EU ruling may force big tax payback

The Treasury faces a multi-million pound bill after judges in Europe's highest court ruled against the way Britain taxed dividends from subsidiaries based abroad but inside the EU.

Yesterday's complex judgment means that the Government could now be forced to pay out sizeable rebates to multinationals including British American Tobacco, which mounted the case.

The ruling from the European Court of Justice is also politically sensitive because it encroaches on taxation policy, one of the areas in which countries including the UK guard their sovereignty jealously.

However, the extent of the bill faced by the Treasury is hard to estimate because the UK courts will have to decide on detailed implementation of the judgment.

The multinationals claimed that the tax treatment of dividends from companies based in other EU member states was less favourable than that applied to their UK subsidiaries.

On that basis the Luxembourg-based court found that some aspects of the system of Advanced Corporation Tax, which was abolished in 1999, had discriminated against companies in other member states.

The ruling said that the Foreign Income Dividend system led to "a difference in treatment which makes the acquisition of a shareholding in a non-resident company less attractive than a shareholding in a resident company". That, it added, "constitutes an infringement of the freedom of establishment which cannot be justified".

BAT's legal action was a test case for up to 20 companies. The court also said any time limit on claims relating to the ruling would depend on domestic law.