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BAT could recoup £1.2bn in overpaid tax from Treasury

Taxpayers face a multi-billion pound bill after the High Court ruled yesterday that British American Tobacco might have to be given £1.2bn in tax rebates. The world's second-largest cigarette maker is in line for the windfall after a judge supported its claim that dividends received from its EU subsidiaries should be exempt from taxation in Britain.

BAT, which owns the Dunhill and Lucky Strike brands, said the exact size of its claim would be the subject of a further hearing. Any judgment might be subject to appeal, which could take four years. BAT brought the action as a test case involving a group of 20 British companies that also includes the advertising giant Aegis.

"The judgment concludes, among many other things, that dividends received from EU subsidiaries should be, and should have been, exempt from UK taxation," BAT said last night.

Under existing law, if a UK-resident company receives dividends from a subsidiary that is also UK resident, it is not liable to pay corporation tax. But if a UK-resident company receives dividends from a subsidiary based overseas, it is liable to pay corporation tax on those dividends. In 2006, the European Court of Justice ruled that the tax rate applied to foreign-sourced dividends must be no higher than the rate applied to nationally-sourced dividends, then passed the case back to the High Court. The Government is expected to appeal but the ruling is in line with principles expressed in Monday's pre-Budget report by the Chancellor, Alistair Darling, who pledged to cut taxes on foreign subsidiaries.

"The ruling is a very significant spur to moving to an exemption system for foreign dividends," said Mark Persoff, a tax partner at Clifford Chance.