The Prudential Assurance Company Ltd v HM Revenue and Customs

Where domestic dividends are exempt but foreign dividends are taxed under an imputation system, EU law requires equivalent treatment. If domestic companies generally pay tax at an effective rate below the nominal rate, credit limited to foreign tax actually paid is insufficient. The credit must take account of the foreign nominal rate, while preserving credit for any higher actual tax, subject to the domestic charge.

A conforming interpretation of Income and Corporation Taxes Act 1988 may extend the statutory tax-credit mechanism to foreign portfolio dividends. The ordinary rules for franked investment income and ACT then apply. In quantifying restitution, lawful and unlawful ACT and corporation tax which were historically undifferentiated should ordinarily be attributed pro rata.

The claimant, a UK life assurance company, sought restitution of corporation tax and advance corporation tax (ACT) unlawfully levied on dividends received from foreign companies in which it held portfolio interests. The claim arose from the incompatibility of the former UK dividend-tax regime with EU free-movement rules.

HMRC appealed from Henderson J’s principal and consequential judgments in the Chancery Division: [2013] EWHC 3249 (Ch) and [2015] EWHC 118 (Ch). The principal issues concerned the amount and operation of the tax credit required for foreign dividends, the calculation of unlawful ACT, restitutionary defences, interest, limitation, and whether HMRC could advance unpleaded points on appeal.

1. Appeal allowed in part. HMRC succeeded only on Issues 21, 22 and 23, concerning the attribution of lawful and unlawful ACT. The appeal was otherwise dismissed.

2. Articles 49 and 63 TFEU required equivalent treatment of domestic and foreign dividends. In the circumstances identified by the CJEU in Test Claimants in the FII Group Litigation, Case C-35/11, a system which exempted domestic dividends but gave credit for foreign tax only at the effective rate was unlawful. The court was bound by that ruling. A compliant credit had to be the higher of the actual underlying foreign tax and the foreign nominal rate, capped by the relevant UK charge after credit for withholding tax. The principle applied equally to portfolio and non-portfolio dividends.

3. The judge was entitled to adopt a conforming interpretation of section 790 of the Income and Corporation Taxes Act 1988. Section 231(1) was to be read as granting the EU-required credit for foreign portfolio dividends. Those dividends entered the domestic ACT system with that credit and were treated, to that extent, as franked investment income. Sections 238 and 241 then operated according to their ordinary meaning. HMRC’s proposed tracing and pro-rating methodology could not be introduced as a separate alteration to section 241.

4. For Issues 21, 22 and 23, however, the fair counterfactual was a pro rata attribution. Where payments, credits or repayments historically comprised indistinguishable lawful and unlawful elements, neither party should be favoured by a notional priority. Excess franked investment income and ACT repayments were therefore allocated proportionately, and a repayment could not be attributed to an ACT payment made only after that repayment.

5. A group litigation order did not remove the duty to plead material facts. HMRC could not raise on appeal new points requiring factual findings, or points raised too late below. Its change-of-position plea also failed: expenditure of tax receipts did not itself establish the defence, and HMRC had pleaded and proved no evidential basis. Compound interest remained recoverable in accordance with Littlewoods Retail Ltd v HMRC, [2015] EWCA Civ 515.

• Court of Appeal (Civil Division): HMRC’s appeal was allowed on the three limited ACT attribution issues and otherwise dismissed: [2016] EWCA Civ 376 .
• High Court of Justice, Chancery Division: Henderson J determined the principal tax, restitution and procedural issues, and later made consequential rulings on relief: [2013] EWHC 3249 (Ch) and [2015] EWHC 118 (Ch) .