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ECJ rules on dividends in FII case

The European Court of Justice (ECJ) handed down, on 12 December 2006, a decision in Test Claimants in the FII Group Litigation (C-446/04) dealing with the compatibility with European Community law of current and past tax systems in the UK regarding the tax treatment of inbound and outbound dividends.

The case involved two main issues:

· the legality of payments made under the UK’s Advanced Corporation Tax (ACT) prior to its abolition in 1999; and

· the tax treatment of foreign sourced dividend income emanating from the EU and paid to UK taxpayers.

As indicated previously in the Advocate General’s Opinion, the ECJ found that the ACT rules operating between 1973, when the UK first joined the EU, and their abolition in 1999 were in breach of Community Law. This decision gives rise to the prospect of substantial rebates to companies that have paid this tax or suffered surplus ACT situations or delays on refunds in the past.

The UK government moved to block the extent to which taxpayers can claim rebates in its November 2006 Pre-Budget Report. This legislation is already subject to legal challenge as a breach of Community Law. Proceedings are underway and companies seeking refunds are unlikely to receive anything until these are concluded.

On the tax treatment of foreign sourced dividends, the ECJ confirmed the principle that foreign sourced dividends should not suffer more UK tax than UK sourced dividends. But it went on to state that the various methods by which this was to be achieved were acceptable.

The UK operates a credit system to relieve double taxation on foreign sourced dividends, while UK-sourced dividend payments to a UK taxpayer are exempted entirely. This is regardless of the actual tax suffered at the level of the subsidiary from whose profits the dividends derive.

The ECJ’s view was that parity of treatment could be achieved through a credit or exemption system, but declined to go further and referred the matter back to the UK courts to determine whether the UK rules operate to achieve this parity.

The ECJ did rule that the discrimination against portfolio investments, which did not provide for relief for overseas taxes, was however illegal.

Far from achieving certainty, these decisions together with the Pre-Budget Report’s narrow interpretation of the ECJ's Cadbury Schweppes ruling, means that the UK tax system is becoming yet more complex and uncertain.

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