November 13, 2012 2:53 pm

UK loses battle over corporation tax

The government moved a step closer to paying out up to £5bn of tax refunds to UK-headquartered multinationals, after the European Court of Justice ruled that the historic tax treatment of dividends paid by foreign subsidiaries breached EU anti-discrimination rules.

The European Court of Justice, based in Luxembourg, ruled that “unlawfully levied advance corporation tax must be repaid”, in the latest in a long series of court cases brought by a group of multinationals led by British American Tobacco.

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The decision comes at a time when multinationals – particularly foreign-owned companies – are facing public criticism over their corporate tax payments. The prospect of paying back big sums may expose the Treasury itself to criticism, as it could previously have settled the cases for much smaller sums at a time when the public finances were under less intense pressure.

Graham Aaronson, barrister for the claimants, said the ruling represented “a resounding success” for them and a potentially “very costly defeat” for HM Revenue & Customs. The ruling destroyed HMRC’s last hope of limiting its payouts to millions of pounds, he said.

Future court cases in Britain and Luxembourg over the next few years would determine whether the bill ran into billions of pounds or was limited to several hundred million pounds.

HMRC said it was disappointed with the ruling: “We will consider the implications of the ruling in the overall context of the case, which has a number of aspects and complexities that remain to be settled in the domestic courts.”

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

Chris Morgan, a partner at KPMG, the professional services firm, said the case was not about tax planning. “It is about companies that were penalised for investing abroad and penalised for bringing the money back to the UK.”

The case centres on the treatment of “franked investment income” under the advance corporation tax rules abolished by Gordon Brown, chancellor, in his first Budget. The ACT system required companies to make an advance payment of tax when they distributed dividend payments to shareholders. A UK parent company receiving a dividend from a UK-based subsidiary treated it as franked investment income, which offset its own ACT bill when it paid dividends.

But UK parent companies receiving dividends from overseas subsidiaries were not able to offset their ACT bills in the same way. The companies argued that this breached anti-discrimination rules in the 1957 Treaty of Rome, as companies with overseas subsidiaries ended up paying more tax than those with British subsidiaries.

In the first European ruling on this issue in 2006, the European Court of Justice decided that the ACT system amounted to illegal discrimination under EU law but there were unanswered questions that required a succession of further cases for clarification.

The ruling means that the government could have to pay refunds for taxes overpaid as far back as 1973, but technical arguments over the sums owed to companies will be subject to further court hearings.

Jake Landman, an associate of Pinsent Masons, an international law firm, said: “This will not be the final judgment in this litigation – it is a long-running and bitterly fought saga”.

A spokesman for British American Tobacco said: “Today’s ruling reconfirms our belief that we are right to seek to reclaim the tax we overpaid in the 70s, 80s and 90s as a result of double taxation.

“UK rules at the time meant that UK profits were only taxed once but that all profits made elsewhere in the EU were taxed twice – once in their country of origin and again when they were distributed to the UK – resulting in us being taxed twice on the same profits over a sustained period of time.

“Today’s ruling is an important step for us, and we welcome the European Court of Justice’s decision, but there is still a way to go and we’re a few years, and several further stages, off a final verdict.”

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