Pirelli Cable Holding NV & Ors v Inland Revenue

The House of Lords allowed the Crown's appeal on three central issues arising from the unforeseen effect of European Community law on the United Kingdom's partial imputation system for corporation tax and the application of bilateral double taxation conventions. First, on a purposive construction of the Netherlands and Italian double taxation conventions (in particular article 10(3)(c) read with section 788(3)(d) ICTA 1988 and the domestic definition of 'tax credit' in section 832(1)), dividends paid as 'election dividends' under a group income election do not attract convention tax credits because such dividends by definition are excluded from the scope of section 231 and do not give rise to ACT. Second, compensation for the breach of the freedom of establishment (as identified in Metallgesellschaft/Hoechst) is to be assessed by reference to the group as a whole; any convention tax credits actually received by overseas parent companies are a countervailing benefit and must be taken into account in fixing compensation payable to the United Kingdom subsidiaries. Third, Advance Corporation Tax (ACT) is not a withholding tax within the meaning of Articles 5.1 and 7.1 of Council Directive 90/435/EEC (the Parent/Subsidiary Directive), so no reference to the European Court of Justice was required on that point. The case was remitted to Park J to resolve a factual question whether the group would have elected to have dividends paid free of ACT.

The Pirelli group brought test litigation following the decision of the Court of Justice in the Metallgesellschaft/Hoechst cases that the United Kingdom's restriction of group income elections to UK‑resident parent companies infringed the Treaty freedom of establishment. The United Kingdom subsidiaries had paid Advance Corporation Tax (ACT) on dividends paid to non‑resident parent companies, which in turn received reduced convention tax credits under double taxation agreements with the Netherlands or Italy.

The proceedings raised three principal issues:

• The election issue — whether, on the hypothetical that a group income election had been available and made so that the dividends in question would have been 'election dividends' (and not subject to ACT), the overseas parent companies would nevertheless have been entitled to convention tax credits under the Netherlands and Italian conventions (article 10(3)).
• The assessment issue — whether, if the parents would not have been entitled to convention tax credits in that hypothetical, the actual convention tax credits they did receive should be taken into account when assessing compensation payable to the UK subsidiaries for the breach of article 43 (formerly article 52) EC.
• The withholding tax issue — whether ACT was a withholding tax prohibited by the Parent/Subsidiary Directive (articles 5.1 and 7.1), requiring a reference to the European Court of Justice.

The House of Lords held (i) that article 10(3)(c) must be read purposively in conjunction with the domestic statutory framework incorporated by section 788(3)(d) ICTA 1988, so that the notion of a 'tax credit' in the conventions imports the domestic concept of a tax credit under section 231 and, therefore, does not extend to election dividends excluded by section 247(2); (ii) that compensation for the Treaty breach must be assessed having regard to the fiscal 'package' affecting both subsidiary and parent, so convention tax credits actually obtained by parents are relevant countervailing benefits to be taken into account when fixing compensation; and (iii) that ACT falls within the exception in article 7.1 of the Parent/Subsidiary Directive and, on the Court of Justice's jurisprudence, is not a withholding tax within article 5.1, so no reference was necessary. The case was remitted to the trial judge to determine whether, on the facts, the group would in fact have elected to have dividends paid free of ACT.

Appeal allowed. The House held that (1) the Netherlands and Italian double taxation conventions (article 10(3)(c)) do not entitle parent companies to convention tax credits in respect of dividends paid as election dividends because the conventions import the domestic concept of a 'tax credit under section 231' which is excluded for election dividends by section 247(2) ICTA 1988; (2) compensation for the breach of the freedom of establishment is to be assessed by reference to the group as a whole and must take account of convention tax credits actually received by the overseas parents as countervailing benefits; and (3) ACT is not a withholding tax for the purposes of Council Directive 90/435/EEC (Articles 5.1 and 7.1), so no preliminary reference was required. The matter was remitted to Park J to decide the unresolved factual question whether the group would have elected to pay dividends free of ACT.

Appeal to the House of Lords from the Court of Appeal ([2003] EWCA Civ 1849; reported at [2004] STC 130). First instance decision by Park J reported at [2003] STC 250. The House allowed the Crown's appeal and remitted factual issues to the trial judge.