UK Inland Revenue Faces Massive Damages and Restitution Claims
October 3, 2003
Three UK Group Litigation Orders (GLO's), equivalent in many respects to a US class action, were issued in recent weeks by the English High Court in respect of claims against the UK tax authority, the Inland Revenue.
The amounts at stake are potentially very large for many taxpayers; therefore, clients are urged to review their positions as a matter of priority to determine whether any of the following applies to them. The position is also time-critical.
It appears that many taxpayers, who were otherwise aware of these developments, nevertheless have not correctly identified all the possible grounds for a claim, or have not appreciated the true potential extent of these issues beyond the geographical scope of the EU, or have not appreciated the degree of urgency.
The effect and intention of these GLO's is to group together a significant number of claims made by UK companies and others that UK tax law infringes European Community (EC) law, which governs relationships within the European Union (EU).
In general terms, a GLO mandatorily groups together similar claims, and enables the selection of a test case or cases with common issues of fact or law, and provides for a proportion of the legal costs to be shared amongst all the claimants. These costs include the costs of bringing the test case(s) as well as the cost liability of the Claimants for the legal costs of the Inland Revenue in the event the claims are unsuccessful.
What Do the Orders Cover?
The GLO's each cover one of the following separate major issues:
1. UK Group Relief, whereby it is possible for a member of a UK Group of Companies to surrender losses for Corporation Tax purposes to fellow members of the same group. The complaint being made by the Claimants is that the rules which prevent UK companies claiming relief for the losses of their fellow non-UK group members unfairly discriminate against the establishment of companies in the EU outside the UK.
2. The UK's so called "Thin Capitalisation" rules, which restrict the amount of tax relief a UK company can claim for interest deductions. These cover both interest paid to parents and fellow subsidiaries, and in certain circumstances can result in the re-characterisation of interest into a dividend. The assertion here is that the UK rules are unenforceable following the decision of the European Court of Justice (ECJ) in the case of Lankhorst-Hohorst GmbH.
3. The UK's Controlled Foreign Company (CFC) legislation, which forces certain subsidiaries of UK companies either to repatriate their profits, or in default of actual repatriation, taxes the parent company on a deemed dividend of those profits. Again, the claim is that these rules discriminate against subsidiaries set up in the EU outside the UK, and is thus incompatible with EC law.
Who Should Consider Joining the GLO?
You should actively consider registering a claim under the GLO procedure if, in the last six years, you have:
- Suffered losses in any subsidiary within the EU that you would have been able to Group Relieve had the non-UK subsidiary in fact been resident in the UK. It is also possible that subsidiaries in non-EU territories with an appropriate non-discrimination clause in their treaties might also be able to make effective claims; or:
- Have had interest disallowed or re-characterised under the UK's so-called Thin Capitalisation legislation, including Section 209 (Distributions) or Schedule 28AA (Transfer Pricing) or, in direct consequence of a threat to apply this legislation, resorted to alternative financing that was more costly; or:
- If, in consequence of the CFC legislation, you have been forced to distribute profits to avoid a CFC apportionment, suffered an apportionment, or believe you have been prejudiced in any other way by the CFC legislation forcing you to do things differently with resultant cost to you.
Why Bother?
Unlike other tax disputes involving widely applicable principles, it is not an option to sit back and wait for the outcome of the test cases. This is for a number of reasons:
- The remedies sought under the GLO's (declaratory relief, restitution or damages) are personal in nature i.e. are specifically granted to the particular Claimants listed on the group register. They are not automatically universally available.
- Accordingly, unlike other cases that set a precedent which may subsequently be relied upon by other taxpayers in their own particular cases, only those Claimants entered on the group register at the time of judgement would be automatically entitled to rely directly upon the judgement, assuming of course that the Court finds in favour of the test case Claimant.
- In any event, the GLO's contain provisions making it mandatory for any similar claims being pursued in other courts to be transferred to the "Management Court" for the Group Litigation under the specified "Management Judge" and entered on the group register. These additional claims are then automatically stayed under the GLO. It is not therefore possible for taxpayers with similar claims to act independently.
- The Management Judge may order that claims shall not be entered on the group register after a particular date. If a corporate taxpayer decides subsequent to the closure of the register that it wants to avail itself of the remedies given to other Claimants, admission of the claim at that stage will be entirely at the discretion of the Management Court. An application will therefore have to be made to the Management Court asking it to exercise its discretion in the new Claimant’s favour and that discretion may not be exercised in favour of the would-be Claimant.
- Under the GLO procedure, a portion of the costs (the "Common Costs") is shared amongst the Claimants. Therefore, win or lose, the GLO offers a cost efficient way of pursuing a claim.
What is the Rush?
As indicated above, taxpayers will be able to look back over a six-year period to determine whether any of the foregoing conditions apply to them.
- The time limit runs from the date on which any tax was paid in consequence of the legislation complained of, or the date of any action by the authorities which it is alleged resulted in financial damage.
- As each day goes by, therefore, all taxpayers are exposed to the possibility of potential claims becoming time barred.
- In addition and as indicated above, under the GLO procedure, the Management Court may specify a date after which no claim may be added to the register unless the Court gives permission, and this is at the Court's discretion.
Within the last few weeks, the UK Government announced the intention to introduce legislation the effect of which is to restore the six year time limit to tax claims. Prior to that, as highlighted by the recent decision in Deutsche Morgan Grenfell Group plc case, taxpayers could look back for an unlimited period to determine whether they had grounds for a claim.
This stemmed from the court decision in Deutsche Morgan Grenfell above that, where restitution was granted as a result of a disadvantage suffered in consequence of a mistake of law, the limitation period under the Limitation Act 1980 only starts to run from the discovery of the mistake.
As in Deutsche Morgan Grenfell, which resulted from an earlier decision of the ECJ in the Hoechst and Metallgesellschaft cases concerning the payment of Advance Corporation Tax (ACT), all the matters covered by the GLO relate to alleged conflicts between UK and EC law. Where EC law prevails, the result is usually that the prior application of UK law, as it was previously understood, amounts to a mistake in law.
The revisions to the Limitation Act above, published as draft legislation, are stated to be effective from the date of the announcement (9 September 2003). Even though the changes will not be enacted until 2004, they will be retrospective to the announcement. There is, of course, always the possibility that these proposals are not enacted, or not enacted in their proposed form.
What Has Given Rise to All These Claims?
The EC Treaty, as amended, contains a number of Articles, which override the provisions of the domestic law of individual member states of the EU.
The purpose of these Articles is to ensure, as far as possible, a level playing field for economic activity within the EU.
In very brief summary, the key provisions that most frequently impact upon tax matters are:
i) Article 12 -No discrimination
ii) Article 39 - Freedom of movement of workers
iii) Article 43 - Freedom of establishment
iv) Article 48 - Treatment of companies or firms in the same way as natural persons
v) Article 49 - Freedom of movement of services
vi) Article 56 - Freedom of movement of capital
vii) Articles 96 & 97 - Prohibition of measures distorting competition
The provisions of Article 56 - Freedom of movement of capital) are subject to Article 58 which permits Member States to apply the relevant provisions of their tax law which distinguish between taxpayers who are not in the same situation with regard to their place of residence, and to take all requisite measures to prevent infringements of national law and regulations, in particular in the field of taxation.
The ECJ has, however, from some of its earliest decisions made it plain that measures purely designed to protect the tax base of one Member State cannot be justified on the grounds of prevention of tax avoidance. The judgements in the ICI and Lankhorst cases effectively say that tax avoidance is not recognised as such if the taxpayers are paying tax somewhere in the EU.
Moreover, discrimination in the tax laws of a Member State against enterprises purely on the grounds of country of residence has been held to be abhorrent in EC law on the grounds that it would "deprive Article 52 [of the EC treaty] of all meaning." (See the cases of Hoechst, Metallgesellschaft and Lankhorst-Hohorst above, and, more recently, Bosal Holdings.)
The interpretation and application of EC law is moving quite rapidly in its development. It is already apparent, however, that the sentiments of the ECJ lie in the direction of harmonising the tax systems of Member States wherever there is an opportunity to do so, and removing differences in tax treatment in the domestic law of Member States wherever those differences are based on country of origin of the enterprises concerned.
Conclusion
As indicated above, clients need to scrutinise their positions very carefully to determine whether they have the basis of a claim.
Some of the circumstances that may give rise to a valid claim may not immediately be obvious.
Further, if the cases succeed, then there is a good chance that they will have effect beyond the confines of the EU in relation to other territories that have appropriate non-discrimination Articles in a tax treaty with the UK.
Although it may be some while before these cases are resolved, particularly if the matter necessitates a reference to the ECJ, and some of the cases or certain aspects of them may not succeed, the amounts involved are potentially enormous for some taxpayers.
