BRUSSELS The British government might have to repay billions of pounds in multinational companies' corporation tax after the EU's highest court found in favor of British American Tobacco (BATS.L) in a judgment delivered on Tuesday.
The European Court of Justice (ECJ) found that by taxing dividends earned from companies based in Britain differently from income gained abroad, Britain's treasury overcharged companies for decades.
"The UK legislation must be regarded as a restriction on freedom of establishment and on capital movements," the ECJ said in a statement, referring to basic tenets of the EU free market.
The case concerns differing treatment of income received in Britain and abroad.
When a company resident in Britain received nationally sourced dividends, it was not liable to corporation tax on those dividends, the ECJ said. But when the company received dividends from a non-resident company, it was liable to tax.
Some companies established in Britain said that these rules resulted in less favorable tax treatment when they had subsidiaries in other EU countries, something that dissuaded investment abroad.
They brought a group case that led to a long English court battle on the taxation of multinationals. The High Court referred the case to the ECJ in 2006, and later asked the EU court for further clarification.
Tuesday's decision was a test claim in the group case and is expected to be re-examined by Britain's High Court next year.
It is not yet clear how far back companies might be able to claim retroactive repayment of taxes, with claims dating back to 1973. This question is scheduled to be examined in a separate ECJ court case in 2013.
"If (companies) did set up any foreign subsidiaries, the corporation tax they paid is potentially repayable," said Jake Landman, an associate at British law firm Pinsent Masons.
Britain's tax authorities said they were disappointed by the ruling, but were not giving up.
"We will consider the implications of the ruling in the overall context of the case, which has a number of aspects and complexities that remain to be settled in the domestic courts," a British government spokesman said.
(Editing by Sebastian Moffett, Gary Hill)