Henderson J handed down judgment in Six Continents v HMRC [2016] EWHC 2426 (Ch), on 5 October 2016. The issues concerned what foreign profits should receive credit at the foreign nominal rate in accordance with the ruling of the CJEU in Test Claimants in the FII Group Litigation v HMRC (Case C-35/11). The judgment holds that Six Continents are entitled to a credit at the FNR on the underlying foreign profits which incorporated adjustments to the commercial profits for the revaluation of shareholdings, the release of warranty provisions and exchange rate adjustments which were removed for local tax. It also held that the same credit would apply to capital gains even though exempt under the Dutch participation exemption.
Until 2009, foreign dividend income on holdings over 10% was taxed with credit for actual tax paid on the underlying profits. In its first two rulings in the FII case in 2006 and 2012, the CJEU held that those provisions were incompatible with EU law in that a lower tax burden was imposed on domestic dividend income which was exempt even in the common scenario where the dividend paying UK subsidiary had reduced its tax base by the use of reliefs and allowances and therefore paid tax at an effective rate below the nominal. In its second FII ruling, the CJEU had indicated that credit at the foreign nominal rate would be required to provide an adequate substitute for the exemption given domestically.
That ruling naturally gave rise to several issues of application. The first was whose nominal rate should apply in circumstances where a dividend from a holding company mixed profits of subsidiaries in several jurisdictions? The answer to that question was given in Henderson J’s judgment of 18 December 2014 in the FII case: it is the foreign nominal rate (FNR) of the EU source states where the profits were earned given as a weighted average.
The next question was what profits should benefit from the FNR credit? Does that credit extend for instance to profits which were exempt from tax or not taxed in the EU source jurisdiction? It was this issue which has been addressed by Henderson J’s decision of earlier this month in Six Continents v HMRC [2016] EWHC 2426 (Ch) (reported in Tax Journal, 14 October 2016).
The claim related to certain dividends paid to a UK holding company from its Dutch subsidiary in the accounting periods ending 30 September 1993, 1996 and 1997. The profits were the profits of the Dutch company itself or of its Dutch subsidiaries earned in either the Netherlands or Belgium. The treatment of the Belgian income was not controversial and does not feature in the judgment.
The Dutch accounting profits for the years concerned however carried very low levels of taxes for three reasons.
First, the commercial profit and loss account had incorporated credits which were not taken into account for Dutch tax (issue 1). These credits mostly comprised the upward revaluation of shareholdings by also included exchange rate credits and a credit resulting from the release of a warranty provision. Secondly (issue 2), the profits included a capital gain on the liquidation of a Dutch subsidiary exempt under the Dutch participation exemption. Thirdly (issue 3), the dividends included distributions from a share premium account which therefore did not comprise profits at all.
Issues 1 and 2 arose out of the essential flaw in the dividend taxation system identified by the CJEU. Such adjustments would also arise in a UK context yet the UK parent company would still receive domestic dividends as exempt even if the effective rate paid on the profits by the UK subsidiary was lowered by these same adjustments. The CJEU identified in FII (CJEU) II that this gave rise to a lack of equivalence between the exemption system available to domestic dividends, which allowed a UK-resident company to pass the advantages of domestic reliefs and exemptions enjoyed by a UK subsidiary up the chain, and the imputation system available to foreign dividends, through which a UK parent company was given a credit for the foreign tax actually paid in respect of the distributed profits but was otherwise chargeable to tax on the dividends at the full UK rate.
It was clear from the reasoning of the court in FII (CJEU) II that the imputation system operated by the UK for foreign-sourced dividends would have been compliant with EU law had the UK parent company been granted a tax credit at the relevant FNR ‘to which the profits underlying the dividends paid would have been ’. If the revaluation adjustments and the liquidation profits were, in principle, subject to the Dutch standard rate of corporation tax, Six Continents were entitled to a tax credit at that rate.
It was the concluding words of that quote which gave rise to the debate. HMRC contended that adjustments to the profit and loss account not recognised for Dutch tax were a ‘tax nothing’. they submitted on a literal reading of the Dutch corporation tax provisions that a capital gain exempt under the participation exemption is not taken into account for Dutch tax. They were not, HMRC contended, therefore profits which had been ‘subject to tax’ in the Netherlands and therefore which could benefit from at the Dutch nominal rate.
This was a matter of Dutch law. Henderson J heard expert evidence from both parties and concluded that he preferred the expert evidence of the claimants. This was in part because the outcome better gave effect to the CJEU’s reasoning in FII (CJEU) II. Henderson J pointed out that ‘the whole thrust of the CJEU’s reasoning is that giving a tax credit at the relevant FNR will mitigate, if not necessarily eliminate, economic double taxation in cases where exemptions and/or reliefs from tax have the effect of narrowing the tax base, and thus reducing the effective rate of taxation on the underlying profits which are passed up the corporate chain’. This objective would not be achieved if domestic tax law in a member state were interpreted such that the underlying profits subject to the relevant FNR were defined in such a way that the reduced tax base coincided with the amount which is in principle subject to tax.
His conclusion on the issues of Dutch law meant that the Judge did not need to consider the alternative submission that in fact the revaluation adjustments and the capital gain represented the distribution of the accumulated profits of the subsidiaries which had been taxed in the Netherlands in their hands, a point subsequently conceded on the facts by HMRC on the delivery of judgment.
This approach was also consistent with Henderson J’s prior judgment in Test Claimants in the FII Group Litigation v HMRC (Case C-35/11) [2014] EWHC 4302 (Ch) (‘FII (High Court) II’).
Henderson J rejected the approach proffered by HMRC’s expert and concluded that the claimants were entitled to a credit at the Dutch standard rate of corporation tax relating to the revaluation adjustments.
The third issue was somewhat different. It related to dividends sourced from the share premium account of a lower tier Dutch subsidiary which had been in a fiscal unity with the Dutch holding company. The members of the fiscal unity were treated as a single taxable entity and transactions between the members are disregarded for Dutch tax purposes.
As HMRC’s expert pointed out, it followed that ‘the dividend distribution from the share premium reserve is a non-event for tax purposes and therefore does not result in a taxable profit’ (para 62). The reasoning of the CJEU in FII (CJEU) II had no application to these parts of the Dividends because, as Henderson J stated ‘on no view were there any underlying profits which were subject to Dutch tax’ (para 63).
Six Continents accepted but argued that the dividends in question were, in substance, a return of capital made by a non-UK resident company. Had the Dutch companies concerned been UK-resident companies, the exemption of the dividend under tax system would have allowed the income to pass up the corporate chain with no tax charge. Thus, the cross-border situation generated a tax charge, whereas the domestic situation did not. Six Continents submitted that this amounted to a separate but related form of discriminatory treatment and was unlawful under EU law.
However, Henderson J considered that this argument rested on a false foundation because the return of capital by a non-UK resident company to its non-UK resident parent is wholly outside the scope of UK tax. The UK does not tax returns of capital made by UK-resident companies more advantageously than it taxes similar returns of capital made by non-resident companies. Therefore, ‘there are no profits in respect of which EU law require a tax credit at the Dutch nominal rate (or any other rate) to be given to Six Continents’ (para 69).
The result of the decision was that the UK holding company was entitled to recover the principal amount of unlawful tax resulting from the failure to give credit on the underlying profits at the Dutch nominal rate plus compound interest thereon. HMRC was refused permission by the judge to appeal against Issues 1 and but was granted permission to appeal on whether Six Continents were entitled to compound interest. This reflected Henderson J’s comment in his judgment that: ‘The order should, however, preserve the right of either side to apply for the interest calculation to be revisited in the event that the principles applied in FII (High Court) II are modified as a result of appeals to the higher courts in that case and/or the Revenue’s pending appeal to the Supreme Court in the Littlewoods case’ (para 72). The period for HMRC to seek permission to appeal from the Court of Appeal was extended to await the pending decision of that court in the FII case which touches on similar issues.
The decision is helpful to claimants. HMRC had argued that the component parts of the profits underlying the foreign dividend had to be unpicked to exclude any exempt income from a tax credit. This would have had two adverse effects:
As more claimants now look to recover these long outstanding claims, this is certainly an encouraging development. However, the end of the road is still to be reached and the extent to which the claimants are able to recover may be influenced by the upcoming decision of the Court of Appeal in FII GLO.
The authors’ firm acted for the claimants in this case.
Henderson J handed down judgment in Six Continents v HMRC [2016] EWHC 2426 (Ch), on 5 October 2016. The issues concerned what foreign profits should receive credit at the foreign nominal rate in accordance with the ruling of the CJEU in Test Claimants in the FII Group Litigation v HMRC (Case C-35/11). The judgment holds that Six Continents are entitled to a credit at the FNR on the underlying foreign profits which incorporated adjustments to the commercial profits for the revaluation of shareholdings, the release of warranty provisions and exchange rate adjustments which were removed for local tax. It also held that the same credit would apply to capital gains even though exempt under the Dutch participation exemption.
Until 2009, foreign dividend income on holdings over 10% was taxed with credit for actual tax paid on the underlying profits. In its first two rulings in the FII case in 2006 and 2012, the CJEU held that those provisions were incompatible with EU law in that a lower tax burden was imposed on domestic dividend income which was exempt even in the common scenario where the dividend paying UK subsidiary had reduced its tax base by the use of reliefs and allowances and therefore paid tax at an effective rate below the nominal. In its second FII ruling, the CJEU had indicated that credit at the foreign nominal rate would be required to provide an adequate substitute for the exemption given domestically.
That ruling naturally gave rise to several issues of application. The first was whose nominal rate should apply in circumstances where a dividend from a holding company mixed profits of subsidiaries in several jurisdictions? The answer to that question was given in Henderson J’s judgment of 18 December 2014 in the FII case: it is the foreign nominal rate (FNR) of the EU source states where the profits were earned given as a weighted average.
The next question was what profits should benefit from the FNR credit? Does that credit extend for instance to profits which were exempt from tax or not taxed in the EU source jurisdiction? It was this issue which has been addressed by Henderson J’s decision of earlier this month in Six Continents v HMRC [2016] EWHC 2426 (Ch) (reported in Tax Journal, 14 October 2016).
The claim related to certain dividends paid to a UK holding company from its Dutch subsidiary in the accounting periods ending 30 September 1993, 1996 and 1997. The profits were the profits of the Dutch company itself or of its Dutch subsidiaries earned in either the Netherlands or Belgium. The treatment of the Belgian income was not controversial and does not feature in the judgment.
The Dutch accounting profits for the years concerned however carried very low levels of taxes for three reasons.
First, the commercial profit and loss account had incorporated credits which were not taken into account for Dutch tax (issue 1). These credits mostly comprised the upward revaluation of shareholdings by also included exchange rate credits and a credit resulting from the release of a warranty provision. Secondly (issue 2), the profits included a capital gain on the liquidation of a Dutch subsidiary exempt under the Dutch participation exemption. Thirdly (issue 3), the dividends included distributions from a share premium account which therefore did not comprise profits at all.
Issues 1 and 2 arose out of the essential flaw in the dividend taxation system identified by the CJEU. Such adjustments would also arise in a UK context yet the UK parent company would still receive domestic dividends as exempt even if the effective rate paid on the profits by the UK subsidiary was lowered by these same adjustments. The CJEU identified in FII (CJEU) II that this gave rise to a lack of equivalence between the exemption system available to domestic dividends, which allowed a UK-resident company to pass the advantages of domestic reliefs and exemptions enjoyed by a UK subsidiary up the chain, and the imputation system available to foreign dividends, through which a UK parent company was given a credit for the foreign tax actually paid in respect of the distributed profits but was otherwise chargeable to tax on the dividends at the full UK rate.
It was clear from the reasoning of the court in FII (CJEU) II that the imputation system operated by the UK for foreign-sourced dividends would have been compliant with EU law had the UK parent company been granted a tax credit at the relevant FNR ‘to which the profits underlying the dividends paid would have been ’. If the revaluation adjustments and the liquidation profits were, in principle, subject to the Dutch standard rate of corporation tax, Six Continents were entitled to a tax credit at that rate.
It was the concluding words of that quote which gave rise to the debate. HMRC contended that adjustments to the profit and loss account not recognised for Dutch tax were a ‘tax nothing’. they submitted on a literal reading of the Dutch corporation tax provisions that a capital gain exempt under the participation exemption is not taken into account for Dutch tax. They were not, HMRC contended, therefore profits which had been ‘subject to tax’ in the Netherlands and therefore which could benefit from at the Dutch nominal rate.
This was a matter of Dutch law. Henderson J heard expert evidence from both parties and concluded that he preferred the expert evidence of the claimants. This was in part because the outcome better gave effect to the CJEU’s reasoning in FII (CJEU) II. Henderson J pointed out that ‘the whole thrust of the CJEU’s reasoning is that giving a tax credit at the relevant FNR will mitigate, if not necessarily eliminate, economic double taxation in cases where exemptions and/or reliefs from tax have the effect of narrowing the tax base, and thus reducing the effective rate of taxation on the underlying profits which are passed up the corporate chain’. This objective would not be achieved if domestic tax law in a member state were interpreted such that the underlying profits subject to the relevant FNR were defined in such a way that the reduced tax base coincided with the amount which is in principle subject to tax.
His conclusion on the issues of Dutch law meant that the Judge did not need to consider the alternative submission that in fact the revaluation adjustments and the capital gain represented the distribution of the accumulated profits of the subsidiaries which had been taxed in the Netherlands in their hands, a point subsequently conceded on the facts by HMRC on the delivery of judgment.
This approach was also consistent with Henderson J’s prior judgment in Test Claimants in the FII Group Litigation v HMRC (Case C-35/11) [2014] EWHC 4302 (Ch) (‘FII (High Court) II’).
Henderson J rejected the approach proffered by HMRC’s expert and concluded that the claimants were entitled to a credit at the Dutch standard rate of corporation tax relating to the revaluation adjustments.
The third issue was somewhat different. It related to dividends sourced from the share premium account of a lower tier Dutch subsidiary which had been in a fiscal unity with the Dutch holding company. The members of the fiscal unity were treated as a single taxable entity and transactions between the members are disregarded for Dutch tax purposes.
As HMRC’s expert pointed out, it followed that ‘the dividend distribution from the share premium reserve is a non-event for tax purposes and therefore does not result in a taxable profit’ (para 62). The reasoning of the CJEU in FII (CJEU) II had no application to these parts of the Dividends because, as Henderson J stated ‘on no view were there any underlying profits which were subject to Dutch tax’ (para 63).
Six Continents accepted but argued that the dividends in question were, in substance, a return of capital made by a non-UK resident company. Had the Dutch companies concerned been UK-resident companies, the exemption of the dividend under tax system would have allowed the income to pass up the corporate chain with no tax charge. Thus, the cross-border situation generated a tax charge, whereas the domestic situation did not. Six Continents submitted that this amounted to a separate but related form of discriminatory treatment and was unlawful under EU law.
However, Henderson J considered that this argument rested on a false foundation because the return of capital by a non-UK resident company to its non-UK resident parent is wholly outside the scope of UK tax. The UK does not tax returns of capital made by UK-resident companies more advantageously than it taxes similar returns of capital made by non-resident companies. Therefore, ‘there are no profits in respect of which EU law require a tax credit at the Dutch nominal rate (or any other rate) to be given to Six Continents’ (para 69).
The result of the decision was that the UK holding company was entitled to recover the principal amount of unlawful tax resulting from the failure to give credit on the underlying profits at the Dutch nominal rate plus compound interest thereon. HMRC was refused permission by the judge to appeal against Issues 1 and but was granted permission to appeal on whether Six Continents were entitled to compound interest. This reflected Henderson J’s comment in his judgment that: ‘The order should, however, preserve the right of either side to apply for the interest calculation to be revisited in the event that the principles applied in FII (High Court) II are modified as a result of appeals to the higher courts in that case and/or the Revenue’s pending appeal to the Supreme Court in the Littlewoods case’ (para 72). The period for HMRC to seek permission to appeal from the Court of Appeal was extended to await the pending decision of that court in the FII case which touches on similar issues.
The decision is helpful to claimants. HMRC had argued that the component parts of the profits underlying the foreign dividend had to be unpicked to exclude any exempt income from a tax credit. This would have had two adverse effects:
As more claimants now look to recover these long outstanding claims, this is certainly an encouraging development. However, the end of the road is still to be reached and the extent to which the claimants are able to recover may be influenced by the upcoming decision of the Court of Appeal in FII GLO.
The authors’ firm acted for the claimants in this case.
.jpg?sfvrsn=335a554c_0 "300 x 250 (MPU)")