ACT Group Litigation – Class II – UK Court of Appeal decision

The U.K. Court of Appeal has upheld in 31 January 2006 the High Court judgment of 24 November 2003 in the case of NEC Semi-Conductors and others. This case is the test case for the third of the group litigation order cases, which follow the decision of the European Court of Justice (ECJ) in Hoechst Case (C-397/98 and C-410/98).

The common feature of the several cases being litigated is that they concern the liability to pay ACT in connection with the payment of dividends by companies incorporated in the UK, which are subsidiaries of other companies incorporated outside the UK. The particular aspect of this appeal is that the parent companies are established in countries outside the European Union (i.e. Japan and US).

Until 1999 UK companies paying dividends to a foreign parent company were required to pay ACT. Such ACT was later set off against the amount of mainstream corporation tax payable. Dividends payable to a UK parent were, upon group income election, not subject to the requirement to pay ACT. In the Hoechst case, the ECJ held that the requirement, that the parent be a UK company in order that a group income election could be made, was a breach of Article 43 of the EC Treaty (freedom of establishment).

In this case the parent companies, based in Japan or in the USA, supported their claim in two aspects: (i) their inability, as a non-resident parent company, to join in a group income election was in breach of provisions of a Tax Treaty, duly incorporated into UK law; (ii) their inability to join in a group income election was also a breach of EU law, in this case of Article 56 of the EC Treaty (freedom of capital).

In 2003, the High Court (Park J) decided rather surprisingly that the legislation was a breach of the non-discrimination article of the relevant treaty, but that these were not part of UK law, so no remedy to the claimant was available!

Allow me to try to explain! UK is a dualist country and as you may know in a dualistic system the treaty obligations have to be incorporated into domestic law. In case the relevant treaty is not incorporated or is improperly incorporated into domestic law, the treaty does not serve much the taxpayer. This is what happened in this case. The judge, based on a literal reading of section 788(3) (provision that gives effect of a Tax Treaty under UK law), simply concluded that the non-discrimination article is not made part of UK law insofar as it relates to ACT.

With regards to the second aspect of the claim, the High Court considered that it was sufficiently clear that the legislation was not in breach of Article 56 of the Treaty, and that he should not refer to the ECJ the question whether there was such a breach.

The U.K. Court of Appeal in its recent decision follows to a great extent the same line of reasoning of the High Court in order to dismiss the claims for ACT compensation by non-U.K. corporate groups. Similarly to the High Court, the Court of Appeal held that although UK’s ACT legislation can be said to be in breach of the non-discrimination clause of the Tax Treaty (Art. 24), that specific part of the Treaty (the non-discrimination clause) had not been implemented by UK legislation. Readers may recall that in the UBS case a similar issue arose.

With regards to the issue of whether the ACT provisions were consistent EC Law, namely Article 56 of the EC Treaty, the Court of Appeal upheld the decision of the High Court not to refer a question under Articles 56 and 57 to the ECJ. Nevertheless, the Court of Appeal left the door open for a possible reference to the ECJ. Accordingly, if the case is to further proceed to the House of Lords, on issues of domestic law, the Court considers preferable not to refer at this stage a question to the ECJ. The Court considers that only if the case would not proceed to the House of Lords would it be appropriate to order a reference to the ECJ.

This decision goes against the plaintiff request for an immediate reference to the ECJ. In fact, the plaintiff was in fact hoping that if the case was immediately referred, there would be a possibility to have a joint hearing with another recently referred case from Austria which raises similar issues under Articles 56 and 57 (Holböck Case - C-157/05).

To situate the readers, Holböck case concerns inbound dividends received from third States being taxed at a rate higher than dividends received from domestic entities. In that Austrian case, the taxpayer claims that the principle of the free movement of capital, which applies between EU Member States and third countries, prohibits Austria from taxing dividends distributed by a non-EU company at a rate higher than comparable domestic dividends are taxed. The Austrian Court, which made a reference to the ECJ decision in the Lenz case (C-315/02), asked the ECJ whether the eventual differential treatment falls under the “standstill clause” of Article 57, namely if such clause allows for a restriction of the transfer of capital in relation to direct investments.

In the same mode, the claim under EC law of the UK plaintiffs was that the ACT provisions were inconsistent with Article 56 of the Treaty, and not saved by Article 57(1).

Article 56(1) states that all restrictions on the movement and payments of capital between member’s states and third countries are prohibited. Article 57 and 58 contain, however, several exceptions to the main rule. More specifically, Article 57 permits restrictions on the freedom of capital relating to third countries on the basis of national or community law, provided that such restrictions existed before 31 December 1993. Accordingly, these measures must relate to direct investment, including in real estate — establishment, the provision of financial services or the admission of securities to capital markets. The scope of Article 57(1) is still far from clear!

In this case, the claimants considered that ACT provisions should be viewed as restrictions on 'payments' within the prohibition in article 56(2). The claimants submitted that the purpose of Article 57(1) is to preserve the direct and indirect effect of a number of strictly limited provisions, which must be aimed at capital movements, and in particular at investment in undertakings. In the case of the ACT provisions, since the dividend arises from capital movements which are not themselves restricted, there should be no justification for an indirect restriction.

This argument failed, apparently, on the basis of the reading by the Court of the Verkooijen case. Accordingly, the ACT provisions were considered analogous in effect to the provision of Dutch law at issue in Verkooijen and therefore should be regarded as restrictions on capital movements, which are also within the protective effect of Article 57(1).

Although it may be expected that a reference to the ECJ may be made if the case reaches the House of Lords, the present decision means ultimately that the same compensation in terms of ACT payments awarded to EU-parented companies in light of the ECJ case is not available to companies held by non-EU investors.

It should be noted that several other Group Litigation Orders (GLO) were formed to make claims against other aspects of UK tax law, which apparently are also contrary to the EU Treaty. In addition to the advance corporation tax (ACT) group litigation there are currently pending: (i) loss relief group litigation; (ii) franked investment income (FII) group litigation; (iii) controlled foreign company (CFC) and dividend group litigation; (iv) foreign income dividend (FID) group litigation; and (v) the thin capitalization group litigation.

More info on pending ECJ cases:
C-196/04 Cadbury Schweppes plc and Cadbury Schweppes Overseas Ltd v Commissioners of
Inl.Rev. (UK) – CFC
C-374/04 Test Claimants in Class IV of the ACT Group Litigation v. Commissioners of Inland
Revenue (UK) – tax credits for dividends, MFN
C-446/04 Test Claimants in the Franked Investment Income (FII) Group Litigation v.
Commissioners of Inland Revenue (UK) – foreign dividends; Art.56 EC
C-524/04 Test Claimants in the Thin Cap Group Litigation v. Commissioners of Inland Revenue (UK)
C-201/05 The Test Claimants in the CFC and Dividend Group Litigation v. The Commissioners
Inland Revenue (UK) - Art. 43, 49, 56
C-203/05 Vodafone 2 v. Her Majesty's Revenue and Customs (UK) – CFC legislation, Art. 43, 49, 56