The European Court of Justice (Grand Chamber) ruled that art. 43 EC (on freedom of establishment) and art. 56 EC (on free movement of capital) did not prevent a member state, on a distribution of dividends by a company resident in that state, from granting companies receiving those dividends which were also resident in that state, a tax credit equal to the fraction of the corporation tax paid on the distributed profits by the company making the distribution, even though it did not grant such a tax credit to non-resident companies receiving such dividends which were not subject to tax on dividends in the first state. Moreover, those provisions did not preclude a situation in which a member state did not extend the entitlement to a tax credit provided for in a double taxation convention (DTC) to companies resident in a third member state with which it had concluded a double taxation convention which did not provide for such an entitlement for companies resident in that third state.

Facts

The taxpayers were participants in group litigation concerning advance corporation tax (ACT) consisting of claims for restitution and/or compensation brought against the Inland Revenue, following the judgment in Metallgesellschaft Ltd & Ors v IR Commrs & Attorney-General (Case C-397/98) [2001] BTC 99. The litigation before the national court concerning ACT comprised four separate classes, in respect of which common issues were identified. Class IV of the litigation, at the time of the order for reference, encompassed claims by 28 groups of companies, all containing at least one non-resident company, which opposed the Revenue's refusal to grant a tax credit to such a non-resident company when it received dividends from a resident company. The four cases selected by the national court as test cases for the purposes of a reference concerned applications brought both by resident companies and by non-resident companies belonging to the same group as the resident companies and which received dividends from them. Unlike the claims in Metallgesellschaft, the present claims were directly concerned with the grant of a tax credit. In those circumstances, the English court decided to stay the proceedings and to make a reference to the ECJ for a preliminary ruling on the interpretation of art. 43 and 56 EC.

Issue

Whether art. 43 and 56 EC precluded a rule of a member state which, on a payment of dividends by a resident company, granted a full tax credit to the ultimate shareholders receiving the dividends who were resident in that member state or in another state with which the first member state had concluded a DTC providing for such a tax credit, but did not grant a full or partial tax credit to companies receiving such dividends which were resident in certain other member states.

Decision

The European Court of Justice (Grand Chamber) (ruling accordingly) said that dividends paid by a company to its shareholders might be subject both to a series of charges to tax, since they were taxed, first, at distributing company level, as realised profits, and were then subject to corporation tax at parent company level, and to economic double taxation, since they were taxed, first, at the level of the company making the distribution and were then subject to income tax at ultimate shareholder level. It was for each member state to organise, in compliance with Community law, its system of taxation of distributed profits and, in that context, to define the tax base as well as the tax rates which applied to the company making the distribution and/or the shareholder to whom the dividends were paid, in so far as they were liable to tax in that state.

In the absence of any unifying or harmonising Community measures, member states retained the power to define, by treaty or unilaterally, the criteria for allocating their powers of taxation, particularly with a view to eliminating double taxation. It was only in the case of companies of member states which had a minimum holding of 25 per cent in the capital of a company of another member state that each member state was obliged either to exempt profits received by a resident parent company from a subsidiary resident in another member state or to authorise that parent company to deduct from the amount of tax due that fraction of the corporation tax paid by the subsidiary which related to those profits and, if appropriate, the amount of the withholding tax levied by the member state in which the subsidiary was resident.

Where a company resident in the UK paid dividends to another company, neither the dividends received by a resident company nor those received by a non-resident company were subject to tax in the UK. There was therefore no difference in treatment in that respect. However, there was a difference between resident

companies receiving dividends and non-resident companies receiving dividends as regards the ability of those companies to pay dividends to their ultimate shareholders under rules which entitled those shareholders to a tax credit equal to the fraction of the corporation tax paid by the company which made the distributed profits. It was not in dispute that only resident companies might do so.

In order for non-resident companies receiving dividends not to be subject to a restriction on freedom of establishment prohibited, in principle, by art. 43 EC, the state in which the company making the distribution was resident was obliged to ensure that, under the national procedures to prevent or mitigate a series of liabilities to tax, non-resident shareholder companies were subject to the same treatment as resident shareholder companies. It was for the national court to determine, in each case, whether that obligation had been complied with, taking account, where necessary, of the provisions of the DTC that that member state had concluded with the state in which the shareholder company was resident.

Since the same reasoning applied in the same way to non-resident shareholder companies to which dividends had been paid on the basis of a holding which did not confer on them any definite influence on the decisions of the resident distributing company and did not allow them to determine its activities, such legislation also did not restrict the free movement of capital for the purposes of art. 56 EC.

In order to avoid distributed profits being taxed both by the member state in which the distributing company was resident and by that of the company receiving them, each of the DTCs concluded by the UK provided for an allocation of taxing powers between that member state and the other contracting state. While some of those DTCs did not provide for dividends received by a non-resident company from a company resident in the UK to be subject to tax in that member state, other DTCs did provide for such a tax liability. It was in the latter case that the DTCs provided, each according to its separate conditions, for the grant of a tax credit to a non-resident company to which dividends were paid.

The situations in which the UK granted a tax credit to companies resident in the other contracting state which received dividends from a UK-resident company were those in which the UK also retained the right to tax the companies on those dividends. The rate of tax which the UK might charge in such cases varied according to the circumstances and in particular according to whether the DTC provided for a full or a partial tax credit. There was thus a direct link between the entitlement to a tax credit and the rate of tax laid down under such a DTC. The grant of a tax credit to a nonresident company receiving dividends from a resident company could not be regarded as a benefit separable from the remainder of those DTCs, but was an integral part and contributed to their overall balance.

The same applied to the provisions of the DTCs which made the grant of such a tax credit subject to the condition that the non-resident company was not owned, directly or indirectly, by a company resident in a member state or a non-member country with which the UK had concluded a DTC which did not provide for such a tax credit. Even where such provisions extended to the situation of a company which was not resident in one of the contracting member states, they applied only to persons resident in one of those member states and were an integral part of the DTCs. The fact that those reciprocal rights and obligations applied only to persons resident in one of the two contracting member states was an inherent consequence of bilateral DTCs. It followed, as regards the taxation of dividends paid by a company resident in the UK, that a company resident in a member state which had concluded a DTC with the UK which did not provide for such a tax credit was not in the same situation as a company resident in a member state which had concluded a DTC which did provide for one.

European Court of Justice (Grand Chamber).
Judgment delivered 12 December 2006.