Europe Rules OK

The long awaited opinion of the Advocate General in the joint cases of Hoechst and Metallgesellschaft (Hoechst) was finally given on 12 September. The cases concerned some fundamental points of principle regarding the payment of cross border dividends by a United Kingdom subsidiary to its German parent.
Another United Kingdom case which it is hoped will be heard by the European Court of Justice in the future is that of Océ van der Grinten NV. The Hoechst and Océ cases are closely linked as they both relate to the payment of cross border dividends by a United Kingdom subsidiary to a European Union parent, although they address different issues.
Hoechst and Océ, together with ICI v Colmer [1999] STC 1089, bring to the fore the relevance of European law to United Kingdom tax law. They send a clear message to both United Kingdom taxpayers and United Kingdom tax authorities that European law cannot be ignored.
We summarise below the key points in Hoechst and in Océ and touch briefly on a number of areas of United Kingdom tax law which we believe are contrary to European Union law. We would not be surprised to see them litigated in the near future, unless the United Kingdom tax rules are changed.
Hoechst
The Hoechst case raises the question of whether a European Union parent company with a United Kingdom subsidiary believes its right of freedom of establishment (as enshrined in the European Community Treaty) has been infringed because it is unable to make a group income election for dividend payments, whereas a United Kingdom company in the same circumstances (save for the country of residence) would be able to make such an election.
If Hoechst UK Ltd had been able to make a group income election with its German parent, it would have been able to pay dividends without accounting for advance corporation tax. The only reason Hoechst UK was not able to make such an election was because United Kingdom law required both companies to be resident in the United Kingdom. Since Hoechst UK was able to set off the advance corporation tax paid against its mainstream corporation tax liability, the only disadvantage to Hoechst UK (compared to a United Kingdom subsidiary of a United Kingdom parent company) was that it paid its corporation tax earlier. Hoechst UK is claiming that this disadvantage amounts to discrimination, and it is therefore seeking compensation (i.e. interest) for the loss of the use of money it suffered by paying its tax early. The Advocate General agreed with Hoechst UK, despite the fact that the company failed to make a group income election at the time it paid its dividends.
Hoechst AG, Hoechst UK's German parent company, made a second and alternative claim. This was that it should be entitled to a full tax credit refund in much the same way as a company in the United Kingdom would be entitled to. Further, Hoechst AG contended that if it could not get the full tax credit to which a United Kingdom resident company would be entitled, then it should, at least, be entitled to the half tax credit available under double tax treaties with the United Kingdom to parent companies resident in other Member States, such as the Netherlands (see Figure 1).
Figure 1: Taxation in the single market?

Having found in favour of Hoechst UK in respect of the group income election claim, the Advocate General decided not to consider the second alternative claim regarding Hoechst AG's entitlement to a full or, at least, a half tax credit. This is a great shame as the case provides a good opportunity to consider to what extent, if at all, Member States are free to treat residents of one Member State more favourably than those resident in another. It is still possible that the European Court of Justice will address this issue and we look forward to the judgment.
It is debatable whether or not Hoechst AG should be entitled to a refund of a tax credit, even where Hoechst UK is treated as paying the dividend under a group income election (the alternative claim in the event that Hoechst UK's claim was not successful). The United Kingdom/Netherlands double tax treaty does not make the benefit of the half tax credit subject to the United Kingdom company having paid advance corporation tax. However, economically (and historically) there is a link between the payment of advance corporation tax and the payment of the half tax credit. Post the abolition of advance corporation tax, Dutch parent companies are still entitled to receive the half tax credit (albeit a significantly reduced amount), despite the United Kingdom subsidiary's not paying advance corporation tax. In the wake of the Hoechst case, it remains to be seen whether other companies will be prepared to litigate the half tax credit point or, indeed, whether groups where European Union/European Economic Area parent companies which have already had the benefit of the tax credit will also claim interest for loss of use of money, arguing that the two claims are not mutually exclusive.
In the next few months the European Court will deliver its judgment. More often than not, its judgments follow the opinion of the Advocate General. Once the judgment has been given, it will not be possible for the Inland Revenue (or Hoechst) to appeal the case further on the same point. Thus, if the opinion of the Advocate General is followed, one would expect Hoechst UK, and any other companies which have taken similar action, to recover the money from the Inland Revenue.
Océ
Océ is a Dutch company with a wholly owned United Kingdom subsidiary. It received dividends from the subsidiary and duly claimed the refund of the half tax credit to which it was entitled under the United Kingdom/Netherlands treaty. It also sent a claim to the Revenue saying that the 5 per cent withheld on the aggregate of the net dividend paid and the half tax credit (which reduced the half tax credit by 45 per cent) is a withholding tax on profits distributed and so contrary to the parent subsidiary directive. In addition, at the hearing before the Special Commissioners, Océ argued that Article 7.2 of the Directive does not make an exemption to the fundamental principle set out in the Directive that there should not be any withholding of tax on profits distributed. But even if it does, says Océ, the article should be declared void as the relevant European Union parliamentary procedures were not followed when the article was implemented. Broadly, Article 7.2 says that the Directive does not affect domestic or agreement-based provisions relating to the payment of tax credits to the recipients of dividends.
In turn, the Revenue argued that the 5 per cent is not a tax, but a reduction of the half tax credit. This flies in the face of the wording of the treaty, which very clearly states that 'tax may also be charged in the United Kingdom at a rate not exceeding five per cent' and of the Revenue's own arguments in the earlier case of Union Texas International Corporation v Critchley [1990] STC 305). Other points put forward by the Revenue were that Article 7.2 preserves the validity of such treaty clauses and that the tax credit does not represent profits distributed.
The Special Commissioners agreed with Océ on every single point and decided to refer the case to the European Court of Justice. The Revenue's appeal to the decision is being heard.
Other contraventions
There are many areas of United Kingdom tax law which may be contrary to European Union law, and the breadth of European Court of Justice decisions shows that taxpayers are willing to fight for their rights. An example of United Kingdom tax law which infringes the freedom of establishment is the group income election for interest payments, which allow payments to be made without deduction of income tax as long as the lender is a United Kingdom resident company. Another example is the United Kingdom thin capitalisation rules which can bite where, for example, there is a loan from a European Union parent company to a 75 per cent United Kingdom subsidiary. If the loan were from a United Kingdom parent, section 212, Taxes Act 1988 should apply to prevent excess interest payments being re-categorised as a distribution, but parent companies based elsewhere in the European Union are not so lucky. In the current environment of non-discrimination, the thin capitalisation rules should not apply where financing is from European Union Member States.
Conclusion
United Kingdom companies which have paid dividends to European Community /European Economic Area parents and had contemplated taking action, but never did, and those which have only recently become aware of these cases should consider making protective claims. More widely, the Hoechst case will embolden companies to take cases in other areas where United Kingdom tax law appears to contradict European Union principles.
Paula Paino is a senior manager and Roopa Sharma is a manager in the European Union tax group in KPMG's international tax department. Paula can be contacted on 0207 311 2993 (or paula.paino@kpmg.co.uk) and Roopa on 0207 311 2830 (or roopa.sharma@kpmg.co.uk

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