The last decade has seen a significant increase in litigation in the United Kingdom in which taxpayers have challenged various provisions of the UK corporate tax legislation on the basis of EU law. The challenges have concerned a broad range of areas, including inbound and outbound dividends, group loss relief, the controlled foreign corporation regime and thin capitalisation rules.
The cases brought by individual taxpayers in Hoechst/Metallgesellschaft (advance corporation tax (ACT) on outbound dividends), Mark & Spencer (cross-border group relief) and Cadbury Schweppes (CFC rules) have been accompanied by collective actions by taxpayers under a series of group litigation orders (GLOs) : the ACT, franked investment income (FII), foreign income dividend (FID), thin cap, loss relief, and CFC and Dividend GLOs.
The various cases led to a series of references by the UK courts to the European Court. In its well publicized rulings the ECJ held the UK rules in the above areas to be unlawful in certain respects. The cases are now back in the UK courts as taxpayers and the Revenue debate the scope of the ECJ’s rulings and the consequences in terms of remedies for the taxpayer. A few examples will illustrate the issues currently being debated.
In the area of cross-border loss relief the issue arises as to what the ECJ meant in Marks & Spencer when it said that cross-border group relief must be available where there is no possibility of local use. Must use be legally impossible or is practical impossibility sufficient ? Marks & Spencer eventually liquidated the loss making subsidiaries, rendering local use impossible. But what if e.g. a subsidiary’s losses, although theoretically capable of use, are so catastrophic that realistically they will never be used ?
The English courts have so far held that the requirement of no possibility of use is met once the company enters liquidation because at that point the possibility of use becomes fanciful. A related issue is to know at what point the no possibilities test must be met : Is it at the end of the accounting period when the loss was made (as the UK Revenue say) or is it later when the claim is made (by which time the subsidiaries may have entered liquidation or been liquidated) ? Another issue is whether the Marks & Spencer ruling applies to other structures. The case concerned a UK company with foreign loss-making subsidiaries. What of a UK subsidiary of a foreign loss making parent company ? All of these issues will be resolved either in the Marks & Spencer litigation itself or in proceedings brought by other taxpayers.
The main issue currently occupying the English courts following the Cadbury Schweppes ruling is whether the UK CFC legislation can be read so as to be consistent with the ECJ ruling or whether it should be simply disapplied. The significance of this is whether it is necessary for UK taxpayers to provide evidence that their CFCs were genuinely established in another Member State so as to benefit from the ECJ ruling. This issue is currently being tested by Vodafone, who won in the High Court but lost in the Court of Appeal. They have now appealed to the Supreme Court. Other taxpayers with CFC claims wait in the wings pending the resolution of that issue.
The FII and CFC and Dividend GLOs raise a number of issues. Were the UK rules taxing dividends from EU subsidiaries (as well as portfolio holdings) unlawful ? What of dividends from third countries ? What are the applicable time limits for claims ? Was it lawful for the UK Parliament to remove without notice a cause of action offering taxpayers a longer time limit and to cancel claims already made ? The taxpayers in the FII group litigation had a significant win on those issues at first instance in the High Court. The decision of the Court of Appeal is now awaited.
The various rulings have produced or contributed to significant legislative change. The unlawful thin cap rules have been superseded by transfer pricing rules which apply both domestically and cross-border. Foreign dividends are generally no longer taxed. The CFC and group relief rules have also been amended to take account of the ECJ judgment, although the changes are considered inadequate by many commentators.
As the cases have progressed further taxpayers not originally involved have made claims. However, the ability to make claims for overpaid corporation tax in the UK will be greatly restricted from 1 April 2010 under the Finance Act 2009. Taxpayers will only be able to make claims for statutory remedies and will be limited in time to 4 years from the date of the claim. Currently, in many circumstances the time period is unlimited and High Court claims are available which permit broader recovery (including compound interest). In order to avoid the limiting effect of Finance Act 2009 any new claim must therefore be issued prior to 1 April 2010.