UK and International Tax news
CJEU Judgment On Taxation Of Foreign Dividends In FII GLO
Wednesday 21st November 2012
The CJEU has recently issued its judgment in Test Claimants FII GLO v CIR [case C-35/11] in respect of the pre July 2009 regime for taxing foreign dividends and has held that the UK rules for applying the imputation method to foreign sourced dividends were not equivalent to the exemption method applied to domestic dividends.
The judgment commented that where a UK resident company received domestic dividends, it was not liable to corporation tax in respect of those dividends under the exemption method, but where overseas dividends were received, these were liable to corporation tax, subject to a credit for tax that the overseas company making the distribution had already paid in its country of residence on the profits thereby distributed (i.e. under the imputation method).
In 2006, the ECJ examined the legislation in question at the request of the High Court and held that it was contrary to EU law in several respects. In the current case, the High Court requested the ECJ to clarify that case law established in 2006.
In the CJEU judgment, it confirmed that EU law in principle permits a Member State to apply the exemption method to nationally sourced dividends and the imputation method to foreign sourced dividends. Those two methods may in fact generally be considered to be equivalent. The CJEU pointed out, however, that this equivalence is capable of being undermined. Indeed, when nationally sourced dividends were paid, they were exempt from corporation tax in the hands of the company receiving them, irrespective of the tax actually paid by the company making the distribution. By contrast, when foreign sourced dividends were paid, the tax credit to which the company receiving the dividends was entitled pursuant to the imputation method was determined by taking account of the effective level of taxation of the profits in the State of origin.
Thus, in such a situation the exemption of domestic dividends from tax gives rise to no tax liability for the resident company which receives those dividends irrespective of the effective level of taxation to which the profits out of which the dividends have been paid were subject. In contrast, application of the imputation method to foreign sourced dividends leads to an additional tax liability for the receiving company if the effective level of taxation to which the profits of the company paying the dividends were subject falls short of the nominal rate of tax to which the profits of the resident company receiving the dividends are subject. Unlike the exemption method, the imputation method therefore does not enable the benefit of the corporation tax reductions granted at an earlier stage to the company paying dividends to be passed on to the corporate shareholder.
The CJEU observed that the exemption and imputation methods did not immediately cease to be equivalent as soon as exceptional cases existed in which nationally sourced dividends were exempt although the profits out of which those dividends had been paid had not been subject in their entirety to an effective level of taxation corresponding to the nominal rate of tax.
However, according to the information supplied by the High Court, the effective level of taxation of the profits of companies resident in the UK was lower in the majority of cases than the nominal rate of tax applicable in that Member State. It followed that application of the imputation method to foreign sourced dividends as prescribed by the legislation at issue did not ensure a tax treatment equivalent to that resulting from application of the exemption method to nationally sourced dividends, and therefore the UK legislation must be regarded as a restriction on freedom of establishment and on capital movements, prohibited by the Treaty on the Functioning of the EU.
The CJEU found that the objective pursued by the national rules of preserving the cohesion of the national tax system could have been achieved by less restrictive measures. It pointed out that the tax exemption to which a resident company receiving domestic dividends was entitled was based on the assumption that the distributed profits were taxed at the nominal rate of tax in the hands of the company paying dividends. The exemption thus resembled the grant of a tax credit calculated by reference to that nominal rate of tax and therefore the UK legislature, with a view to preserving the cohesion of the tax system, could also have taken account under the imputation method of the nominal rate of tax applicable to the company making the distribution and not of the tax that it had actually paid.
The referring court also wished to ascertain whether a company that was resident in a Member State and had a controlling shareholding in a company established in a third country may rely upon the Treaty provisions on the free movement of capital in order to call into question the consistency with EU law of the tax treatment which the legislation of that Member State accords to dividends received from such a subsidiary. The CJEU held that in the context of the tax treatment of dividends originating in a third country it is sufficient to examine the purpose of the tax legislation at issue in order to determine whether that legislation falls within the scope of the Treaty provisions on the free movement of capital. Where it is apparent from the purpose of such national legislation that it can only apply to those shareholdings which enable the holder to exert a definite influence on the decisions of the company concerned and to determine its activities, neither the Treaty provisions on freedom of establishment nor those on the free movement of capital may be relied upon.
Where national rules relating to the tax treatment of dividends from a third country, like the UK rules at issue, do not apply exclusively to situations in which the parent company exercises decisive influence over the company paying the dividends, they must be assessed in the light of the Treaty provisions on the free movement of capital. A company resident in a Member State may therefore rely on those provisions in order to call into question the legality of such rules, irrespective of the size of its shareholding in the company paying dividends established in a third country.
The CJEU decision has clarified that the pre 2009 rules were in breach of EU law and the UK courts will now have to judge on its implementation. For a UK resident parent company, it should at least be able to claim an overseas tax credit based on the underlying nominal rate of tax on profits [or actual paid rate if higher] of the overseas company although this may still result in additional UK tax where the nominal rate is lower than the UK rate. Exemption from tax would clearly be preferable.
For overseas dividends paid up through a chain of overseas companies, it will be necessary to consider the nominal or actual paid rate at each level in the chain.
If you would like to discuss the implications of the CJEU decision in more detail, or need assistance with claims [given the general time limit being four years from the end of the accounting period if that period is not already under enquiry], please contact Keith Rushen on +44 (0)20 7486 2378.Contact Us