In a judgment handed down on 18 February 2011 the Court of Appeal (Rimer and Stanley Burnton LJJ, Arden LJ dissenting in part) overturned the decision of Henderson J in Test Claimants in the Thin Cap Group Litigation v Commissioners for HMRC  EWCA Civ 127 and concluded that the United Kingdom's thin capitalisation legislation was compatible the freedom of establishment under Article 43 TFEU.
The appeal turned on the true meaning of the judgment of the CJEU on a preliminary reference in these proceedings in Case C-524/04 Test Claimants in the Thin Cap Group Litigation  STC 906;  2 CMLR 31. HMRC contended that the CJEU had concluded that thin cap legislation was permissible under EU law in so far as it applied to transactions between related companies which were not concluded on arm's length terms. The Test Claimants contended that even if a transaction was not on arm's length terms, the legislation contravened their rights of establishment if they were not given the opportunity to demonstrate that the transaction was nevertheless commercially justified.
Rimer and Stanley Burnton LJJ considered that the CJEU's judgment in Thin Cap had been substantially clarified in subsequent jurisprudence, most notably in Case C-231/05 Proceedings brought by Oy AA  STC 991  3 C.M.L.R. 1 and Case C311/08 Société de Gestion Industrielle SA (SGI) v État Belge  ECR 1-0000. They concluded that in the light of those cases, legislation which involves the application of an arm's length test does not unlawfully interfere with the freedom of establishment. Arden LJ dissented on the grounds that the CJEU should not be considered to have cast doubt on its earlier jurisprudence in Case C-324/00 Lankhorst-Hohorst GmbH v Finanzamt Steinfurt  E.C.R. I-11779;  2 C.M.L.R. 22.
Of particular interest are the Court of Appeal's obiter observations on what constituted a sufficiently serious breach of European Union law such as to give rise to a liability on the part of a Member State to pay damages. The Court of Appeal considered that even if, following a judgment of the CJEU, it becomes clear that domestic legislation is incompatible with European law, it would be unreasonable not to allow the Government time to consider it and the terms of remedial legislation, and if thought appropriate to consult with outside bodies, and time to bring the legislation before Parliament, before it could fairly be held to be in sufficiently serious breach. The Court of Appeal also rejected the Test Claimants' submissions that a failure on the part of the Government to be open and honest with taxpayers as to its opinion as to the legality of its legislation and is plans for amendment constituted a sufficiently serious breach.
The judgment is here.
Sarah Ford appeared for HMRC.