Trinity Term [2018] UKSC 39 On appeal from: [2016] EWCA Civ 376

JUDGMENT
Prudential Assurance Company Ltd (Respondent) v
Commissioners for Her Majesty’s Revenue and
Customs (Appellant)
before
Lord Mance
Lord Sumption
Lord Reed
Lord Carnwath
Lord Hodge
JUDGMENT GIVEN ON
25 July 2018
Heard on 20 and 21 February 2018
Appellant Respondent
David Ewart QC Graham Aaronson QC
Rupert Baldry QC Tom Beazley QC
Andrew Burrows QC (Hon) Jonathan Bremner
Barbara Belgrano
(Instructed by HMRC
Solicitors Office
)
(Instructed by Joseph
Hage Aaronson LLP
)
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LORD MANCE, LORD REED AND LORD HODGE: (with whom Lord
Sumption and Lord Carnwath agree)
1. This is a test case brought against the Commissioners for Her Majesty’s
Revenue and Customs (“HMRC”) by the Prudential Assurance Co Ltd (“PAC”).
PAC is a typical United Kingdom-resident recipient of dividends on “portfolio”
investments overseas, representing less (usually much less) than 10% of the relevant
overseas companies’ share capital. The issues originate from two features of the UK
tax position in the period 1990 to 1 July 2009. First, throughout that period dividend
income received from overseas investments was in principle taxable, subject (as will
appear) to certain reliefs. Second, until 6 April 1999 Advance Corporation Tax
(“ACT”) was levied on dividends distributed to UK companies’ shareholders. The
scope of the issues arising from these features and open on this appeal is, as will
appear, itself in some dispute, but the appeal on any view involves a number of
conceptually difficult points.
2. The principal issues on this appeal can be summarised as follows:
I. Does EU law require a tax credit in respect of overseas dividends to
be set by reference to the overseas tax actually paid, or by reference to the
foreign nominal tax rate (“FNR”)?
II. Is PAC entitled to compound interest in respect of tax which was
levied in breach of EU law, on the basis that HMRC were unjustly enriched
by the opportunity to use the money in question?
III. Subject to HMRC’s being granted permission to argue the point, does
a claim in restitution lie to recover lawful ACT which was set against
unlawful mainstream corporation tax (“MCT”)?
IV. If the answer to (I) is that EU law requires a tax credit to be set by
reference to the overseas tax actually paid, PAC seeks permission to crossappeal on the following question: should the charge to corporation tax on the
foreign dividend income under Case V of Schedule D (Income and
Corporation Taxes Act 1988 (“ICTA”), section 18) (“DV tax”) be disapplied,
or should PAC be allowed to rely on FNRs, or on consolidated effective tax
rates, as a simplification or proxy for tax actually paid?
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V. If HMRC are granted permission to argue Issue III, PAC seek
permission to cross-appeal on the following questions:
(a) where ACT from a pool which includes unlawful and lawful
ACT is utilised against an unlawful MCT liability, should the unlawful
ACT be treated as a pre-payment of the unlawful MCT liability, or is
the ACT so utilised to be treated as partly lawful and partly unlawful;
and
(b) where domestic franked investment income (“FII”) was carried
back to an earlier quarter, is it to be treated as having been applied to
relieve the lawful and unlawful ACT pro rata, or only lawful ACT?
Issue I
3. The first issue – Issue I – arises from the approach adopted by UK law in order
to avoid or mitigate double taxation of dividends. It is now clear that this was
inconsistent with EU law, but in what precise respects and what is due by way of
restitution or compensation are live issues. The inconsistency with EU law arose as
follows. Domestically, dividends received by one UK-resident company, the source
of which was a distribution made by another UK-resident company, were exempt
from tax under section 208 of ICTA. The effect is that corporation tax was only
levied once, on the latter company which made the profit out of which it distributed
the dividend to the former company.
4. In contrast, dividends received by a UK-resident company, the source of
which was an overseas company, were in principle subject to DV tax. But where the
UK-resident company controlled a certain percentage of the voting power of the
relevant overseas company (typically 10%), certain relief was given for foreign tax
paid on the underlying profits out of which such dividends were paid. This was done
either pursuant to a double taxation treaty or unilaterally under ICTA, section 790.
No relief against DV tax was however afforded in respect of “portfolio” investments,
that is investments involving lesser percentage holdings.
5. In Metallgesellschaft Ltd v Inland Revenue Comrs; Hoechst v Inland Revenue
Comrs (Joined Cases C-397/98 and C-410/98) EU:C:2001:134; [2001] ECR I-1727;
[2001] Ch 620, the European Court of Justice (“CJEU”) held that the unharmonized
domestic tax regime fell under the EC Treaty, and could therefore be challenged if
inconsistent with a Treaty provision. Pursuant to a group litigation order dated 30
July 2003, PAC was on 13 November 2003 appointed to conduct the present test
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case, in which PAC’s primary contention has been that the UK tax position is
inconsistent with article 63 of the FEU Treaty.
6. Article 63FEU (ex article 56 of the EC Treaty) provides:
“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.”
7. At an early stage in the present case, a reference to the CJEU was found
necessary. But, before that reference was heard, the CJEU determined a separate UK
reference, in Test Claimants in the FII Group Litigation v Inland Revenue Comrs
(Case C-446/04) EU:C:2006:774; [2006] ECR I-11753; [2012] 2 AC 436 (“FII ECJ
I” – “FII” standing for franked investment income). In it, the CJEU held, at paras 1
and 2 of the operative part:
“1. … 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.
[The Treaty provisions] do not preclude legislation of a
member state which exempts from corporation tax dividends
which a resident company receives from another resident
company, when that state imposes corporation tax on dividends
which a resident company receives from a non-resident
company in which the resident company holds at least 10% of
the voting rights, while at the same time granting a tax credit in
the latter case for the tax actually paid by the company making
the distribution in the member state in which it is resident,
provided that the rate of tax applied to foreign-sourced
dividends is no higher than the rate of tax applied to nationallysourced dividends and that the tax credit is at least equal to the
amount paid in the member state of the company making the
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distribution, up to the limit of the amount of the tax charged in
the member state of the company receiving the distribution.
Article [63FEU] precludes legislation of a member state which
exempts from corporation tax dividends which a resident
company receives from another resident company, where that
state levies corporation tax on dividends which a resident
company receives from a non-resident company in which it
holds less than 10% of the voting rights, without granting the
company receiving the dividends a tax credit for the tax
actually paid by the company making the distribution in the
state in which the latter is resident.
2. [The Treaty provisions] preclude legislation of a
member state which allows a resident company receiving
dividends from another resident company to deduct from the
amount which the former company is liable to pay by way of
advance corporation tax the amount of that tax paid by the latter
company, whereas no such deduction is permitted in the case
of a resident company receiving dividends from a non-resident
company as regards the corresponding tax on distributed profits
paid by the latter company in the state in which it is resident.”
8. This ruling was re-affirmed in the Reasoned Order by which the CJEU
disposed of the reference made by the High Court in the present case: Test Claimants
in the CFC and Dividend Group Litigation v Inland Revenue Comrs (Case C201/05) EU:C:2008:239; [2008] ECR I-2875; [2008] STC 1513. The issue of a
Reasoned Order, without a formal Advocate General’s opinion and with the same
juge rapporteur involved as in FII ECJ I, indicates that the CJEU saw the position
as relatively straightforward.
9. In the light of these two decisions of the CJEU, it is common ground that the
UK’s treatment of overseas dividends was incompatible with EU law. In a judgment
in the present case, Prudential Assurance Co Ltd v Revenue and Customs Comrs
[2013] EWHC 3249 (Ch); [2014] STC 1236, Henderson J held (para 148) that the
appropriate means of rectifying this was for PAC to be accorded an appropriate tax
credit. (This was on the basis that a complete exemption from UK corporation tax
would go further than the CJEU had stated that EU law required.) HMRC also accept
that PAC is entitled to repayment or restitution of any corporation tax unlawfully
charged as a result of the incompatibility: Amministrazione delle Finanze dello Stato
v SpA San Giorgio (Case C-199/82) [1983] ECR 3595 (“San Giorgio”). However,
the amount to be awarded depends significantly on issues of EU law and domestic
law which are either open or which HMRC seek to raise on this appeal.
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10. Issue I is whether the credit in respect of overseas dividends should under EU
law be set by reference to the overseas tax actually paid, as HMRC submit, or by
reference to the foreign nominal tax rate (“FNR”), as PAC submits. HMRC rely in
this connection upon the CJEU’s judgments in FII ECJ I and on its Reasoned Order
in the present case, as well as upon a further judgment of the CJEU in Haribo
Lakritzen Hans Riegel BetriebsgmbH v Finanzamt Linz and Österreichische Salinen
AG v Finanzamt Linz (Joined Cases C-436/08 and C-437/08) EU:C:2011:61; [2011]
ECR I-355; [2011] STC 917. In all three cases, the juge rapporteur was Judge
Lenaerts, now the President of the CJEU. In HMRC’s submission, these cases
demonstrate, first, a difference in principle between portfolio investments, such as
PAC held, and non-portfolio investments, conferring a significant measure of
control, and, secondly, that at any rate in relation to portfolio investments the credit
to be imputed to PAC is in respect of the actual tax incurred overseas.
11. In response, PAC relies upon a later CJEU decision in the FII litigation, Test
Claimants in the FII Group Litigation v Revenue and Customs Comrs (formerly
Inland Revenue Comrs) (Case C-35/11) EU:C:2012:707; [2013] Ch 431 (“FII ECJ
II”). Judge Lenaerts was once again the juge rapporteur. In this judgment, PAC
submits, the CJEU refined its jurisprudence to require the use of the FNR in respect
of all dividends received by PAC from overseas. HMRC in reply point out that FII
ECJ II was concerned essentially with non-portfolio dividends, and criticise some
aspects of its reasoning, particularly its treatment of Haribo. Finally, HMRC submit
that the European legal position is unclear, and requires a further reference to the
CJEU.
12. There are further issues which HMRC seek to attach to Issue I. The first,
identified before us as “issue 4 CA”, is whether, when considering the relevant
overseas tax position, attention should focus on the overseas company directly
responsible for the remission of the dividend to the UK (the overseas “water’s edge”
company) or on the overseas company (or companies) responsible for generating the
profits out of which such dividend was paid and on which it (or they) paid tax
overseas. The second issue, which HMRC submit that the Supreme Court should
“take into account”, was identified as “issue 6 CA”, and is whether any difference
has been shown to exist between the effective rate incurred by domestic companies
declaring dividends to PAC and the nominal rate payable by UK companies. This is
relevant, HMRC submit, because the existence of such a difference was a reason
why the CJEU indicated in FII ECJ II that it was appropriate to give a credit for the
FNR, rather than the actual tax, incurred on an overseas dividend. PAC submits that
neither of issues 4 CA and 6 CA is open in this court. The Court of Appeal refused
permission for either issue to be raised before it, and neither issue is properly part
of or essential to the resolution of Issue I.
13. The CJEU in FII ECJ I and in its Reasoned Order in the present case clearly
established that the discrimination involved in the UK’s arrangements for taxation
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of dividends sourced domestically and from overseas could be resolved by a mixed
system, whereby dividends with a domestic source remained exempt, while credit
was given against DV tax for tax actually incurred overseas on dividends received
from overseas.
14. HMRC point out that the CJEU in FII ECJ I addressed separately the position
of dividends received from non-portfolio and from portfolio companies. In relation
to the former, the question arose whether a mixed system of exemption in respect of
domestically sourced dividends coupled with a credit in respect of dividends
received from overseas was compatible with EU law. The CJEU dealt with this at
paras 46 to 57. The claimants drew attention to the situation arising if, under the
relevant UK legislation, such an exemption was granted in respect of a nationallysourced dividend received from a company which for some reason had no
corporation tax liability or paid corporation tax at a lower rate than the normal UK
rate (para 54). The CJEU understood the UK Government to explain that this arose
only exceptionally (para 55), and on that basis contented itself with saying (para 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.”
15. The inference seems to be that, were a significant difference to exist between
the effective rate of tax paid by the UK source of the dividend (eg because of some
relief or allowance available to the company which was the source of the dividend)
and the nominal rate of tax to which the exemption under section 208 of ICTA
applied, then a system of credit in respect of overseas-sourced dividends which
limited the tax credit to tax actually paid overseas (ie the effective rate of tax) would
not be consistent with EU law – because the overseas-sourced dividend would
remain liable for any DV tax chargeable after the credit had been taken into account.
In other words, the overseas-sourced dividend would not be enjoying, under the tax
credit system, any relief or allowance which had reduced the tax actually paid on it,
whereas the UK-sourced dividend would enjoy any such relief or allowance.
16. In respect of portfolio dividends, the CJEU faced a more fundamental
objection. The UK system was inherently discriminatory, because it failed to give
any credit at all for overseas tax paid (paras 61 to 72). The CJEU gave short shrift
to the UK Government’s argument that practical difficulties in ascertaining the tax
actually paid justified a different system for portfolio dividends.
17. It does not however follow from the separate treatment of non-portfolio and
portfolio holdings in FII ECJ I that the CJEU saw any significant difference between
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them regarding the manner in which the deficiencies in the UK tax system needed
to be addressed. It is true that the judgment in Haribo in February 2011 concerned
portfolio dividends; following FII ECJ I and the Reasoned Order in the present case,
it spoke of the need to credit tax actually paid. But it was only in FII ECJ II, where
the focus was on non-portfolio holdings, that the CJEU identified the FNR as a more
relevant criterion in any context. That therefore in no way indicates that the FNR is
not also relevant to portfolio investments.
18. As a matter of logic and principle, there seems no basis in this connection for
any distinction between portfolio and non-portfolio holdings, when applying the
mixed system of domestic exemption coupled with a credit in respect of overseassourced dividends to each. Rather than concentrating on the practical difficulties
advanced before the CJEU in FII ECJ II, HMRC now suggest that there are
important differences in the approaches and expectations which investors would
have with regard to portfolio investments, when compared with non-portfolio
investments. There are of course differences between holdings giving a degree of
control and smaller holdings, but it is not obvious what relevance they have to the
question of central interest on this appeal: that is, the proper treatment of
domestically-sourced and overseas-sourced dividends so as to avoid unfair
discrimination between them.
19. The CJEU’s change of approach in FII ECJ II arose from correction of the
misunderstanding evidenced in paragraph 54 in FII ECJ I. Far from being
exceptional, it had been established conclusively that it was commonly the position
in the UK that a company’s effective rate of tax was (due for example to group relief,
or the carry forward of trading losses or other reasons) less than the nominal tax rate,
and on that basis it was held that the UK tax system infringed what is now article
63: Test Claimants in the FII Group Litigation v Revenue and Customs Comrs
[2008] EWHC 2893 (Ch); [2009] STC 254 (“FII High Court I”), affirmed [2010]
EWCA Civ 103; [2010] STC 1251 (“FII CA”).
20. Pursuant to an order for a further reference made by Henderson J on 20
December 2010, it became necessary for the CJEU to address the implications. The
European Commission in written submissions in FII ECJ II said (para 28) that in
circumstances where the effective rate borne by the company making the profits
from which the dividend came was lower than the nominal rate:
“28. … to exempt domestic dividends (which in effect
amounts to giving credit for the full amount of tax at the
statutory rate even where this full amount has not been paid)
while giving credit only for the actual amount of tax paid in
respect of the profits giving rise to foreign dividends results in
more favourable treatment for domestic dividends.”
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21. The Commission drew from this (para 29) that:
“29. … It can no longer be said that the credit method is
equivalent to exemption, because foreign dividends receive
less favourable treatment than domestic dividends. To
understand why, let us imagine identical resident and nonresident companies which each have revenues of 100 and have,
say, a loss carry-forward of 50. The tax rate is 30% in both the
source and residence states. A company which is a shareholder
in the resident company and receives a dividend from it will
have no further tax obligation, even though that company has
paid only 15 in tax (that is, has an effective rate of 15%). A
shareholder in the non-resident company will receive a credit
equivalent to only 15% and will have to pay an additional 15%.
The same result will ensue where both states grant, for
example, an identical research and development incentive.
That is not equal treatment, and it constitutes a serious obstacle
to outward investment.”
22. The Commission then discussed how the problem might be addressed (paras
31-34):
“31. In such circumstances there seem to the Commission to
be two ways of ensuring equal treatment. One is to exempt both
domestic and foreign dividends. That solution has the
drawback, as outlined above, that it may permit excessively
favourable treatment of foreign dividends where the tax rate in
the source state islower than in the United Kingdom. The other,
which is wholly consistent with the court’s reasoning in Case
C-446/04 [‘FII ECJ I’], is to have regard solely to the nominal
rate of tax in calculating the tax credit on foreign dividends.
32. That is to say, recipients of such dividends should
receive a tax credit representing the amount which would flow
from the application of the nominal rate of tax in the source
state to the accounting profits of the distributing company.
Such a measure would correspond more truly to the exemption
of domestic dividends, since the latter amounts in effect to the
grant of a credit for tax at the nominal rate. The court has seen
and approved a measure of this kind in Joined Cases C-436/08
and C-437/08 Haribo, judgment of 10 February 2011 … see
point 99 of the judgment. It would no doubt be desirable for a
member state applying such a measure to insert a safeguard
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clause limiting its scope to dividends distributed by a company
which is subject to the normal system of taxation in the source
state.
33. It should be noted that such a measure would also
alleviate to a very large extent the administrative burden faced
by taxpayers in relation to foreign dividends, especially
taxpayers with small shareholdings.
34. Such a solution does not ensure substantive equal
treatment in all cases. In particular, where the tax system in the
source state is a simple one in which the effective rate is
systematically the same as the nominal rate (because the tax
base is constituted by accounting profits, with no
modifications), foreign dividends will treated less favourably
than domestic dividends, since the latter will benefit from any
tax advantages enjoyed by the distributing company. However,
to ensure full substantive equal treatment would require
systematic re-calculation of the tax position of the foreign
company – essentially a simulation of the tax which it would
have paid were it resident in the United Kingdom. Such an
approach seems impractical. The solution advocated by the
Commission ensures formal equality of treatment, is easy to
apply and achieves a fair result.”
It is worth noting in passing para 33. The Commission evidently had no doubt about
the relevance of its proposed solution to overseas portfolio holdings.
23. It was a neat solution which evidently appealed to the juge rapporteur, who
(according to the informal transcript with which the Supreme Court has been
supplied) put to counsel for the UK a series of points, starting with this “very simple”
question:
“… does such an exemption system not in fact come down to
as Mr Lyal said, ‘tantamount to’ a credit system applied at the
normal rate of tax applicable to the taxing of those dividends
with the shareholding company?”
Judge Lenaerts went on to put that an exemption system does more than a system
crediting tax actually paid, because
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“It gives more relief than the tax actually paid by the
distributing company and … when you say that you have an
exemption system, in fact, you exonerate from any tax liability,
you exempt from any tax liability, the shareholding companies
at the rate applicable to the taxing of dividends with that
shareholding company.”
The reasoning was the same as the Commission’s.
24. Subsequently various questions were put by Advocate General Jääskinen to
Mr Lyal for the Commission. The Advocate General expressed some doubt whether
the Commission’s proposed solution was really consistent with the CJEU’s previous
judgment. He suggested that it would seem to work if there was equivalence of both
the domestic and the overseas nominal and effective tax rates, but pointed to a risk
of distortion if the nominal and effective tax rates were similar in one state, but
diverged significantly in the other. Mr Lyal’s response was:
“Yes, my Lord, that’s quite right. That’s a danger. It is a danger
that can be minimised, if what I said a moment ago about
recognizing only the type of tax benefits or discounts or
manners of calculation that are recognized in the state of
residence of the parent. The practical likelihood of the problem
is to some extent limited to the extent that there is something
of a correlation between higher taxes, higher company tax rates
and lots of discounts, and equally a correlation between lower
company tax rates and broad tax bases. So, if there is a source
company in Slovakia, say, which has set their tax at, whatever
their rate now is, 17%, perhaps, one can be pretty sure that it’s
17% on accounting profits. And thirdly, this is after all said to
be a rough equivalent because the only other practical option
that I can see for a rough equivalent of the domestic exemption
is exemption for foreign-source dividends as well which would
compound the problem that your Lordship refers to. That is to
say you would not only have the freedom from taxation
represented by the difference between the lower rate, the lower
effective rate and [?in] the source state, but also the difference
between the statutory rate in the UK and the lower statutory
rate. So, again, the problem that your Lordship advances is
certainly a correct one, but in circumstances in which the
resident state applies an exemption system, we need to find
something that gives substantive equivalent taxation for
inbound dividends, a measure of which focuses on the actual
tax, the effective rate of tax borne by inbound dividends simply
is not equivalent.”
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25. Against this background, the CJEU in FII ECJ II addressed the problem as
follows. First, it pointed out (paras 43 to 48) that the tax rate applied to foreignsourced dividends would be higher than that applied to domestic-sourced dividends,
and their equivalence compromised, if the resident company generating the
dividends was subject to either a nominal or an effective rate of tax below that to
which the resident company receiving the dividends was subject, since in a case
where an overseas company generating dividends was subject to an effective tax rate
lower than the UK nominal rate, the difference would be chargeable to DV tax. On
this basis, it explained that in its judgment in FII ECJ I, para 56, the reference to the
“tax rates” related to the nominal rate of tax while the reference to the “different
levels of taxation … by reason of a change to the tax base” related to the effective
levels of taxation.
26. The CJEU in FII ECJ II, after stating why such discrimination could not be
justified under EU law as necessary to preserve the cohesion of the domestic tax
system, then adopted use of the FNR as an acceptable solution in the following
paragraphs:
“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 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 the Haribo
case [2011] ECR I-305, para 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
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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 …
65. In light of the foregoing, the answer to the first question
is that articles 49FEU and 63FEU 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.”
27. These paragraphs are generally stated, and there is no reason why they should
not be as applicable to portfolio holdings as they are to non-portfolio holdings. There
is no hint of any distinction between portfolio and non-portfolio holdings. If any had
been intended, one would have expected it to be mentioned, particularly when the
same juge rapporteur was active in all four of the key decisions, covering between
them both types of holding. Instead, in para 63 of FII ECJ II, quoted above, reliance
is actually placed on Haribo, a case of portfolio holdings, in support of the use of
the FNR. The reliance may, as Mr David Ewart QC for HMRC submitted, be
misplaced, achieving a coherence in the development of the jurisprudence that is
more apparent than real – because the reference to FNR in Haribo was in the context
of a simplified method permitted by the Austrian tax authorities to show the tax
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actually paid. But that is presently irrelevant. What matters is that the CJEU in FII
ECJ II presented its development of the law in the context of non-portfolio holdings
as being in line with, and supported by, its previous jurisprudence in the context of
portfolio holdings. It is inconceivable that it contemplated any material distinction
in the principles applicable to both. It follows that, subject to one reservation, the
CJEU’s jurisprudence establishes clearly that the credit for foreign dividends in the
present case should be by reference to the FNR, rather than by reference to the actual
or effective tax incurred overseas.
28. The one reservation arises from the assumption made throughout the
discussion in FII ECJ II, that, in the Commission’s words (para 20 above): “to
exempt domestic dividends … in effect amounts to giving credit for the full amount
of tax at the statutory rate even where this full amount has not been paid;” or in
Judge Lenaerts’ words (para 23 above) that “an exemption system does more than a
system crediting tax actually paid by the distributing company”.
29. This assumption is readily understandable, if one also assumes that the
domestic company which is the source of and distributes the dividend has an
effective tax rate less than the nominal tax rate, while the receiving company which
is exempted from tax would, but for the exemption, pay tax at the full nominal rate.
There is then a benefit from the exemption, which would have no parallel if the
credit in respect of overseas-sourced dividends was by reference only to the actual
tax incurred overseas. However, in the UK domestic context, there appears to be no
reason to think that companies receiving domestically-sourced dividends are any
less able to reduce the effective tax rate they would have borne on such dividends
than are the companies from which the dividend is sourced. In other words, the
evidence appears to have been that all UK companies are generally taxed at an
effective level below the nominal rate. That being so, the domestic exemption does
not confer a benefit at the nominal rate, but at their effective rate.
30. It follows that to give a credit for overseas dividends at the FNR may confer
a benefit on overseas dividends, compared with domestic dividends. By way of
example, given by HMRC, one can suppose an overseas water’s edge company with
a nominal tax rate of 20% and an effective rate of 10%, which makes a profit after
tax of 100 and distributes a dividend of 100. The UK recipient company has a
nominal rate of 30%, but an effective tax rate of 20%. One would expect the UK
company to bear a 10% charge on the dividend to reflect the higher tax rate charged
in the UK (and that is so, whether one is looking at and comparing the nominal or
the effective tax rate in this connection). But a tax credit can necessarily only reduce
the tax which would actually otherwise be charged. Here, since the UK company’s
effective tax rate is only 20%, the effect of giving credit to the UK company for the
FNR of 20% is in fact to eliminate any UK tax charge.
Page 15
31. Does this reservation about the rationale and solution adopted by the CJEU
mean that we should once again refer the case back to the CJEU, for it to reconsider
once again whether its approach is appropriate? In our opinion, it does not. It is clear
that the CJEU was well aware that the adoption of the FNR would not eliminate all
inequities or incongruities: see the Commission’s written observations, para 34,
cited in para 22 above, the Advocate General’s question put to Mr Lyal and Mr
Lyal’s answer cited in para 24 above and the CJEU’s own judgment, para 64, cited
in para 26 above. There could, depending on the incidence of nominal and effective
tax rates, be swings and roundabouts in the equivalence achieved by a mixed system
of domestic exemption combined with overseas credits. But the “ideal” alternative
of a comparison between two tax systems to ensure equivalence (subject only to
each state’s right to set its own nominal tax levels) was consciously rejected as
wholly impractical. In these circumstances, such inequity as may arise from the
reservation discussed in the previous three paragraphs is not in our view a reason for
referring the matter yet again to the CJEU. The prospect that the CJEU would, at
this stage in history, contemplate revising yet again its jurisprudence appears to us
negligible to the point where it can be discarded.
32. We turn finally to the two further issues which HMRC suggest should be
taken into account, and should lead to or encourage the making of a reference. The
short answer in relation to each is that permission to raise it before the Court of
Appeal was specifically refused by that court: [2016] EWCA Civ 376; [2016] STC
1798. In these circumstances, there is no constitutional basis for consideration of
either before the Supreme Court: Access to Justice Act 1999, section 54(4), Supreme
Court Practice Direction No 1 para 1.2.5. Issue I at first instance might have been
wide enough to embrace one or both of issues 4 CA and 6 CA, since it asked inter
alia what the appropriate amount of any tax credit required was, but in fact neither
issue was raised at the trial before Henderson J. Issue 6 CA was first raised six weeks
after the trial by letter to the judge, who refused permission to appeal on it. Issue 4
CA only emerged as ground 2 in HMRC’s Grounds of Appeal to the Court of
Appeal. The Court of Appeal expressly refused permission to appeal to it on Issues
4 and 6 CA, and the declaration it made read simply that (para 99):
“… the effect of the rulings of the CJEU is that the foreign
dividend should be afforded equivalent treatment, taking the
form of the imputation method according to which credit
should be given for the relevant foreign tax at the effective rate
[ie the actual tax paid] or the nominal rate (whichever is the
higher), subject to a cap at the rate of the UK’s nominal rate of
ACT [ie the corporation tax rate or the rate of ACT as
applicable].”
This declaration does not address or require the Supreme Court to address either of
Issues 4 and 6 CA. (In the event, the Supreme Court has not even been asked to
Page 16
address the question whether the Court of Appeal was right to declare that credit
required to be given for the higher of the effective and nominal foreign rate, that
issue being we were told of no present relevance, but reserved for a further
instalment of the FII litigation.)
Issue IV
33. It is however appropriate at this point to deal with Issue IV which is before
the Supreme Court. That is whether, if PAC had no entitlement under EU law to a
credit by reference to the FNR, effect should, in the light of what is said to be the
impossibility of showing the tax actually borne by its portfolio holdings, be given to
the CJEU’s judgments either: (a) by disapplying the DV charge; or (b) by allowing
PAC to rely on FNRs (or consolidated effective tax rates) as a simplification or
proxy for tax actually paid. The short answer to this issue is that it does not arise or
need answering, having regard to our conclusion that PAC is entitled to credit in
respect of overseas-sourced dividends by reference to the FNR.
Issue II: Introduction
34. PAC seeks restitution, on the ground of unjust enrichment, of an amount
calculated on the basis of compound interest, in respect of each category of claim
which has succeeded. The amounts on which interest is sought, and the periods over
which it is submitted that interest should be compounded, are as follows:
(a) unlawfully levied ACT which was subsequently set off against
lawfully levied MCT, from the date of payment by PAC to the date of setoff;
(b) all other unlawfully levied tax (including unlawfully levied ACT
which was never set off against lawful MCT, and unlawfully levied ACT
which was set off against unlawfully levied MCT), from the date of payment
by PAC to the date of repayment by HMRC; and
(c) the time value of utilised ACT (resulting from (a) above), from the
date of set-off to the date of payment by HMRC.
PAC submits that the interest should be compounded at conventional rates
calculated by reference to the rates of interest, and rests, applicable to borrowings
by the Government in the market during the relevant period, that being the approach
Page 17
favoured by a majority of the House of Lords in Sempra Metals Ltd v Inland Revenue
Comrs (formerly Metallgesellschaft Ltd) [2007] UKHL 34; [2008] 1 AC 561.
35. HMRC have accepted that compound interest is payable in respect of the
utilised ACT falling within category (a) above, since that is what the House of Lords
decided in Sempra Metals. PAC submits that the principles set out in Sempra Metals
entail that the same approach should also apply to the amounts falling within
categories (b) and (c) above. HMRC, on the other hand, submit that only simple
interest should be awarded, in accordance with section 35A of the Senior Courts Act
1981 (“the 1981 Act”), inserted by the Administration of Justice Act 1982, section
15(1) and Schedule 1, Part I. An award of interest on that basis would, they argue,
be compatible with the requirement under EU law that PAC should receive an
“adequate indemnity”, in accordance with the decision of this court in Littlewoods
Ltd v Revenue and Customs Comrs [2017] UKSC 70; [2017] 3 WLR 1401.
36. Although the difference between simple and compound interest is modest in
the present case, the point also arises in other cases which are pending against
HMRC, and the total amount at stake, on HMRC’s estimate, is of the order of £4-5
billion. The point is also one of considerable importance from a legal perspective,
since it raises some fundamental issues in the law of unjust enrichment.
The approach of the courts below
37. In a careful judgment, Henderson J held that compound interest should be
awarded in respect of all three categories of claim, on the basis that, applying the
reasoning of the majority in Sempra Metals, PAC was entitled on the ground of
unjust enrichment to compound interest on all its claims: [2013] EWHC 3249 (Ch);
[2014] STC 1236, paras 242-246. His Lordship subsequently followed that decision
in other proceedings, concerned with the recovery of VAT paid under a mistake:
Littlewoods Retail Ltd v Revenue and Customs Comrs [2014] EWHC 868 (Ch);
[2014] STC 1761, para 417. That paragraph was then expressly approved by the
Court of Appeal in the Littlewoods proceedings: Littlewoods Ltd v Revenue and
Customs Comrs [2015] EWCA Civ 515; [2016] Ch 373; [2015] STC 2014, paras
203-204. When the present case reached the Court of Appeal, it dismissed the appeal
on this issue on the basis that it was bound by its previous decision in the Littlewoods
case. So the only detailed consideration of this issue, in the context of the present
case, has been that of Henderson J.
38. It is only necessary to add that, following the decision of this court in the
Littlewoods proceedings (Littlewoods Ltd v Revenue and Customs Comrs [2017]
UKSC 70; [2017] 3 WLR 1401), which reversed the decision of the Court of Appeal,
it is no longer argued that there is a right to compound interest under EU law.
Page 18
A preliminary point
39. As a preliminary point, PAC submits that HMRC should not be permitted to
advance an argument to the effect that the opportunity to use money mistakenly paid
is not a benefit obtained at the expense of the person who made the mistaken
payment. They point out that HMRC did not advance any argument along these lines
at the trial before Henderson J in 2013. On the contrary, it was conceded in advance
of the trial that PAC was entitled to compound interest in respect of the claims in
category (a), following Sempra Metals, and that position was maintained in the
agreed Statement of Facts and Issues. Although HMRC do not seek to withdraw that
concession, PAC submits that the proposed argument challenges the reasoning in
Sempra Metals, and therefore the basis on which the concession was made. Against
this background, it is submitted that HMRC should not be permitted to advance this
argument for the first time in this court.
40. In so far as HMRC wish to advance submissions questioning the soundness
of the reasoning in Sempra Metals, the court is not inclined to prevent them from
doing so, in the particular circumstances of this case. As will be explained, there
have been some significant developments in the law of unjust enrichment since the
trial before Henderson J, and indeed since the present appeal was brought. In
particular, the concept of a benefit being obtained at the expense of the claimant,
and the related concept of a transfer of value, were considered by this court only
relatively recently. In this appeal, PAC invites the court to extend the reasoning in
Sempra Metals beyond the scope of that decision itself, albeit PAC submits that the
extension is the logical consequence of that decision. The appeal therefore involves
analysing the reasoning in Sempra Metals, and unavoidably requires the court to
consider whether that reasoning is consistent with the approach which it has more
recently adopted, so as to form part of a coherent body of law. As we explain later,
there is indeed a difficulty involved in reconciling Sempra Metals with this court’s
more recent case law. Accordingly, even if HMRC had not wished to subject the
decision in Sempra Metals to critical analysis, that is an exercise which this court
could not have avoided. In addition, it is important to bear in mind that this appeal
has to be decided in the context of a group litigation order, and also that the point of
law which HMRC wish to argue is undoubtedly one of general public importance.
41. We do not consider that allowing these matters of law to be argued involves
unfairness to PAC. The essence of HMRC’s argument was set out in the written case
which they submitted in advance of the hearing of the appeal, although, as often
happens, the argument was refined during the hearing.
Page 19
What did Sempra Metals decide?
42. The issue in Sempra Metals was how effect should be given in domestic law
to the judgment of the CJEU in the Metallgesellschaft case (Metallgesellschaft Ltd
v Inland Revenue Comrs (Joined Cases C-397/98 and C-410/98) EU:C:2001:134;
[2001] Ch 620; [2001] ECR I-1727) (Sempra Metals Ltd being the same company,
under a new name, as Metallgesellschaft Ltd). The case concerned claims for
compound interest in respect of unlawfully levied ACT which had been set off
against lawful MCT: in other words, claims falling within category (a) above. The
CJEU made it clear that it was for domestic law to determine the juridical basis of
the claims: in particular, whether they lay in restitution or in damages. On the
hypothesis that, under domestic law, the appropriate basis was restitution, the CJEU
stated:
“87 … In such circumstances, where the breach of
Community law arises, not from the payment of the tax itself
but from its being levied prematurely, the award of interest
represents the ‘reimbursement’ of that which was improperly
paid and would appear to be essential in restoring the equal
treatment guaranteed by article 52 of the [EC] Treaty.
88. The national court has said that it is in dispute whether
English law provides for restitution in respect of damage
arising from loss of the use of sums of money where no
principal sum is due. It must be stressed that in an action for
restitution the principal sum due is none other than the amount
of interest which would have been generated by the sum, use
of which was lost as a result of the premature levy of the tax.”
Equally, on the hypothesis that the claim properly lay in damages, the argument that
the claimants could not be awarded interest could not be accepted.
43. Giving effect to the judgment of the CJEU, the lower courts held that the
claimants were entitled to recover compound interest on the ACT in respect of the
period between the date of payment and the date of set-off. They also expressed the
view, obiter, that the same principles should apply to claims in respect of unutilised
ACT, falling within category (b) above.
44. HMRC’s appeal to the House of Lords was dismissed ([2008] AC 561). For
varying reasons, the House held, by a majority, that a claim would lie in unjust
enrichment for restitution of compound interest on money which had been paid
Page 20
prematurely as the consequence of a mistake, and that the appropriate measure of
restitution in the instant case was compound interest calculated on a conventional
basis applicable to government borrowing. The House also held that compound
interest was available as damages, where it was the measure of the loss foreseeably
suffered by the claimant from the loss of the use of his funds. That aspect of the
decision is not in issue in the present case and need not be considered.
45. Lord Nicholls of Birkenhead and Lord Hope of Craighead, who were in the
majority on the question of unjust enrichment, emphasised that the interest was not
ancillary to a claim for the recovery of a principal sum: rather, the interest was itself
the principal sum, claimed as restitution of the time value of money. They
interpreted the CJEU’s judgment in Metallgesellschaft as meaning that EU law
required, as Lord Hope put it at para 9, that “the companies must be provided with
a remedy in domestic law which will enable them to recover a sum equal to the
interest which would have been generated by the advance payments from the date
of the payment of the ACT until the date on which the MCT became chargeable”:
see also, to the same effect, the speech of Lord Nicholls at para 60. In that regard,
both Lord Hope and Lord Nicholls referred to para 88 of the judgment of the CJEU,
cited above. Lord Nicholls identified the crux of the dispute, at paras 71-73, as being
whether the provision English law made for the payment of interest satisfied the EU
principle of effectiveness.
46. Lord Hope and Lord Nicholls adopted similar analyses of the basis of the
claim in unjust enrichment, at paras 33 and 102 respectively. Lord Hope described
the Revenue’s enrichment at para 33 as “the opportunity to turn the money to
account during the period of the enrichment”. Lord Nicholls analysed the issue in
terms of Professor Birks’s theory of unjust enrichment by subtraction (that is, at the
expense of the claimant), and stated at para 102:
“The benefits transferred by Sempra to the Inland Revenue
comprised, in short, (1) the amounts of tax paid to the Inland
Revenue and, consequentially, (2) the opportunity for the
Inland Revenue, or the Government of which the Inland
Revenue is a department, to use this money for the period of
prematurity. The Inland Revenue was enriched by the latter
head in addition to the former. The payment of ACT was the
equivalent of a massive interest free loan. Restitution, if it is to
be complete, must encompass both heads. Restitution by the
Revenue requires (1) repayment of the amounts of tax paid
prematurely (this claim became spent once set off occurred)
and (2) payment for having the use of the money for the period
of prematurity.”
Page 21
47. Since the enrichment which had to be undone was the opportunity to turn the
money to account during the period before it was lawfully due, it followed that the
measure of the enrichment did not depend on what HMRC actually did with the
money during that period (Lord Hope at para 33, Lord Nicholls at para 117). In that
connection, Lord Nicholls drew an analogy at para 116 with the award of “user
damages”, although such awards are based on wrongdoing and are designed to
compensate for loss: One Step (Support) Ltd v Morris-Garner [2018] UKSC 20;
[2018] 2 WLR 1353, para 30. In the ordinary course, the market value of the benefit
arising from having the use of money was said to be the cost the defendant would
have incurred in borrowing the amount in question for the relevant period: a sum
which, like all borrowings, would inevitably be calculated in terms of compound
interest (Lord Nicholls at para 103). The court could however depart from the market
value approach if it were established that it would produce an unjust outcome (Lord
Hope at para 48, Lord Nicholls at para 119).
48. Lord Hope and Lord Nicholls proceeded on the basis of a presumption that
the innocent recipient of a mistaken payment has benefited from the use of the
money, the value of the benefit being the market cost of borrowing the money over
the relevant period. The onus is on the defendant to displace that presumption. The
innocent recipient, rather than the mistaken payer, is thus exposed to the risks of
litigation.
49. Lord Nicholls acknowledged at para 125 that the decision might have serious
consequences for public finances, because of the extended limitation period
available in cases of mistake, but considered that the issue had been addressed by
legislation:
“The seriously untoward consequences this may have for the
Inland Revenue flow from the open-ended character of the
extended limitation period prescribed by section 32(1)(c) of the
Limitation Act 1980. Parliament has now recognised this
extended period should not apply to payments of tax made by
mistake: see section 320 of the Finance Act 2004.”
50. Lord Walker of Gestingthorpe stated that he was essentially in agreement
with Lord Hope and Lord Nicholls (para 154), and that he too would dismiss the
appeal, “largely for the reasons which they give”. He also observed that the “crucial
insight” in their speeches was the recognition that income benefits were more
accurately characterised as an integral part of the overall benefit obtained by a
defendant who is unjustly enriched (para 178). He went on, however, to state that he
must confess that his own inclination would be to extend the equitable jurisdiction
to award compound interest, rather than to recognise a restitutionary remedy
available as of right at common law (para 184). He added that he “felt some
Page 22
apprehension” about the suggested conclusion that compound interest should be
available as of right, subject only to an exception for “subjective devaluation”.
51. The other members of the Appellate Committee disagreed with the majority.
Lord Scott of Foscote rejected the view that “the mere possession of mistakenly paid
money – and accordingly the ability to use it if minded to do so – is sufficient to
justify not simply a restitutionary remedy for recovery of the money, but a remedy
also for recovery of the wholly conceptual benefit of an ability to use the money”
(para 145). A restitutionary remedy could not in his view encompass the recovery
of anything other than the money which the defendant had actually received. In
reality, in his view, Sempra was asserting a claim for compensation for its loss of
the use of the money, dressed up as a claim in restitution in order to take advantage
of the more generous limitation period allowed by section 32(1)(c) of the Limitation
Act 1980 (“the 1980 Act”).
52. Lord Mance also noted the practical context of the issue. The basis on which
Sempra principally put their claim was that they had paid the ACT under a mistake
of law. On that basis, section 32(1)(c) of the 1980 Act would postpone the
commencement of the limitation period until the time when Sempra discovered or
could with reasonable diligence have discovered that the ACT was not due: a time
which they identified with the date in 2001 when the CJEU issued its judgment in
the Metallgesellschaft case. Lord Mance commented (para 200) that the
appropriateness of an extended time limit in this context was questionable. As he
noted, Lord Hoffmann had recognised in the Kleinwort Benson case (Kleinwort
Benson Ltd v Lincoln City Council [1999] 2 AC 349, 401) that “‘allowing recovery
for mistake of law without qualification, even taking into account the defence of
change of position, may be thought to tilt the balance too far against the public
interest in the security of transactions’, adding that ‘the most obvious problem is the
Limitation Act, which as presently drafted is inadequate to deal with the problem of
retrospective changes in law by judicial decision’”. Like Lord Nicholls, Lord Mance
noted that, as regards the future (although not as regards the instant case), section
320 of the Finance Act 2004 meant that section 32(1)(c) of the 1980 Act would no
longer apply to mistakes of law relating to a taxation matter under the care and
management of HMRC.
53. Like Lord Walker, Lord Mance cautioned against a radical reshaping of the
law, observing at para 205 that “we must navigate using the reference points of
precedent, Parliamentary intervention and analogy, and we should bear in mind the
limitations of judicial knowledge and the assistance offered by a series of Law
Commission reports”. European law left it, in his view, to national law to provide
an effective remedy and did not prescribe that this should be by way of compound,
rather than simple, interest (paras 201-204). The common law had recognised a
claim for money had and received, but not a claim for the use of money had and
received. A claim of the latter kind faced a long line of authority over a period of
Page 23
nearly 200 years, including the recent decision of the House in Westdeutsche
Landesbank Girozentrale v Islington London Borough Council [1996] AC 669
(paras 203-220). The common law rule had been recognised and effectively
endorsed by the Law Revision Committee, whose recommendations on interest in
their Second Interim Report, 1934 (Cmd 4546) were implemented by provisions of
the Law Reform (Miscellaneous Provisions) Act 1934 (later replaced by section 35A
of the 1981 Act) (paras 211-212), by the Law Commission in all its reports on the
subject (paras 222-224), and most importantly by Parliament, which had legislated
in recent times for the payment of interest, but invariably on a simple basis (paras
212 and 221). There were in addition policy reasons making it unwise to introduce
an absolute right to compound interest in restitution. As the Law Commission had
noted, compound interest evoked deep-seated fears, because it increased in an
exponential rather than a linear way, especially during periods of high inflation (para
222). In the light of such concerns, the Law Commission had made a number of
recommendations relating to the introduction of a right to compound interest on a
restricted basis. Those recommendations had not been acted on (para 224).
54. The decision of the House on the issues relevant to the present appeal can
therefore be summarised as follows:
(1) By a majority consisting of Lord Hope, Lord Nicholls and Lord
Walker, the House held that the court had jurisdiction at common law (Lord
Hope and Lord Nicholls) or at least in equity (Lord Walker) to make an award
on the ground of unjust enrichment in respect of the time value of money
which was paid prematurely as the consequence of a mistake. The basis of
the award was that the benefit by which the recipient of the money was
enriched was the time value of the money. The benefit was presumptively
quantified as the market value of the use of the money during the period
before it was lawfully due, that is, the cost of borrowing an equivalent amount
in the market.
(2) The same majority held that:
(a) in the instant case, the presumption that the Government had
benefited from the premature payment of the tax had not been
displaced; but
(b) the Government was in a different position from ordinary
commercial borrowers, in that it could borrow at more favourable
rates; and accordingly
Page 24
(c) the claims should be quantified on a conventional basis
applicable to Government borrowing.
Legal developments since Sempra Metals
55. A number of relevant developments in the law have occurred since Sempra
Metals. First, the jurisprudence of the CJEU has developed since its
Metallgesellschaft judgment. As was noted above, that judgment described the sum
due under EU law, where tax was paid prematurely, and on the hypothesis that the
appropriate remedy in domestic law lay in restitution, as “the amount of interest
which would have been generated by the sum, use of which was lost as a result of
the premature levy of the tax” (para 88). More recent judgments have provided
greater clarity.
56. For example, in Littlewoods Retail Ltd v Revenue and Customs Comrs (Case
C-591/10) EU:C:2012:478; [2012] STC 1714, the CJEU stated at para 27 that “it is
for the internal legal order of each member state to lay down the conditions in which
such interest [that is, interest on amounts levied in breach of EU law] must be paid,
particularly the rate of that interest and its method of calculation (simple or
‘compound’ interest)”. The CJEU also made it clear, in relation to the principle of
effectiveness, that national rules in relation to the calculation of interest “should not
lead to depriving the taxpayer of an adequate indemnity for the loss occasioned”
(para 29). In Littlewoods Ltd v Revenue and Customs Comrs [2017] 3 WLR 1401,
this court held that an award of simple interest was sufficient to comply with that
requirement, and that an award of compound interest on overpaid tax was therefore
not required by the EU law principle of effectiveness. Recognition that an award of
compound interest is not necessary in order to comply with the EU principle of
effectiveness affects the context in which these issues have to be considered.
57. Secondly, the Littlewoods case also revealed a conflict between the decision
in Sempra Metals and prior legislation. Long before Sempra Metals was decided,
Parliament had created a scheme for the repayment of overpaid VAT, currently set
out in section 80 of the Value Added Tax Act 1994 (“the 1994 Act”), with provision
for the payment of simple interest in section 78. That section requires HMRC to pay
interest on the repaid tax “if and to the extent that they would not be liable to do so
apart from this section”. Entitlement to interest under section 78 is subject to
limitations which would be defeated if it were possible for taxpayers to bring a
common law claim for interest on mistaken payments.
58. Until Sempra Metals, it had been settled law for about 200 years that no such
claim could be brought. In enacting section 78, Parliament legislated on that basis.
In deciding Sempra Metals as it did, however, the House of Lords failed to have
Page 25
regard to the scheme which Parliament had established. Nor did it take account of
section 826 of ICTA, which also provides for the payment of simple interest on
overpaid tax, and covers a range of direct taxes, including ACT and MCT. These
provisions are matched by corresponding provisions limiting the liability of
taxpayers towards HMRC to simple interest on underpaid tax: see section 74 of the
1994 Act and section 826 of ICTA.
59. The persuasiveness of the majority’s approach in Sempra Metals is
diminished by their failure to have regard to these provisions. As Lord Hoffmann
observed in Johnson v Unisys Ltd [2001] UKHL 13; [2003] 1 AC 518, para 37:
“… judges, in developing the law, must have regard to the
policies expressed by Parliament in legislation … The
development of the common law by the judges plays a
subsidiary role. Their traditional function is to adapt and
modernise the common law. But such developments must be
consistent with legislative policy as expressed in statutes. The
courts may proceed in harmony with Parliament but there
should be no discord.”
60. Against the background of the 1994 Act, in particular, the effect of Sempra
Metals, was to create discord of a serious character: it rendered section 78 a dead
letter, if that provision were given its natural construction. This court therefore
decided in Littlewoods that, in order for section 78 to have the effect which
Parliament had intended, it was necessary to depart from its natural construction.
Thus the approach of the majority in Sempra Metals led, as Lord Mance had
predicted, to a dislocation in a related area of the law which the Appellate Committee
had not considered.
61. Thirdly, in Kleinwort Benson [1999] 2 AC 349 it was realised that allowing
recovery of payments made under a mistake of law could create problems as the law
of limitation then stood, since section 32(1)(c) of the 1980 Act would enable claims
to be brought within six years of the mistake being discovered, no matter how long
in the past the payment had been made. For that reason, Lord Browne-Wilkinson
considered that “the correct course would be for the House to indicate that an
alteration in the law is desirable but leave it to the Law Commission and Parliament
to produce a satisfactory statutory change in the law which, at one and the same
time, both introduces the new cause of action and also properly regulates the
limitation period” (p 364). The majority, however, were unpersuaded that reform of
the law of restitution should be delayed, and assumed that legislation could be
enacted if Parliament considered it desirable to address the limitation question (see,
for example, Lord Hoffmann at p 401). Parliament duly enacted such legislation. By
the time of the decision in Sempra Metals, the majority therefore considered that the
Page 26
“seriously untoward consequences” for HMRC (as Lord Nicholls described them at
para 125) of claims arising from mistaken payments of tax in the distant past were
guarded against by section 320 of the Finance Act 2004, which provided that section
32(1)(c) of the 1980 Act should not apply in relation to a mistake of law relating to
a taxation matter under the care and management of the Commissioners of Inland
Revenue.
62. What has become apparent since Sempra Metals, however, is that the
problems in relation to limitation which arise from the retrospective effect of that
decision, and the decision in Kleinwort Benson, are incapable of being fully
addressed by legislation. Repeated attempts by Parliament to address the
retrospective impact of those decisions by introducing a limitation period with
retrospective effect have been held to be incompatible with EU law: section 80 of
the Value Added Tax Act 1994, as originally enacted, in Fleming (trading as
Bodycraft) v Revenue and Customs Comrs [2008] UKHL 2; [2008] 1 WLR 195;
section 320 of the Finance Act 2004 in Test Claimants in the FII Group Litigation
v Revenue and Customs Comrs (Case C-362/12) EU:C:2013:834; [2014] AC 1161;
and section 107 of the Finance Act 2007 in Test Claimants in the FII Group
Litigation v Revenue and Customs Comrs [2012] UKSC 19; [2012] 2 AC 337.
63. This problem, of which the House of Lords was unaware at the time when
Kleinwort Benson and Sempra Metals were decided, illustrates the risks of effecting
major changes to the law of restitution by judicial decision. By applying the
declaratory theory of adjudication, the law as altered by the decisions was deemed
always to have applied, and the previously settled understanding of the law was
treated as a mistake for the purposes of limitation. Consistently with that theory, in
Kleinwort Benson the House of Lords held that a right of action had arisen when
payments were made under a mistake of law, notwithstanding that no such right of
action was recognised by the courts at that time. Similarly in Sempra Metals, the
right of action in unjust enrichment arose when the defendant obtained the
opportunity to use the money mistakenly paid, notwithstanding that no such right
was understood to exist at that time. The tension inherent in the decisions is that the
House adhered to the declaratory theory for the purpose of finding that a cause of
action based on unjust enrichment had accrued in the past, based on a mistake of
law capable of invoking section 32(1)(c) of the 1980 Act, while straining the premise
of the theory, namely the need for judicial development of the law to be justifiable
by reference to existing legal principles.
64. The consequence was that the rights established by those decisions were
deemed to have vested in the claimants before the decisions were reached, with the
result that, under EU law, they could not be taken away by retrospective legislation
excluding or restricting the operation of section 32(1)(c) without a reasonable
transitional period during which claims could be made. The position would have
Page 27
been different if the changes had been effected by legislation, since legislation can,
and normally does, take effect prospectively.
65. Fourthly, decisions subsequent to Sempra Metals have demonstrated the
degree of disruption to public finances which the decision in that case, taken together
with Kleinwort Benson, is capable of causing. The decision in Kleinwort Benson
enabled claims to be brought for the repayment of tax which had been paid in
ignorance of the fact that the UK law under which it was levied was incompatible
with EU law. Since the limitation period did not begin to run until the mistake was
or could reasonably have been discovered, such claims could in principle be
backdated to the UK’s entry into the EU in 1973. Not only could the principal
amounts go back, in principle, for a period of several decades, but they had earned
interest over that period. If, following Sempra Metals, the interest was compounded
over that period, the resultant claims were potentially enormous.
66. The Littlewoods case, for example, concerned overpaid VAT on goods
supplied to agents employed to make catalogue sales, as a form of commission paid
in kind. Like the present appeal, it was a test case. The amount turning on the
outcome of that appeal was estimated by HMRC at £17 billion. That was not the
amount of the overpaid tax, or even the amount of the interest on the overpaid tax.
It was the difference between compound interest and simple interest. In the present
case, as we have explained, the total amount turning on the outcome is estimated by
HMRC at £4-5 billion. Even in the context of public finances, these are very large
sums.
67. Fifthly, the law of unjust enrichment has developed since Sempra Metals in
ways which cannot easily be reconciled with the reasoning of the majority in that
case. The development of greatest significance has been a more detailed analysis of
the “at the expense of” question, in Investment Trust Companies v Revenue and
Customs Comrs [2017] UKSC 29; [2018] AC 275. It is necessary next to consider
that issue.
“At the expense of”
68. Assuming for the present that an enrichment arises from having the
opportunity to use money mistakenly paid, the question whether it is obtained “at
the expense of” the claimant can best be answered by reference to the analysis of
that question in the Investment Trust case. Lord Reed explained at para 42 that
Page 28
“the law of unjust enrichment … is designed to correct
normatively defective transfers of value, usually by restoring
the parties to their pre-transfer positions.”
He went on at para 44 to endorse Lord Clyde’s dictum in Banque Financière de la
Cité v Parc (Battersea) Ltd [1999] 1 AC 221, 237 that the principle of unjust
enrichment:
“… requires at least that the plaintiff should have sustained a
loss through the provision of something for the benefit of some
other person with no intention of making a gift, that the
defendant should have received some form of enrichment, and
that the enrichment has come about because of the loss.”
Lord Reed also explained at para 50 that, as a general rule, a cause of action based
on unjust enrichment is only available in respect of a benefit which the claimant has
provided directly to the defendant (the only true exception identified being
subrogation following the discharge of a debt, which is arguably based on a different
principle). A causal connection between the claimant’s incurring a loss (in the
relevant sense) and the defendant’s receiving a benefit was not enough to establish
a transfer of value.
69. When money is paid by mistake, the claimant normally provides a benefit
directly to the defendant: he pays him the money. He normally does so at his own
expense: he is less wealthy by virtue of the payment. The transaction is normatively
defective: the benefit is provided as the result of a mistake. In those circumstances,
an obligation arises immediately under the law of unjust enrichment to reverse the
enrichment by repaying the money (or an equivalent amount). The cause of action
accrues when the money is mistakenly paid.
70. The majority in Sempra Metals considered that there was also an additional
and simultaneous transfer of value, comprising the opportunity to use the money,
which also gave rise to a cause of action based on unjust enrichment. That
enrichment had to be reversed by the payment of compound interest.
71. This analysis has a number of questionable features, which can be illustrated
by an example. If on 1 April the claimant mistakenly pays the defendant £1,000,
with the result that the defendant is on that date obliged to repay the claimant £1,000,
the defendant’s repayment of £1,000 on that date will effect complete restitution.
Restitution of the amount mistakenly paid in itself restores to the claimant the
opportunity to use the money: there is no additional amount due in restitution. That
Page 29
is because there has been only one direct transfer of value, namely the payment of
the £1,000. The opportunity to use the money mistakenly paid can arise as a
consequence of that transfer, but a causal link is not sufficient to constitute a further,
independent, transfer of value. Contrary to the analysis of Lord Nicholls in Sempra
Metals(at para 102), the recipient’s possession of the money mistakenly paid to him,
and his consequent opportunity to use it, is not a distinct and additional transfer of
value.
72. The position is essentially the same if the £1,000 is repaid not on 1 April but
on 1 May. There has been no transfer of value subsequent to 1 April, when the
mistaken payment was made. The only transfer of value needing to be reversed
remains the payment of the £1,000. The claimant can however be awarded, in
addition to the £1,000, simple interest on that amount under section 35A of the 1981
Act. That is because the obligation which arose under the law of unjust enrichment
on 1 April, upon the making of the mistaken payment, created a debt. Interest can
normally be awarded on a debt under section 35A of the 1981 Act.
73. That interest is intended to compensate the claimant for the loss of the use of
the money to which he became entitled to restitution on 1 April. There is no right to
interest on the basis of unjust enrichment: failure to pay a sum which is legally due
is not a transfer of value, and does not give rise to an additional cause of action based
on unjust enrichment. If there was no distinct cause of action for restitution of the
opportunity to use the money on the date of the mistaken payment (as explained
above), a cause of action based on unjust enrichment cannot have subsequently
accrued, since no further defective transfer of value has taken place.
74. The point can also be illustrated by an example used by HMRC. If D owes C
£1,000 under a contract, a claim also lies against D for interest under section 35A,
from the date when the contractual payment became due. There is no claim against
D for interest on the ground of unjust enrichment (even if an unjust factor is present).
That is because any benefit obtained by D from his failure to pay the debt on time is
not obtained at the expense of C in the relevant sense. There has been no transfer of
value from C to D. The latter’s opportunity to use the money which remains in his
possession is the result of his failure to pay the contractual debt. The same analysis
applies where the debt is imposed by the law of unjust enrichment, for example as
the result of a mistaken payment of £1,000. Any benefit obtained by D as a
consequence of his possession of the £1,000 is derived from his failure to pay that
debt. It cannot be said to have been transferred from C to D.
75. All this is consistent with a long-established understanding of, first, the nature
of the cause of action based on a mistaken payment, and secondly, the basis on which
interest is payable. As to the first of these, Lord Mansfield stated in the classic case
of Moses v Macferlan (1760) 2 Burr 1005, 1010, that the defendant in an action for
Page 30
money had and received “can be liable no further than the money he has received”.
That approach was followed in many later authorities, until Sempra Metals: see, to
give only a few examples, Walker v Constable (1798) 1 Bos & P 306, 307 (“The
court were of opinion, on the authority of Moses v Macferlan, 2 Burr 1005, that in
an action for money had and received the plaintiff could recover nothing but the net
sum received without interest”), Depcke v Munn (1828) 3 C & P 111 per Lord
Tenterden CJ (“… the courts have held again and again that interest cannot be
recovered in an action for money had and received … This has been decided so
often, that I cannot now venture to allow the question to be agitated.”), Johnson v
The King [1904] AC 817 and the Westdeutsche case [1996] AC 669.
76. As to the basis on which interest is payable, a clear explanation was provided
by Lord Wright, a judge who was well aware of unjust enrichment (see, for example,
Fibrosa Spolka Akcyjna v Fairbairn Lawson Combe Barbour Ltd [1943] AC 32),
and had also had to consider interest as a member of the Law Revision Committee
which reported in 1934, mentioned earlier. In Riches v Westminster Bank Ltd [1947]
AC 390, 400, he stated:
“… the essence of interest is that it is a payment which becomes
due because the creditor has not had his money at the due date.
It may be regarded either as representing the profit he might
have made if he had had the use of the money, or conversely
the loss he suffered because he had not that use. The general
idea is that he is entitled to compensation for the deprivation.”
77. Once it is understood that the claim to interest is not truly based on unjust
enrichment but on the failure to pay a debt on the due date, the conclusion inevitably
follows that interest can be awarded on the claims within categories (b) and (c) under
section 35A of the 1981 Act: see BP Exploration Co (Libya) Ltd v Hunt (No 2)
[1979] 1 WLR 783, and Sempra Metals at paras 104 (Lord Nicholls) and 175 (Lord
Walker).
78. On a literal reading of section 35A, no such interest could have been awarded
on the claims under category (a). That is because section 35A applies only where
there are proceedings for the recovery of a debt (or damages), and therefore does not
apply where the defendant has repaid the debt (or has set it off) before the creditor
has commenced proceedings for its recovery. An award of interest is nevertheless
required in such circumstances by EU law, if an effective restitutionary remedy is
to be available under English law in respect of San Giorgio claims: that was the
point decided in Metallgesellschaft. It is unnecessary to decide in this appeal how
an award of interest should be made available in those circumstances (and the court
has heard no argument on the point). But there are a number of potential solutions.
Page 31
79. For the foregoing reasons, we therefore depart from the reasoning in Sempra
Metals so far as it concerns the award of interest in the exercise of the court’s
jurisdiction to reverse unjust enrichment. As mentioned earlier, it is unnecessary for
us to consider the reasoning in that case so far as it concerns the award of interest as
damages, and nothing in this judgment is intended to question that aspect of the
decision. Since the award of compound interest to PAC by the courts below was
based on the application of the reasoning in Sempra Metals which we have
disapproved, it follows that HMRC succeed on Issue II, and PAC’s claims to
compound interest under categories (b) and (c) must be rejected. PAC’s claim to
compound interest under category (a) would also have been rejected, if it had not
been accepted by HMRC.
80. Finally, in relation to this aspect of the appeal, it is worth adding that the view
of the majority in Sempra Metals that the opportunity to use money mistakenly paid
should be regarded as an enrichment also raises a number of questions, particularly
in relation to the method by which, and the date or dates as at which, the enrichment
is to be measured. In addition, if one stands back and considers the realism, and also
the fairness, of the approach to enrichment adopted by the majority in Sempra
Metals, the results which it produces are concerning. As Professor Burrows has
written, in relation to the decision of Henderson J in the Littlewoods case, in his
contribution to Commercial Remedies: Resolving Controversies, eds Virgo and
Worthington (2017), p 266:
“… if one were to step back from the complex detail, the result
of Henderson J applying compound interest on all the mistaken
payments from the date of receipt appears to be tantamount to
saying that, had the Revenue not been paid those sums, it would
have borrowed the same sums at a compound interest rate for
five decades. Surely that cannot be right.”
These issues were not, however, discussed in argument in the present appeal, and in
the circumstances it is inappropriate to consider them further.
The remaining issues
81. There remain two issues which are relevant to the computation of the
amounts which EU law requires HMRC to repay. In order to understand those issues
it is necessary to recollect how, under the legislation which was in force in the
relevant years, ACT was charged on distributions by a UK-resident company and
was set against the paying company’s subsequent liability to MCT. Under section
14 of ICTA, ACT was charged when a UK-resident company paid a “qualifying
distribution”, which included the payment of a dividend (section 209).
Page 32
82. Under section 231 of ICTA, when a UK-resident company made a qualifying
distribution, the recipient of the distribution was entitled to a tax credit equal to the
proportion of the amount of the distribution which corresponded to the rate of ACT
in force when the distribution was made. Under section 238, when a UK-resident
company made a qualifying distribution, the sum of the amount of that distribution
together with the proportion of that amount which corresponded to the rate of ACT
in force when the distribution was made was known as a “franked payment” (“FP”).
Section 238 also provided that when a UK-resident company received a distribution,
in respect of which it was entitled to receive a tax credit, the aggregate of the
distribution and the amount of the tax credit was “franked investment income”
(“FII”). When the recipient company itself made a qualifying distribution in the
same accounting period as it received FII, it paid ACT only on the excess of FP over
FII (section 241).
83. The UK-resident company (“company A”) had to make a return and account
to HMRC for the ACT quarterly by disclosing the FPs which it made and the FII
which it received, foreign income dividends paid and received, and the ACT payable
on the FPs and the foreign income dividends: paragraphs 1 and 3(1) of Schedule 13
to ICTA. The ACT which company A paid during an accounting period was then
set against its liability (if any) to MCT on its profits in the accounting period by the
operation of section 239 of ICTA, which we discuss below.
84. Thus, if company A received a distribution from another UK-resident
company (company B) it would not be liable to pay MCT on that distribution
(section 208). If company A, having received a distribution from company B, itself
made a distribution, it would be liable to pay ACT on the excess of its FP over its
FII. When company A came to pay MCT on its profits in the same accounting period
it would have been entitled to set off the ACT which it had paid (section 239).
85. The illegality under EU law, which was caused by the UK’s failure to match
the exemption conferred on dividends received from UK-resident companies by an
equivalent credit in respect of overseas-sourced dividends, is to be remedied by a
credit for foreign dividends by reference to the FNR, as we have held under Issue I
above. Applying the example above but with the receipt by company A of overseassourced dividends in place of UK-sourced dividends, under EU law the FNR credit
would fall to be applied to its payment of MCT. Thus the MCT which company A
paid was unlawful to the extent that the credit had not been given. If company A had
itself paid a dividend, the FNR credit should have been applied to reduce the ACT
which it had paid.
86. With that introduction we turn to Issue III.
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Issue III
87. Issue III, on which HMRC seek permission to appeal, is whether a claim for
restitution lies to recover “lawful ACT”, which has been set against “unlawful
MCT”. By the expression “lawful ACT” we refer to the element within an
undifferentiated ACT charge which did not represent unduly levied tax on overseassourced dividends. Lawful ACT on the (UK-resident) Company A’s distribution
refers to such ACT as is due after giving effect to (i) the exemption given to income
from dividends of UK-resident companies and (ii) (in light of our answer to Issue I)
the tax credit which EU law requires to be given to income from dividends from
overseas companies. “Unlawful MCT” in this context refers to such part of the
charge to MCT as is attributable to the failure to give the overseas-sourced
dividends, which company A received, a tax credit at the FNR to achieve
equivalence to the exemption which section 208 gave to dividends received from
UK-resident companies.
88. This issue was not argued in the courts below because Henderson J and the
Court of Appeal, when considering this case, were bound by the Court of Appeal’s
earlier decision in Test Claimants in the FII Group Litigation v Revenue and
Customs Comrs [2010] EWCA Civ 103; [2010] STC 1251 (“FII CA”). In that
judgment the Court of Appeal held that a taxpayer was entitled to reimbursement of
lawful ACT, which HMRC had retained because it had been set against an unlawful
MCT charge. The court held that such ACT related directly to the unlawful MCT
because the CJEU treated ACT as an advance payment of MCT: FII CA paras 148-
151.
89. The statutory provisions governing the set-off of ACT against MCT were as
follows.
90. Section 239(1) of ICTA provided for the automatic set-off of ACT against
MCT, thereby reducing company A’s liability to pay MCT. It provided:
“… advance corporation tax paid by a company (and not
repaid) in respect of any distribution made by it in an
accounting period shall be set against its liability to corporation
tax on any profits charged to tax for that accounting period and
shall accordingly discharge a corresponding amount of that
liability.”
Page 34
91. Where the tax-paying company did not have a sufficient liability to MCT on
its profits to use up the ACT by way of set-off in the same accounting period, the
unused ACT could be carried back under section 239(3) which provided:
“Where in the case of any accounting period of a company
there is an amount of surplus advance corporation tax, the
company may, within two years after the end of that period,
claim to have the whole or any part of that amount treated for
the purposes of this section (but not of any further application
of this subsection) as if it were advance corporation tax paid in
respect of distributions made by the company in any of its
accounting periods beginning in the six years preceding that
period … and corporation tax shall, so far as may be required,
be repaid accordingly.
In this subsection ‘surplus advance corporation tax’ in relation
to any accounting period of a company, means advance
corporation tax which cannot be set against the company’s
liability to corporation tax for that period because the company
has no profits charged to corporation tax for that period …”
92. The surplus ACT could also be carried forward automatically under section
239(4) which provided:
“Where in the case of any accounting period of a company
there is an amount of surplus advance corporation tax which
has not been dealt with under subsection (3) above, that amount
shall be treated for the purposes of this section (including any
further application of this subsection) as if it were advance
corporation tax paid in respect of distributions made by the
company in the next accounting period.”
93. Section 239(5) explained how the set-off operated under both subsections (1)
and (4). It provided:
“Effect shall be given to subsections (1) and (4) above as if on
a claim in that behalf by the company and, for that purpose, a
return made by the company under section 11 of the
Management Act containing particulars of advance corporation
tax or surplus advance corporation tax which falls to be dealt
with under those subsections shall be treated as a claim.”
Page 35
Company A could also surrender its ACT to its subsidiary in accordance with section
240, with the result that the ACT would be treated as ACT paid by the subsidiary
and set against the subsidiary’s liability to pay MCT.
94. HMRC’s case is simple. They argue that if a taxpaying company included
relevant details of ACT paid in its tax return, sections 239(1) and (5) mandated an
automatic set-off of the ACT against the company’s liability for MCT. If, on a
proper understanding of the law, the company did not owe sufficient MCT in the
relevant accounting period, the ACT remained surplus and available to be set off in
the next accounting period under section 239(4). In other words, HMRC argue that
the law treats an unlawful MCT charge as a nullity, with the result that there is no
set off under section 239(1) and no enrichment of HMRC by the payment of the
ACT, which remained available to offset the taxpaying company’s lawful MCT in
other accounting periods.
95. PAC opposes the grant of permission to HMRC on this issue and submits that
it is a detailed issue of computation which is likely only to affect the appeal in PAC’s
case if PAC’s approach to Issue V is correct. If this court were to give permission to
appeal, PAC advances three arguments. First, it submits that the court’s approach
should be governed by the principle that the taxpayer should be entitled to recover
unduly levied tax. Secondly, it argues that, because the CJEU has characterised ACT
as “nothing more than a payment of corporation tax in advance” (eg FII ECJ I para
88), ACT could only lawfully be charged where it is itself a pre-payment of a lawful
charge to MCT. As a result, it contends that the correct analysis is that a payment of
ACT, which is subsequently set against an excessive liability to MCT, is an advance
payment of an excessive tax liability and is itself the payment of an excessive tax
liability. As such, it is liable to be recovered in a claim in restitution. Alternatively,
PAC contends that the payment of the ACT relates directly to the unlawfully levied
MCT and so is recoverable in a claim in restitution. In support of those contentions
PAC relies on dicta of the CJEU in FII ECJ I and FII ECJ II. PAC’s third argument
is that, if it had been aware that it did not have any liability for a substantial part of
the MCT, it would have not have paid the ACT. PAC was a subsidiary of Prudential
plc and it had no subsidiaries of its own which generated profits giving rise to a
liability to corporation tax against which PAC’s ACT could have been used. It would
therefore have paid dividends to its parent company within a group income election
so that the ACT was paid at the level of the parent company and would have been
available for set-off against the MCT of other subsidiary companies within the
group. This, it submits, would have been the only sensible course to avoid the ACT
being stranded in PAC’s accounts.
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Analysis
96. In our view it is appropriate to give HMRC permission to raise this issue as
it is a point of law of general public importance in an appeal to this court in the
context of a group litigation order. While PAC submits that it alone is likely to be
affected by the determination of this issue, the court is not in a position to assess
whether or not that is so. The matter also arises in the FII litigation. HMRC had
applied for permission to appeal the Court of Appeal’s ruling on this issue in FII CA
but the determination of that application was postponed by this court by orders dated
8 November 2010 and 9 May 2017. The issue, which will be of relevance to the final
determination of the FII litigation, therefore comes to this court in this appeal before
this court has addressed the application to appeal in that litigation.
97. In addressing this issue, the starting point is to recall that an entitlement to
repayment or restitution in this context requires that there has been an unlawful
charge to tax as a result of incompatibility with EU law: San Giorgio. The question
we are asked to consider is in substance: have HMRC unlawfully levied ACT by
setting it against MCT which has been unlawfully charged? But there is a logically
prior question, which is whether there has been any set-off.
98. Company A may have received income which has funded its distribution
from UK-resident companies and also from companies resident elsewhere in the EU.
In this computational issue the court is not concerned with “unlawful” ACT, which
has been charged on a distribution by company A derived from income which it has
received from an overseas-resident company in the absence of sufficient credit for
foreign tax on the latter company’s distributions. We are concerned with ACT which
is unquestionably lawful but which has purportedly been set against an unlawful
MCT charge on company A.
99. PAC relies on dicta in FII ECJ I and FII ECJ II to argue that this prima facie
lawful charge on company A’s dividend is tainted by its being merely an advance
payment of an unlawful MCT charge. But the CJEU, when it characterised ACT as
constituting “a form of advance payment of corporation tax” (FII ECJ I para 88 and
FII ECJ II paras 68 and 110), was well aware of the provisions of ICTA which
allowed the taxpaying company to utilise the ACT which it had paid in different
ways. Thus, in FII ECJ II at para 6, the CJEU stated:
“A company had the right to set the ACT paid in respect of a
distribution made during a particular accounting period against
the amount of mainstream corporation tax for which it was
liable in respect of that accounting period, subject to certain
restrictions. If the liability of a company for corporation tax
Page 37
was insufficient to allow the ACT to be set off in full, the
surplus ACT could be carried back to a previous accounting
period or carried forward to a later one, or surrendered to
subsidiaries of that company, which could set it off against the
amount for which they themselves were liable in respect of
corporation tax.”
(The reference to the surrender of ACT to a subsidiary is a reference to section 240
of ICTA.)
100. As we have shown, section 239 of ITCA did not confine the MCT, against
which the ACT could be set, to MCT due for the same accounting period as that in
which the ACT was paid (“the same accounting period”). If there was insufficient
MCT due in the same accounting period, the surplus ACT was carried forward
automatically to the next accounting period, unless company A elected to use it
otherwise, such as by carry back under section 239(3). If the company did not so
elect, and if in the same accounting period and subsequent accounting periods
company A did not have sufficient MCT to use up the ACT which it had paid, or if
Company A did not surrender the ACT under section 240, the ACT was, in PAC’s
words, “stranded”. But that stranding of the ACT, were it to have occurred, would
not affect the lawfulness of the ACT charge.
101. In our view, HMRC are correct in their submission that, if an apparent charge
to MCT was unlawful, that charge was a nullity. The ACT could not have been set
against a nullity but remained available to be carried back if a claim were made
under section 239(3) or for automatic set-off against lawful MCT in a subsequent
accounting period under section 239(4) or otherwise to be utilised. Being so
available, the lawful ACT did not directly relate to the unlawful MCT in the same
accounting period in the sense that penalties and interest may relate to an unlawfully
levied tax. Accordingly, HMRC in receiving payment of the lawful ACT did not
receive unlawfully levied tax which gave rise to a San Giorgio claim.
102. Further, PAC was obliged by ICTA to pay the lawful ACT. The payment of
the ACT did not entail a defective transfer of value which falls to be corrected: the
ACT was due when it was paid, and was available to PAC to utilise thereafter.
PAC’s loss in the context of Issue III (ie in relation to lawful ACT) is the result of
the levying of unlawful MCT, and, through the misunderstanding of the law which
it shared with HMRC, of its not having been able to set the unutilised ACT against
its liability for lawful MCT in the same or other accounting periods or otherwise to
utilise the ACT to reduce its liability to tax. Its loss in that sense does not support a
claim in restitution: Investment Trust Companies v Revenue and Customs Comrs,
especially paras 41-45 per Lord Reed.
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103. We are informed that PAC’s corporation tax liabilities in its accounting
periods from 1994 to 1998 are not finalised as PAC’s returns in those years are still
open and that therefore it may be possible for PAC to carry forward unutilised ACT
to set against its MCT liabilities in those periods. But, whether or not that is the case,
in agreement with Henderson J in FII High Court 1 ([2008] EWHC 2893) we
consider that an enquiry into whether, and if so how, surplus ACT would otherwise
have been used within a group of companies cannot give rise to a claim in restitution
but would form part of a claim for damages if the criteria for such a claim were met.
104. We therefore, in agreement with Henderson J in the FII litigation, answer the
question raised in Issue III (“Does a claim in restitution lie to recover lawful ACT
set against unlawful corporation tax?”) in the negative.
Issue V
105. PAC seeks permission to cross-appeal if (as we have done) we grant HMRC
permission to appeal on Issue III. Again, the issue arises in the context of a GLO
and we are unable to assess its significance in other cases within the GLO. But it is
closely connected with Issue III and has significant consequences for PAC’s claim
for interest. It is appropriate that we address it in the context of this appeal. We
therefore grant permission for the issue to be raised.
106. Issue V comprises two related questions concerning the utilisation of ACT
on a hypothesis that an undifferentiated fund of lawful and unlawful ACT was
purportedly set off against an amount of MCT which was in part lawful and in part
unlawful. The first question (Issue V(a)) which the parties have raised is:
“Where ACT from a pool which includes unlawful and lawful
ACT is utilised against an unlawful corporation tax liability, is
the unlawful ACT regarded as a pre-payment of the unlawful
corporation tax liability or is the ACT so utilised regarded as
partly lawful and unlawful pro rata?”
107. PAC contends that the unlawful ACT which company A has paid is to be
regarded as utilised first against the unlawful MCT. HMRC have argued for a pro
rata approach by which the unlawful MCT is regarded as having been met by the
utilisation of lawful and unlawful ACT in the same proportion as the unlawful MCT
bears to the overall MCT charge. The background is that in so far as unlawful ACT
has been utilised against lawful MCT, HMRC have conceded that the time value of
the prematurely-paid ACT is recoverable in compound interest, as explained earlier
in the discussion of Issue II. In so far as the unlawful ACT has purportedly been
Page 39
utilised against unlawful MCT, the unlawful ACT which the taxpaying company has
paid is recoverable together with interest under section 35A of the 1981 Act, as
explained in relation to Issue II, as both the ACT charge and the MCT charge were
nullities.
108. Henderson J in his second judgment in this case ([2015] EWHC 118 (Ch);
[2015] STC 1119) addressed this issue at paras 34-37. He expressed an initial
inclination to adopt the pro rata approach as everyone at the time had assumed that
the whole of both the ACT and the MCT had been lawfully charged. He decided
however that PAC’s approach was correct because, if the unlawful ACT was
regarded as a prepayment of the unlawful MCT, the end result reflected precisely
the credit for foreign tax which EU law required, whereas on HMRC’s approach
company A would have an additional and unnecessary claim to recover the element
of lawful ACT which had been utilised against the unlawful MCT. His ruling was
made expressly on the basis that he was bound by the Court of Appeal’s ruling on
Issue III above, a ruling which we have now overturned.
109. The Court of Appeal (paras 113-127) disagreed with Henderson J’s approach.
It stated that the issue was how to determine the extent of the benefit for HMRC in
money terms from the payment or bringing into account of an unlawful MCT charge
for the purpose of determining the extent of HMRC’s unjust enrichment. The court
looked for a fair way of determining that enrichment in a situation where an
undifferentiated fund of lawful and unlawful ACT had purportedly been set against
an apparent liability to MCT, which in fact comprised both lawful and unlawful
MCT. The court attached weight to the fact that both PAC and HMRC were unaware
of the meaning and effect of the relevant EU law at the time; neither was to blame
for the situation; both were disabled by their ignorance of the true state of affairs
from applying their minds at the time to the allocation of lawful and unlawful ACT
as between the lawful and unlawful elements of MCT. As a result, the court sought
to strike a fair balance between their interests by adopting an objective standard.
That standard was the pro-rating approach which Henderson J had earlier favoured
in his judgment in Test Claimants in the FII Group Litigation v Revenue and
Customs Comrs [2014] EWHC 4302 (Ch); [2015] STC 1471 (“FII (High Court)
Quantification”), para 205.
110. We are not able to reconcile the Court of Appeal’s ruling with our decision
on HMRC’s appeal on Issue III, which is inconsistent with the ruling in FII CA by
which the Court of Appeal in this case was bound. As HMRC have submitted and
we have held under that issue, section 239 has the effect that lawful ACT is not set
against unlawful MCT, which is a nullity. The pro rata method, which involves
unlawful MCT being met in part by unlawful ACT and in part by lawful ACT,
cannot therefore work. Instead, lawful ACT, which was not utilised against lawful
MCT, remained available to be claimed against lawful MCT in the same or other
accounting periods. The unlawful ACT, which company A paid, was not set against
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the unlawful MCT charge in a given accounting period because both the unlawful
ACT charge and the unlawful MCT charge are nullities. The principled answer is
therefore that the unlawful ACT, which company A has paid, must be treated as
having been utilised first against the unlawful MCT charge. Where there is no
unlawful MCT against which to set the unlawful ACT which has been paid, the
residual unlawful ACT is to be treated as utilised against lawful MCT. Because both
of the unlawful charges are nullities, the unlawful ACT is itself recoverable, unless
it has been set against a lawful MCT charge. When unlawful ACT has been set
against lawful MCT, company A has a claim for interest on the ACT so used, as
stated in para 78 above.
111. The second question under Issue V relates to the carry back to an earlier
quarter of domestic FII received in a later quarter in the same accounting period. To
address this, it is necessary to explain the operation of paragraph 4 of Schedule 13
to ICTA. Rather than set out the provision we gratefully adopt the explanation of its
effect which Henderson J gave in FII (High Court) Quantification at para 209:
“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.”
If the excess FII was not so used in repayment of ACT paid in the earlier quarter, it
was carried forward into the next annual accounting period to set against FPs in the
same way (section 241(3)).
112. Issue V(b) asks:
“Where domestic FII was carried back to an earlier quarter is it
to be regarded as having been applied to relieve lawful and
unlawful ACT pro rata or only lawful ACT?”
113. Henderson J in his second judgment in this case discussed the issue briefly in
paras 40-43 after hearing full argument on the point. He decided, with considerable
hesitation, that the FII was to be regarded as having been applied to relieve only
lawful ACT in the earlier quarter because otherwise FII from UK-sourced dividends,
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which was entirely lawful, would be used to cancel out part of the credit which EU
law requires on foreign income. In reaching this conclusion he departed from the
view which he had reached on essentially the same issue in FII (High Court)
Quantification at paras 207-211.
114. The Court of Appeal disagreed and (paras 128-133) adopted an approach
similar to that which it took on Issue V(a). Again, the court laid stress on the fact
that at the time nobody appreciated that the ACT against which the FII was carried
back might comprise both lawful and unlawful elements and no-one was to blame.
The fair course therefore was to adopt the pro rata approach which the court had
taken in relation to Issue V(a). The effect of that approach would be that “the primary
period of unjust enrichment of HMRC” through receipt of the unlawful ACT would
be brought to an end and HMRC’s enrichment would be measured by the time value
of the ACT payment. The court did not see this as cancelling out any part of the
credit which EU law required on overseas-sourced dividends.
115. In this appeal PAC renews the arguments which Henderson J favoured. The
UK tax system was unlawful because credits were not given under section 231 for
tax on overseas-sourced dividends in order to relieve an ACT liability. The use of
carried-back FII to relieve unlawful ACT deprived company A of the credits which
it should have had for the overseas-sourced dividends. The carried-back FII should
therefore be regarded as having been applied to relieve only lawful ACT.
116. HMRC’s answer in their written case is that EU law does not mandate a form
of credit for overseas-sourced dividends. They quote the statement of the CJEU in
para 72 of FII ECJ II:
“As is clear from para 62 [of the present judgment], the
obligation presently imposed on the resident company by
national rules, such as those at issue in the main proceedings,
to pay ACT when profits from foreign-sourced dividends are
distributed is, in fact, justified only in so far as that advanced
tax corresponds to the amount designed to make up the lower
nominal rate of tax to which the profits underlying the foreignsourced dividends had been subject compared with the nominal
rate tax applicable to the profits of the resident company.”
HMRC, unexceptionably, interpret this statement as meaning that it is lawful to
charge ACT on a dividend paid by company A only to the extent that it was lawful
to charge MCT on the profits out of which that dividend was paid. But HMRC go
on to say that the relief required was not in the form of a credit which was the
equivalent of further FII.
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117. We do not accept HMRC’s submission on Issue V(b) for the following three
reasons.
118. First, it follows from the answer which we have given on Issue I that we reject
the contention that no particular form of credit is mandated by EU law. What the
CJEU said in para 72 of FII ECJ II must be construed in the light of what it said in
paras 61-65 which we have quoted in para 26 above. That in turn falls to be
understood against the earlier ruling of the CJEU in FII ECJ I, which we have quoted
in para 7 above. In other words, EU law requires a tax credit by reference to the FNR
to which the profits of the overseas company have been subject. As a result, the UK
can charge ACT in relation to company A’s dividends so far as they comprise profits
from overseas-sourced dividends only to the extent that there is tax due in respect
of those dividends after it has given company A that tax credit.
119. Secondly, the consequence of this is that PAC is correct in its contention that
HMRC’s approach would result in depriving company A of the tax credits on
overseas-sourced dividends which EU law mandates. Using the example which PAC
gave in its written case, suppose that company A paid ACT of £100 in the first
quarter when it had received overseas-sourced dividends which (if EU law had been
applied correctly) would have entitled it to a credit of £25. If EU law had been
applied correctly in that quarter, the ACT paid would have been £75. Suppose then
that in the third quarter company A received FII for UK-sourced dividends which
carried credits of £75 which it carried back to the first quarter. On PAC’s approach,
the carried back FII would result in the repayment of all the ACT which had properly
been paid. If, as on HMRC’s approach, the £75 of FII, which is carried back from
the third quarter, were utilised pro rata between the lawful and unlawful ACT which
comprised the £100 paid in the first quarter, £18.75 (1/4 of the £75) would be
attributed to the unlawful ACT, thereby cancelling to that extent the credit to which
company A was entitled in EU law.
120. Thirdly, we are not persuaded by the arguments as to fairness which
influenced the Court of Appeal in relation to both of Issues V(a) and V(b). As
unlawful ACT is a nullity, the principled answer is that domestic FII carried back to
an earlier quarter is to be regarded as having been applied to relieve only lawful
ACT so that any excess FII remained available for carry forward under section
241(3).
121. We therefore answer Issue V(b) by holding that domestic FII which is carried
back to an earlier quarter under paragraph 4 of Schedule 13 of ICTA is to be regarded
as having been applied to relieve only lawful ACT.
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122. In further written submissions HMRC and PAC disagree on factual matters
which may affect the working out of the rulings which we have made. This court is
not in a position to resolve these matters. We will invite submissions in response to
our judgment as to how our rulings may be applied.
Conclusions
123. For the foregoing reasons, we allow HMRC’s appeal on Issues II and III, and
dismiss it on Issue I. PAC’s proposed cross-appeal on Issue IV does not arise, as a
result of its success on Issue I, and it also succeeds in its cross-appeal on Issue V(a).
In relation to Issue V(b), the court holds that FII carried back to an earlier quarter is
to be treated as having been applied to relieve only lawful ACT.