A judgment handed down in the Court of Justice of the EU has forced HMRC to pay back tax which had been overcharged, and may open the floodgates for further claims back to 1973.

The CJEU has judged in favour of Franked Investment Income (FII) Group Litigation in a case which concerns the different UK corporation tax treatment of UK and foreign dividends in the hands of UK companies, and whether this differential tax treatment is compatible with EU law.

The Court had originally issued a decision on the matter in December 2006, but the case was referred back to the ECJ from the UK Court of Appeal for further clarification.

Now the CJEU has held that the different UK corporation tax treatment of UK and foreign dividends is in breach of EU law, and that in the case of foreign dividends, credit should be given for the nominal rate of tax in the territory of the company paying the dividend.

The ruling related to three key issues - old UK tax rules on the taxation of dividends from foreign companies as compared to the dividends received from companies residing in the UK; the rules on Advance Corporation Tax; and dividends received from a country outside the EU, ie, a third country.

Concerning the UK's old rules for taxation of dividends from foreign companies compared with UK-resident companies, the CJEU held in December 2006 that in principle, the UK rules were not in breach of European Union (EU) law provided that the foreign profits were not subject to a higher tax rate than domestic dividends. It was for the domestic court to decide whether the tax rates were indeed the same or whether a difference existed more frequently than in exceptional situations.

The CJEU has now clarified its earlier judgment, holding that as the effective rate of tax on UK dividends was generally lower than the rate of tax on foreign dividends and this was a breach of EU law.

On the issue relating to the rules on Advance Corporation Tax (ACT) and Franked Investment Income (FII), the CJEU had held in its first judgment that the FII rules were unlawful. Where a UK company received a foreign dividend which was paid out of tax profits, it should have received a credit for the foreign tax to offset the ACT due on its own dividends. Any ACT which had been unlawfully charged therefore had to be repaid.

The Court has now confirmed this is also the case even where there is a more complicated group structure. It therefore does not matter that the foreign tax was paid by a lower tier subsidiary or the ACT was paid by a parent company of the one receiving the foreign dividend.

In relation to dividends received from a country outside the EU (ie, a third country), the question asked of the CJEU was whether a UK resident company could rely on the principle of the free movement of capital (Article 63 of the Treaty of Functioning of the European Union (TFEU)), in respect of dividends received from a subsidiary over which it exercises decisive influence.

HMRC claimed that such a situation fell only within the scope of the freedom of establishment (Article 49 TFEU), which was confined to establishments in EU member states.

The CJEU held that if the rule, like the UK rules at issue, does not apply exclusively to situations in which the parent company exercises definite influence over the company paying the dividends, the EU freedom at stake will be free movement capital. Therefore, the EU rules also apply to the tax treatment of the dividends paid by the company established in a third country irrespective of the size of its shareholding, ie, even if the dividends paid do not relate to a portfolio investment.

Commenting on the judgment, Chris Morgan, head of tax policy at KPMG, said that the case deals with a simple premise: that companies which have been over charged tax (on dividends or in the form of advance corporation tax.