spent, in some cases many years ago."
Interest: compound or simple?
"It is also convenient to deal here with another point which I have not yet separately addressed. On the assumption that my primary conclusion is correct, should compound interest continue to run to the date of judgment, or should it stop running when the relevant repayments of principal sums were made and be replaced at that point by simple interest under s 35A of the Senior Courts Act 1981? Neither side addressed me at any length on this question, because I have recently considered it, and resolved it in the taxpayers' favour, in Portfolio Dividends (No 2)  STC 1236,  2 CMLR 312 at  to . In short, it seemed to me that although there had been no appeal in Sempra from the decision of Park J that interest should run pursuant to s 35A for the period from utilisation of ACT until judgment, the logic of the majority speeches in the House of Lords showed that compound interest should also be available in respect of the post-utilisation period. I confirm that I remain of the same opinion, and I would therefore answer the comparable question in the present case in Littlewoods' favour. The Revenue did not, of course, concede the point before me, but recognised that it would be more sensible to reserve it for a higher court since I had so recently considered it myself and decided it against them."