The ECJ has given its decision in Test Claimants in the FII Group Litigation v HMRC (C-446/04). Although the case deals with a number of aspects relating to the UK’s former franked investment income regime which are now of purely historical interest (save for the litigants) it is also important because it deals with whether the current UK rules concerning the taxation of dividends received by companies comply with EU law. In relation to dividends received by UK resident companies with holdings in EU/EEA resident companies of at least 10%, the ECJ has departed from the Advocate General’s opinion (delivered earlier this year) and found in favour of the UK Government.
Under UK rules a UK resident company is exempt from corporation tax on a dividend from a UK resident company but is subject to corporation tax on a dividend received from a foreign company. However, double tax relief is available for any tax withheld on payment of the dividend and in the case of a UK company holding at least 10% of the voting rights in the foreign company, relief is also available for the underlying tax of the foreign company attributable to the profits distributed.
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The ECJ has given its decision in Test Claimants in the FII Group Litigation v HMRC (C-446/04). Although the case deals with a number of aspects relating to the UK’s former franked investment income regime which are now of purely historical interest (save for the litigants) it is also important because it deals with whether the current UK rules concerning the taxation of dividends received by companies comply with EU law. In relation to dividends received by UK resident companies with holdings in EU/EEA resident companies of at least 10%, the ECJ has departed from the Advocate General’s opinion (delivered earlier this year) and found in favour of the UK Government.
Under UK rules a UK resident company is exempt from corporation tax on a dividend from a UK resident company but is subject to corporation tax on a dividend received from a foreign company. However, double tax relief is available for any tax withheld on payment of the dividend and in the case of a UK company holding at least 10% of the voting rights in the foreign company, relief is also available for the underlying tax of the foreign company attributable to the profits distributed.
The ECJ held that giving a UK resident company exemption for dividends received from a UK company but taxing the dividends received from a foreign company was not a breach of EU law in those cases where the UK company holds at least 10% of the voting rights in the foreign company paying the dividend. Essentially, the ECJ has concluded that there is not a material difference in the tax treatment of a dividend that attracts exemption (UK source dividends) and a dividend that although subject to UK tax receives the benefit of double tax relief for not only dividend withholding tax but also underlying tax on the profits distributed. The ECJ focussed on the rate of tax suffered on the foreign source dividend. Provided the foreign source dividend was not subject to a higher rate of UK tax (taking account of the double tax relief) than that applied to a UK source dividend there is no breach of EU law.
However, where a UK company receives a dividend from a EU/EEA company and holds less than 10% of the voting rights (so that underlying tax relief is not available) the UK rules do not comply with Article 56 EC Treaty (free movement of capital).
It appears that on this issue (as distinct from the issues arising in relation to the franked investment income regime) the Government has come out best. Although it has lost in relation to dividends received by UK companies with a less than 10% holding in the EU/EEA company the bigger concern for the Government was likely to have been in relation to dividends received on holdings of more than 10%.
It is also noteworthy that in his Pre-Budget Report the Chancellor announced that next year’s Finance Bill would contain measures that will further limit the extent to which payments of tax made under a mistake of law may be recovered. In 2003 changes were introduced so that such payments in respect of direct taxes made under a mistake of law more than six years before a claim could not be recovered. Previously, the six-year period only started to run from the date that a claimant became aware of the mistake or should reasonably have become aware of it. In the context of EU litigation the six-year period would not generally start to run until a final decision of the ECJ. However, the 2003 changes did not apply to claims that had already commenced.
Many of the EU tax claims going through the Courts (including the claims in this litigation) commenced before 2003. The changes announced in the Pre-Budget Report extend the six-year limit so that it applies to all claims (not just those brought on or after 8 September 2003), which have not been decided by a final judgment as at 6 December 2006. These measures therefore seek to limit the number of years that a claimant can go back. This would tend to confirm that the Government has become more concerned about the amount of money at stake in relation to this and other EU tax claims. However, there is also every possibility that these measures may be challenged on the basis that they are in breach of EU law particularly as it does not seem as if they will include any transitional provisions.
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The original publication date for this article was 14/12/2006.