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Discriminatory UK tax law

Category Technical Articles
AuthorTechnical Department
What will Hoechst and Metallgesellschaft really mean?

This article examines the practical implications of the Hoechst case itself, its possible broader application, and also some of the other areas of UK tax law that may be incompatible with the right to freedom of establishment under Community law.

Article by Anton Hume, international tax partner in Grant Thornton's International Tax Group in London and Robert Langston, a tax consultant in the firm's National Tax Department. The views expressed are their own and not necessarily those of the firm. Published in the February 2002 issue of Tax Adviser.

On 8 March 2001, the European Court of Justice (ECJ) delivered its ruling in the cases of Hoechst AG & Hoechst UK Ltd v IR Commrs & Attorney-General (Case C-410/98)[2001] BTC99 and Metallgesellschaft Ltd v IR Commrs & Attorney-General (Case C-397/98) [2001] BTC 99. As expected, the ruling agreed with that of the Advocat General which was delivered in October 2000.

Hoechst UK Ltd is a wholly owned subsidiary of Hoechst AG, a company resident in Germany. Hoechst UK Ltd paid dividends to Hoechst AG and accounted for ACT on them in accordance with the requirements of UK tax law. However, the ECJ ruled that it was not consistent with Community law for Income and Corporation Taxes Act 1988 (ICTA 1988), s. 247 (1) - under which a dividend could be paid under a group income election by a subsidiary resident in the UK to its parent company which is also resident in the United Kingdom (UK) without advance corporation tax (ACT) – to be restricted to cases where both parent and subsidiary were resident in the UK. United Kingdom law in this respect was held to infringe the right to freedom of establishment under Art. 52 of the Treaty of Rome (now Art. 43 of the Treaty of Amsterdam).

Although Hoechst UK Ltd was able to set the ACT paid against its mainstream corporation tax liability, the ECJ ruled that the company is entitled to compensation for the financial loss sustained – in other words, the loss of use of its cash resulting from the early payment of corporation tax. The ECJ held that it is for the UK to lay down the detailed procedural rules governing the payment of financial restitution, and ancillary questions such as the payment of interest, but that those rules must not ‘render practically impossible or excessively difficult the exercise of rights conferred by Community law’. The Inland Revenue have since issued further information on how to they intend to proceed with claims to compensation made as a result of the Hoechst decision.

It is also becoming increasingly apparent that the consequences of the decision and those of a number of other ECJ cases on the subject of discrimination may be much wider than the particular facts addressed in Hoechst.

This article examines the practical implications of the Hoechst case itself, its possible broader application, and also some of the other areas of UK tax law that may be incompatible with the right to freedom of establishment under Community law.

Mechanism for making claims under Hoechst

Following the Hoechst decision, the Revenue have received a number of initial claims to compensation from companies in comparable positions to Hoechst. Their response has been that there are a number of important issues ‘not determined by the European Court of Justice’. Principal amongst them is not the entitlement to compensation itself – this right is clear from the decision. However, not determined by the ECJ is the amount of compensation – essentially a procedural issue which the ECJ held was for the UK to determine.

In light of this, the Revenue decided to apply for a Group Litigation Order (GLO) in the High Court, which will decide the issues common to all claims which can been made following the Hoechst decision. It also aims to address other related issues which the decision raises.

The application was approved on 26 November 2001, and test cases will be selected shortly. The issues decided will then be binding on all claimants.

Scope and nature of claim

The GLO will examine a number of issues arising from UK provisions which provide for the payment of ACT. Common to all claims are:

  • the nature of the claim i.e. restitution based on a mistake of law or as a claim for damages;
  • the rate and period of, and basis for, interest used in calculating damages or restitution;
  • whether compensation equivalent to surplus ACT still being carried forward can be claimed, as well as further compensation for the loss of use of the ACT; and
  • any limit on the period for which claims can be made.
In addition, the GLO will examine other issues which may affect some UK subsidiaries which have paid ACT on dividends to parent companies in the European Economic Area (EEA):
  • whether the entitlement of the parent company to a partial tax credit refund under the terms of any of the UK's double tax treaties affects the right of the subsidiary to compensation;
  • whether a non-UK company is entitled to a payment equivalent to the tax credit on the dividend to which a UK company would have been entitled;
  • whether the court has the authority and, if so, whether it will exercise it, to decide whether a double tax treaty can be held to be contrary to a European Union Directive; and
  • whether a reduction in the tax credit refund by, for instance, the imposition of a five per cent ‘restriction’ (common in the UK's treaties which provide for a partial reclaim of tax credits to foreign corporate shareholders) is in contravention of the parent/subsidiary directive.
Finally, the GLO will also examine these issues (and others) in the context of UK subsidiaries which have paid ACT on dividends to non-EEA parent companies:
  • whether a company resident in a jurisdiction with which the UK has a double tax treaty which does not provide for a tax credit refund entitles it to the payment of an amount equivalent to the partial tax credit which would have been available to it had it been resident in another state;
  • whether the court has the authority and, if so, whether it will exercise it, to decide whether the provisions concerned are contrary to the anti-discrimination provisions of the UK's double tax treaties and, if so, the rate and period of, and basis for, damages or restitution; and
  • whether provisions providing for the payment of ACT in the case of shareholders beyond the EEA constitute discrimination under the European Convention on Human Rights (ECHR).
Analysis of the GLO

We examine a number of the tax specific issues in the GLO in turn below and then go on to briefly consider the broad effects of non-discrimination on UK tax law in the wider context.

Compensation for surplus ACT

Most of the attention surrounding the Hoechst decision has focussed on claims to compensation in the context of the facts examined in that particular case. However, the basis of the claim to compensation in the Hoechst case was that ACT should not have been accounted for. The GLO raises the prospect of a company in these circumstances claiming compensation for this.

Limit on period of claim

Where companies have paid ACT for a number of years, the issue of the period for which claims can be made could be significant. Although claims to compensation are not governed by tax time limits, the Statute of Limitation imposes a six year time-limit. The Court will have to decide whether this time-limit applies, and from when. In particular, the Court will need to consider whether such procedural rules ‘render practically impossible or excessively difficult the exercise of rights conferred by Community law’.

Does entitlement to a tax credit refund affect the right to claim?

Where claimants are not in the same position as Hoechst UK Ltd – for instance, if their parent company is resident outside the EEA, or resident in an EEA country which allows part of the tax credit to be reclaimed – it is quite possible that the Revenue will dispute their entitlement to compensation.

The UK treaties with EEA countries which do allow companies to a partial reclaim of the tax credit on dividends from UK companies are those with Belgium, Italy, Luxembourg (excluding 1929 holding companies), The Netherlands, Norway and Sweden. The treaty with Denmark also allowed a partial tax credit reclaim until 1 January 1998.

It is unclear as to why a distinction has been made by the Revenue between subsidiaries of parent companies resident in states which allow a partial tax credit refund and those which do not. This does not appear to have any validity in the light of the ECJ decision. An entitlement to a tax credit is not conditional on an obligation (or otherwise) to account for ACT. Indeed para. 96 of the decision makes no such distinction – indeed, it does not even mention the right of the parent company to reclaim a partial tax credit:

‘Where a subsidiary resident in one Member State has been obliged to pay advance corporation tax in respect of dividends paid to its parent company having its seat in another Member State even though, in similar circumstances, the subsidiaries of parent companies resident in the first Member State were entitled to opt for a taxation regime that allowed them to avoid that obligation, Article 52 of the Treaty requires that resident subsidiaries and their non-resident parent companies should have an effective legal remedy in order to obtain reimbursement or reparation of the financial loss which they have sustained and from which the authorities of the Member State concerned have benefited as a result of the advance payment of tax by the subsidiaries.’

Is the imposition of a five per cent limitation to a partial tax credit refund discriminatory?

Hoechst AG (the German parent company of Hoechst UK Ltd) made a separate claim to reclaim the tax credit (or a part thereof) attaching to the dividend paid by Hoechst UK Ltd. This claim was not considered by the ECJ as (perhaps mistakenly) a connection was made in the case between the ACT liability on the dividend and the credit attaching to it. As no ACT should have been paid, the ECJ considered that no tax credit attached to the dividend.

However, the basis of Hoechst AG’s claim may still be valid. Under the principle of non-discrimination, any EEA parent company may be entitled to a partial refund of the tax credit on dividends received from UK subsidiaries which equates to the refund to which, say, a Dutch parent company would be entitled (the UK-Netherlands tax treaty provides for a refund of half the credit less a five per cent ‘withholding’). The argument here is that a Spanish parent company, for instance, is discriminated against because its treaty with the UK (unlike the Netherlands’) does not provide for a tax credit refund.

Although the GLO makes reference to this argument, it is about to be separately heard by the ECJ in the case of IR Commrs v Océ van der Grinten [2001] BTC 22.

In any event, this discrimination would appear to be entirely separate from the discrimination suffered as a result of the ACT provisions, and Hoechst AG’s claim would therefore appear to stand regardless of any claim to compensation by Hoechst UK Ltd. However, the Revenue have clearly made the same connection as the ECJ, as the original classes of claimant differentiated between those whose parent companies were entitled to a refund of the tax credit (or part thereof), and those who could not. And it may be that they will therefore seek to deny (or at least decrease) compensation to UK companies where a tax credit refund has already been made.

Non-EEA groups of companies

Although the Hoechst decision was based on the non-discrimination provisions of the Treaty of Rome, it raises the question as to whether the non-discrimination clauses in the UK’s other treaties can apply with similar effect. Many Double Tax Agreements (DTAs) contain non-discrimination clauses which (in the light of the Hoechst and related decisions) may apply to override discriminatory aspects of the provisions of UK domestic tax law.

In Sun Life Assurance Company of Canada v Pearson [1986] STC 335, Vinelott J, dealing specifically with the non-discrimination articles of the UK-Canada agreements of 1966 and 1978, stated that the purpose of the articles was to preclude and nullify specific discriminatory provisions. He held the view that the articles appeared to be directed primarily at differential rates of tax and differences in granting reliefs.

The argument runs that a UK subsidiary company of, say, a US parent would not have been required to account for ACT on dividends paid had the parent instead been UK resident (and assuming that a group election had been made), and that this is discriminatory under the UK-US DTA.

Indeed, the wording of the Treaty of Rome closely mirrors that of the standard non-discrimination clauses of UK DTAs. Article 52 of the Treaty of Rome provides that:

‘Freedom of establishment shall include the right to … set up and manage undertakings, in particular companies or firms within the meaning of the second paragraph of Art. 58, under the conditions laid down for its own nationals by the law of the country where such establishment is effected, subject to the provisions of the Chapter relating to capital.’

Article 58 of the Treaty of Rome treats companies which are incorporated in a European Union (EU) member state and have their registered office, central administration or principle place of business in the EU in the same way as ‘natural persons’ for the purposes of Art. 52.

Article 24(2) of the UK-US DTA (for instance) provides that:

‘The taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favourably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities.’

The Revenue have contended in the past, however, that the non-discrimination article of a treaty does not enable one UK resident company to pay dividends without accounting for ACT. They may well hold that the proper construction of the non-discrimination clause of an appropriate double tax treaty is not to compare the position with that which would apply if the parent were UK resident, but to compare the situation with that applying to a UK company owned by a resident of some other state. This argument has not been heard before the Courts and therefore a claim to compensation (and also a claim to repayment of any surplus ACT) may be advisable.

Other UK tax provisions

The Hoechst case and other recent ECJ cases have also brought into question the extent to which other UK tax legislation is compatible with the Treaty of Rome.

The UK has recently taken various steps to eliminate some areas of discrimination but there are arguably a number of other provisions in UK tax law which, following on from the Hoechst case and other ECJ decisions (most notably Staatssectretaris van Financien v B G M. Verkooijen (C-35/98) ), are discriminatory where domestic tax law treats other EEA-resident persons differently from those resident locally.

To name but one example of possible UK discrimination (whether direct or indirect), the taxation of dividends on both individuals and companies differs depending on the residency status of the payer.

Individual UK resident shareholders are taxed at a maximum rate of 32.5 per cent on dividends from UK companies, with a tax credit of ten per cent. Dividends from non-UK companies are taxed at a maximum rate of 40 per cent, potentially with double tax relief for foreign withholding taxes. For corporate shareholders, the disparity is even more marked. Dividends received by UK companies from other UK companies are exempt from tax altogether, whilst dividends from non-UK companies are taxed under Sch. D Case V at the company’s marginal rate of tax (again with possible double tax relief) – indeed this point is addressed in the GLO (s. 208). Such an analysis is reinforced (at least in an EEA context) by the ECJ decision in the case of Verkooijen, in which it was provided that (albeit in the context of natural persons):

‘Article 1(1) of Council Directive 88/361/EEC of 24 June 1988 for the implementation of Article 67 of the Treaty precludes a legislative provision of a Member State which, like the one at issue in the main proceedings, makes the grant of an exemption from the income tax payable on dividends paid to natural persons who are shareholders subject to the condition that those dividends are paid by a company whose seat is in that Member State.’

In practice, this could mean that shareholders in non-UK companies may be entitled to a repayment of tax, and compensation in respect of tax already paid on dividends received.

Other potentially discriminatory UK tax measures include, amongst others, the Controlled Foreign Company provisions (ICTA 1988, s. 747), the exempt distribution demerger provisions (ICTA 1988, s. 213), the consortium relief provisions (ICTA 1988, s. 406), the provisions dealing with the attribution of gains to members of non-resident companies (Taxation of Chargeable Gains Act 1992 (TCGA 1992), s. 13) and certain aspects of the double tax relief on-shore pooling regime (ICTA 1988, s. 806 A–J).

However, the Revenue have yet to – and as far as we are aware, do not plan to – issue guidance covering other discriminatory UK tax provisions, and the GLO only covers the issues surrounding ICTA 1988, s. 247.


The ramifications of the Hoechst decision are considerable, and amounts of compensation involved may be significant. The impact of Community law as it applies to discrimination and also potentially non-discrimination clauses in the UK's treaties on UK tax legislation may extend far beyond ACT and ICTA 1988, s. 247. It seems very likely that the Revenue will soon be deluged with claims to reliefs and compensation.

Technical Department
020 7235 9381

February 2002 by


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