HMRC saves £5bn in Supreme Court compound interest ruling

HMRC is set to receive a £5bn boost after the Supreme Court ruled that tax repayments due to the Prudential Assurance Company (PAC) should be made on a simple interest basis

PAC was a test claimant in the litigation, which relates to periods running from 1990–2009 and concerns the tax treatment of UK-resident companies that received dividends from portfolio shareholdings (i.e. where the investor holds less than 10% of the voting power in the company) in overseas companies.

Under the tax system at the time, a UK-resident company receiving dividends from an overseas company was subject to corporation tax under schedule D of the Income and Corporation Taxes Act 1988 (ICTA) (‘DV tax’). Furthermore, it did not receive a tax credit on the dividends, which did not qualify as franked investment income (FII), although it could be entitled to some relief against double taxation under domestic rules, or conventions between the UK and other countries. 

This was not the same treatment as a UK-resident recipient company receiving dividends from a UK-resident company, which was exempt from corporation tax under s.208 of ICTA, and by s.231(1) ICTA, would receive a tax credit equal to the amount of advance corporation tax (ACT) that the distributing company had paid on the distribution.
By s.238(1) ICTA, the dividend received and the tax credit together constituted FII in the hands of the recipient company, which, by s.241 ICTA, could be used to eliminate or reduce its own liability to ACT on distributions (‘franked payments’) to its own shareholders.

PAC brought a claim to recover corporation tax and ACT levied, arguing it was contrary to EU law. Before PAC’s claim was heard, the Court of Justice of the European Union (CJEU) concluded in two decisions that the UK’s treatment of overseas dividends was contrary to EU law in that it treated dividends received from overseas companies less favourably than dividends from UK-resident companies.
Following these decisions, PAC was entitled to an appropriate tax credit, and to repayment of any tax unlawfully charged. The issue the Supreme Court was required to consider related to the amount to be awarded, which depends on issues of domestic and EU law.  [Prudential Assurance Company Ltd  v Commissioners for Her Majesty’s Revenue and Customs 2018 UKSC 39].
The Supreme Court dismissed HMRC’s appeal on issue I, which was whether EU law required the tax credit to be set by reference to the overseas tax actually paid, as HMRC submitted, or by reference to the foreign nominal tax rate (FNR), as PAC argued.

However, the Supreme Court found in favour of HMRC on issue II, which related to the question of compound interest payments. It rejected PAC’s claims to compound interest, partly because of the possibility of ‘unjust enrichment’ from a mistake.
The Supreme Court allowed HMRC’s appeal on issue III, stating it was not possible to have a claim in restitution lie to recover lawful ACT which was set against unlawful mainstream corporation tax (MCT).
On issue V, the Supreme Court found in favour of PAC, deciding that where ACT from a pool which includes unlawful and lawful ACT is utilised against an unlawful MCT liability, unlawful ACT is treated as set first against unlawful MCT. Further, because unlawful MCT is a nullity, the unlawful ACT is recoverable unless it has been set against a lawful MCT charge. 

The Supreme Court also allowed PAC’s cross appeal on the issue of where domestic FII was carried back to an earlier quarter, whether it should be treated as having been applied to relieve the lawful and unlawful ACT pro rata, or only lawful ACT. The court stated that domestic FII which is carried back to an earlier quarter is to be regarded as having been applied to relieve only lawful ACT. HMRC’s pro rata approach would deprive a company of the tax credit at the FNR required under EU law.

Dan Robertson, corporate tax partner at RSM, said the Supreme Court decision reverses the rulings of the lower courts in the case and departs from the reasoning of the same court in the earlier case of Sempra Metals.
'In Prudential it seems that the difference between simple and compound interest was only modest but, more importantly, the judgment is likely to put a stop to many other claims that had been lodged following the earlier court decisions. 
'HMRC have estimated that the total amount of interest that had been at stake was in the region of £4bn to £5bn. This would have represented a substantial cost to the UK exchequer, so the decision should come as a great relief to the Treasury.
'This latest case is also of considerable importance from a legal perspective and provides some much-needed clarity on some of the fundamental issues in the law of unjust enrichment,' Robertson said.

Prudential Assurance Company Ltd  v Commissioners for Her Majesty’s Revenue and Customs 2018 UKSC 39 is here

Report by Pat Sweet

Pat Sweet |Reporter, Accountancy Daily [2010-2021]

Pat Sweet was the former online reporter at Accountancy Daily and contributor to the monthly Accountancy magazine, pub...

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