Law and Tax

Continuity and the tax system ...

Recent posts have discussed the Deutsche Morgan Grenfell and Gaines-Cooper cases. HM Revenue and Customs lost one and won the other. Perhaps it is revealing that they reacted to both cases in the same way: by reinstating the status quo?

Tax paid under mistake of law

In 2001 the European Court of Justice the (“ECJ”) held that the UK’s advance corporation tax (“ACT”) regime, which applied to dividends, was contrary to European law. (Joined Cases C-397/98 and C-410/98, Metallgesellschaft and Hoechst.) Although the ACT regime was abolished in 1999, it continues to send ripples through the UK tax system.

Under the ACT regime, companies generally had to pay ACT to the UK authorities when they paid dividends. They could offset this against their “mainstream” corporation tax liabilities, and UK-based shareholders could claim credit for ACT in respect of the dividends they received.

Where a company paid a dividend to its parent company, the two companies could elect that ACT would not be payable. This was only possible, however, if both companies were resident in the UK for tax purposes. It was not possible where the parent company was resident in another EC Member State (or anywhere else).

The ECJ held, in effect, that this denial of relief from ACT had been an unjustified barrier to the freedom of companies based in other European Member States to set up subsidiaries in the UK.

UK companies with EC parents had, in effect, paid tax earlier than they should have because they could not opt out of the ACT system. The ECJ held that this gave rise to a right of compensation or restitution.

One UK company in this situation was Deutsche Morgan Grenfell Group plc (“DMG”). (Deutsche Morgan Grenfell Group plc v Inland Revenue Commissioners and the Attorney General [2007] STC 1.) It started legal proceedings, claiming restitution, in October 2000 and later added further claims. The Inland Revenue argued that the time limit for the claims was six years from the date of payment, and that the claims had been made too late. DMG, however, argued that it had made the payments under mistake of law. On that basis the six-year limitation period began to run from the date it discovered its mistake, or could with reasonable diligence have discovered it. The Inland Revenue, on the other hand, argued that claims for restitution based on a mistake of law could only be brought in cases involving private transactions, and not where tax was concerned.

This case reached the House of Lords (the highest English court) in summer 2006, and the Lords gave their decision at the end of October. The Lords held that, contrary to the Inland Revenue’s contention, it was possible to claim for restitution of money paid under mistake of law.

It has long been possible, at common law, to go to court to recover money paid under mistake of fact. The right to recover sums paid under mistake of law has only developed more recently. The Deutsche Morgan Grenfell case has extended this right to situations where tax is involved. This does not absolve the taxpayer from checking the position before making payments to the tax authorities! It might sometimes, however, make it easier to recover sums that have been paid.

Time limits for claims: Where an action for restitution of tax based on mistake of law is brought after 7th September 2003, the action must generally be brought within six years of the tax having been paid. This rule did not affect Deutsche Morgan Grenfell, which had started proceedings before the time limit was introduced.

On 6th December 2006 the UK Government announced that it would extend the time limit of six years from the date of payment to other cases, similar to Deutsche Morgan Grenfell, where final judgment had not yet been given. This moving of the goalposts is designed to protect the Government from large liabilities to refund tax, but seems very unfair to taxpayers who have already begun proceedings. It may well be in breach of European law. It seems likely, therefore, that this story has further to go.