Pirelli Cable Holding NV & Ors v Inland Revenue [2003] EWCA Civ 1849

Case No C3/2003/0326[2003] EWCA Civ 1849
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
Park J.
Venue Royal Courts of JusticeDate Wednesday 17 December 2003
Strand,
London, WC2A 2LL
Before
LORD JUSTICE PETER GIBSONLORD JUSTICE LAWSSIR MARTIN NOURSE
Between
PIRELLI CABLE HOLDING NV AND OTHERSRespondentTHE COMMISSIONERS OF INLAND REVENUEAppellants
(Transcript of the Handed Down Judgment ofSmith Bernal Wordwave Limited, 190 Fleet StreetLondon EC4A 2AGTel No: 020 7421 4040, Fax No: 020 7831 8838Official Shorthand Writers to the Court)
Mr. Graham Aaronson Q.C., Mr. David Cavender and Mr. Paul Farmer (instructed by Messrs Dorsey & Whitney of Finsbury Square) for RespondentMr. Ian Glick Q.C., Mr. David Ewart and Ms. Zoe O’Sullivan (instructed by The Solicitor of Inland Revenue) for Appellants
Judgment

Peter Gibson L.J. (giving the judgment of the court):

[1]The Commissioners of Inland Revenue (“the CIR”) appeal with the permission of Park J. from the order made by him on 22 January 2003 in the first in a series of test claims which Chief Master Winegarten, by a Group Litigation Order (“GLO”) made on 26 November 2001, ordered to be tried. The GLO was made following a preliminary ruling of the Court of Justice of the European Communities (“the CJEC”) in joined cases Metallgesellschaft Ltd. v CIR and Hoechst AG v CIR [2001] STC 452 (“Metallgesellschaft/ Hoechst”).[2]Before we set out what Metallgesellschaft/ Hoechst decided and its relevance to the present appeal, we will attempt to explain the statutory background so far as material. The statutory background[3]This case is concerned only with the system of corporation tax, called the imputation system, which applied in the United Kingdom between 1973 and 1999 to the taxation of distributions (typically dividends). Prior to 1973 the Finance Act 1965 had introduced corporation tax in a way which made the taxation of company profits entirely separate from the taxation of distributions made by a company. But under that system there was in effect double taxation of company profits, once in the hands of the company and again in the hands of the shareholders when the profits were distributed. As appears from the White Paper, Reform of Corporation Tax (Cmnd. 4955, April 1972), this system was perceived to discriminate against distributed profits, and accordingly the imputation system was introduced by the Finance Act 1972.[4]The features of the imputation system were:(1) the company paid corporation tax on all its profits, whether or not distributed;(2) income tax was no longer deducted from distributions;(3) a company making distributions to its shareholders made a payment of Advance Corporation Tax (“ACT”) in respect of distributions so made;(4) ACT paid in respect of distributions made in an accounting period was to be set off against the corporation tax, often called Mainstream Corporation Tax (“MCT”), on the company’s profits for that period;(5) the recipient of a distribution in respect of which ACT was payable was entitled to a tax credit corresponding to the ACT.[5]The company was ordinarily chargeable to corporation tax on all its profits (meaning income and chargeable gains) under s. 6 of the Income and Corporation Taxes Act 1988 (“ICTA”). Under s. 14 (1), subject to s. 247 (to which we will come later), where a company resident in the UK made a qualifying distribution (defined in s. 14 (2) as meaning any distribution with limited exceptions), it became liable to pay ACT in respect of that distribution. Unlike the system operating between 1965 and 1973 when income tax under Schedule F fell to be deducted by the company from the dividends paid to the shareholders, ACT was not so deducted but was an additional payment to be made by the company to the CIR.[6]Schedule F continued to be the Schedule under which distributions were charged to income tax in the hands of shareholders. It was defined in s. 20 in this way, so far as material:
“1. …. income tax under this Schedule shall be chargeable for any year of assessment in respect of all dividends and other distributions in that year of a company resident in the United Kingdom which are not specifically excluded from income tax …. 2. For the purposes of this Schedule and all other purposes of the Tax Acts …. any such distribution in respect of which a person is entitled to a tax credit shall be treated as representing income equal to the aggregate of the amount or value of that distribution and the amount of that credit, and income tax under this Schedule shall accordingly be charged on that aggregate.”
Individual shareholders could set off the tax credit against their personal liability to income tax.[7]A company which paid ACT in consequence of any distribution made by it in an accounting period was required, subject to a right of surrender, to set off the paid ACT against the company’s liability for MCT for that period (s. 239 (1) ICTA). The right of surrender was the right of a parent to surrender to its subsidiaries the benefit of ACT payments it had made. The subsidiaries then set off the surrendered ACT against their corporation tax liability (s. 240 ICTA).[8]ACT was always payable well in advance of the liability to MCT against which it could be set off. ACT was payable within 14 days of the end of the quarter in which the distribution was made. MCT was payable on the chargeable profits in any accounting period 9 months after the end of that period. The effect therefore of ACT on a paying company is that the date for payment of the corresponding MCT which would otherwise be due is advanced by a period of between 8 ½ months (if the distribution was made on the last day of an accounting period) to 1 year 5 ½ months (if the distribution was made on the first day of an accounting period). That assumes that the company had chargeable profits such that corporation tax was payable. If and to the extent that corporation tax was not payable for the period, for example because the company had no chargeable profits, ACT could be set off against profits in subsequent periods, in which case the ACT would not be set off until the corporation tax on those profits was payable. Indeed there might never be a corporation tax liability against which the ACT could be set off. The company could also claim to carry back surplus ACT to a previous period subject to certain limitations. We have been told that very substantial sums of surplus ACT collected by the CIR have not been set off and that at the time ACT was abolished the estimated surplus ACT was as much as one billion pounds per annum.[9]Where a subsidiary paying a dividend and its parent (having at least 51% of the voting power in the subsidiary) were bodies corporate resident in the UK, they were given the right to what was known as a group company election (s. 247 ICTA). Provided that both parent and subsidiary jointly elected, ACT was not payable in respect of the dividends (“election dividends”) received by the parent from the subsidiary during the currency of the election. Either company joining in the election could at any time give notice terminating the election. The subsidiary remained liable to corporation tax on the profits out of which the election dividends were paid. That corporation tax was payable 9 months after the end of the subsidiary’s accounting period. The advantage therefore gained from the election was one of cashflow: by not having to pay ACT, it had the use of what it would otherwise have had to pay as ACT until the time at which it was required to pay MCT.[10]Chapter IV of ICTA relates to tax credits. S. 231 (1) provided for certain recipients of qualifying distributions to be entitled to tax credits in this form (so far as material):
“Subject to section …. 247 …. where a company resident in the United Kingdom makes a qualifying distribution and the person receiving the distribution is another such company or a person resident in the United Kingdom, not being a company, the recipient of the distribution shall be entitled to a tax credit equal to such proportion of the amount or value of the distribution as corresponds to the rate of advance corporation tax in force for the financial year in which the distribution is made.”
[11]S. 247 (2) provided:
“So long as an election under subsection (1) above is in force the election dividends shall be excluded from sections 14 (1) and 231 and are accordingly not included in references to franked payments made by the paying company or the franked investment income of the receiving company but are in the Corporation Tax Acts referred to as “group income” of the receiving company.”
[12]The term “franked payment” was defined in s. 238 (1) as meaning the sum of the amount or value of a qualifying distribution and such proportion of that amount or value as corresponds to the rate of ACT in force for the financial year in which the distribution is made, but subject to s. 247 (2). The term “franked investment income” was also there defined as meaning income of a UK-resident company which consists of a distribution in respect of which the company is entitled to a tax credit and which accordingly represents income equal to the aggregate of the amount or value of the distribution and the amount of that credit, but again subject to s. 247 (2). By s. 241 (1) where in an accounting period a company receives franked investment income the company is not liable to pay ACT in respect of qualifying distributions made by it in that period unless the amount of the franked payments made by it in that period exceeds the amount of the income.[13]To return to s. 231 (1), in addition to being made subject to s. 247, it was made subject to various other statutory provisions in ICTA and subsequent Acts. Further, other provisions were enacted governing what could be done with the tax credit. Thus subs. (2) prescribed circumstances governing the right of a UK-resident company to be paid the amount of the tax credit, to which it was entitled, and subs. (3) provided what a person, not being a company resident in the UK, could do with the tax credit. This included the right, where the tax credit exceeded the income tax on his total income for the year of assessment in which the distribution was made, to have the excess paid to him.[14]A non-UK resident company which did not carry on a trade in the UK through a branch or agency was not chargeable to corporation tax. However it was chargeable to UK income tax under Schedule F in respect of UK source income such as dividends paid by UK-resident companies. In the 1972 White Paper at para. 32 mention was made of a power being taken to entitle a non-resident shareholder to receive a tax credit under a Double Taxation Agreement (“DTA”). It was envisaged that the particular terms on which non-resident shareholders would be entitled to a tax credit in respect of a qualifying distribution under any DTA would be a matter for negotiation.[15]That power is in s. 788, which refers to DTAs as “arrangements” made with the government of any territory outside the UK with a view to affording relief from double taxation in relation to (amongst other things) income tax and corporation tax. S.788 (3) provides, so far as material:
“the arrangements shall, notwithstanding anything in any enactment, have effect in relation to income tax and corporation tax in so far as they provide – (a) for relief from income tax, or from corporation tax in respect of income or chargeable gains; or …. (d) for conferring on persons not resident in the United Kingdom the right to a tax credit under section 231 in respect of qualifying distributions made to them by companies which are so resident.”
[16]DTAs have been negotiated with, amongst other countries, Italy and the Netherlands. They grant to persons resident in those countries and holding shares in and receiving qualifying distributions from companies resident in the UK a right to tax credits under s. 231. DTAs with other countries such as Germany make no provision for tax credits. Where a tax credit is granted, the general pattern is to grant the tax credit only in part and to make a reduced charge to tax on the aggregate of the amount of the dividend and the amount of the tax credit.[17]There are two DTAs with which this appeal is concerned, the UK/Netherlands Double Taxation Convention 1980 (“the Netherlands DTA”) and the UK/Italy Double Taxation Convention 1988 (“the Italy DTA”). They are in similar form, so far as material, and it is only necessary to refer in detail to the provisions of the Netherlands DTA. That DTA like the Italy DTA is notable for the extraordinarily detailed terms governing the entitlement of particular persons resident in one or other country to particular reliefs or credits.[18]By Article 3 (2) of the Netherlands DTA:
“As regards the application of the Convention by one of the States any term not defined therein shall, unless the context otherwise requires, have the meaning which it has under the law of that State concerning the taxes to which the Convention applies”
. That DTA contains no definition of tax credit.[19]Article 10 relates to dividends. Article 10 (1) provides that dividends derived from a company resident in one of the states by a resident of the other state may be taxed in that other state. Article 10 (3) contains the applicable provisions where a company resident in the UK pays dividends to a resident of the Netherlands, so long as an individual resident in the UK is entitled under UK law to a tax credit in respect of dividends paid by a UK-resident company. Those provisions are:
“(a)(ii) Where a resident of the Netherlands is entitled to a tax credit in respect of such a dividend under sub-paragraph (c) of this paragraph tax may also be charged in the United Kingdom, and according to the laws of the United Kingdom, on the aggregate of the amount or value of that dividend and the amount of that tax credit at a rate not exceeding 5 per cent. …. (c) …. where the beneficial owner of the dividend is a company which either alone or together with one or more associated companies controls directly or indirectly 10 per cent or more of the voting power in the company paying the dividend …. a company which is a resident of the Netherlands and receives dividends from a company which is a resident of the United Kingdom shall, …. provided it is the beneficial owner of the dividends, be entitled to a tax credit equal to one half of the tax credit to which an individual resident in the United Kingdom would have been entitled had he received those dividends, and to the payment of any excess of that tax credit over its liability to tax in the United Kingdom.”
Like the judge, we will use the term “Article 10 DTA payment” to mean the payment to be made in accordance with those provisions and the corresponding provisions of the Italy DTA.[20]Thus, if the ACT rate was 25% and the amount of the dividend was £1,000,000, a UK-resident company paying the dividend to an individual resident in the UK would pay £250,000 ACT, generating a tax credit of the same amount for the individual. Under Article 10 (3)(c) a Netherlands-resident company, controlling at least 10% of the voting power in the paying company and owning the dividend beneficially, would be entitled to a tax credit under s. 231 of half that amount, £125,000. Under Article 10 (3)(a)(ii) the UK tax chargeable at 5% of (£1,000,000 + £250,000) would be £56,250. The Article 10 DTA payment would be £68,750 (£125,000 - £56,250).[21]The relevant provisions of ICTA were altered by the Finance (No. 2) Act 1997 with effect from 6 April 1999 and ACT was abolished by s. 31 Finance Act 1998 with effect from the same date. The origins of the issues in this case[22]We return to Metallgesellschaft/ Hoechst. In those cases the claimants were groups of companies, the parent companies being resident in Germany and the subsidiaries being resident in the UK. Because of the residence of the parents, a group income election was not possible under s. 247 ICTA, and so the cashflow advantage to which we have referred in para. 9 above was not available. Those claimants brought actions against the CIR in 1995 claiming that the UK fiscal legislation discriminated in favour of groups with UK-resident subsidiaries and parent companies contrary to what was then Article 52 but is now Article 43 of the Treaty of Rome as amended, providing for freedom of establishment. That is one of the fundamental freedoms guaranteed under Community law.[23]Neuberger J. referred a number of questions to the CJEC. The first was paraphrased in para. 35 of its judgment as being “whether it is contrary to Article …. 52 …. for the tax legislation of a Member State …. to afford companies resident in that Member State the possibility of benefiting from a taxation regime allowing them to pay dividends to their parent company without having to pay advance corporation tax where their parent is also resident in that Member State but to deny them that possibility where their parent company has its seat in another Member State”. The CJEC answered that question in the affirmative.[24]The second question was paraphrased in para. 77 of the judgment as being “whether on a proper construction of Article 52 …. where a subsidiary resident in the Member State concerned and its parent company having its seat in another Member State have been wrongfully deprived of the benefit of a taxation regime which would have enabled the subsidiary to pay dividends to its parent company without having to pay advance corporation tax, that subsidiary and/or its parent company are/is entitled to obtain a sum equal to the interest accrued on the advance payments made by the subsidiary from the date of those payments until the date on which the tax became chargeable, even when national law prohibits the payment of interest on a principal sum which is not due.” The CJEC pointed out that the English court framed that question on two bases: one where the claim was made by the subsidiary and/or parent company in an action for restitution of taxes levied in breach of Community law, and the other where the claim was made in an action for compensation for damage resulting from the breach of Community law. The CJEC answered that question in para. 96 by saying that Article 52 requires that resident subsidiaries and their non-resident parent companies should have an effective legal remedy in order to obtain reimbursement or reparation of the financial loss which they have sustained and from which the authorities of the member State concerned have benefited as a result of the advance payment of tax by the subsidiaries. The CJEC left it to the national court to assign a legal classification to the claimants’ action and to lay down the procedural rules for safeguarding the claimants’ rights under Community law subject to the principles of equivalence and effectiveness. It declined to consider an alternative claim by the German parents in that case that they should be entitled to tax credits corresponding to the ACT paid by the UK subsidiaries.[25]The present case differs from Metallgesellschaft/ Hoechst cases in that the UK/Germany Double Taxation Convention 1965 did not provide for parent companies resident in Germany to receive any tax credit in respect of dividends paid to them by their UK-resident subsidiaries, whereas the Netherlands and Italy DTAs did so provide.[26]The Claimants in the present case are(1) Pirelli Cable Holding NV and(2) Pirelli Holding NV (both companies resident in the Netherlands),(3) Pirelli SpA (a company resident in Italy), and(4) Pirelli General plc and(5) Pirelli UK plc (both companies resident in the UK). The Fourth Claimant is a wholly owned subsidiary of the Fifth Claimant. Each of the First, Second and Third Claimants owned one third of the shares of the Fifth Claimant. The First Claimant is indirectly (through another Italian company it wholly owns) the wholly owned subsidiary of the Third Claimant which owned throughout the relevant period (14 July 1995 – 20 April 1999) between 88% and 99.82% of the shares in the Second Claimant. We will call the first three Claimants “the Pirelli parents” and the Fourth and Fifth Claimants “the Pirelli UK subsidiaries”.[27]As no group income election was available under s. 247 (1) in respect of dividends paid by the Fifth Claimant to the Pirelli parents, throughout the relevant period one or other of two options was taken: either ACT was paid in respect of those dividends or the Fourth Claimant paid ACT on dividends it paid to the Fifth Claimant, in each case no later than 14 days after the quarter day in which quarter the dividend was declared. On 19 occasions the Fifth Claimant paid dividends attracting ACT in a total amount of £20,220,000. Of that amount £15,180,000 was later set off against the MCT of the Pirelli UK subsidiaries, the time between paying ACT and the set off varying between 260 and 810 days. £5,040,000 of ACT was not set off against MCT. The Fourth Claimant on two occasions paid dividends attracting ACT which it paid in July 1997 in a total amount of £2,975,000. That was set off against MCT on dates 352, 444 and 717 days after payment of the ACT.[28]One other issue, not directly connected with Metallgesellschaft/ Hoechst, has arisen. It relates to the true meaning and application of certain provisions of Council Directive 90/435, known as the Parent and Subsidiary Directive (“the Directive”). In its recitals it was stated that the grouping together of companies of different Member States might be necessary, it was noted that existing tax regimes in Member States differed but were generally less advantageous to groups of companies of different Member States than they were to groups of companies of the same Member State and that cooperation between companies of different Member States was thereby disadvantaged, and it was said that it was necessary to eliminate that disadvantage. It was further recited:
“Whereas it is furthermore necessary, in order to ensure fiscal neutrality, that the profits which a subsidiary distributed to its parent company be exempt from withholding tax.”
Article 1 (1) requires each Member State to apply the Directive to distributions of profits by companies of that State to companies of other Member States of which they are subsidiaries. Article 2 defines “company of a Member State” by a number of criteria including that the company is “subject to one of the following taxes, without the possibility of an option or of being exempt: …. - corporation tax in the United Kingdom …” By Article 5 (1): “Profits which a subsidiary distributed to its parent company shall, at least where the latter holds a minimum of 25% of the capital of the subsidiary, be exempt from withholding tax. Article 7 is in this form: “1. The term ‘withholding tax’ as used in this Directive shall not cover an advance payment or prepayment (précompte) of corporation tax to the Member State of the subsidiary which is made in connection with a distribution of profits to its parent company. 2. This Directive shall not affect the application of domestic or agreement-based provisions designed to eliminate or lessen economic double taxation of dividends, in particular provisions relating to the payment of tax credits to the recipients of dividends.” “Profits which a subsidiary distributed to its parent company shall, at least where the latter holds a minimum of 25% of the capital of the subsidiary, be exempt from withholding tax. “1. The term ‘withholding tax’ as used in this Directive shall not cover an advance payment or prepayment (précompte) of corporation tax to the Member State of the subsidiary which is made in connection with a distribution of profits to its parent company.[29]Article 5 of the Directive was considered by the CJEC in Athinaiki Zithopiia v Greek State [2001] ECR I – 6797. The Claimants rely on certain observations of the CJEC on the scope of Article 5 to argue that the ACT paid by the Fourth and Fifth Claimants was a withholding tax which should be refunded. The CIR say that because of the characteristics of a withholding tax identified in the later decision of the CJEC, Océ van der Grinten v CIR [2003] STC 1248, ACT is not a withholding tax. They further say that in any event ACT is a prepayment of corporation tax within the meaning of Article 7.1 of the Directive and so not a withholding tax for the purpose of the Directive. The proceedings[30]On 13 June 2001 these proceedings were commenced by the Claimants as a CPR Part 8 claim. By their claim as amended they sought:(a) a declaration that the provisions of s. 247, insofar as they restricted the right to make a group income election to where both the parent and subsidiary are resident in the UK, are contrary to Article 43 and therefore unlawful;(b) further or alternatively a declaration that the payment to or retention by the CIR of the ACT was unlawful, as being contrary to Article 5 (1) of the Directive;(c) damages for breach of and/or failure to comply with Article 43;(d) damages for breach of and/or failure to comply with Article 5 (1) of the Directive;(e) restitution of/compensation for ACT paid by the Fourth and Fifth Claimants.[31]As respects the £5,040,000 surplus ACT paid by the Fifth Claimant and not set off against MCT, there was nothing equivalent in Metallgesellschaft/ Hoechst. That sum is sought to be recovered in full with interest. As respects the balance of the ACT paid by the Fifth Claimant and the ACT paid by the Fourth Claimant, compensation or restitution calculated by reference to interest for the period between the payment of ACT and the dates when it was set off against MCT is claimed in the same way that the subsidiaries in Metallgesellschaft/ Hoechst were held entitled.[32]Before the judge on the issue relating to Article 43 it was conceded by the CIR that the Claimants should have been entitled to make group income elections and so liability to the Claimants was admitted. The main issue debated before the judge arose out of the CIR’s submission that in calculating any compensation or restitution, the Article 10 DTA payments paid to the Pirelli parents must be taken into account as countervailing advantages which operate to reduce or extinguish the Pirelli UK subsidiaries’ claim. That gave rise to two sub-issues. The first was whether the receipt of the Article 10 DTA payments by the Pirelli parents was a countervailing advantage at all, and that depended on whether, if UK law had permitted the dividends paid by the Pirelli UK subsidiaries to be election dividends and so paid without the payment of ACT, the Pirelli parents would still have been entitled to the Article 10 DTA payments. The Claimants submitted that it was not a countervailing advantage, the Pirelli parents’ entitlement under the DTAs being unaffected by whether or not ACT was paid. The CIR argued the contrary. The second sub-issue was whether, as the CIR argued, if the receipt of the Article 10 DTA payments by the Pirelli parents was a countervailing advantage, that advantage must operate to reduce or eliminate the compensation or restitution otherwise available to the Pirelli UK subsidiaries, because in this context the Claimants must be regarded as a single economic unit, and further, the claims being by the Claimants as a group, this court must not put them in a better position than a comparable group of companies resident in the UK. The Claimants submitted that that too was wrong.[33]The judge rejected the CIR’s arguments, and therefore the issue whether the UK was in breach of the Directive was not material. However, he held that if he was wrong on the Article 43 issue, the issue on the Directive raised a question of Community law which was not acte clair and had to be referred to the CJEC rather than be decided by him. He declined to order a reference at that stage. The appeal[34]On this appeal we have had the benefit of excellent arguments economically deployed on both sides, and we are grateful to counsel for their skilled guidance through the statutory thickets and the complexities of the DTAs.[35]Mr. Ian Glick Q.C. for the CIR identified the following issues:(1) If the UK-resident subsidiary of a parent company resident elsewhere in the European Union paid a dividend under a group income election free of ACT, would the parent company have been entitled to a tax credit in respect of that dividend? Mr. Glick called that “the election issue”.(2) If the parent would not have been entitled to a tax credit in those circumstances, would the subsidiary in fact have paid that dividend under an election? Mr. Glick called that “the causation issue”.(3) If the parent would not have been entitled to a tax credit in those circumstances, then in assessing damages or restitution due to the subsidiary arising from the UK’s breach of Article 43, should the tax credit in fact paid to the parent be brought into account? Mr. Glick called that “the assessment issue”.(4) Should the question whether ACT constituted a withholding tax within the meaning of Article 5 of the Directive and, if it did, whether it is excepted by Article 7 be referred to the CJEC? Mr. Glick called that “the withholding tax issue”.[36]On the election issue Mr. Glick submitted that the EU-resident parent company receiving a dividend from its UK-resident subsidiary under a group income election would not be entitled to a tax credit in respect of that dividend. Aliter if there was no election in force and ACT had been paid in respect of the dividend. He said that this was the combined effect(i) of the exclusion by s. 247 (2) of election dividends from s. 231,(ii) of s. 788 (3)(d) with its express reference to “a tax credit under s. 231”,(iii) of Article 43 and(iv) of Article 10 of the Netherlands and Italy DTAs. He also relied on the definition in s. 832 (1) ICTA of “tax credit” as “a tax credit under section 231”. He referred us to the decision of this court in Union Texas Petroleum Corp. v Critchley (1990) 63 TC 244 that a tax credit under s. 231 conferred by a DTA is a true tax credit, and he relied on Article 3 (2) of the Netherlands and Italy DTAs for “tax credit” being given the meaning which it has in UK tax law. He accepted that there was an inconsistency between the DTA and the condition in s. 231 that the company receiving the distribution must be resident in the UK, and that such condition was displaced by s. 788 (3)(d), but he said that there was no inconsistency between the DTA and s. 247 (2) to which s. 231 was subject. He submitted that the judge was wrong in para. 40 of his judgment to dismiss the CIR’s argument based on s. 247 (2) with the comment “So what” on the basis that the exclusion of election dividends from franked investment income made no difference to the operation of Article 10. Mr. Glick said that in UK tax law a tax credit that is not available to a parent company in respect of an election dividend is not a “tax credit under section 231”.[37]The causation issue was mentioned to the judge, the Claimants claiming that, if UK law permitted it, they would have made group income elections and that the dividends which the Pirelli UK subsidiaries paid subject to ACT would have been paid free of ACT under the elections. The CIR reserved their position on this factual point. They wish to argue, if they succeed on appeal on the election issue but lose on the assessment issue, that it may not always be to the economic advantage of the group as a whole for dividends to be paid under an election and that it needs to be established on the facts that the group income election would have been made. It was agreed for the purposes of the hearing before the judge that it should be assumed(i) that elections would have been made if they had been permitted,(ii) that the Pirelli UK subsidiaries would have paid the same dividends as those which they actually paid, but(iii) that they would not have paid ACT. That issue is therefore not live before us, and we need say nothing further about it.[38]On the assessment issue Mr. Glick submitted that the financial loss which the Claimants have sustained and from which the UK has benefited is the difference between the UK tax treatment of a group consisting of a subsidiary resident in the UK and a parent resident in another Member State (“an EU group”) and the UK tax treatment of a group consisting of a subsidiary and parent both resident in the UK (“a UK group”). The court’s task, he said, is to grant such an EU group reimbursement or reparation which will, so far as practicable, put that EU group in the same position as a comparable UK group. He submitted that because the right to elect is conferred by s. 247 (1) on parent and subsidiary together as a joint right, the subsidiary could not obtain damages for being denied the right to elect and pay dividends free of ACT without giving credit for the tax credit in fact paid to the parent which the parent could not have received if the election had been permitted. Nor, he submitted, could the subsidiary obtain restitution in the form of repayment of the surplus ACT and interest on the ACT paid on the footing of the unjust enrichment of the CIR without account being taken of the Article 10 DTA payments which were paid by the CIR to the Pirelli parents but which would not have been paid if an election had been allowed. He acknowledged that ordinarily a parent company and its subsidiary are treated as distinct persons, but he pointed out that English law recognised exceptions and he described the present case as falling within the category dealt with by this court in Adams v Cape Industries [1990] Ch. 433 at p. 536 in relation to what was called “the single economic unit argument”. This court, he said, recognised that on the wording of particular statutes or contracts members of a group could be treated as one unit. He submitted that s. 247 (1) justified such treatment. He also drew attention to para. 96 of the judgment in Metallgesellschaft/ Hoechst where the CJEC, in giving its answer to the second question raised in that case, referred to the parents and the subsidiaries together when holding that they should have an effective legal remedy.[39]On the withholding tax issue, which will become live if the CIR succeed on the election issue, Mr. Glick submitted that the judge was wrong in holding that there should be a reference. First, he relied on what was said by the CJEC in Océ at para. 47:
“The court has already held that any tax on income received in the state in which dividends are distributed is a withholding tax on distributed profits for the purposes of art. 5 (1) of the directive where the chargeable event for the tax is the payment of dividends or any other income from shares, the taxable amount is the income from those shares and the taxable person is the holder of the shares (to this effect see [Ministerio Publico, Fazenda Publica v Epson Europe BV [2000] ECR I – 4243] para. 23 and Athinaiki Zithopiia, paras. 28 and 29).”
In para. 53 the characteristics of a withholding tax were said to have been set out in the cases referred to in para. 47. Mr. Glick pointed out that the taxable person in the present case is not the parent holding the shares but the subsidiary liable for ACT when paying the dividend. Second, he said that ACT was plainly a prepayment of corporation tax, and the fact that there was on occasion surplus ACT did not stop that tax from falling within what was excepted by Article 7 (1) from a withholding tax.[40]Mr. Graham Aaronson Q.C. for the Claimants submitted that the judge was right for the reasons which he gave. On the election issue he adopted the reasoning of the judge that the Pirelli parents’ entitlement to a tax credit derived from the DTAs, that Article 10 of the Netherlands DTA set out all the conditions to such entitlement and that even if ACT has not been paid by the UK-resident subsidiary, the non-UK resident parent satisfying the conditions of the DTA would still have been entitled to the credit. He said that there is no connection between the tax credit granted under a DTA and any election under s. 247 because they were dealing with entirely different things: tax credits given by a DTA are designed to reduce in part and on a reciprocal basis the economic double taxation which would otherwise be suffered when dividends are charged to tax and the income out of which those dividends are paid is also charged to tax; elections under s. 247, as s. 247 (2) makes clear, relate to franked investment income. He described the negotiations leading up to a DTA as very hard-nosed, the Revenue authorities of the two countries concerned thrashing out between them the extent of the mitigation of the double taxation. That, he pointed out, was far removed from the concept of franked investment income. He further argued that the provision in Article 10 of the DTAs granting an entitlement to tax credit equal to half of the tax credit to which an individual UK resident would have been entitled if he received the dividends shows that the sort of tax credit involved is what an individual receives and not the tax credit a company receives which is relevant to franked investment income. He submitted that the DTA in effect added a notional subsection to s. 231, conferring a tax credit which is not displaced by s. 247.[41]On the assessment issue Mr. Aaronson and Mr. Cavender submitted that the Article 10 DTA payments do not constitute countervailing advantages which reduce or extinguish the compensation or restitution due to the Pirelli UK subsidiaries. They argued that under English law there was no justification for treating the Claimants as a single economic unit. They further contended that under English law the right to restitution did not permit the setting off of any countervailing advantage, and that recent CJEC decisions (and in particular Staatssecretaris van Financien v BGM Verkooijen [2000] ECR 4071, Lankhorst-Hohorst GmbH v Finanzamt Steinfurt [2002] ECR I-1779 and Bosal Holding BV v Staatssecretaris van Financien (decided on 18 September 2003) make clear that, where there has been a breach of a fundamental freedom conferred by Community law by the improper collection of tax, there must be restitution of the tax collected, that it is no defence to claim a countervailing advantage unless it relates to the same taxpayer and the same tax, and that a parent and a subsidiary are treated as separate persons for that purpose.[42]On the withholding tax issue, Mr. Aaronson submitted that the judge was right that there should be a reference if the issue fell to be decided. Mr. Aaronson referred us to a very recent decision of Park J. on 24 November 2003 in another case decided pursuant to the GLO, NEC Semi-Conductors Ltd. v CIR [2003] EWHC 2813 Ch. In that case the judge held that ACT, while a species of corporation tax, is not corporation tax in respect of income or chargeable gains. Mr. Aaronson submitted that the CJEC was wrong in Océ in stating in para. 47 that the cases therein mentioned had established as a characteristic of a withholding tax that the taxable person is the shareholder. Further, he submitted that ACT was not a true prepayment of corporation tax within the meaning of Article 7 (1) of the Directive. For these reasons he argued that the judge was right to consider that this issue raised a question of Community law which should be referred to the CJEC. The election issue[43]The starting point on this issue must be s. 788, which provides the means whereby DTAs have effect in UK tax law. Provided that the DTAs make provision falling within the lettered paragraphs of s. 788 (3), they shall have effect in relation to income tax and corporation tax. The mandatory “shall” renders the words “notwithstanding anything in any enactment” scarcely necessary, but those words serve to emphasise what is implicit in the very notion of DTAs: that they are intended to give relief for double taxation even though the provisions of the UK legislation by their ordinary application would not allow such relief.[44]Para (d) of s. 788 (3) by its terms allows the DTAs to confer on non-resident persons the right to a tax credit under s. 231 in respect of qualifying distributions made to them by resident companies. That conveys to us that if, for example, the provisions of the Italy DTA are that a company resident in Italy is to have a tax credit under s. 231 in respect of a qualifying distribution made by a UK-resident company, then that tax credit must be conferred even though there are provisions in the UK fiscal legislation which prescribe otherwise. Thus it is not in dispute that the condition in s. 231 (1) that the receiving company be resident in the UK is necessarily displaced. Whether in any particular case the company in Italy is entitled to the tax credit will depend on whether it satisfies the conditions prescribed in the DTA. That was the view of

the judge when he said in para. 41 of his judgment:

“by virtue of Article 10(3)(c) and notwithstanding anything in any other enactment (such as another enactment about franked investment income), if an Italian company with a 10% plus holding in a United Kingdom company received a dividend, it was entitled to receive from the United Kingdom a payment (the Article 10 DTA payment) calculated as described in the article and working out at 6.875% of the dividend.”
[45]The impression that the provisions of the DTAs are intended to be exhaustive for prescribing the circumstances in which the right to a tax credit under s. 231 in respect of qualifying distributions made by a UK-resident company is conferred on a non-resident is strongly confirmed by consideration of the Italy and Netherlands DTAs themselves. They are extremely detailed, and although they are substantially similar they are not identical. For example the Italy DTA provides as a condition for obtaining the tax credit that the recipients should be taxed in their own country of residence (Article 10 (3)(d)), but that is not found in the Netherlands DTA. The DTAs contain their own formulas for calculating the amount of tax credit that is allowed, different from the amount of the tax credit available to a UK resident shareholder, albeit expressed by reference to what an individual UK-resident shareholder would have received by way of tax credit. They contain their own conditions governing entitlement to the tax credit in particular amounts. They provide for what is to happen once there is an entitlement to a tax credit, viz. payment of the excess of the tax credit over the recipient’s liability to United Kingdom tax, so that it is unnecessary to look to s. 231 (3). They provide for the rate of tax that each country may charge on what amounts. They contain anti-avoidance provisions (see, for example, para. 10 (5) and (9) of the Italy DTA).[46]Given the elaborately detailed nature of the DTAs and their purpose of relieving double taxation, we would find it very surprising if specific provisions limiting the conferring of tax credits in the domestic tax legislation so as to exclude it in particular circumstances were intended to govern the availability of tax credits to a non-resident. Is it really to be supposed that every statutory qualification enacted from time to time in the UK fiscal legislation to the availability of a tax credit under s. 231 qualifies the entitlement conferred by the DTA to the limited relief of double taxation by the tax credit as provided for in the DTA? We think not.[47]Moreover, s. 247 (2), which forms the linchpin of Mr. Glick’s argument, is not in fact purporting to affect the meaning of “tax credit” in UK tax law. It is merely limiting the circumstances in which a tax credit under s. 231 will be granted. To our minds therefore Article 3 (2) of the Italy and Netherlands DTAs therefore does not assist. Further the purpose of s. 247 (2) is clear from its terms. Election dividends during the currency of an election are excluded from ss. 14 (1) and 231 and “accordingly” are neither franked payments nor franked investment income but are referred to as group income of the receiving company. Like the judge we find it hard to see what relevance that has to the availability under the DTAs of a tax credit to an Italian or Dutch parent company receiving a dividend from a UK subsidiary.[48]What then is the significance of the words “tax credit under s. 231” in s. 788 (3)(d)? In our judgment the reference to s. 231 was necessary in order to cause the tax credit to be aggregated with the distribution in respect of which the tax credit is conferred and so to be rendered chargeable to tax under para. 2 of Sch. F. We do not regard that reference as apt to import all the qualifications to the availability under ICTA of tax credits.[49]We do not obtain much assistance from the Union Texas case, although, if we may respectfully say so, the decision of this court was undoubtedly correct. The taxpayer, the parent company resident in the USA of a subsidiary resident in England received a dividend from the subsidiary and a tax credit under the DTA with the USA. That tax credit was half the tax credit to which an individual resident in the UK would have been entitled if he received the dividend. It was argued that it was not a tax credit under the predecessor of s. 231 because it was in amount only half the tax credit under the UK fiscal legislation. Not surprisingly this court roundly rejected that. Mr. Aaronson does not say that the tax credit under the Italy and Netherland DTAs is not a tax credit under s. 231. It plainly is but of a different amount and subject to different conditions from those pertaining to tax credits made available to UK residents.[50]For these reasons we conclude that the judge was right on the election issue. The causation issue[51]We have already explained why this is not a live issue on this appeal. The assessment issue[52]In the light of the conclusion on the election issue, it is not necessary to decide this issue. However, as we have heard full argument on it, we will briefly express our reasons why in our judgment the CIR are wrong on their arguments on this issue.[53]In our judgment the fact that s. 247 (1) provides that both the subsidiary paying the dividend and the parent receiving the dividend may jointly make a group income election does not lead to the conclusion that, where the UK fiscal legislation breaches a fundamental freedom in Community law by denying that right of election to an EU group, the damages or restitution available to the UK-resident paying company should be reduced or eliminated by the tax credit which the receiving company received under a DTA. As the judge said (in para. 45 of his judgment) the problem is that the harm caused by the breach was suffered by companies different from those which received the advantage of the tax credit under the DTAs.[54]Mr. Glick disclaimed reliance on any argument that this was a case where it was appropriate under English law for the corporate veil to be lifted or that the Pirelli UK subsidiaries were the agents of the Pirelli parents. His case rested solely on the fact that this court in Adams had recognised that there were cases in which particular statutory wording justified treating parent and subsidiary as one unit. In Ord v Belhaven Pubs Ltd. [1998] 2 BCLC 447 Hobhouse L.J. at p. 457 said that this court in Adams recognised that the concept of a single economic unit was “extremely limited indeed”. There is no case to indicate that for the purposes of tax that concept is appropriate. The fundamental rule in English law remains that laid down in Salomon v Salomon [1897] AC 22. We agree with Park J. that the requirement that a group income election be made jointly is simply a machinery provision and does not justify treating the group as some form of joint entity. In this context it is to be borne in mind that the election can be made where the subsidiary has shareholders, other than the parent, owning as much as 49% of the shares.[55]Some of Mr. Glick’s arguments on the appropriateness of taking account of the Article 10 DTA payments as a countervailing advantage rested on his submissions on the election issue which we have rejected. As for his reliance on para. 96 of the judgment of the CJEC in Metallgesellschaft/ Hoechst, we do not think that the CJEC were there treating the subsidiaries and parent companies as having some form of joint entitlement. The CJEC was merely directing itself to the wording of the second question in that case which had asked whether the subsidiary and/or its parent company had a right (see para. 24 above).[56]From the CJEC cases to which Mr. Aaronson took us and to which we refer in para. 41 above he was able to make good his submission that under Community law, save for a narrow exception the conditions for which are not applicable here, it is no defence to a breach of a fundamental freedom that countervailing advantages have been obtained by a related person. The primary rule is that where a tax has been levied in breach of Community law, there must be restitution in full to the taxpayer. The withholding tax issue[57]It is sufficient on this issue to say that we see no reason to disagree with the judge’s conclusion that the matter is not acte clair and that a reference to the CJEC is appropriate if the point becomes material. Conclusion[58]For these reasons we would dismiss this appeal.

Order

Appeal dismissed. Costs reserved generally pending determination of the costs hearing before park J. Permission to appeal to the House of Lords refused. The parties are at liberty to apply for further directions as to the determination of the costs of the appeal. (Order does not form part of the approved judgment)

Cited in 12 later judgments

and 3 more of the most senior