Prudential Assurance Company Ltd v Commissioners for Her Majesty’s Revenue and Customs

EU law requires foreign portfolio dividends to receive a tax credit calculated by reference to the foreign nominal tax rate where domestic dividends are exempt.

Unjust enrichment reverses a defective transfer of value. A recipient’s opportunity to use mistakenly paid money is a consequence of the payment, rather than a separate enrichment transferred by the payer. Interest for delayed repayment is therefore compensatory and may be awarded under section 35A of the Senior Courts Act 1981, but compound interest is not recoverable merely as restitution.

Lawful advance corporation tax cannot be set against an unlawful mainstream corporation tax charge, because that charge is a nullity. Unlawful advance corporation tax is allocated first against unlawful mainstream corporation tax, while carried-back domestic franked investment income relieves only lawful advance corporation tax.

Prudential Assurance Company Ltd v Commissioners for Her Majesty’s Revenue and Customs concerned a test claim by a United Kingdom company which had received dividends from portfolio investments in overseas companies. During the relevant period, domestic dividends were exempt from corporation tax, while foreign dividends were taxed without equivalent relief.

Henderson J held that the company was entitled to a tax credit and to compound interest: [2013] EWHC 3249 (Ch); [2014] STC 1236. He subsequently determined questions about the allocation of lawful and unlawful advance corporation tax: [2015] EWHC 118 (Ch); [2015] STC 1119. The Court of Appeal gave judgment at [2016] EWCA Civ 376; [2016] STC 1798.

The principal questions before the Supreme Court concerned the rate of the foreign-dividend tax credit, the availability of compound interest in unjust enrichment, restitution of lawful advance corporation tax purportedly set against unlawful mainstream corporation tax, and the allocation of advance corporation tax and carried-back franked investment income.

1. Disposition. Lord Mance, Lord Reed and Lord Hodge delivered a joint judgment, with which Lord Sumption and Lord Carnwath agreed. HMRC’s appeal was dismissed on Issue I and allowed on Issues II and III. PAC succeeded on Issue V(a), and Issue V(b) was determined in its favour. Issue IV did not arise.

2. Foreign-dividend credit. The jurisprudence of the Court of Justice, particularly Test Claimants in the FII Group Litigation v Revenue and Customs Comrs EU:C:2012:707, established that the credit for foreign portfolio dividends must be calculated by reference to the foreign nominal tax rate. There was no relevant distinction between portfolio and controlling investments. The nominal-rate solution was adopted despite possible inequities because a complete comparison between national tax systems was impracticable. No further reference to the Court of Justice was required.

3. Interest and unjust enrichment. Unjust enrichment corrects a normatively defective transfer of value. The opportunity to use mistakenly paid money is not an additional transfer distinct from the payment itself. Repayment of the principal reverses the enrichment, while interest compensates for delayed payment of the resulting debt. Simple interest could therefore be awarded under section 35A of the Senior Courts Act 1981. The court disapproved the restitutionary reasoning in Sempra Metals Ltd v Inland Revenue Comrs [2007] UKHL 34, while leaving its reasoning concerning damages unaffected. PAC’s compound-interest claims in categories (b) and (c) were rejected. Its category (a) claim remained because HMRC had conceded it.

4. Lawful ACT and unlawful MCT. A mainstream corporation tax charge incompatible with EU law was a nullity. Lawful advance corporation tax could not be set against that nullity and remained available for carry-back, carry-forward or other lawful utilisation under section 239 of the Income and Corporation Taxes Act 1988. Its payment was not a defective transfer and gave rise to no restitutionary claim. Any loss resulting from its non-utilisation could be relevant to damages, if the requirements of such a claim were established.

5. Allocation. A pro rata allocation between lawful and unlawful tax was inconsistent with the nullity analysis. Unlawful advance corporation tax was to be treated as utilised first against unlawful mainstream corporation tax; any residual unlawful advance corporation tax was treated as utilised against lawful mainstream corporation tax. Domestic franked investment income carried back under paragraph 4 of Schedule 13 was applied only to lawful advance corporation tax, preserving the foreign-dividend credit required by EU law.

• United Kingdom Supreme Court: HMRC’s appeal was allowed on Issues II and III and dismissed on Issue I. PAC succeeded on Issue V(a), and Issue V(b) was determined in its favour: [2018] UKSC 39.
• Court of Appeal: The court declared that foreign dividends should receive credit at the effective or nominal foreign rate, whichever was higher, subject to the domestic cap. It upheld compound interest because it considered itself bound by earlier authority and adopted pro rata allocation on Issues V(a) and V(b): [2016] EWCA Civ 376; [2016] STC 1798.
• High Court: Henderson J held that an appropriate tax credit and compound interest were recoverable: [2013] EWHC 3249 (Ch); [2014] STC 1236.
• High Court, subsequent judgment: Henderson J determined the allocation questions concerning lawful and unlawful advance corporation tax and carried-back franked investment income: [2015] EWHC 118 (Ch); [2015] STC 1119.