Prudential Assurance Company Ltd v Revenue and Customs [2018] UKSC 39

Prudential challenged UK tax rules taxing overseas portfolio dividends differently from domestic ones. The Supreme Court held EU law required tax credits at the foreign nominal rate, but rejected compound interest claims, departing from Sempra Metals, and clarified the treatment of lawful and unlawful ACT.

Facts

Prudential Assurance Company Ltd (PAC) was a typical UK-resident recipient of dividends on portfolio investments overseas (holdings of less than 10% of share capital). Between 1990 and 1 July 2009, the UK tax regime exempted from corporation tax dividends received from UK-resident companies (under section 208 ICTA), but in principle taxed dividends received from overseas companies (DV tax under Case V of Schedule D). For non-portfolio holdings, certain credits were available, but no credit was given for overseas tax in respect of portfolio investments. In addition, until 6 April 1999, Advance Corporation Tax (ACT) was levied on dividends distributed by UK companies.

Following CJEU rulings in Metallgesellschaft, FII ECJ I, the Reasoned Order in the present case, Haribo, and FII ECJ II, it was common ground that the UK regime breached EU law (article 63 FEU). PAC was appointed test claimant under a group litigation order. The case concerned how restitution should be quantified, and in particular the basis of the tax credit for overseas dividends, the availability of compound interest, and the treatment of lawful and unlawful ACT and MCT.

Issues

The Supreme Court considered five principal issues:

• Issue I: Whether the EU-law tax credit for overseas dividends should be set by reference to overseas tax actually paid (the effective rate) or the foreign nominal rate (FNR).
• Issue II: Whether PAC was entitled to compound interest, on the basis of unjust enrichment, in respect of tax levied in breach of EU law.
• Issue III: Whether a claim in restitution lay to recover lawful ACT which had been set against unlawful MCT.
• Issue IV: (Conditional cross-appeal) If actual tax were the relevant measure, whether the DV charge should be disapplied or FNRs allowed as a proxy.
• Issue V: (Conditional cross-appeal) The treatment, where ACT and MCT pools comprised both lawful and unlawful elements, of (a) utilisation of ACT against unlawful MCT, and (b) carry-back of domestic FII.

Arguments

Issue I

HMRC argued that the CJEU jurisprudence (especially FII ECJ I, the Reasoned Order, and Haribo) required only a credit for tax actually paid overseas, particularly in respect of portfolio investments, and that FII ECJ II concerned non-portfolio holdings. HMRC submitted that a further reference was warranted. PAC contended that FII ECJ II refined the jurisprudence so that the FNR governed all overseas dividends, including portfolio dividends.

Issue II

PAC sought compound interest in respect of three categories of unlawful tax payments, relying on Sempra Metals. HMRC accepted compound interest was payable on category (a) (unlawful ACT set against lawful MCT) but argued that only simple interest under section 35A of the Senior Courts Act 1981 was available otherwise, consistently with Littlewoods and the EU principle of effectiveness.

Issue III

HMRC argued that lawful ACT set against unlawful MCT had not in truth been set off, because unlawful MCT was a nullity, and thus the ACT remained available; no restitutionary claim lay. PAC argued that ACT was an advance payment of MCT and so unlawful MCT tainted the linked ACT, supporting recovery in restitution.

Issue V

PAC contended that unlawful ACT should be treated as utilised first against unlawful MCT, and that domestic FII carried back should be treated as relieving only lawful ACT. HMRC favoured a pro-rata approach in both situations.

Judgment

Issue I: FNR is the correct measure

The Court (Lord Mance, Lord Reed and Lord Hodge, with whom Lord Sumption and Lord Carnwath agreed) held that the CJEU’s jurisprudence, particularly FII ECJ II at paragraphs 61-65, established that credit must be given by reference to the FNR. There was no principled basis to distinguish portfolio from non-portfolio holdings; indeed, FII ECJ II relied on Haribo, a portfolio case, to support FNR use. Although the Court acknowledged a ‘reservation’ arising because the rationale of FII ECJ II assumed a domestic exemption operating at the nominal rate when in practice UK companies’ effective rates were below nominal, this did not justify a further reference; the CJEU had consciously accepted that FNR would not eliminate every inequity. The further sub-issues HMRC sought to raise (Issues 4 CA and 6 CA) were not open before the Supreme Court because the Court of Appeal had refused permission to raise them.

Issue IV

This did not arise given PAC’s success on Issue I.

Issue II: Compound interest not available

The Court permitted HMRC to argue, despite a prior concession on category (a), that the reasoning in Sempra Metals should be revisited. The Court reviewed legal developments since Sempra Metals, including: the clarification by the CJEU in Littlewoods that simple interest suffices for the EU principle of effectiveness; the inconsistency of Sempra Metals with the statutory schemes in section 78 of the Value Added Tax Act 1994 and section 826 ICTA; the practical difficulties revealed in attempts at retrospective limitation legislation; and the development of the law on enrichment ‘at the expense of’ the claimant in Investment Trust Companies v HMRC.

Applying the analysis in Investment Trust Companies, the Court held that when money is mistakenly paid there is only one direct transfer of value, namely the payment itself; the recipient’s opportunity to use the money is a consequence of, not a separate transfer of value from, that payment. The Court endorsed Lord Wright’s classic explanation in Riches v Westminster Bank Ltd [1947] AC 390, 400:

… the essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have made if he had had the use of the money, or conversely the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation.

The Court also noted Lord Mansfield’s statement in Moses v Macferlan (1760) 2 Burr 1005, 1010 that a defendant in money had and received

can be liable no further than the money he has received

and quoted Professor Burrows on the unrealistic implication of compounding interest for decades:

… if one were to step back from the complex detail, the result of Henderson J applying compound interest on all the mistaken payments from the date of receipt appears to be tantamount to saying that, had the Revenue not been paid those sums, it would have borrowed the same sums at a compound interest rate for five decades. Surely that cannot be right.

The Court accordingly departed from the reasoning in Sempra Metals on unjust enrichment, holding that interest is recoverable as compensation for the failure to pay a debt on the due date and that simple interest under section 35A of the 1981 Act is appropriate. PAC’s claims to compound interest in categories (b) and (c) were rejected; category (a) would also have been rejected absent HMRC’s concession.

Issue III: No restitutionary claim for lawful ACT set against unlawful MCT

Permission to appeal was granted given the issue’s general public importance. The Court held that an unlawful MCT charge is a nullity. Section 239 ICTA could not effect a set-off against a nullity, so lawful ACT remained available to be carried back, carried forward or surrendered. Accordingly the receipt of lawful ACT did not amount to unlawfully levied tax giving rise to a San Giorgio claim. PAC’s loss derived from the unlawful MCT and from the parties’ shared misunderstanding, but that did not support restitution; following Investment Trust Companies, this is not the kind of defective transfer of value the law of unjust enrichment corrects. Any further loss would lie in damages, if criteria were met.

Issue V: Allocation of unlawful ACT and carried-back FII

On Issue V(a), because unlawful ACT and unlawful MCT are both nullities, unlawful ACT must be treated as utilised first against unlawful MCT; any residual unlawful ACT is treated as utilised against lawful MCT. The Court of Appeal’s pro rata approach was inconsistent with the conclusion on Issue III. On Issue V(b), domestic FII carried back to an earlier quarter under paragraph 4 of Schedule 13 ICTA must be treated as relieving only lawful ACT; otherwise EU-mandated credits would be eroded.

Implications

EU-law tax credits

The decision confirms that the UK’s now-abolished regime for taxing overseas dividends infringed article 63 FEU and that, under the imputation method required to remedy the discrimination, credit must be given by reference to the foreign nominal rate, including for portfolio dividends. This applies regardless of the size of the holding.

Restitution and interest

The Supreme Court has materially curtailed Sempra Metals. It is no longer correct to treat the opportunity to use mistakenly paid money as a separate enrichment giving rise to compound interest in unjust enrichment. Interest claims rest on the failure to pay a debt on the due date and are governed by section 35A of the Senior Courts Act 1981, ordinarily yielding only simple interest. The Court emphasised the inconsistency of Sempra Metals with statutory regimes such as section 78 of the Value Added Tax Act 1994 and section 826 ICTA, the absence of any EU-law requirement for compound interest after Littlewoods, and the disruption to public finances caused by Sempra taken with Kleinwort Benson. The decision restores coherence between the law of unjust enrichment and Parliament’s interest regimes for tax.

ACT and MCT

Lawful ACT set against unlawful MCT is not recoverable in restitution because unlawful MCT is a nullity and no set-off can occur against a nullity. Where pools of lawful and unlawful ACT and MCT coexist, unlawful ACT is treated as applied first against unlawful MCT, and FII carried back is treated as relieving only lawful ACT. These principles preserve the EU-mandated credits while maintaining the integrity of section 239 ICTA.

Wider significance

The decision is highly significant for HMRC and corporate taxpayers in the FII GLO and similar group litigation, with very substantial sums at stake (estimated at £4-5 billion in this case alone). It also marks an important evolution in the law of unjust enrichment, reinforcing the requirement of a direct, normatively defective transfer of value as articulated in Investment Trust Companies, and confining the remedy of compound interest to circumstances such as damages claims where it represents the measure of foreseeable loss. The Court signalled caution about further judicial reshaping of restitutionary doctrine where Parliament has legislated, citing Lord Hoffmann in Johnson v Unisys Ltd on the need for harmony between common law development and statutory policy. Some questions, including the precise mechanism for awarding interest on San Giorgio claims falling outside section 35A, were left for another occasion.

Verdict: HMRC’s appeal allowed on Issues II and III; dismissed on Issue I. PAC’s cross-appeal on Issue IV did not arise; PAC succeeded on Issue V(a); on Issue V(b) the Court held that FII carried back to an earlier quarter is to be treated as having been applied to relieve only lawful ACT.

Source: Prudential Assurance Company Ltd v Revenue and Customs [2018] UKSC 39