Current Litigation in the UK Courts Under European Community Law
by Jonathan S. Schwarz  
 
1. ACT GROUP LITIGATION

Background
On 8 March 2001, the European Court of Justice (ECJ) delivered a ruling in the Metallgesellschaft Limited and Others v. CIR and HM Attorney General and Hoechst AG and Hoechst UK v. CIR and HM Attorney General (joined cases C-397/98 and C-410/98) [2001] STC 452 (ECJ). The Claimants were UK companies and their German parent companies, who argued that section 247 of the Income and Corporation Taxes Act 1988 was contrary to the EC Treaty in permitting a group income election (allowing dividends to be paid by a subsidiary to its parent without accounting for advance corporation tax (ACT) only where both the subsidiary and parent were resident in the UK.). The ECJ agreed and ruled that companies could claim damages or restitution for the loss suffered as a result of the UK breach of Community law. Since then, many other companies have issued similar claims in the High Court in respect of ACT.

To enable the Court to manage all the claims effectively, the Revenue applied to the High Court for a Group Litigation Order (GLO). A GLO is an order, made under Part III of Rule 19 of the Civil Procedure Rules 1998, whereby claims raising the same issue are grouped by reference to those issues. Test cases can then be chosen and the costs shared amongst all the Claimants. Under a GLO, a group register is set up. Where a judgment or order is given or made in a claim on the group register in relation to one or more GLO issues, that judgment or order is binding on the parties to all other claims that are on the group register at the time the judgment is given or the order is made unless the Court orders otherwise. The Court has now made the GLO.

The ECJ did not consider the effect of tax treaties such as the UK-Netherlands Treaty which permits a partial payment of tax credits to qualifying shareholders. Issues relating to this are now before the Court.

The relevant questions posed to the Court are as follows:-

Quantum
(a) Where an amount of ACT has been set off against a UK company's corporation tax liability or has been surrendered to another group company or has been carried back and set off against the UK company's corporation tax liability arising in an earlier year, at what rate and for what period and on what basis is interest due in calculating the damages and/or restitution in respect of the loss of use of the sum paid as ACT?

(b) At what rate and for what period and on what basis is interest due on the amount calculated in accordance with (a) above?

(c) Where a Claimant has surplus ACT which has not been utilised and if the Claimant is entitled to payment in compensation of a sum equivalent to such surplus ACT, plus further compensation to reflect the loss of use of that ACT, the issue to be determined is at what rate, for what period and on what basis is interest due in calculating the damages and/or restitution in respect of the loss of use of the surplus ACT?

(d) What effect, if any, does the fact have upon the calculation of damages in (a), (b) and (c) above, that the Claimant is a member of a group, a member of which received a half tax credit under the terms of a relevant double tax convention in respect of sums paid on account of ACT by a UK Claimant company?

Liability
(a) Does the fact that a Claimant or another company has been paid or is entitled to a half tax credit under the terms of a relevant double tax convention in any way bar a claim for relief?

(b) Does the fact that a Claimant or another company has been paid or is entitled to a half tax credit under the terms of a relevant double tax convention restrict claims for damages and/or restitution in respect of sums paid on account of ACT by a UK company, and if so, how?

(c) Is a Claimant entitled to recover ACT paid but not utilised against mainstream corporation tax liabilities of any company (or damages equivalent thereto) without deduction on the grounds that the payment of the ACT is unlawful being contrary to Article 5(1) Council Directive 90/435?

(d) If a Claimant is entitled to recover ACT as in (c) above, from what date does the limitation period commence?

(e) Has the High Court jurisdiction to hear a claim that the retention by the Revenue of unutilised ACT is unlawful as contrary to a Council Directive?

(f) If so, does the High Court have a discretion whether to hear such a claim?

(g) If so, should the High Court exercise its discretion in favour of hearing the claim or should the claim be pursued, if at all, by way of an appeal to the Special Commissioners?

(h) Where the applicable double tax convention allows a partial tax credit in respect of dividends paid by UK companies, is any reduction in that partial tax credit (a 5% charge on the aggregate of the tax credit and dividends) unlawful as contrary to Article 5(1) Council Directive 90/435?

(i) Is a Claimant company resident in a State having a convention which does not allow any tax credit in respect of dividends paid to it by UK companies entitled to payment of a sum equal to the partial tax credit which would have been available had it been resident in a state with a convention allowing such a credit?

The question of most favoured nation status was raised by Hoechst in the ECJ. It argued that, as a German resident, it was entitled to the benefits of the UK-Netherlands Treaty, but the issue was not addressed there, as discrimination was found on other grounds. Although it was initially included in the GLO, no test cases have emerged as it has now been deleted.

Bilateral Treaty Issues
In addition to the claims under EC law, a number of claims have been made under bilateral treaties. These argue that similar discrimination existed in relation to ACT under treaties without a non-discrimination article based on the OECD Model. The questions before the Court are as follows:-

Liability
(a) Has the High Court jurisdiction to hear a claim based on the anti-discrimination article of a double taxation convention?

(b) If so, does the High Court have a discretion whether to hear such a claim?

(c) If so, should the Court exercise its discretion in favour of hearing the claim or should the claim be pursued, if at all, by way of an appeal to the Special Commissioners?

(d) Is the Claimant entitled by virtue of section 788 ICTA 1988 to rely upon the anti-discrimination article of the relevant double taxation convention?

(e) Are sections 14, 208, 231, 247 and Schedule 13 ICTA 1988 contrary to the non-discrimination provisions of the relevant double tax conventions between the UK and the country in which the non-UK company is resident and, if so, are the Claimants entitled to claim compensation if there has been a breach of and/or failure to implement the non-discrimination provisions of the relevant convention?

(f) Are sections 209(4) and 209(5) of ICTA contrary to the non-discrimination provisions of the relevant double tax conventions between the UK and the country in which the parent is resident and if so are the Claimants entitled to claim compensation if there has been a breach of and/or failure to implement the non-discrimination provisions of the relevant convention?

(g) If it would otherwise be entitled to claim compensation, is the Claimant nevertheless precluded from doing so in respect of ACT which has been utilised as against mainstream corporation tax prior to the date of issue of the claim?

(h) Does the fact that a Claimant or another company has been paid or is entitled to a half tax credit under the terms of a relevant double tax convention restrict or bar claims for damages and/or restitution in respect of any sums paid on account of ACT by a UK company and, if so, how?

(i) Does the effect of all or any of Sections 14, 208, 209(4), 209(5), 231 and 247 and Schedule 13 of ICTA and/or the statutory predecessors of those sections, which provide for the payment of ACT upon UK resident company taxpayers with shareholders in countries beyond the EEA, amount to discrimination in breach of article 14 and 1st article of the 1st protocol of the European Convention of Human Rights?

Limitation
(a) Is any claim which accrued more than 6 years before the issue of the writ or claim form statute-barred by reason of the provisions of the Limitation Act 1980?

Quantum
(a) How should compensation or relief be assessed?

(b) What effect, if any, does the fact have upon the calculation of damages in (a) above that the Claimant is the member of a group, a member of which received a half tax credit under the terms of relevant double tax convention in respect of sums paid on account of ACT by a UK Claimant company?
 

2. WITHHOLDING ON TAX CREDIT PAYMENTS

The question of the status of tax credit repayments on dividends paid to parent companies in certain treaty countries has recently come before the UK courts in Océ Van Der Grinten NV v. IRC SpC 231. The case involves a claim by a Dutch parent company against the imposition of the 5% deduction on the repayment of the tax credit plus dividend pursuant to Article 10(3)(a)(ii) of the Netherlands-UK Treaty, on the basis that the restriction of the tax credit repayment by the 5% was contrary to the Parent-Subsidiary Directive. In the case of non-residents, there was no further UK tax. A number of treaties provide for a repayment of the tax credit to qualified treaty resident shareholders subject to a retention which ranges from 5% in the case of substantial participation to 15% for portfolio investors.

The issues in this case are whether the 5% referred to in Article 10(3)(a)(ii) was a "withholding tax" on "profits that a subsidiary distributes to its parent"? If it was, is the Inland Revenue's right to require the deduction preserved by Article 7(2) of the Directive? Assuming that Article 7(2) preserved the 5% from the effect of Article 5(1), was Article 7(2) valid?

The operation of Article 5(1) depended on three related issues:-

(1) As a matter of UK law, whether the 5% was a tax?

(2) Under UK law, whether the 5% ranked as a tax on profits which a subsidiary distributed to its Netherlands parent?

(3) As a matter of Community law, if it was such a tax on profits, whether the 5% was a withholding tax?
 

The Special Commissioner concluded that, in all the circumstances, the 5% was a tax and a tax "on profits that a subsidiary distributes to its parent". Withholding tax, he concluded, is not a term of art in UK tax law. It is usually meant the tax which is deducted at source by the payer of income and accounted for to the Revenue in some means or another. The scope of the expression "withholding tax" in the Directive was, however, too vague to enable him to decide with the requisite level of confidence whether the 5% tax was a withholding tax within the context of Article 5(1) of the Directive and therefore the question should be referred to the European Court of Justice.

The taxpayer argued that Article 7(2) did not preserve the UK's right to impose the 5% tax. The provisions of the Treaty which authorise the imposition of the tax on the aggregate of the dividend and the tax credit did not "eliminate or lessen economic double taxation of dividends". Instead, they were calculated to impose or increase it. The Revenue argued that the Treaty provisions were within Article 7(2). They were provisions "relating to" the payment of tax credits and they were "agreement based" provisions designed to eliminate or lessen double taxation of dividends. It would appear that he ruled that "had there been no treaty, there would have been no double taxation of the subsidiary's dividends because, under domestic law, Taxes Act 1988 Section 233(1)(a) precluded the dividends from charge to income tax. The Treaty had the effect of dis-applying that Section, because it gave the Netherlands recipient of the dividends a partial tax credit. It left the UK Revenue with the 5% tax charge on the aggregate of the amounts of the dividend and the tax credit. It also compensated the recipient of the dividend by entitling it to payment of the balance.

In addition, the tax credits and their payment were, as far as UK tax law was concerned, an essential feature of the system of tax on dividends. They were not designed to eliminate or lessen double taxation of dividends, nor were they example of provisions that did. Consequently, the construction of Article 7(2) as advanced by the Revenue would mean that it provided an exception to the exemption from withholding tax laid down by Article 5(1) of the Directive, wherever the charge to such tax was associated with the payment of a tax credit. There was real doubt whether Article 7(2) could be read as providing that result and nothing in the Directive that gave any indication of an intention to produce such an exception. As a result, this was referred to the European Court of Justice.

The Inland Revenue attempted to block the reference to the European Court of Justice by appeal to the High Court, Océ Van Der Grinten NV v. IRC [2000] STC 951 (ChD). The Inland Revenue argued in the High Court that the 5% withholding was not a tax as a matter of UK domestic law and that the reference to the European Court of Justice was not necessary.

Jacob J held that whether a particular national law was characterized as a "tax" as a matter of national law was immaterial to the question of whether it was a withholding tax as a matter of Community law. What mattered was how the law operated and not whether it could be called a "tax" under national law. He applied the decision in Ministério Público Fazenda Publica v. Epson Europe BV on the basis that the substance of the legislation rather than its form is determinative.

He further concluded that the 5% withholding was a tax under UK law in any event. It was a reduction in what the shareholder would have received if there had been no abatement. The deduction stemmed from the distribution, and this was supported by the language of the treaty.

In Athinaiki Zithopiia AE v. Greece (Case C-294/99), the ECJ considered the application of the term "withholding tax" within Article 5(1) of the Directive in the context of dividends paid by a Greek subsidiary to its Dutch parent. Under Greek law, certain amounts which were excluded from the tax base until they were distributed as dividends when they were re-included was held to be a withholding tax. If the amounts were not distributed to the parent company, they would remain tax-free. In addition, the Court held that the Greek government could not rely on Article 7(2) of the Directive, which preserves domestic or treaty based measures designed to lessen or eliminate double taxation on the basis that double taxation was in fact contemplated by the Netherlands-Greece Treaty.
 

© Jonathan Schwarz 2002. All rights reserved, and all moral rights are asserted.