Pirelli Cable Holding NV v Commissioners of Inland Revenue
| Jurisdiction | England & Wales |
| Judge | LORD NICHOLLS OF BIRKENHEAD,LORD HOPE OF CRAIGHEAD,LORD SCOTT OF FOSCOTE,LORD WALKER OF GESTINGTHORPE,LORD BROWN OF EATON-UNDER-HEYWOOD |
| Judgment Date | 08 February 2006 |
| Neutral Citation | [2006] UKHL 4 |
| Date | 08 February 2006 |
| Court | House of Lords |
and others
[2006] UKHL 4
Appellate Committee
Lord Nicholls of Birkenhead
Lord Hope of Craighead
Lord Scott of Foscote
Lord Walker of Gestingthorpe
Lord Brown of Eaton-under-Heywood
HOUSE OF LORDS
Appellants:
Ian Glick QC
David Ewart
Ms Kelyn Bacon
(Instructed by Acting Solicitor to the Commissioners for HM Revenue and Customs)
Respondents:
Graham Aaronson QC
David Cavender
Paul Farmer
(Instructed by Dorsey & Whitney)
My Lords,
The primary issue on this appeal concerns the application of two double taxation conventions in circumstances not envisaged when they were made. The problem arises from the unforeseen impact of Community law on the partial 'imputation' system of corporation tax operated within the United Kingdom between 1973 and 1999. This system was introduced by the Finance Act 1972 as a means of avoiding the perceived double taxation of distributed profits, once in the hands of the company and again in the hands of its shareholders. The central principle of the new taxation scheme was that part of the corporation tax paid by a company was 'imputed' to its shareholders by giving them an appropriate tax credit. The means adopted for this purpose was that a company was required to pay a tax on its dividends known as advance corporation tax, or ACT in short, and its shareholders were given a corresponding tax credit. Nowhere did the legislation state that liability to pay ACT was a precondition of entitlement to a tax credit. But this unspoken linkage lay at the heart of the scheme, and the legislation was drawn in a form which achieved this result. This linkage is central to the first issue raised by this appeal.
In broad outline the legislation provided as follows. Where a company resident in the United Kingdom paid a dividend to its shareholders it became liable to pay ACT in respect of the dividend. ACT was set against the company's liability to 'mainstream' corporation tax. A recipient of the dividend, if resident in the United Kingdom, became entitled to a tax credit. The amount of the tax credit corresponded to the current rate of ACT. In the case of an individual a tax credit was utilised primarily as a credit against his income tax. Any excess was paid to the individual. Where the recipient of the dividend was a company the amount of the dividend plus the amount of the tax credit constituted franked investment income. This could be used to frank dividends paid by the company so the company would not be liable to ACT on its dividends: see sections 14, 231 and 238-241 of the Income and Corporation Taxes Act 1988, or ICTA 1988 in short.
This basic scheme was subject to an important exception. Special provision was made for dividends paid by one company to another company in the same group. These companies could jointly make a group income election under section 247 ICTA 1988. A group income election had a twofold effect, reflecting the linkage between payment of ACT and entitlement to a tax credit. Dividends paid by a subsidiary to its parent while the election was in force, conveniently described as 'election dividends', did not trigger liability to pay. Nor did their receipt trigger entitlement to a tax credit. So election dividends did not constitute franked investment income of the parent. They constituted, in the language of the legislation, 'group income' of the receiving company: hence the description 'group income election'.
On the face of the legislation the right to make a group income election was expressly confined to cases where both companies were resident in the United Kingdom. In March 2001 the Court of Justice of the European Communities ruled that affording groups of companies the right to make a group income election where they were resident in the United Kingdom but denying them that right where the parent companies were not resident in the United Kingdom was contrary to article 52 (now article 43) of the EC Treaty providing for freedom of establishment: Joined Cases C-397/98 and C-410/98 Metallgesellschaft Ltd and Hoechst AG v Commissioners of Inland Revenue [2000] ECR I-1727. The court held that the claimant companies in these cases were entitled to compensation for loss of the use of the money paid as ACT between the date of payment and the date when the ACT was used by being set off against the subsidiary company's mainstream corporation tax liabilities.
This ruling had a widespread effect in practice. Shortly stated, the effect of this decision was that wherever group companies had been denied the opportunity to make a group income election, the United Kingdom government became liable to compensate them for the loss they suffered if the denial was an infringement of article 43 of the EC Treaty as interpreted by the court in the Hoechst decision.
Not surprisingly, many groups of companies sought to take advantage of this ruling. The present appeal concerns the assessment of compensation payable to one such group, the Pirelli group, chosen as a test case in one category of claims within a group litigation order. For the purposes of this appeal the detailed facts, summarised in the speech of my noble and learned friend Lord Scott of Foscote, are not material. The essential facts are that dividends were paid by a subsidiary company resident in the United Kingdom to parent companies resident in Italy or the Netherlands. Group income election was not available, because the parent companies were not resident in the United Kingdom. So ACT was paid by the subsidiary company in respect of the dividends. For the same reason the parent companies were not entitled to tax credits under section 231 ICTA 1988. But under double taxation conventions made by this country with Italy and the Netherlands the parent companies became entitled to tax credits of a reduced amount calculated as set out in those conventions. I shall call these 'convention tax credits'.
The first question
In the present case the first question arising on the assessment of compensation is this. If the United Kingdom legislation had permitted parent companies resident in other member states of the European Community to make a group election, and if an election had been made in respect of the dividends in question, would the parent companies have been entitled to payment of the convention tax credits they in fact received under the double taxation conventions? If they would have been so entitled then no deduction should be made in respect of these tax credits when calculating the compensation. If, however, the parent companies would not have been so entitled, then in principle - and subject to the other issues raised on this appeal - due allowance should be made in respect of these tax credits when calculating the compensation. Due allowance should be made because, in this event, the convention tax credits received by the parent companies comprise financial benefits they would not have received had the group been able to make a group income election and had the group duly done so.
Whether the parent companies would have been entitled to convention tax credits in this hypothetical circumstance depends upon the proper interpretation of the relevant double taxation conventions. The two conventions are the Netherlands Convention of 7 November 1980 (S I 1980/1961) and the Italian Convention of 21 October 1988 (S I 1990/2590). Both conventions have effect in United Kingdom law pursuant to Orders in Council made under section 788 ICTA 1988.
In all respects material on the present issue the two conventions are in similar form. For convenience I will refer only to the Netherlands convention. The relevant provision in the Netherlands convention is article 10(3). This was applicable as long as an individual resident in the United Kingdom was entitled to a tax credit in respect of dividends paid by a company resident in the United Kingdom. Article 10(3)(c) entitled a company resident in the Netherlands which received dividends from a company resident in the United Kingdom to a tax credit calculated and payable as follows:
'.. 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.'
'Tax credit' in this subparagraph has the same meaning as in ICTA 1988: see article 3(2) of the convention. Entitlement to a convention tax credit was subject to tax at a rate not exceeding 5% on the total amount of the dividend and the tax credit: article 10(3)(a)(ii). Nothing turns on this additional provision.
The first point to note is that, as would be expected, article 10(3)(c) accords with the scheme of the underlying legislation whereby entitlement to a tax credit marched hand-in-hand with liability to pay ACT. Article 10(3)(c) did not, in terms, exclude election dividends from its scope. But this was not necessary. On the face of the legislation a parent company resident in the Netherlands could not make a group income election. By definition, an election dividend was payable only to a company resident in the United Kingdom. So, on the face of the legislation, there could be no question of a Netherlands resident company ever being in a position to claim a convention tax credit on a dividend whose payment did not attract ACT.
This analysis of article 10(3)(c) accords with the intended purpose of the Netherlands convention as stated in section 788. The object of section 788 is to enable effect to be given to arrangements made with the governments of other countries 'with a view to affording relief from...
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