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September 10, 2013
U.K.'s Retroactive Shortening of Tax Restitution Statute of Limitations Violates EU Law, Advocate General Says
by Randall Jackson

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This document originally appeared in the September 9, 2013 edition of Worldwide Tax Daily.

In a September 5 opinion in Test Claimants in the Franked Investment Income (FII) Group Litigation v. HMRC (C-362/12), Advocate General Melchior Wathelet recommended that the European Court of Justice hold that a member state may not retroactively and without notice shorten the statute of limitations on the recovery of taxes paid that were not due. The advocate general said that using retroactive legislation to block a taxpayer's chosen remedy to recover illegal taxes violates the EU principle of effectiveness.

An HMRC spokesperson told Tax Analysts that HMRC is studying the advocate general's opinion but that it must wait for the ECJ's final decision.

The case was referred to the ECJ by the U.K. Supreme Court in a May 2012 judgment in which the Court was divided on whether legislation enacted by the U.K. Parliament in 2004 that retroactively excluded application of an extended time limit to mistake-of-law claims violated EU law. The appellants contend that the retroactive nature of the 2004 legislation, and the fact that it was promulgated without notice, violated the EU principles of effectiveness, legal certainty, and the protection of legitimate expectations.

The advocate general opinion is the latest in the FII Group Litigation family of cases surrounding the U.K.'s former advance corporation tax (ACT) regime for taxing foreign dividends. The original case was referred to the ECJ in 2004 over the question of whether the tax regime violated EU law.

Simon Letherman of the London office of Shearman & Sterling LLP told Tax Analysts that the FII Group Litigation case has created a "huge backwash" of cases involving remedies and other peripheral issues.

Nicholas Aleksander of the London office of Gibson, Dunn & Crutcher LLP agreed, telling Tax Analysts that though the FII Group Litigation cases are winding down, "satellite litigation will continue for a while as individual claims now work their way through the system."

He said that HMRC has recently been challenging taxpayers on more specific aspects of individual claims, such as the running of the statute of limitations, and that FII Group Litigation could have an impact on these related cases.

Aleksander added that an important result of all the FII Group Litigation cases has been the heightened relevance to U.K. tax policy of the extent to which U.K. tax law can treat nonresident taxpayers less favorably than resident taxpayers -- and the impact of EU rules and the nondiscrimination article in many tax treaties insofar as non-EU nonresidents are concerned.

"Clearly those drafting tax laws are acutely aware of these provisions, and take them into account in their drafting," he said.

The current ECJ referral is the third regarding the FII Group Litigation case. The first referral, made by the High Court of Justice, resulted in the ECJ holding in C-446/04 that the U.K. ACT dividend taxation regime was in violation of EU law. However, the case was later referred back to the ECJ for clarification. On November 13, 2012, in case C-35/11, the ECJ clarified the meaning of "tax rates" and other issues in the earlier decision and again held that the former ACT regime violated EU law.

Two Remedies

In the case at hand, the question referred involves the two causes of action available to taxpayers to recover ACT paid over the period 1973-1999, when the ACT regime was in place.

The first, called the Woolwich cause of action, generally allows the recovery of all taxes paid that were not legally due. This remedy has a statute of limitations of six years, which runs from the time the tax is paid and is therefore of limited application in the Test Claimants case.

The other is the Kleinwort Benson cause of action, which allows a taxpayer to recover money paid through a mistake of either fact or law. In the July 18, 2003, High Court of Justice decision, Deutsche Morgan Grenfell (DMG), the judge explicitly stated that the Kleinwort Benson remedy may be used to obtain restitution for taxes paid under a mistake of law.

Under section 32(1)(c) of the Limitation Act 1980, the Kleinwort Benson remedy also has a six-year statute of limitations; however, the clock starts when the taxpayer knew (or should have known) of the mistake. That would have occurred on March 8, 2001, when the ECJ found in Metallgesellschaft and Others (C-397/98 and C-410/98) that the ACT system was incompatible with EU law. Thus, under the Kleinwort Benson remedy, no taxes paid since 1973 would be time-barred.

Fearful of the large amount of taxes the U.K. government could have to reimburse, Parliament in 2004 passed the Finance Act 2004, including section 320(1), which reads: "Section 32(1)(c) of the Limitation Act 1980 . . . does not apply in relation to a mistake of law relating to a taxation matter under the care and management of the Commissioner of Inland Revenue." The change was made retroactive to any actions brought on or after September 8, 2003, the date on which the FII Group Litigation litigants brought their case.

Further, in 2007 Parliament adopted Finance Act 2007, in which section 107 states that section 32(1)(c) of the Limitation Act 1980 does not apply to actions concerning reimbursement for taxes paid under a mistake of law, retroactive to all claims filed before September 8, 2003.

Letherman told Tax Analysts that the U.K. government's attempts to shut off the tax reimbursement possibility were in part due to the huge sums of money (billions of pounds) at stake. The U.K. government made this explicit in the case when it stated that the possibility of repaying billions could raise "questions of the protection of the public interest in the prevention of the disruption of public finances."

However, the advocate general dismissed this argument, a reaction applauded by Rita de la Feria, professor of tax law at Durham University Law School and programme director at the Oxford University Centre for Business Taxation.

"Unfortunately one of the side effects of the current financial crisis has been a progressive, but clear, erosion of taxpayers' rights in Europe over the last few years," she told Tax Analysts. "The difficult public finances situation that the U.K. -- and other EU countries -- find themselves in cannot be used as an argument to dismiss the rule of law."

Initially, the Supreme Court considered the two pieces of legislation and unanimously found that the 2007 legislation was in violation of EU law. Regarding the 2004 legislation, the Court was split, 5-2 (with five judges saying it violated EU law), prompting the referral to the ECJ.

Letherman told Tax Analysts that the key difference was that while the 2004 legislation altered the timing -- pushing the availability of the Kleinwort Benson remedy back to claims before September 8, 2003 -- the 2007 legislation (in conjunction with the 2004 legislation) cut it out completely.

Effectiveness, Legal Certainty, and Legitimate Expectations

The Supreme Court majority argued that the imposition of Finance Act 2004 violated the EU effectiveness principle because it was retroactive, issued without notice, and did not provide transitional arrangements for those claims already started.

In citing the transitional arrangement requirement, the majority made reference to Marks and Spencer (C-62/00), in which the ECJ found that reducing the statute of limitations is not a violation of the effectiveness principle as long as the change is "reasonable" and "the new legislation includes transitional arrangements" for taxpayers entitled to repayment under the original structure.

The minority argued that the mere existence of the Woolwich cause of action satisfied the U.K.'s obligation under EU law to provide an effective legal remedy, even though the case was time-barred under that remedy. The minority distinguished this case from Marks and Spencer by pointing out that in Marks and Spencer, there was only one remedy available -- absent the transitional arrangements, taxpayers had no options.

But the advocate general took the position that the key issue is that because the legislation was introduced retroactively and without notice, and with no transitional arrangement offered, taxpayers were caught by surprise and left unable to pursue a claim they had already started.

The advocate general acknowledged that member states are not required to have multiple remedy options but said that once a taxpayer chooses a remedy, blocking that remedy with retroactive legislation violates the EU principle of effectiveness and makes it impossible for the taxpayer to exercise its rights under EU law.

"There are two key legal principles at stake in this case," de la Feria told Tax Analysts. "The right to reimbursement of unduly paid tax, and the principle of nonretroactivity of tax law. The AG in his Opinion found -- rightly in my opinion -- that the U.K. had violated both."

De la Feria added that the outcome was unsurprising because the ECJ has frequently defended those principles in previous cases. She predicted that with this background, and the fact that the Court follows the advocate general's advice about 80 percent of the time, it is very likely that the Court will follow Wathelet's recommendation.

The advocate general also addressed the EU principles of legal certainty and legitimate expectations. The Supreme Court minority, in agreement with the U.K. government, had argued that because the DMG ruling occurred just a few months before the FII Group Litigation case was brought, and because it had yet to be decided at the highest U.K. court, the taxpayers could not have had legitimate expectations that the law would remain in place.

However, the advocate general disagreed, saying that the taxpayers had the right under the principles of legal certainty and the protection of legitimate expectations to expect that their claim would be ruled on by the courts based on the law in force on the date of the claim.

"This is not the first case where the [ECJ] has intervened to reestablish [and] defend taxpayer rights," de la Feria said. "There have been many cases . . . where tax authorities have been either too formalistic or too restrictive; unduly limiting the right of taxpayers to refund tax . . . and the Court has deemed their actions to be against EU law."

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