High Court backs European Court Decision paving way for billions of pounds in tax rebates

The prospect of billions in tax rebates according to the UK government’s own estimates came a step closer today when the UK’s High Court backed an earlier European Court of Justice decision that the UK’s system of taxing foreign dividends contravenes EU law.
The payouts relate to UK tax levied in the past (and currently) on dividends paid from EU-based companies paid to UK taxpayers (mostly corporates) going back several years.

And although HM Treasury confirmed in this week’s pre-budget report that it intends to change the rules such that dividends received by UK companies from foreign companies will not be taxed in the UK, the UK taxation of previously paid foreign dividends is in dispute with hundreds of claims for refunds already filed in the UK Courts and with HMRC.

The sums of money at stake are considerable; in a submission to the European Court of Justice in 2006, the UK government estimated HM Treasury stood to lose billions in potential tax refunds.

Jonathan Bridges, Associate Partner, International Corporate Tax at KPMG in the UK, said

“Today’s High Court judgement makes absolutely clear that the UK dividend taxation rules breach EU law. This paves the way for massive tax rebates. Given the fragile state of public finances and the forecast drop in tax receipts as a result of the economic downturn, the last thing that the Treasury will want to do is make refunds on this scale so we fully expect there to be an appeal. But today’s decision is a significant step on the way to a victory for the taxpayers in this case.”

Background and technical details of the case

At the heart of this case is the principle that member states should not discriminate against one another so a transaction between two member states should be treated in the same way as a domestic situation.

In line with this principle, in an earlier ruling (December 2006) the European Court of Justice confirmed that foreign sourced dividends should not suffer more UK tax than UK-sourced dividends but the ruling went on to state that various methods by which to achieve this equanimity are acceptable.

What this means is that, in the view of the ECJ, parity can in principle be achieved through a credit or exemption system. The ECJ then referred the matter back to the British courts to determine whether the UK rules operate to achieve this parity.

The UK currently operates a credit system to relieve double taxation on foreign sourced dividends. In contrast, the UK exempts UK sourced dividend payments to a UK taxpayer entirely irrespective of the actual tax suffered at the level of the UK subsidiary from whose profits the dividends derive and this is the kind of model expected for all foreign dividends once the changes announced in the pre-budget report have been drafted into law and enacted. The current rules often result in profits generated overseas being taxed more heavily that profits generated in the UK.