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UK's tax treatment of foreign-sourced dividends was discriminatory, says CJEU

A long-running case on the tax treatment of dividends could cost the UK Government "hundreds of millions of pounds", an expert has said, after a European court found that taxing dividends from outside the UK differently was discriminatory.14 Nov 2012

However tax expert Jake Landman of Pinsent Masons, the law firm behind Out-Law.com, warned that the ruling by the Court of Justice of the European Union (CJEU) would not be the final judgment in the Franked Investment Income Group Litigation (FII GLO).

The case was brought against HM Revenue and Customs (HMRC) by UK-based multinational companies in relation to the tax treatment of their income from non-UK subsidiaries between 1973 and 1999. During this period the UK offered UK parent companies an exemption from corporation tax on dividends paid up by UK subsidiaries. Dividends paid up by foreign subsidiaries were taxable, although in most cases offset by relief for the foreign tax borne by the subsidiary. This was known as the 'imputation method'.

The judgment follows on from a decision by the CJEU in 2006, which left open the question of whether HMRC's approach was unlawful discrimination under EU law. In the latest judgment, although the CJEU held that the two types of tax treatment could be equivalent, it found that the UK's position was discriminatory as this would not always be the case.

"Unlike the exemption method [which applied to the UK-sourced dividends], the imputation method [which applied to the foreign-sourced dividends] ... does not enable the benefit of the corporation tax reductions granted at an earlier stage to the company paying dividends to be passed on to the corporate shareholder," the judgement said.

The rules in place at the time meant that the application of the imputation method to foreign-sourced dividends did not "ensure a tax treatment equivalent to that resulting from application of the exemption method to nationally sourced dividends," it said.

The CJEU added that as the difference in the tax treatment of the two categories of dividend was not "justified by a relevant difference in situation", the rules at the time amounted to "a restriction on freedom of establishment and on capital movements" that was contrary to EU law.

Landman said that although there would have been only a minor percentage difference in value between the two types of tax treatment, the length of time and the value of the dividends involved meant that the difference was now worth hundreds of millions of pounds. The FII GLO involves more than 20 separate tax issues, and depending on the outcome of future court decisions the final bill could end up in the billions, he added. However, he warned that HMRC would fight to limit the eventual payments "every step of the way".

"This is a long-running and bitterly-fought saga, but if the multinationals win there will be plenty of procedural hurdles to jump over before they get their final payouts," he said. "HMRC will hope that time limits on claims, for example, could protect them from having to repay all the overpaid taxes, or that they can argue a 'change of position' defence – essentially, that the Government shouldn't have to pay the money back because they have spent it."

Of particular interest would be the result of another referral made to the CJEU earlier this year, in which the Supreme Court asked whether it would be able to block claims made after 8 September 2003, he added.

In a statement, HMRC said that it was disappointed with the ruling but added that the case had "a number of aspects and complexities" that were still to be settled in the domestic courts.

"There are also further proceedings pending at the European Court following a recent Supreme Court reference there for the third time," the statement said. "Because of the further hearings in the UK and European courts there is currently no tax to be repaid following this judgment."