The Court of Appeal upheld a decision of the High Court ([2007] BTC 362), on an inquiry into the compensation payable to companies in the Pirelli group by Revenue and Customs, that, if a group income election had been made under ICTA 1988, s. 247(1), the non-UK resident parent companies would not have been entitled to a tax credit upon the subsequent payment by the UK subsidiaries of mainstream corporation tax (MCT).

Facts

Between 1995 and 31 March 1999, Pirelli UK plc and Pirelli General plc paid advance corporation tax (ACT) on payment of dividends to their parents, resident in Italy and the Netherlands. Because the parents were nonresident they could not make a group income election, as the law then stood. Had such an election been made, the subsidiaries would have been exempt from liability to pay ACT. But on payment of ACT, the parents did receive tax credits pursuant to double taxation agreements (DTAs) with Italy and the Netherlands.

To require the subsidiaries resident in the UK to pay corporation tax prematurely (in the form of ACT) by depriving them of the opportunity to make a group income election was held by the European Court of Justice to be contrary to art. 52 of the EC Treaty (art. 43 EC) in the case of Metallgesellschaft Ltd v IR Commrs; Hoechst AG v IR Commrs (Joined Cases C-397/98 and C-410/98) [2001] BTC 99; [2001] ECR I-1727. The subsidiaries then sought compensation by requiring the Revenue to return the ACT plus interest, representing the time value of early payment of ACT, in those cases in which ACT could not be utilised against their mainstream corporation tax liability. When it could be so utilised, they sought only interest. They resisted repayment of the tax credits received. In test cases for more than 50 other claims, the House of Lords ([2006] UKHL 4; [2006] BTC 181) decided that if the Pirelli subsidiaries had avoided liability to ACT, by choosing, with their parents, to make a group income election, they would not have been entitled to tax credits under the relevant DTAs, because a tax credit under the DTA, by virtue of art. 3(2) and s. 788(3)(d) of ICTA 1988, meant a tax credit under s. 231.

In the light of their decision, the House of Lords remitted the case back to the Chancery Division to decide the unresolved factual question of whether, had group income election been available to the Pirelli group, the group would have elected to have the UK subsidiaries pay the dividends in question free of ACT or, instead, would have chosen that the UK subsidiaries should pay the dividends outside group income elections, thus enabling the overseas parents to receive convention tax credits, so that it could be determined whether the amount of the tax credits should be brought into account in assessing the amount of compensation payable. On the remittal the taxpayers contended that on payment of MCT, the parents were entitled to tax credits and, accordingly, should not be required to bring them into account. Rimer J disagreed ([2007] BTC 362). He concluded that had the group made a group income election, the subsidiaries would not have been liable to ACT and on payment by the subsidiaries of MCT, their parents would not have been entitled to tax credits. The taxpayers appealed, arguing that, since the subsidiary had now paid MCT on the underlying profits, after payment of the dividend, the tax credit claimed had been funded and the potential for economic double taxation on that distribution in the hands of the recipient parent had arisen. Thus the pre-conditions for entitlement to a tax credit were satisfied and the risk of double taxation needed to be alleviated. The taxpayers further contended that since the UK and Italy and the Netherlands had sought to allocate the right to tax dividends received by a parent resident in Italy or the Netherlands from a UK subsidiary and thus mitigate the effect of double taxation by means of a DTA, the UK had assumed responsibility for eliminating double taxation, whether the risk of double taxation arose on payment of ACT or MCT.

Issue

Whether, on the hypothesis that a group income election had been made, the appellants would have been entitled to a tax credit on payment by the UK subsidiaries of MCT on their underlying profits out of which the dividends had been paid.

Decision

Moses LJ (dismissing the appeal; Jacob and Rix L JJ agreeing) said that it was not disputed that the tax credit was designed to avoid economic double taxation in the hands of the ultimate shareholder (see e.g. Test Claimants in the Thin Cap Group Litigation v IR Commrs (Case C-524/04) [2007] ECR I-2107). The question was whether there was any responsibility to avoid economic double taxation under Community law and if there was, on which member state that responsibility lay. Community law was concerned to remove discrimination which restricted freedom of establishment contrary to art. 43 EC. The decision in Test Claimants in Class IV of the ACT Group Litigation v IR Commrs (Case C-374/04) [2006] ECR I-11673 demonstrated how the obligation to avoid such restrictions operated in the context of cross-border distribution of profits. Where a member state alleviated economic double taxation on dividends paid to residents by resident companies, Community law required it to treat dividends paid to residents by non-resident companies in the same way. However, Community law did not require the member state in which the company making the distribution was resident to alleviate economic double taxation on a distribution to a nonresident shareholder. The responsibility for alleviating economic double taxation rested ‘usually’ on the member state in which the recipient shareholder resided. The qualification ‘usually’ was necessary because such a responsibility might be triggered if a member state exercised its taxing powers in respect of a dividend paid to a non resident company. It must, in such circumstances, afford the same relief against double taxation to the non-resident recipient as to a resident.

There were no uniform or harmonised measures for the elimination of double taxation within Community law. Member states might apportion fiscal sovereignty between themselves and thereby avoid double taxation by means of DTAs. But Community law imposed no obligation to do so, absent discrimination (Kerckhaert and Morres v Belgium (Case C-513/04) [2006] ECR I-10967).

It did not follow that, by virtue of the agreement, set out in art. 10 of the DTAs reached between the UK and Italy and the Netherlands, that under Community law the UK was under any obligation to eliminate the economic double taxation which might arise on receipt of the dividend by a parent resident in Italy or the Netherlands. As the House of Lords recognised, the payment of the tax credit under art. 10(3)(c) depended on payment of ACT. Although the DTA made no reference to ACT, there was no basis for assuming that the parties intended to allocate the right to tax a dividend received by a non-resident parent, absent payment of ACT by the UK resident subsidiary. Such an assumption ignored art. 3(2), s. 788(3)(d) and the decision of the House of Lords.

Since there was no agreement by the parties to the DTAs as to the payment of a tax credit in the circumstances of a group income election, there was no foundation for concluding that the UK had assumed responsibility for eliminating double taxation on the dividend received by the parent resident in Italy. The UK imposed no tax on receipt of that dividend, whether the recipient parent was resident in the UK or in another member state. So it could not be said to discriminate against the parent resident in Italy. Accordingly, Community law imposed no requirement on the UK to eliminate double taxation. That was a matter for Italy or the Netherlands in respect of the dividend received by a resident there.

Consistency with Community law was achieved by affording the Pirelli group the same opportunity to make a group income election as that afforded to a group resident in the UK. In the circumstances in which the UK levied no tax on the dividend received by the non-resident parent, no obligation to eliminate any subsequent double taxation was imposed on the UK under Community law.

Court of Appeal (Civil Division).

Judgment delivered 13 February 2008.