Case No. EWHC-583-(Ch)

The matter before me is an inquiry into the compensation payable to companies in the Pirelli group by the defendants, the Commissioners for HM Revenue and Customs (“HMRC”). The litigation is part of what, in Deutsche Morgan Grenfell Group plc v. Inland Revenue Commissioners and another [2006] UKHL 49; [2006] 3 WLR 781, at paragraph 2, Lord Hoffmann described as the “forensic fall-out” from the decision of the Court of Justice of the European Communities (“the ECJ”) in Metallgesellschaft Ltd v. Inland Revenue Commissioners and Hoechst AG v. Inland Revenue Commissioners (Joined Cases C-397 and 410/98); [2001] Ch. 620 (“Hoechst”)). As Lord Hoffmann explained, the essence of that decision was that United Kingdom revenue law, which had between 1973 and 1999 allowed companies with parents resident in the United Kingdom (“UK”) to elect to pay dividends to those parents free of advance corporation tax (“ACT”), discriminated unlawfully against companies with parents resident in other member states by not giving them a like right of election. The exaction by the Inland Revenue (HMRC’s predecessors) of ACT from such companies had been unlawful and entitled them to compensation.

The claimants, all members of the Pirelli group, have brought such claims. They are merely five of many such claimants, the actions having been brought within a Group Litigation Order (“GLO”) made by Chief Master Winegarten on 26 November 2001. The first claimant, Pirelli Cable Holding NV, is resident in the Netherlands. So is the third claimant, Pirelli Tyre Holding NV. They are both wholly owned, directly or indirectly, by the second claimant, Pirelli SpA, which is resident in Italy. These three companies (“Pirelli Netherlands/Italy”) between them held all the issued shares in the fifth claimant, Pirelli UK Plc (“Pirelli UK”), of which the fourth claimant, Pirelli General Plc (“Pirelli General”), is a subsidiary. Pirelli UK and Pirelli General are resident in the UK.

In 1997 Pirelli General paid two dividends to Pirelli UK, which in turn paid dividends to Pirelli Netherlands/Italy. Between 1995 and 1999 Pirelli UK paid other dividends to Pirelli Netherlands/Italy. As Pirelli Netherlands/Italy were resident outside the UK, they and Pirelli UK had no right to exercise a group income election and so avoid a liability on the part of Pirelli UK to pay ACT, which Pirelli UK duly paid. The case therefore raises issues similar to those in Hoechst. Pirelli UK has made the main claim for compensation and Pirelli General has made a relatively minor like claim. The Pirelli claims are in the nature of test cases for more than 50 other claims in the GLO.

The questions before me arise under a remission of the case to the Chancery Division by the House of Lords following its decision on 8 February 2006 at the culmination of an earlier round of this litigation (see Pirelli Cable Holding NV and others v. Inland Revenue Commissioners [2006] UKHL 4; [2006] 1 WLR 400). The relevant part of the Order provided:

As Park J has, in the meantime, exercised an election to retire from the Bench, the conduct of the remitted questions has been assigned to me. The only matters I have to decide at this stage are, however: (i) a procedural question as to whether Pirelli’s claim to raise before me a point of principle said to go to the computation of the claimed compensation amounts to an abuse of the process of the court such that they should not be allowed to raise it at all; and (ii) if Pirelli can raise the point, whether or not it is well-founded.

Both issues are ultimately fairly short but to explain them I must first outline the legislative and procedural background against which they arise. To those familiar with this and related litigation, the former will be well known; and a repetition of it by me will no doubt be viewed as the tedious re-telling of that which has already been better told elsewhere by others. But if this judgment is to be understood on a stand-alone basis, I must undertake the exercise.

The Finance Act 1965 introduced the UK system of company taxation under which corporation tax became charged on the total profits of companies, including income and chargeable gains, earned in an accounting period. The end date of the accounting period is usually chosen by the company and an accounting period typically lasts 12 months. For all periods relevant to this litigation, the general rule was that corporation tax became payable nine months after the end of the accounting period. The applicable law became consolidated in the Income and Corporation Taxes Act 1988 (“ICTA”). All section references which follow are to sections of ICTA in its form before certain amendments made in 1997 came into effect in 1999. Sections 6, 8 and 10 are the main statutory provisions relating to corporation tax.

Under the corporation tax system in force between 1965 and 1973, company profits were taxed separately from company distributions. In effect, the profits were taxed twice - once in the hands of the company and then again (by the deduction of income tax under Schedule F) when the profits were distributed to shareholders by way of dividend. This was known as “economic double taxation”, meaning the double taxation of the same funds, and became regarded as undesirable by corporation tax systems. The problem became addressed by the introduction of so-called “imputation” and “partial imputation” systems, which are shorthand concepts for systems under which the tax on profits borne by the corporation is either wholly or partially “imputed” to its shareholders. Each shareholder was itself taxable in respect of the company’s dividends (i.e. the company’s distributable profits paid to it) but such systems recognised the company as pre-paying the whole or part of the shareholder’s own tax liability in respect of the dividend.

The UK’s chosen method was a partial imputation system, which it introduced by the Finance Act 1972, the material provisions of which became incorporated into ICTA and remained in force until 6 April 1999. Under that system, the company continued to pay corporation tax on all its profits, whether or not distributed, but a new system of taxation was introduced as regards any so-called “qualifying distribution” (as defined in section 14(2), and it included dividends) that the company made. A company resident in the UK that made a “qualifying distribution” was no longer required to deduct income tax from the distribution but was instead required to pay ACT on a sum equal to the amount or value of the distribution; and the shareholder received a tax credit corresponding to the ACT so paid. Section 14 was the main charging provision and Schedule 13 governed the collection of ACT. Section 14(1) provided:

ACT was payable two weeks after the end of the quarter during which the dividend was paid and so it fell due for payment before (and often well before) the time that the company had to pay its corporation tax due in respect of the total profits of its accounting period during which the quarter fell. That tax on profits became known as “mainstream” corporation tax (“MCT”), although that was not a statutory term of art. The rate of ACT during the relevant period was 25%. If a company declared a dividend of £100, it would pay £100 to its shareholders and £25 ACT to the Revenue. The 25% ACT rate was lower than the MCT rate during the relevant period, which went from 33% to 31% to 30%. It was this differential that made the system a “partial” imputation system: as the amount of the credit was fixed at a level which was lower than the MCT rate, the company would pay a residual amount of MCT that would not be capable of being credited against the shareholder’s own tax liability.

ACT paid by the company was set off against its MCT liability for the annual accounting period in which it was paid: section 239(1). If no MCT was payable for that accounting period (because, for example, the company had no taxable profits), the ACT could be carried back and set off against the company’s MCT for a prior period, so entitling the company to a repayment of corporation tax: section 239(3). Any ACT not so carried back could be carried forward and set off against MCT payable for the next accounting period: section 239(4). The company could also surrender any surplus ACT to a subsidiary company: section 240. ACT that was set off against the MCT of the paying company or that of its UK resident subsidiary became known as “utilised” ACT. ACT which had not been and could not be so set off was known as surplus or “unutilised” ACT.

The ACT system can be perceived as yielding an apparent financial benefit to the Revenue and as imposing an apparent disadvantage upon the paying company. As for the Revenue, it received the ACT ahead of the time at which, but for the payment of the dividend, the company would pay the entirety of its MCT on its profits for the accounting period. As for the company, it was disadvantaged between those two payment dates by the loss of the use of the money it had so paid in ACT. As regards any ACT that became unutilised, the company’s position was even starker: such ACT amounted, in effect, to an additional irrecoverable cost over and above the company’s MCT for the accounting period in which the dividend was paid.

So far I have considered the position from the viewpoint of the company paying the dividends. As for the recipients, section 231(1) conferred a tax credit for the ACT that had been paid: it was conferred both on UK resident companies and UK resident individuals which or who received a qualifying distribution – including a dividend – from a UK resident payer. The amount of the credit was equivalent to the amount of ACT payable on the dividend. Section 231(1) provided:

Different regimes applied according to whether the recipient of the credit was an individual or a company. A UK resident individual continued to be chargeable to income tax under Schedule F on the aggregate of the dividend and the tax credit, but he could set the tax credit against his income tax liability for the year or, if the credit exceeded that liability, could claim a repayment from the Revenue: section 231(3). By contrast, where the recipient shareholder was a UK resident company subject to corporation tax the company was exempt from corporation tax on the dividend (section 208) but was not generally able to claim a repayment of the tax credit. In its case, the dividend payment plus the associated tax credit was known as “franked investment income” and the tax credit could be used to cover - or “frank” - any onward payment of a dividend that it made in respect of which it would otherwise itself be accountable for ACT: section 238. For example, if A Ltd paid a dividend of £100 to its parent, B Ltd, it would be accountable for ACT of £25 and B Ltd would be entitled to a tax credit of £25. If B Ltd then paid a dividend of £100 to its own parent, its tax credit would “frank” the obligation that it would otherwise have to pay ACT in respect of that dividend. If it paid an onward dividend of £150, the tax credit would frank £25 of the ACT, and it would have to pay ACT of £12.50. If it did not pay an onward dividend, it could not normally use its tax credit save by carrying forward its surplus franked investment income for use against its ACT liability on future dividends.

I turn to the position of companies that were not resident in the UK and did not trade there through a branch or agency. They were not subject to corporation tax in the UK. Nor, as section 233(1) provided, were they liable to income tax in the UK in respect of dividends paid to them by their UK subsidiaries unless those dividends also entitled them to a tax credit. It is central to this case that - as section 231(1) made explicit - the conferring of tax credits under section 231 only applied to qualifying distributions made or paid by UK resident companies to UK resident companies or to UK resident individuals: in particular, it did not apply to such distributions made or paid to companies not so resident, and so section 231 did not, by itself, entitle any such non-resident parent company to a tax credit in respect of a dividend paid to it by its UK subsidiary.

It is, however, equally central that the entitlement to such a tax credit could be extended to non-UK resident recipients by virtue of treaty credits granted under double taxation treaties between the UK and the country of the recipient’s residence. Where the parent company was entitled to such a credit under a double taxation treaty concluded between the UK and its state of residence, it was subject to UK income tax under Schedule F on dividends paid to it by its UK subsidiary (see again section 233(1)). In short, from the parent’s perspective, if it did not have the benefit of any treaty tax credit in respect of the dividend paid to it by its UK subsidiary, it was not liable to UK income tax. It was only so liable if had the benefit of such a credit. It could then set the credit against the income tax for which it was liable in the UK and, where the credit exceeded the tax liability, it could recover the excess.

Double taxation treaties - also called conventions or agreements, and I will call them agreements - have been entered between the UK and various overseas states. When ratified by the contracting parties they become binding in international law. As section 788(1) explained, subject to an appropriate declaration by Order in Council, they have domestic effect for UK tax purposes in accordance with section 788(3). Such agreements have the purpose and effect of preventing double taxation by determining which state may exercise taxing powers in respect of a particular type of income or activity; and/or by providing that one state should allow a credit against its own tax charge for taxes paid in respect of the same income or activity in the other state. Where, as commonly occurs, the effect of a provision in a double taxation agreement differed from the position which would obtain in the UK as a matter of domestic law, section 788(3) provided that the provisions of the double taxation agreements shall prevail “notwithstanding anything in any enactment” in so far as they relate to matters specified in the four sub-paragraphs following. Section 788(3)(a) and (d) provided that such agreements shall have effect in relation to income and corporation tax in so far as they provide:

In several such double taxation agreements, the UK has agreed that non-UK resident shareholders in UK companies should be entitled to a tax credit in respect of dividends paid to them by a UK resident company. Pirelli’s claims in this litigation mainly concern dividends paid by Pirelli UK (a UK company) to its non-resident parents, Pirelli Netherlands/Italy. The UK entered into a double taxation agreement (“DTA”) with each of the Netherlands and Italy (see the Double Taxation Relief (Taxes on Income) (Netherlands) Order 1980, SI 1980/1961; and the Double Taxation Relief (Taxes on Income) (Italy) Order 1990, SI 1990/2590). Article 10(3)(c) of each DTA provided that the recipient company shall:

Section 247 – the provision primarily responsible for the Hoechst litigation - provided that, in a case in which a 51% (or more) UK subsidiary company paid a dividend to its UK parent, the two companies could jointly elect that section 247(1) should apply to the dividend so paid. Such an election became known as a “group income election”; and dividends covered by it were known as “election dividends” (section 247(1)). The effect of such an election was provided for by section 247(2), which reads:

The effect of that was, therefore, that the election dividends remained “qualifying” distributions - which were defined in section 14(2) - but that the subsidiary became exempt from liability under section 14(1) to pay ACT upon their payment. For reasons given, the making of a group income election could achieve a financial advantage for the subsidiary. Even if any ACT that might otherwise be paid could in due course be utilised in full against the subsidiary’s (or its subsidiaries’) MCT, there would be a cash flow penalty resulting from its payment, since it was payable no later than two weeks after the end of the quarter in which the dividend was paid whereas the MCT would not be due until nine months after the end of the accounting period; and if the ACT could not be utilised either at all or in full at that payment date, the or any surplus ACT could remain unutilised for years or even indefinitely. The corollary of the exercise of a group income election was, however, that the recipient parent would not obtain a tax credit under section 231 either upon the payment of the dividend or upon the subsequent payment by the subsidiary of its MCT, so that the dividend was not franked investment income in the parent’s hands. If, therefore, the parent decided to pay the dividend onward to its own shareholders, it would have to pay ACT (unless it and its parent could and did exercise a group income election).

Crucially, however, section 247(1) applied only to the case in which both subsidiary and parent were resident in the UK. If a 51% (or more) subsidiary paid a dividend to its resident parent outside the UK (for example, in another EU member state), it had no choice but to pay ACT on the distribution, since section 247 afforded no option to the two companies to make a group income election. It was this discriminatory element that was held to be unlawful in the Hoechst decision. It was the very large amount of unutilised ACT paid, in particular, by groups with multinational operations that became the main driver behind the Community law challenge to the ACT system leading to that decision. In such cases the claimants have sought compensation from the Commissioners for (a) having to pay their unutilised ACT at all, and (b) having to pay their utilised ACT earlier than the MCT payment date. Their case was that, if section 247(1) had not unlawfully discriminated against them by depriving them of the right to exercise a group income election to pay dividends to non-resident parents free of ACT, they would not have had to pay it at all. In the present case, when Pirelli UK paid dividends to Pirelli Netherlands/Italy, the group had no choice but to suffer the payment by Pirelli UK of ACT in respect of those dividends.

The details relating to the Pirelli dividends do not matter for present purposes, although they are explained in paragraph 13 of the Park J judgment. In summary, on two dates in May and/or July 1997 (the Park J judgment appears to give inconsistent dates) Pirelli General paid dividends to Pirelli UK which attracted ACT of £2,975,000, the whole of which was later set off against Pirelli General’s MCT, and corresponding dividends were then paid by Pirelli UK to Pirelli Netherlands/Italy. When making those two onward payments, Pirelli UK did not have to pay ACT, because its liability for that was franked by the tax credit it had received from Pirelli General. Apart from this, on 19 occasions between May 1995 and March 1999 Pirelli UK paid dividends to Pirelli Netherlands/Italy which attracted ACT of £20,220,000, of which £15,180,000 was later set off against the MCT liability of either Pirelli UK or its UK subsidiaries. £5,040,000 of ACT was not so set off and so represented an additional tax cost of unutilised ACT. Upon the payment of the dividends, Pirelli Netherlands/Italy received tax credits under the applicable DTAs (see paragraph 18 above for the calculation). Pirelli UK makes claims for compensation in respect of the ACT it paid on the 19 dividends, and Pirelli General claims compensation on the ACT paid by it on the two dividends it paid to Pirelli UK in May 1997. HMRC have accepted that if in principle Pirelli UK is entitled to succeed against them, so is Pirelli General.

I should say a little about this. The first issue was whether it was contrary to (inter alia) what is now article 43 (freedom of establishment) of the EC Treaty to require a UK resident subsidiary of a non-UK resident parents to pay ACT on dividends paid to the parent when a UK resident subsidiary with a UK resident parent could make a group election under section 247 enabling the subsidiary to avoid paying ACT in a like situation. In paragraphs 43 and 44 of its judgment, the ECJ identified this apparently discriminatory treatment and the cash flow advantage that it gave a subsidiary and parent both resident in the UK. The UK Government argued that section 247 was objectively justified because its primary purpose was to shift the obligation to pay ACT from the subsidiary to the parent; and as a non-resident parent would never be obliged to pay ACT (which was only payable in respect of distributions by UK resident companies) there was no relevant discrimination. The ECJ rejected that argument. It disagreed that ACT was a tax in its own right, but regarded it as the payment of corporation tax in advance. The effect, therefore, of allowing a subsidiary and parent comprising a UK group to make a group income election was simply to enable the subsidiary to pay all its corporation tax on the due date for the payment of its MCT. The election did not allow the subsidiary to avoid any tax on its profits distributed by dividend. A UK subsidiary of an overseas parent was liable for MCT in respect of its profits distributed by dividend in the same way as was a like subsidiary of a UK parent:

The second issue raised in Hoechst was whether, assuming the UK partial imputation system breached (inter alia) article 43 of the EC Treaty, the claimants were entitled to recover interest in respect of ACT which was paid and then utilised by being set off against MCT. The ECJ answered this in paragraph 96:

I set out at the beginning of this judgment the questions remitted by the House of Lords to the Chancery Division. In what follows I shall, for simplicity, treat the only claims made as those by Pirelli UK – there is no need to refer separately to Pirelli General’s claims. The first remitted question was described as the “unresolved factual question” of whether, had a group income election been available to Pirelli, the group would (i) have exercised it and so enabled Pirelli UK to pay dividends to Pirelli Netherlands/Italy free of ACT; or (ii) have chosen not to exercise it, have therefore elected to pay the ACT which Pirelli UK in fact paid and so enabled Pirelli Netherlands/Italy to enjoy the benefit of the DTA tax credits they in fact received.

Pirelli UK’s claims are to recover from the Commissioners unutilised ACT paid following the paying of dividends to Pirelli Netherlands/Italy plus interest; and to recover interest for the loss of the use of utilised ACT from the time of payment until the time when it became utilised by being set off against MCT. Viewing the matter through exclusively domestic law spectacles, it might be thought that there would be a solid argument for the view that Pirelli UK could only achieve any such recovery if it could first prove, as a matter of fact, that had the exercise of a group income election been open to the Pirelli group, they would have exercised it: since if - had such an election been so open - they had chosen not to exercise it but instead to pay the ACT (so enabling Pirelli Netherlands/Italy to receive the corresponding DTA tax credit), there could be no question of Pirelli UK being entitled to any recovery from HMRC. The point is a basic one of causation, which requires no extended explanation: Pirelli UK cannot be entitled to be compensated for what it cannot be said to have lost. The form of the order made by the House of Lords appears to reflect that the House recognised that a factual inquiry in relation to causation would or might be necessary. Lord Scott of Foscote said in his speech that the:

Pirelli’s present position is that in fact that issue of fact does not need to be resolved. Their claim is, they say, an exclusively restitutionary one in which they do not have to pass any causation test. Their right to restitution flows purely and simply from the fact that the ACT that was paid was exacted on the back of UK legislation that infringed Community law; and they say that the Community jurisprudence shows that they cannot now be required to reconstruct hypothetical discussions at Pirelli board meetings some ten years after the time when the payment of the dividends was being considered. If wrong on that, they say also that an exercise of hypothetical reconstruction anyway cannot be undertaken until they first know the answer to the main question of principle they have now raised before me.

HMRC disagree with Pirelli’s approach to the causation issue. But, save for recording that, I need say no more about the parties’ differences because the outcome of discussion with counsel was that they agreed that I should adjourn the causation issue until after I had ruled on the point of principle, and I did so adjourn it.

The anterior question of principle has arisen like this. So far in this litigation (right up to the House of Lords) Pirelli’s primary case has been that, had any available group income election been exercised so as to enable Pirelli UK to avoid the payment of ACT, Pirelli Netherlands/Italy would still have been entitled to the DTA credit which they received upon the payment of the ACT that Pirelli UK paid. If so, it was said to follow that Pirelli UK did not have to give credit for that DTA credit in its claim against HMRC for compensation. Pirelli’s further argument has hitherto also been that, even if they were wrong that the DTA credit would have been payable even if the group had been able to exercise, and had exercised, a group income election, Pirelli UK still did not have to give credit for the DTA credit. That was because, even if its payment was to be regarded as a countervailing gain, it was not one that accrued to Pirelli UK - it accrued exclusively to Pirelli Netherlands/Italy, whose corporate identities were separate from that of Pirelli UK. All that the court had to do was to focus on Pirelli UK’s loss – as to which any countervailing gain by Pirelli Netherlands/Italy was irrelevant.

Pirelli persuaded Park J of the correctness of both points and the Court of Appeal to uphold Park J unanimously. But Pirelli’s luck expired in the House of Lords, which unanimously reversed the Court of Appeal’s decision on both points. The decision of the House of Lords was that there was an obvious, if unspoken, linkage between the payment of ACT on a dividend paid to a non-UK parent and the availability of a DTA credit to that parent: no ACT, no DTA credit. It followed that: (i) if Pirelli had exercised any available section 247 group income election, Pirelli Netherlands/Italy would not have received the DTA credit they in fact received; and credit for it had to be given in the computation of the loss sought to be recovered from HMRC; and (ii) in that connection, Pirelli’s “separate corporate identity” point was bad because the right to a section 247 election, of which the Pirelli group had been wrongfully deprived, was a group income election and so compensation had to be assessed on a group basis, with a parent’s gain set against its subsidiary’s loss.

In the light of that outcome, HMRC’s present position is simple. They say that (assuming, on another day, Pirelli successfully crosses the causation threshold), the compensation recoverable in respect of Pirelli’s loss of the use of any payment of utilised ACT requires a credit to be given (on a pound for pound basis, plus interest) for the DTA credit received by Pirelli Netherlands/Italy on the payment of the corresponding dividend; and that a like credit, plus interest, must be given in respect of Pirelli UK’s claim to recover its unutilised ACT and interest.

Pirelli say that this misses the point that the DTA credit which Pirelli Netherlands/Italy received (and which Pirelli now concede must be brought into account in calculating the compensation) should not be characterised as a DTA credit to which Pirelli Netherlands/Italy were not entitled to at all. The true analysis, say Pirelli, is (i) that if a group income election had been open to and exercised by it, the dividends paid to Pirelli Netherlands/Italy would have been paid free of ACT; (ii) that admittedly (as the House of Lords has decided) at that point no DTA credit could or would have been payable or paid to Pirelli Netherlands/Italy; but (iii) that when Pirelli UK subsequently paid its MCT on its profits for the accounting period in which the dividends were paid, a DTA credit would then have been payable and paid to Pirelli Netherlands/Italy by way of compensation for the MCT so paid by their subsidiary; (iv) moreover, that credit ought to have been a larger credit than that which had been wrongly paid earlier, because it should have been equal to the full tax credit that a UK resident shareholder would have received under the UK’s dividend taxation rules rather than the half-rate credit payable under the DTAs; therefore (v) the most that HMRC can say on this inquiry as to compensation is that Pirelli Netherlands/Italy received early a smaller credit than the larger one they would have been entitled to later. Pirelli asserts that this analysis of the position is of fundamental significance to the calculation of the group’s loss at least in respect of its claim in respect of utilised ACT.

Pirelli advanced this point on the basis that it is obvious that it is one that can properly be taken under the terms of the House of Lords’ reference back to the Chancery Division. They say that the House did not spell out how the inquiry as to compensation had to be conducted and so the raising of this point is open to Pirelli as a matter of right. In fact, it is a brand new point, at least as far as the issues argued before the Court of Appeal and the House of Lords were concerned, although it is not new as far as Pirelli’s advisers have been concerned, and they argued it (or at least raised it) before Park J. Mr Glick QC, for HMRC, submitted that for Pirelli now to raise this point was an attempt to go behind the essence of the House of Lords’ decision and an abuse of the court’s process. His primary submission, however, was that the point was wrong.

For my own part, I do not find it entirely easy to identify the extent to which the new point can be said to arise on an inquiry as to the loss suffered by Pirelli General and Pirelli UK, which is all that the House of Lords remitted back to the Chancery Division. I recognise that the “group approach” to that inquiry requires the DTA credit that Pirelli Netherlands/Italy actually received to be brought into account. But, subject to what I say in the next paragraph, I do not follow how it can require their notional, unpaid and higher tax credits (payable, so it is said, when Pirelli UK paid its MCT) also to be brought into account. The non-receipt of a notional tax credit by Pirelli Netherlands/Italy following the payment of MCT following a hypothetical group income election is not obviously relevant to the computation of the loss of the use by Pirelli UK of the ACT it paid between the time it paid it and the time when the ACT later became utilised against its MCT. If any claim is to be made to bring such a notional tax credit into account, it must, so it seems to me, be the subject of a separate claim against HMRC by Pirelli Netherlands/Italy for the failure to pay them that full tax credit at the appropriate date. In fact, on 30 March 2005 (between the hearings before the Court of Appeal and the House of Lords) the Pirelli claimants (other than Pirelli General) did issue fresh proceedings seeking relief in respect of the non-payment of such a credit. It remains to be seen what their future will be.

But there remains another element to the point. Pirelli say that it is relevant to the computation of Pirelli UK’s loss that the DTA credit actually received was merely an early part payment of the credit that ought (upon the exercise of a group income election having been made) properly to have been paid later - and whether or not the balance of any such later, larger credit is now actually recoverable by Pirelli Netherlands/Italy. That is said to make all the difference to the manner in which the Pirelli group must give credit in the compensation assessment in relation to its utilised ACT for the value of the DTA credit that was actually paid, and it goes to HMRC’s point that the DTA credits actually paid must be brought into account by way of a pound for pound set off. It is said to mean that the only deduction to be made from the claimed compensation is the time value of Pirelli Netherlands/Italy being paid the actual DTA credit they received at the time of the payment of the dividends rather than being paid later, when the MCT was paid, at least an equivalent DTA credit.

I have not yet heard any fully developed argument on the merits of that proposition. What I have heard argument on, and what I have to rule on, are (a) whether it is now open to Pirelli to take this new tax credit point at all, whatever its consequences on the computation of the assessment; and (b) if it is, whether in principle the point is well founded – that is, whether, upon the payment of dividends to Pirelli Netherlands/Italy under a group income election, Pirelli Netherlands/Italy would have become entitled to a full tax credit when Pirelli UK later paid its MCT. In order to deal with both points I must first look more closely at the history of this litigation. It is, in particular, important to focus on what the House of Lords decided.

These proceedings came before Park J over four days in December 2002, with Park J delivering his reserved judgment on 22 January 2003. I have earlier given its references. Mr Aaronson QC, Mr Cavender and Mr Paul Farmer appeared for Pirelli, and Mr Glick QC and Ms O’Sullivan for HMRC. In paragraphs 10 to 24, Park J gave an illuminating explanation of the legislative and treaty background, upon which I have in part gratefully drawn. He explained (paragraph 26) that Pirelli UK claimed the full amount of its unutilised ACT of £5,040,000, plus interest; and that, as regards its utilised ACT, it claimed compensation or restitution calculated by reference to interest for the period between the dates of payment of the ACT and the dates when it became utilised. Pirelli General claimed only the latter type of relief. He had said earlier (paragraph 7) that HMRC’s case was that the receipt by the parents of the article 10 payments under the DTAs operated to extinguish or reduce those claims. He said that issue had occupied most of the argument. In paragraph 28 he referred to the “causation” point, where he said:

Park J then explained that HMRC’s position was that, on those assumptions, and subject to their points on article 10 in the DTAs, the Pirelli claims would in principle be well-founded. But their point was that the receipt by Pirelli Netherlands/Italy of the article 10 DTA payments represented countervailing advantages which served to reduce or extinguish the claims of their UK subsidiaries. Pirelli’s answer to this was (i) that those payments would have been payable and paid even if the group had been entitled to make a group income election in respect of the dividends, so that their receipt was not a countervailing advantage; and (ii) in any event, that advantage was enjoyed by the recipient parents, whereas the suffered loss was incurred by the paying subsidiaries, and so the separate corporate identities of the players prevented any set off of loss and gain. The Revenue’s rejoinder was that (i) a condition of the entitlement of Pirelli Netherlands/Italy to the DTA payments was that Pirelli General and Pirelli UK were liable to pay ACT in respect of the dividends, whereas Pirelli’s case was that they could (and would) have elected against making such a payment; and (ii) the compensation claimed was a group claim and so the court must not place the group in a better position than would have been enjoyed by a comparable group of UK resident companies.

Park J considered the first point (i.e. the relationship between the payment of ACT and the entitlement to the article 10 payments) in paragraphs 34 to 44. He preferred the Pirelli argument that there was no linkage between the two and held that Pirelli Netherlands/Italy would have been entitled to the payments even if the Pirelli group had been entitled to make, and had made, a group income election. He recognised (paragraph 35) that in the minds of those who devised the imputation system, “there was an association between the payment of ACT by the company and the conferring of tax credits on shareholders.” But he said that nowhere in the legislation was there any requirement that a condition of the entitlement to a tax credit was the payment by the company of ACT, or the incurring of a liability for ACT. Park J anyway regarded the question as turning upon the true interpretation of article 10 of the DTAs, which he analysed in paragraph 37. He held that all the article 10 conditions for the payment of a tax credit to Pirelli Netherlands/Italy were satisfied and (in paragraph 38) that “there is no provision in the article that the dividends do not qualify the recipient … to obtain art 10 DTA payments unless ACT was paid or payable by Pirelli UK or by other United Kingdom companies lower down the corporate hierarchy.” He said (paragraph 43) that:

That led Park J to the further conclusion that Pirelli Netherlands/Italy’s receipt of the DTA article 10 payments could not be regarded as countervailing advantages to be set against the disadvantages to which Pirelli UK and Pirelli General were subjected in having to pay ACT. If he was wrong in that, he then (paragraphs 45 to 57) rejected the Revenue’s argument that the Pirelli claim should be looked at on a group basis and that Pirelli Netherlands/Italy’s gains should be set off against Pirelli UK and Pirelli General’s losses.

Finally, in paragraphs 58 to 62, Park J dealt with another issue which was before him, which he described as the Athinaiki issue (Athinaiki Zithopiia AE v. Greece (Case C-294/99) [2002] STC 559, [2001] ECR I-06797). That concerns an unrelated point taken by Pirelli which is no longer alive.

The Park J judgment therefore reflects that (i) Pirelli’s point as regards Pirelli Netherlands/Italy’s entitlement to tax credits was that, had any group income election been exercised, the two parents would have still have been entitled to the same DTA tax credits that they had actually received; it does not reflect that any point was advanced that (if the primary argument was wrong) they would anyway have been entitled to like or larger tax credits payable at a later time; and (ii) the “countervailing advantages” point depended on recognising the separate corporate personality of each group company.

Although, however, the Park J judgment made no reference to it, it is apparent from the transcript of the proceedings before him that Mr Aaronson’s fifth main submission was that, assuming Pirelli lost on both main points just summarised, there would then arise on the quantification of Pirelli’s loss the consideration that the DTA credit actually paid was paid early and should not have been paid until the MCT was paid. Mr Aaronson explained the point to Park J over pages 44 to 49 of the transcript of day two, and it appears to me that it was in essence the same as that which is now sought to be taken. I do not understand that either Mr Glick or Park J made any suggestion that the point was not properly raised. In the result, however, Park J found for Pirelli on the two main points, and did not rule on, or refer to, that further point.

The Revenue took the case to the Court of Appeal, where it was argued over three days in December 2003 before Peter Gibson, Laws L.JJ and Sir Martin Nourse, with the judgment of the court delivered by Peter Gibson LJ being handed down on 17 December 2003 (Pirelli Cable Holding NV v. Inland Revenue Commissioners [2003] EWCA Civ 1849; [2004] STC 130). Pirelli was represented by the same counsel, as were HMRC with the addition of Mr Ewart. The court dismissed the appeal on the basis of essentially the same reasoning as that of Park J. The judgment made no reference to the new point now raised before me, and which had earlier been raised before Park J. I understand it was neither raised in a respondents’ notice nor argued.

HMRC’s appeal to the House of Lords was argued on 23 and 24 November 2005, with the decision being handed down on 8 February 2006 (Pirelli Cable Holding NV and others v. Inland Revenue Commissioners [2006] UKHL 4; [2006] 1 WLR 400). The House unanimously reversed the Court of Appeal on both issues, set aside Park J’s order and remitted the case to the Chancery Division in the terms earlier quoted. It is necessary for present purposes only to consider the decisions of the House on the first issue, that of the availability of the DTA tax credit that was actually paid to Pirelli Netherlands/Italy.

Lord Nicholls of Birkenhead, dealing first with the operation of the new partial imputation system as between a UK resident company and its UK resident shareholders, said (paragraph 1) that whilst ICTA nowhere stated that a liability to pay ACT was a precondition of an entitlement by the shareholder to a tax credit, that “unspoken linkage lay at the heart of the scheme, and the legislation was drawn in a form which achieved this result.” In paragraph 3 he said the exercise of a section 247 group income election reflected the same linkage. In paragraph 7 he identified the question as being whether, had Pirelli been entitled to exercise, and had exercised, a group election, Pirelli Netherlands/Italy would have been entitled to the DTA credits they had in fact received. That depended on the proper interpretation of the two DTAs, which were essentially similar. Lord Nicholls pointed out (paragraph 9) that article 3(2) of the Netherlands DTA showed that “tax credit” in the agreement had the same meaning as in ICTA, and (paragraph 10) that article 10(3)(c) “as would be expected … accords with the scheme of the underlying legislation whereby entitlement to a tax credit marched hand-in-hand with liability to pay ACT.” In Lord Nicholls’s view all that was clear, but the further question was whether article 10 required a different interpretation in the new, post-Hoechst, world in which a group income election may be exercised in a case in which the parent company is not resident in the UK. His view (paragraphs 12 to 16) was that, whilst a literal interpretation of the DTAs justified the conclusion that even in such a case there was an entitlement to a tax credit, their correct, purposive interpretation required article 10(3)(c) to be read in a circumstance for which it had not been designed, namely that a Netherlands company could receive a dividend that had not attracted the payment of ACT. In his view it was plain that no tax credit would be payable in such circumstances, since otherwise it would entitle a company resident overseas to a convention tax credit where a UK resident company was not entitled to a tax credit:

Mr Aaronson made a point that in paragraph 14 Lord Nicholls had referred, allegedly inaccurately, to “the tax credit to which a United Kingdom resident would have been entitled had he received the dividend.” The point was that the article referred to the position of an individual resident in the UK and that Lord Nicholls’s choice of language reflected that he had momentarily overlooked that. There is nothing in the point. It is obvious that Lord Nicholls was referring to an individual who was so resident, to whom in the same sentence he referred as “he”.

Lord Hope of Craighead explained that section 832(1) of ICTA defined a “tax credit” as meaning a tax credit under section 231; and that section 788(3)(d) gave effect to the arrangements in DTAs for conferring on non-resident companies “the right to a tax credit under section 231 in respect of qualifying distributions paid to them.” He explained (paragraph 35) that the effect of a group income election under section 247 was that ACT was not payable on the election dividends and that, as section 247(2) made clear, dividends so paid did not qualify for a tax credit under section 231. Lord Hope continued:

Lord Hope explained (paragraphs 36 and 37) why, in the domestic context, the right on the part of the recipient company to a tax credit arose only in cases in which the subsidiary company was liable to pay ACT on the dividend. Turning to how the DTAs should be interpreted on the hypothesis that Pirelli had been entitled to exercise a group income election under section 247, he said:

Lord Scott of Foscote (with whose speech all their Lordships agreed) explained that whilst the DTAs did not in terms define the expression “tax credit” as used in article 10(3)(c), the sense of article 3(2) was to require “tax credit” to bear the meaning given to it by section 832(1), which defined it as meaning a tax credit under section 231. It followed from the combined effect of sections 231(1) and 247(2) that the exercise of a group income election precluded the recipient of the dividend from claiming a section 231 tax credit. He then considered how article 10(3)(c) must be regarded as operating on the hypothesis that a group income election was exercisable in a case in which the dividend was paid to an overseas parent. He concluded that, on the true construction of article 10(3)(c), it followed that, as an individual resident in the UK would not have been entitled to a section 231 tax credit in respect of such dividends if paid to him, then nor could the overseas parent. He said:

Lord Walker of Gestingthorpe did not find the question easy but agreed with HMRC’s case. He said:

That perhaps reflects an uncharacteristic inaccuracy on the part of Lord Walker, reflecting what he had earlier said at paragraph 98g. With respect, section 247(2) does not affect the meaning of a “qualifying distribution”, which is defined in section 14(2). Election dividends remain a “qualifying distribution”, but what section 247(2) does is to provide that they are excluded from sections 14(1) and 231; and what section 14(1) does is to impose upon a UK resident company a charge to ACT when it makes a “qualifying distribution”. But that error does not in my view affect the substance of Lord Walker’s reasoning, which is in line with that of the others of their Lordships.

Lord Brown of Eaton-under-Heywood agreed with all four speeches.

The first issue – although it was argued by Mr Glick only after he had first addressed me on the merits of the new point – is whether Pirelli is entitled to argue its new point at all. That point is that (a) accepting that the House of Lords has finally decided that Pirelli Netherlands/Italy would not, had a group income election been exercisable and exercised, have been entitled to the DTA credit that they actually received, nevertheless (b) Community law required the UK to pay an appropriate tax credit to Pirelli Netherlands/Italy upon the subsequent payment of its MCT that Pirelli UK would have paid upon that hypothesis. The point is based on the proposition that under Community law the function of tax credits is not just to relieve ACT but to relieve underlying corporation tax of which ACT was merely an advance payment. Mr Aaronson admitted that, whilst that point had been raised before Park J, it was not argued either before the Court of Appeal or the House of Lords. He conceded that “it may be that some or all of their Lordships, probably some, assumed that the parent company would not be entitled to any form of tax credit at all.” I prefer the view that it is apparent that all their Lordships were operating on the basis that as the only available tax credit was one in respect of which the precondition was the payment of ACT, it followed that, upon the exercise of a group income election, no tax credit was available at all – including on the payment by Pirelli UK of its MCT. Mr Aaronson said that, had their Lordships asked for argument on the new point, Pirelli would have dealt with it, but that otherwise Pirelli had no intention of taking the point at that stage. They had of course won on both main issues in the courts below.

As to whether the attempt to raise the point now – on the remitted reference – amounts to an abuse of the process, it is necessary first to identify what it was that the prior litigation was all about. It is apparent that it was directed at identifying the key questions of principle relevant to the computation of the loss claimed by Pirelli UK; and, in particular, as to whether the DTA credits actually received had to be brought into account in that computation. It appears to me to be obvious that, if Pirelli’s stance was (i) that, if they were wrong on their primary arguments in that respect, nevertheless they would anyway have been entitled to a like, but larger, tax credit upon the payment by Pirelli UK of its MCT, and (ii) that the entitlement to such a credit was relevant to the computation of loss, then it follows that (iii) Pirelli should have argued that point at the same time as it argued its primary points.

Of course Pirelli did just that, at any rate before Park J: as explained, Mr Aaronson squarely raised the matter with Park J as being the Pirelli position if all else failed. That was, I consider, plainly the correct course to adopt. In the event Park J did not rule on the matter. Whether he would have done had he decided the two main points against Pirelli is unknown, although it seems to me probable that either he would have done or, if he had felt it necessary, he would first have invited further argument on the point: I have the impression that it was not fully argued before him. On any footing it appears to me to be clear that Pirelli could not fairly have been charged with any abuse of process if (assuming the matter had then proceeded directly to an inquiry as to their loss) they had sought to have the point decided.

Things did not, however, turn out like that. Pirelli had a famous victory before Park J on both primary points. But nothing is certain in litigation and it is a rash litigant who assumes that his first instance success is bound to be upheld in the Court of Appeal. I consider, therefore, that Pirelli ought to have raised their present point before the Court of Appeal by way of a respondents’ notice, although whether the Court of Appeal would either have wanted, or entertained, argument on it is another unknown. Similar considerations apply to the appeal to the House of Lords. Again, since the central argument before the House was as to the availability of DTA credits, I regard it as obvious that Pirelli should have made clear in their case to the House that their fallback position was that (i) even if no tax credit would have been payable on the notional exercise of a group income election, (ii) it would at least have been payable on the subsequent payment by Pirelli UK of its MCT, and (iii) if so, that went directly to the computation of Pirelli’s loss. Again, I cannot know whether the House would have wanted, or entertained, argument on the point, although my instinct is that the House would have been reluctant to decide merely half the relevant question, leaving the potentially important other half to be answered by another court on another day. The questions are so closely linked that it would seem obvious that they ought to have been decided at the same time. There is no question of Pirelli having in the meantime forgotten the point. On 30 March 2005 they started the new proceedings to which I have referred; and - immediately before and after the hearing before the House of Lords - Mr Aaronson was arguing two cases in the ECJ which he says provide important illumination on the point.

In these circumstances, whilst giving Pirelli due credit for raising the matter before Park J, it appears to me there is much to be said for the view that it is now too late to raise this new question of principle. I do not accept that the House of Lords had any contemplation that any such question - being one so closely related to the very point they were tasked to decide - would be raised in the inquiry they referred back to the Chancery Division. The inference from their speeches and from the terms of that reference is that all tax credit arguments had been done and dusted and that Pirelli had lost them. Does the attempt to raise the point now amount to an abuse of the process of the court?

The guidance as to how deal with such a question was considered by the House of Lords in Johnson v. Gore Wood & Co (a firm) [2002] 2 AC 1, and the relevant principle is to be found in the speech of Lord Bingham of Cornhill, at page 31. He there said:

That statement is of course directed to the raising in a second claim of an issue which could have been raised in an earlier claim. But its general thrust must be equally applicable to, for example, a case in which there is a split trial on liability and damages. If the claimant succeeds on liability, it is potentially abusive for the defendant to seek to raise on the inquiry as to damages a point which goes to liability and which he could and should have raised at the liability trial. Similarly, if Pirelli could and should have raised their new tax credit point before the Court of Appeal and House of Lords (it being closely related to the points which were there argued and being said to go to the principles by reference to which the computation of loss was to be assessed), it is arguably abusive for Pirelli to seek to raise that point for the first time in the context of an inquiry as to that computation. HMRC are entitled to say that they should not now be subjected to the new point.

I have not found this issue to be a straightforward one. I have made clear that I consider that Pirelli should have raised their new point as part of their argument in the House of Lords. I have, however, also observed that I cannot be certain as to whether the House would in fact have entertained it. Since that observation reflects the possibility that the House would not have entertained it, I consider that it follows that it would be a harsh judgment on Pirelli to decide the abuse of process issue on the basis that their last chance of raising the point, and of having it conclusively decided, was when the matter was before the House of Lords. That consideration indicates to me that the just disposal of the abuse of process issue requires the benefit of any doubt on the matter to be given to Pirelli. I find further support for that conclusion from the facts that (a) the point is not a new one as far as HMRC are concerned, and they have known since the hearing before Park J that it was waiting in the wings; (b) the point is a short one (the whole hearing before me occupied less than two days); (c) it is one that is of importance not just to Pirelli, but to more than 50 other litigants who are in a like interest, a consideration which Mr Glick accepted was a relevant factor; and (d) Mr Glick in fact chose to argue the merits of the point before arguing that I should not entertain any argument on it at all, which struck me as illogical: the whole point of HMRC’s assertion that the new point amounted to an abuse of the process was, in theory, to relieve them from the burden of having to argue it. Collectively, those considerations have satisfied me that I should not regard the raising of the point as amounting to an abuse of the process, and I hold that it is not. I propose, therefore, to decide it on its merits.

Pirelli of course accepts the decision of the House of Lords that the credits that were actually given to Pirelli Netherlands/Italy would not have been given had the Pirelli group exercised a group income election and thereby escaped a liability to ACT on the payment of the relevant dividends: I understood Mr Aaronson to accept that the UK’s domestic legislation only conferred the entitlement to a tax credit upon the payment of ACT. But Mr Aaronson’s submission was that Pirelli Netherlands/Italy’s right to a DTA credit on the payment by Pirelli UK of its MCT was established as a matter of Community law. Treaty credits were, he said, there for the purpose of preventing economic double taxation in respect of a company’s corporation tax, not in respect purely and simply of ACT, which, as its name suggests, was merely corporation tax paid in advance; and Community law therefore required the UK to grant Pirelli Netherlands/Italy a tax credit when Pirelli UK paid its MCT. Moreover, this tax credit should have been the full tax credit that a UK resident shareholder company would have received under the UK’s dividend taxation rules.

As regards the proposition that ACT was merely corporation tax paid in advance, Mr Aaronson referred to various pieces of support. In Hoechst, at paragraph 52 of its judgment, the ECJ described ACT as “in no sense a tax on dividends but rather an advance payment of corporation tax ….” In Deutsche Morgan Grenfell, supra, Lord Hoffmann, in paragraph 3, described ACT as “in theory corporation tax payable in advance of the due date on which it would otherwise have been payable.” Mr Glick expressly abstained from any argument that ACT is not to be regarded as corporation tax paid in advance and so for present purposes I will proceed on the basis that that is its correct characterisation.

On 12 December 2006 the ECJ gave its judgments on two sets of references by the Chancery Division in other proceedings within the GLO. Mr Aaronson relied on these decisions as making good his Community law point. The oral hearings in both cases had been conducted separately over a year before, on 22 and 29 November 2005 (and so straddled the argument in Pirelli before the House of Lords). Mr Aaronson, Mr Farmer and Mr Cavender were advocates in both cases, as was Mr Ewart. Both cases had a common Rapporteur and Advocate General. The first case I will refer to has the title Test Claimants in the FII Group Litigation v. Commissioners of Inland Revenue (Case C-466/04) (“FII” standing for “franked investment income”). The judgment opens by explaining that the reference was made in proceedings concerning the receipt by UK resident companies of dividends received from non-resident companies. That was, of course, the reverse of the circumstances in the present litigation, and the case concerned the different treatment applied to such a situation as compared with that applied to the case in which a UK resident company received dividends from its UK subsidiary. Mr Aaronson said the judgment provides relevant guidance on the point he has now raised.

By way of relevant legislative background, the ordinary principle was that where a UK resident company received dividends from a company resident in the UK it was not liable to corporation tax on that dividend (section 208). If no group income election had been made, it would, however, receive a tax credit under section 231 and the dividend and credit would constitute franked investment income. On the other hand, when a UK resident company received a dividend from a subsidiary resident outside the UK, it was liable to corporation tax on those dividends. It was not entitled to a tax credit which could be set off against ACT payable in respect of dividends which it later itself paid and the dividends did not qualify as franked investment income; but it would or might be entitled to relief against its MCT in respect of any tax withheld on the payment of the dividends in its state of residence by the overseas company making the distribution and, in certain cases, in respect of the foreign corporation tax paid on the underlying profits out of which the dividends were paid (sections 788 and 790). These last two factors tended to cause the resident company to accrue surplus ACT following its payment of dividends deriving from income from its foreign subsidiaries. This principle was modified as from 1 July 1994 (and until 1999) when a UK resident company receiving dividends from a non-resident company could elect that a dividend paid to its shareholders should be treated as a “foreign income dividend” (“FID”). ACT was payable on the FID but, to the extent that the FID matched the foreign dividends received, the resident company could claim repayment of the surplus ACT.

Question 2 of the nine questions before the ECJ was explained in paragraph 75 of its judgment as follows:

The UK Government’s argument (as explained in paragraph 85) was that this differential treatment involved no discrimination prohibited by Community law since it was founded on a distinction between dividends on which ACT had been paid (those paid by a resident company) and those on which it had not (those paid by a non-resident company). As no ACT had been paid on the latter dividends, there was no risk of economic double taxation as regards ACT. The ECJ observed, in paragraph 86, that the distinction nevertheless led, in practice, to a company receiving foreign-sourced dividends being less favourably treated than one receiving nationally-sourced dividends. That was because, on a subsequent payment of dividends, the former was obliged to account for ACT in full, whereas the latter had to pay ACT only to the extent to which the distribution paid to its own shareholders exceeded that which the company had itself received. The court proceeded to say:

The principle which can be derived from that is clear and is summarised in paragraph 94 of the judgment. But save that the quoted passage provides further support for the proposition that ACT is corporation tax paid in advance, the passage and its principle provide no direct assistance to the resolution of Pirelli’s point in the present case. The FII case was concerned with the equality of treatment enjoyed as between (a) a UK resident company which received dividends from a UK resident subsidiary, and (b) a UK resident company which received dividends from a foreign subsidiary. The former could set off an ACT tax credit against its own ACT liability when it paid a dividend, whereas the latter could not. The present case concerns equality of treatment following the exercise of a group income election under section 247 as between (a) a UK resident company with a UK subsidiary and (b) a foreign-resident company with a UK subsidiary. Mr Aaronson relied on the cited passage in support of the case that the DTA credits that Pirelli Netherlands/Italy in fact received should be characterised as credits received early not simply against ACT, but against the underlying corporation tax payable on the profits of Pirelli UK out of which the dividends were paid. He claimed to derive further support for the same point from paragraphs 158 and 159 of the judgment:

Thus, said Mr Aaronson, it follows equally, in the reverse factual situation with which I am concerned, that there is a similar risk of economic double taxation in respect of dividends paid under a group income election by a resident company to a non-resident company and that the function of the DTAs was to entitle such payees to a tax credit by way of protection against such risk. I can, however, find no support in the FII decision for Pirelli’s case that, upon the payment of a dividend to Pirelli Netherlands/Italy following a group income election and the subsequent payment by Pirelli UK of its MCT, those parents would have become entitled to the full tax credit claimed.

The other ECJ decision on which Mr Aaronson relied was its decision delivered on the same day in Test Claimants in Class IV of the ACT Group Litigation v. Commissioners of Inland Revenue (Case C-374/04). I found this to be of rather more assistance for present purposes than the FII case, although again it was concerned with rather different facts. The reference to the ECJ concerned the compatibility with Articles 43 or 56 of the EC Treaty of the UK’s denial of tax credits to non-resident companies receiving dividends from UK subsidiaries, when it grants such credits to (a) UK resident parents and (b) parents resident in member states pursuant to DTAs. The ECJ’s answers were that (a) it was not contrary to articles 43 or 56 of the EC Treaty for the UK, on a distribution of dividends by UK resident subsidiaries, to grant UK resident parents a tax credit equal to the fraction of the corporation tax paid on the distributed profits by the subsidiary when the UK did not grant such a tax credit to parents resident in another member state who were not subject to UK tax on dividends, and (b) nor did such articles prevent the UK from refusing to pay a tax credit provided for in a DTA concluded with one member state for companies resident in that state that received dividends from a UK resident subsidiary to companies resident in a third member state with which the UK had concluded a DTA that did not provide for such an entitlement for companies so resident.

In paragraph 49 the ECJ recognised that dividends paid by a company may be subject to a series of charges to tax: first, at distributing company level, as realised profits; second, to corporation tax at parent company level; and, third, to income tax at ultimate shareholder level. In paragraph 50 it said it is for each member state “to organise, in compliance with Community law, its system of taxation of distributed profits …”. In paragraph 55 it held that where a member state has a system for preventing or mitigating a series of charges to tax, or economic double taxation for dividends paid to residents by resident companies, it must treat dividends paid to residents by non-resident companies in the same way. In paragraph 57, however, it drew a distinction between that situation and the case in which a company resident in a particular member state pays dividends to (a) shareholders also resident in that state, and (b) shareholders resident in another member state. The point there made was that it is not necessarily true that the tax legislation of the former member state must treat both types of shareholder comparably. In paragraph 58 it explained that by saying that the former member state is “not in the same position, as regards the prevention or mitigation of a series of charges to tax and of economic double taxation, as the Member State in which the shareholder receiving the distribution is resident.” In paragraph 59 it explained that the member state in which the company making the distribution is located has no obligation (inter alia) to pay a non-resident shareholder “… a tax advantage equal to the tax paid on those profits by the company making the distribution, [since this] would mean in point of fact that that State would be obliged to abandon its right to tax a profit generated through an economic activity undertaken on its territory.” In effect, it was there saying that it is not the job of the state of residence of the dividend-paying company to prevent double taxation falling on shareholders in some other state. In paragraph 60, it said that, as regards preventing or mitigating economic double taxation by the grant of a tax advantage to the ultimate shareholder:

The principle which I derive from all that is, therefore, that (on the facts of the present case) it was the job of the Netherlands and Italy to protect Pirelli Netherlands/Italy and the ultimate shareholders (or at any rate those resident in the Netherlands and Italy) from any economic double taxation in respect of the dividends paid by Pirelli UK. It was not, however, the job of the UK to do so. A qualification to that is explained in paragraphs 55, 65 and 66 of the ECJ’s judgment, namely that were (in this case) any dividends to be onward paid by Pirelli Netherlands/Italy to ultimate shareholders resident in the UK, the UK would be:

That qualification does not, however, by itself have any impact upon whether, upon the payment by a UK subsidiary to a foreign parent any tax credit is required to be given. The effect of the ECJ’s judgment is that the default position is that there is no such requirement. However, there is an exception to that as explained in paragraph 68 and following. That arises in circumstances in which a member state “… unilaterally or by a convention imposes a charge to income tax not only on resident shareholders but also on non-resident shareholders in respect of dividends which they receive from a resident company” (paragraph 68). In such circumstances, the position of the non-resident shareholders becomes comparable to that of resident shareholders. As the ECJ explained (paragraph 69), that type of case arose in circumstances in which, under certain DTAs, “the United Kingdom provides that a shareholder company which is resident in the other contracting Member State is entitled to a full or partial tax credit for dividends which it receives from a company resident in the United Kingdom.” Examples of such DTAs are those entered into by the UK with the Netherlands and Italy. As I have explained, they provided for a tax credit of 12.5% of the dividend paid by a UK subsidiary to its foreign parent in circumstances in which ACT had been paid on the dividend. The sum of the dividend so paid and the tax credit was then subject to a UK income tax charge of 5%, resulting in a net credit of 6.875% of the dividend being paid to the foreign parents.

The exceptional case so identified by the ECJ was, therefore, one in which the UK taxed both the dividend paid to the UK parent and also that paid to the foreign parent. In such a case the ECJ held that the UK was required to confer a tax credit on that foreign parent by way of relief against the economic double taxation that it caused although only if it provided equivalent relief against such double taxation in the case of a UK resident parent. If, however, the UK did not tax the dividend in the hands of the foreign parent – and so did not itself cause any economic double taxation - it was under no Community law obligation to ensure that the foreign parent was not liable to either a series of charges to tax or to economic double taxation: that was a matter for the state of residence of the foreign parent. The ECJ concluded its answer to the relevant question as follows:

A key principle, which is to be derived from paragraph 70, is that it is “solely” if the UK not only taxes the underlying profits of the UK subsidiary but also taxes the dividend payable to the foreign parent “that, irrespective of any taxation in another Member State, a risk of a series of charges to tax may arise.” Therefore in this case it is only when (and if) the UK taxed the dividends payable by Pirelli UK to Pirelli Netherlands/Italy that there was any risk of such a series of tax charges and that it had to ensure that Pirelli Netherlands/Italy were subject to the same treatment as resident shareholder companies. Having summarised the holdings of the ECJ in its judgment, it is perhaps helpful also to refer to three paragraphs in the Opinion of the Advocate General, which I regard as fully reflected in the decision of the ECJ. He said:

Applying to the present case the principles reflected in paragraphs 55 to 74 of the ECJ’s judgment (paragraph 70 of which was recently re-affirmed by the ECJ in paragraph 90 of its judgment in Test Claimants in the Thin Cap Group Litigation v. Commissioners of Inland Revenue Case-524/04), I am unable to understand how they are said to support Pirelli’s assertion that, had it exercised a group income election, it would have become entitled to a tax credit, let alone an enhanced one of the nature for which Pirelli contends.

The starting point is that it is clear, as a matter of domestic law, that in the case of a group income election as between exclusively UK resident companies, the UK parent would not be entitled to a tax credit either when the dividend was paid or when its UK subsidiary later paid its MCT. It would, therefore, be odd if, in the case of a like election between a UK subsidiary and its foreign parent, the latter were to be entitled to a tax credit in circumstances in which a UK parent would not. Why should Community law be thought to intend such discriminatory treatment in favour of a foreign parent? I cannot see that the Class IV case provides any support for the thought that it does or might. What it does show is (i) that Community law requires the UK to relieve economic double taxation suffered by a group in respect of a dividend paid by a UK subsidiary to a foreign parent in cases in which (a) the UK itself imposes economic double taxation by exercising taxing rights over the dividend and (b) where the UK relieves such economic double taxation in the case of a UK parent; but (ii) that the UK is not responsible for relieving economic double taxation caused by the tax regime in the home state of the parent company.

In the circumstances of the present case, there can be no question of the UK being under an obligation to relieve Pirelli Netherlands/Italy from any suggested economic double taxation suffered in respect of the relevant dividends. The House of Lords has decided, in a decision binding on Pirelli, that, as Lord Scott put it:

As it appears to me, there is no more to Pirelli’s case than that. I have also failed to understand what credit Pirelli Netherlands/Italy could have been entitled to. The relevant hypothesis is that the Pirelli group had exercised a group income election and that a dividend had been paid to Pirelli Netherlands/Italy in respect of which no ACT had been payable or paid. Assume that Pirelli UK’s distributable profits had enabled a dividend of £100,000 to be paid and that when, say nine months later, it paid its MCT (at a rate of 30%) its liability was only £10,000. What credit is said to be payable to Pirelli Netherlands/Italy at that point? Apparently it is said to be 25% of something, but of what and why I do not understand. Domestic law does not provide any such entitlement either to a UK parent or to a foreign parent; and I do not understand Community law to regard UK law as deficient in this respect.

In the light of that conclusion I regard it as unnecessary to consider Pirelli’s claim that, upon the payment of the MCT, it would have been entitled not just to a credit but to an enhanced credit. I simply do not follow the premise on which that claim is said to arise. Moreover, I anyway regard as irrelevant to the loss computation exercise which the House of Lords has remitted to the Chancery Division the notion that Pirelli Netherlands/Italy might in theory have some claim to an enhanced credit that they have never received and in respect of which only in March 2005 did they think fit to make a claim.

In my judgment Pirelli’s argument that, had it exercised a group income election, Pirelli Netherlands/Italy would have been entitled to a tax credit upon the subsequent payment by Pirelli UK of its MCT is mistaken. I hold that they would not and will so declare.