Case Preview: Prudential Assurance Company Ltd v Commissioners for Her Majesty’s Revenue and Customs
27 Tuesday Mar 2018
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Pat Dugdale, consultant in the tax team at CMS, offers a preview of the decision awaited in Prudential Assurance Company Ltd v Commissioners for Her Majesty’s Revenue and Customs:
The litigation arising out of the UK’s former tax rules for foreign dividends has been so protracted that there is now a generation of younger tax lawyers with no recollection of what it was all about in the first place. It is now 19 years since the abolition of ACT and 9 years since the introduction of a general tax exemption for most UK and foreign dividends but litigation arising from the earlier tax rules still rumbles on.
On Tuesday 20 and Wednesday 21 February 2018, the UK Supreme Court heard the appeal of Prudential Assurance Company Ltd v Commissioners for HMRC and the outcome is awaited. Prudential is a Test Claimant in group litigation, which relates to periods from 1990-2009, so a lot of tax revenue hinges on the outcome of this litigation. The issues in dispute are extremely complex (even for those of us with long memories), so it’s worth re-capping briefly on the old rules and why they fell foul of EU law.
The case concerns the tax treatment of UK-resident companies which received dividends from portfolio shareholdings in companies resident in the EU and other countries. At that time UK companies were not taxed on dividends from other UK companies but were taxed on foreign dividends, including dividends from companies in EU member states. Where a UK company held 10% or more of the voting power in the foreign company in question, a credit was available for a corresponding share of the “underlying tax”, (the tax paid by the foreign company on the profits out of which the dividend was paid), but no credit was available for underlying tax in the case of “portfolio shareholdings”, being shareholdings below this 10% threshold. The ECJ confirmed that the UK’s tax treatment of foreign dividends breached Article 56 of the EC Treaty (now Article 63 TFEU) and was unlawful to the extent that the UK company shareholder received no tax credit for this underlying tax.
HMRC accepts that a tax credit should be available in principle. The current dispute focuses on how to quantify this tax credit in order to avoid discriminatory treatment of national and foreign sourced dividends, in particular whether the credit should be at the “nominal” rate or the “effective” rate of tax paid by the foreign company. The amounts could be very different. The nominal rate would be the main rate of tax on corporate profits but a company may in reality pay a significantly lower effective rate of tax due to tax reliefs and exemptions. HMRC’s position is that the tax credit should be at the effective rate paid in the foreign country. The Court of Appeal, however, held that it should be the higher of the nominal and effective rates on the basis that a UK company receiving a dividend from a UK company would not be taxed on the dividend even if the dividend paying company had paid corporation tax at a lower effective rate than the dividend recipient.
The position was aggravated by the old ACT regime under which a UK company paying a dividend had to account for advance corporation tax. This could be credited against its liability to mainstream corporation tax so was often just a timing disadvantage. Furthermore a dividend from a UK resident company would “frank” a dividend paid by the recipient company removing the need for the recipient to account for ACT when paying an equivalent dividend to its shareholders. However, the ACT system involved real additional cost for companies receiving foreign income. Foreign dividends were taxable and did not “frank” dividends paid out of them. Furthermore if the UK resident dividend-paying company was entitled to substantial double taxation relief for foreign taxes, its mainstream corporation tax liability could be lower than its ACT, so ACT was a real additional cost. The introduction of the FIDs (foreign income dividends) regime in 1994 was designed to mitigate this problem by enabling UK companies to pay dividends funded by foreign dividend receipts in a way which did not trigger surplus ACT. However there remained many companies which had accounted for corporation tax and/or ACT subsequently ruled to be unlawful and this has resulted in further issues to be decided by the UK Supreme Court, including how to quantify how much ACT was unlawful and whether lawful ACT may only be set against lawful corporation tax, and unlawful ACT against unlawful corporation tax, or whether both types of ACT can be utilised pro rata.
Some the issues in this case are of only historical interest as the dividend exemption introduced in 2009 applies to both UK and foreign dividends, but a lot of tax is at stake so this is a case which very much still matters.
