(A) The issue
The defendant sold her 50% shareholding in the claimant company, One Step. The sale, to which the company was a contracting party, included covenants undertaking not to solicit business from certain third parties, protecting confidential information of the company, and restricting competition with the company. The defendant was in breach of all the covenants, and the company claimed damages. How should the damages be assessed for the breaches of contract?
(B) The decisions in the Commercial Court and the Court of Appeal under appeal
The commercial judge ordered an assessment ‘on the basis of the amount which would notionally have been agreed between the parties, acting reasonably, as the price for releasing the defendants from the restrictions’. The judge thought that the claimant company had ‘a right to elect how its damages should be assessed’. The company could choose between damages assessed for the business lost by it, or on the basis set out in his order. Prior to the decision of the Supreme Court, this basis might have been referred to as ‘Wrotham Park Damages’, a label derived from Wrotham Park Estate Co Ltd v Parkside Homes Ltd [1974] 1 WLR 798, where this formula was used to award damages for breach of a restrictive covenant concerning land. It is now called ‘Negotiating Damages’ (a term coined by Neuberger LJ in Lunn Poly Ltd v Liverpool & Lancashire Properties Ltd [2006] 2 EGLR 29).
The Court of Appeal decided that it was within the discretion of the commercial judge to decide the basis on which damages were to be awarded, taking into account that the breaches had been deliberate. It was said that there would be difficulty in establishing precisely the loss to the claimant’s business and that the discretion was to be exercised on ‘a broad brush basis’. This can be contrasted with the principle that damages are to compensate for the loss caused by the breach.
(C) The decision and reasons in the Supreme Court
The judgment agreed to by four of the five judges was given by Lord Reed. The ratio of that judgment is binding precedent. It decides that the sole measure of damages was the loss caused to the claimant’s business, including its loss of profits. The order made by the judge, which had been upheld by the Court of Appeal, was set aside. The judge assessing damages might or might not have regard to evidence as to what a reasonable release fee would have been but the hypothetical release fee would not itself be awarded as a measure of the loss.
Lord Sumption reached the same conclusion, stating that he took ‘broadly the same view as Lord Reed, although for reasons which I would express more simply’, and considered that ‘… the notional price of a release may … be relevant, not as an alternative measure of damages but as an evidential technique of what the claimant can reasonable be supposed to have lost’. Lord Carnwath agreed with the reasons given by Lord Reed, and added some observations about compensation to be awarded under certain statutory provisions. He considered that there were ‘significant differences’ between Lord Reed and Lord Sumption. Lord Carnwath described Lord Reed’s analysis as ‘an entirely orthodox approach’, declined to accept Lord Sumption’s ‘reformulation as a helpful guide in the general run of cases’, and was ‘unpersuaded that it is necessary or helpful to redefine, or break down the barriers between, the established categories; [or] that to do so [would offer] any improvement in the coherence of the law.’
Lord Reed decided that ‘Negotiating Damages’ can be awarded for breach of contract in certain cases concerning ‘assets’. Thus damages for breach of a restrictive covenant on land are given for invasion of a property right (the restrictive covenant) which qualifies as an ‘asset’. Breach of the covenant damages the asset. A price or reasonable hypothetical release fee compensates for the damage to the asset. ‘Negotiating Damages’ are available at common law in cases where there is to be compensation for the damage to an ‘asset’. These include infringement of patent rights, misuse of tangible property (e.g. taking someone else’s horse or car without permission), use of someone else’s land without permission, trespass on land, and use of intangible property without permission (e.g. a trademark). Damages for passing off or misuse of confidential information may be awarded on this basis, by analogy. In contrast, there are many negative covenants breach of which only attracts compensation for the loss caused by the wrong, and where ‘Negotiating Damages’ have no part to play. An example might be a contractual promise not to order a ship to an unsafe port. The damages would not be assessed on the basis of what would have been the price for a licence to do so. Lord Reed decided that One Step was not an ‘asset’ case, and so, ‘Negotiating Damages’ were not available. Breach of a restrictive covenant protecting land and breach of a restrictive covenant protecting the value of shares which have been sold do not attract the same measure of damages because whilst the former involves invasion of a right of property, the latter does not. Goodwill can be regarded as a capital asset in company accounts. Lord Reed considered that damage caused by the breaches of contract to the goodwill of the claimant’s business did not suffice to bring the case within the damage to an ‘asset’ category. This is because the damage to the goodwill did not constitute taking or misusing the company’s ‘asset’, or infringing its property rights in that ‘asset’. Likewise the covenant protecting the ship from damage at an unsafe port is a covenant given to protect an asset, but the contractual promise does not qualify as an ‘asset’ for this purpose.
(D) Damages under Lord Cairns’ Act and Section 50 Senior Courts Act 1981
The judgments touch upon the damages jurisdiction under Lord Cairns’ Act, section 2 of the Chancery Amendment Act 1858, and discuss some of the case law. That jurisdiction, which survived repeal of the section many years ago, is the subject of extensive case law. Section 50 of the Senior Courts Act 1981 which now continues the jurisdiction, provides:
‘50. Power to award damages as well as, or in substitution for, injunction or specific performance.
Where the Court of Appeal or the High Court has jurisdiction to entertain an application for an injunction or specific performance, it may award damages in addition to, or in substitution for, an injunction or specific performance.’
This includes the jurisdiction originally conferred by section 2 of the 1858 Act, which was confined to where the court ‘has jurisdiction to entertain an application for an injunction against a breach of any covenant, contract, or agreement, or against the commission or continuance of any wrongful act, or for the specific performance of any covenant, contract, or agreement’. Section 50 is not limited to these categories of case. The boundaries of section 50 are considered in Gee on Commercial Injunctions (6thedition) at paragraphs 2-047 to 2-048, and 14-049 to 14-052.
The 1858 Act empowered the old High Court of Chancery to award damages in cases within section 2, thus avoiding the need for damages to be dealt with in the courts of common law. It also had substantive consequences. It enabled compensation to be awarded for loss not yet sustained, and also allowed a measure of damages to be awarded which could include ‘Negotiating Damages’. The damages to be awarded were in substitution for, or in addition to, a decree of specific performance or the granting of an injunction. If an injunction were granted, the defendant caught in the grip of the order could purchase his release by negotiating with the plaintiff and arriving at a monetary solution. If an injunction were refused, and damages were to be awarded, then the plaintiff should be in the same position, and so permitted to obtain a reasonable fee for releasing his rights.
Claimants often do not commence proceedings until long after the breaches of contract have occurred and the losses have been sustained. In One Step, the covenants lasted for three years from December 2006. The breaches and the losses were sustained long before commencement of the court proceedings in July 2012. The claim appears to have been advanced without seeking damages under section 50. In contrast, in Pell Frischmann Ltd v Bow Valley Iran Ltd [2011] 1 WLR 2370, it was common ground before the Privy Council that damages could be awarded under Lord Cairns’ Act (‘presumably by analogy’) in proceedings in Jersey, when those proceedings were commenced long after the breaches and the losses had taken place.
Lord Reed, at [95] subparagraph (3), stated that ‘Damages can be awarded under Lord Cairns’ Act in substitution for specific performance or an injunction, where the court had jurisdiction to entertain an application for such relief at the time when the proceedings were commenced. Such damages are a monetary substitute for what is lost by the withholding of such relief’. Proceedings seeking an injunction are often issued after breaches of contract have taken place, losses have been sustained, and there is a threat of further breaches and further losses. The wording of section 50 is not confined to awarding damages for loss sustained after action brought. Provided that the proceedings commenced are within the section, there is a discretion to award the statutory damages. That these can include past losses sustained prior to action brought, is supported by Mance LJ in Experience Hendrix LLC v PPX Enterprises Inc[2003] 1 All ER (Comm) 830 at [34] to [35]. The example was of a pop concert which started when a person entitled to enforce a restrictive covenant, was away on holiday and brought proceedings to stop the concert when he returned home. The claimant could get damages under the Act, including the loss caused while he was abroad, unable to commence the proceedings. These are “in addition to” the granting of the injunction.
What principles apply and what measures of damages are available is governed by the section. This depends upon its interpretation. The words of section 50 allow damages ‘in addition to’, as well as ‘in substitution for’, the injunction. Where there is a continuing course of conduct both prior to and continuing after commencement of the proceedings in respect of which there is jurisdiction to grant an injunction, one would expect all the losses to be covered by section 50. This view avoids different methods of assessment of damages for the period prior to commencement of proceedings and that afterwards. It avoids different measures of damages being available for the period before, and the period after. It is to be expected that Parliament intended that there could be a single award of damages under section 50 in respect of the entire course of conduct. This is because this avoids complexity, provides a just remedy, and is supported by its wording.
Lord Reed says ‘such damages are a monetary substitute for what is lost by the withholding of such relief.’ If this were the limit of the jurisdiction, the damages would only be available in substitution for the granting of the injunction. The words ‘in addition to’ in section 50, go further. They are not limited to a substitute for the injunction. Nor are the words limited to covering the case where an injunction is granted, but still, losses will be sustained because of the limited wording of the injunction or because the injunction is not granted immediately. Where an injunction is sought ‘quia timet’ (literally ‘since he fears’ [the commission of a wrong]), no loss would have been suffered prior to the commencement of the proceedings and damages would be confined to compensating for the refusal of the injunction. In that situation, the words of Lord Reed apply because the damages would be a substitute for the injunction. However, there can be cases where losses start before the commencement of the proceedings, and part of the overall losses would not be avoided even were an injunction to be granted which prevented any further wrong. The wording of section 50 appears to be sufficiently wide to allow an award of damages under the section in respect of the entire loss caused by the wrongful course of conduct. Lord Reed was not asked to consider such a case. As a result, there may well be cases which remain well outside of the zone of impact of the decision in One Step.
(E) What does the future hold?
The First-tier Tribunal (‘FTT’) has held in Patel v HMRC [2018] UKFTT 185 (5 April 2018) that a voluntarily submitted self-assessment return does not qualify as a return under section 8(1) of the Taxes Management Act 1970 (‘TMA’). Consequently, HMRC cannot open an enquiry into a voluntary return.
The appellants had completed paper tax returns as they had been unsuccessful in registering for online self-assessment. The returns were voluntary, meaning HMRC had not given the appellants notice under section 8(1) TMA requiring the delivery of such returns. Following amendments made by the appellants to the tax return so as to reduce tax liabilities, HMRC sent them notices of enquiry under section 9A TMA.
The FTT held that, on the wording of section 8 TMA, ‘a return under section 8’ plainly meant a return which the taxpayer had been ‘required by a notice given to him by an officer of the Board to make and deliver to the officer’. The words ‘may be required by a notice given to him’ confers a discretion on HMRC whether or not to issue a notice; for example, tax liabilities can be collected without such notice under the PAYE system. However, the fact that HMRC did not issue a notice did not mean a voluntary return became one under section 8 TMA. This conclusion could not be changed by applying the doctrine of purposive construction, as the words used by Parliament as well as its expressed intention were ‘entirely clear’. However, it was open to HMRC, on receipt of a voluntary return and within prescribed time limits, to issue a notice under section 8 TMA requiring the taxpayer to make a return (and effectively resubmit the voluntary return).
This article appears in the JHA April 2018 Tax Newsletter, which also features:
The CJEU has held in C-302/17 PPC Power that the Slovak tax on sold or unused greenhouse gas emission allowances is not compatible with EU law as it is contrary to the principle of the free allocation of allowances.
During 2011-2012 Slovakia levied a tax of 80% on allowances that were sold or were not used by entities participating in the EU Emission Trading System (‘EU ETS’). The allowances had been allocated to those entities free of charge in accordance with Directive 2003/87/EC (the ‘EU ETS Directive’).
The CJEU held that the free allocation of allowances was intended to prevent EU ETS regulated entities from losing competitiveness as a result of the introduction of the EU ETS. The economic value of allowances underpins the EU ETS, as selling unused allowances encourages undertakings to invest in emission reducing measures. However, depriving these undertakings of 80% of the value of such allowances removes most of the economic incentive to invest in measures to reduce emissions. In conclusion, the tax has the effect of neutralising the free allocation of allowances and is therefore incompatible with the EU ETS Directive.
This article appears in the JHA April 2018 Tax Newsletter, which also features:
The German Ministry of Finance has published its official guidance on the German anti-treaty shopping rule, in direct response to the decision of the Court of Justice of the European Union (‘CJEU’) in Joined Cases C-504/16 and C-613/16 Deister Holding and Juhler Holding (reported in the January 2018 newsletter). The CJEU had held that the German anti-treaty shopping provisions breached the Parent-Subsidiary Directive (‘PSD’).
Issued on 4 April 2018, the guidance provides that the previous German laws on anti-treaty shopping (dated 2007) are no longer to be applied in open cases where the foreign recipient of a distribution of profits claims a tax refund under the PSD, so that all such open cases must now be approved by the Federal Central Tax Office. Significantly, the guidance also comments on the applicability of the subsequent (2012) anti-treaty shopping provision. The guidance stipulates that the 2012 provision allows holding entities that only carry out asset management to claim tax relief under the PSD, provided that the said entity actually exercises its shareholder rights and does not merely exist for the purpose of avoiding tax.
It is worth noting that the guidance only concerns dividend withholding tax under the PSD. Specifically, the guidance does not affect withholding tax relief on interest or royalties (under the Interest and Royalties Directive) or relief on other dividends not falling within the scope of the PSD.
This article appears in the JHA April 2018 Tax Newsletter, which also features:
David Green QC is stepping down as Director of the Serious Fraud Office (SFO) this month, after six years in the job. The name of his successor remains undisclosed to date. Whoever that may be, he or she stands to inherit a complex legacy, which includes the increasing popularity of US-style Deferred Prosecution Agreements (DPAs).
The SFO has had a bumpy ride in its 30-year history. Mr Green’s appointment followed the controversial decision to terminate the investigation into bribery and corruption allegations at BAE Systems in relation to a multi-billion dollar arms deal with Saudi Arabia. Mr Green also inherited a botched investigation into the collapse of Icelandic bank Kaupthing: the badly mishandled dawn raids led to the SFO being sued by the Tchenguiz brothers and scathing judicial criticism.
It remains to be seen in which direction the SFO will be steered by its incoming director. During Green’s tenure, the only four DPAs that have ever been entered into in the UK were judicially approved in relation to Standard Bank, Rolls-Royce, Tesco and XYZ, a company whose anonymity is currently preserved on legal grounds. The financial penalty flowing from the Rolls-Royce DPA was the most significant at just under £500m.
The rationale behind DPAs is for corporates to avoid the uncertainties and reputational damage of a criminal prosecution and conviction (which may give rise to debarment from public tenders in certain circumstances) while encouraging self-reporting and cooperation by the potential targets of regulatory investigations. DPAs are resolved more quickly and cheaply than lengthy criminal trials and provide a corporate with the opportunity for PR control by virtue of the agreed statement of facts. Moreover, there is a financial incentive on both sides: the penalty is reduced for the corporate in line with guilty plea credit guidelines, and the Treasury is able to recoup the profit from the wrongdoing.
This system has been compared to having a “probation officer” for corporate entities – if the hefty financial penalty is not enough to deter, the threat of prosecution further down the line certainly will be. In addition, DPAs require signatories to remediate their alleged failings by the expiry of the agreement’s term and can impose other obligations, such as cooperation with overseas prosecution agencies and with any prosecution of individual employees in the UK.
Ultimately, however, the public interest against prosecution must outweigh those factors in favour of it. Whilst the SFO has described the stance the company takes once it becomes aware of the issue as a key factor in determining whether it will be offered a DPA or be subject to criminal prosecution, it should be noted that Rolls-Royce did not self-report, and only obtained a DPA (and a 50% reduction in financial penalty) on account of its “extraordinary” co-operation with the SFO. The large reduction afforded to Rolls-Royce in circumstances where the unlawful activity only came to light as a result of public statements made by a whistle-blower has been criticised as undermining the motivation for companies to self-report, particularly as there is no guarantee that a DPA will be offered and the company might be bringing to the attention of the SFO wrongdoing that would otherwise never have been discovered.
For his part, Mr Green has expressed his hope that the DPA system will continue for those firms that self-report and cooperate with the SFO.
‘Artificial intelligence’ (AI) no longer conjures up images from the early Noughties film Minority Report, but instead is vying to become the most powerful weapon in the fight against financial crime. What does AI mean in the legal and regulatory context? Data analysis technology is not new, but it is being newly applied to areas previously entrusted to human judgement, notably compliance.
According to the Financial Conduct Authority (FCA), UK banks spend around £5bn every year combating financial crime – £1bn more than the country spends on prisons. It was only a matter of time before banks would try to make their fraud and money laundering detection processes speedier, cheaper and more effective, and this is where AI can help. Speaking at the FinTech Innovation in Anti-Money Laundering (AML) and Digital ID regional event in London last year, Rob Gruppetta, Head of the Financial Crime Department at the FCA, was confident that AI can be particularly useful in monitoring a bank’s transactions to detect suspicious activity in real time, an area where there is significant potential for human error. The Financial Stability Board (FSB) also published a report last year on the impact of AI on financial services which identified potential benefits and risks to be monitored in the near future.
The financial services industry is increasingly turning to machine-based data analysis for their compliance processes. HSBC has recently partnered with UK start-up Quantexa and Silicon Valley-based Ayasdi to use their AI technology as part of a drive to automate compliance and process transactional data to identify potential money laundering activity. Other banks, from Singapore-based OCBC to Denmark’s Danske Bank, are rapidly following suit and innovating in fraud-detecting AI. Defence experts BAE Systems now provide financial crime technology solutions which allow banks and the National Crime Agency to share information, thus facilitating both compliance and law enforcement.
Beyond the perceived benefits that AI can bring, regulators such as the FCA and the FSB are rightly wondering if there are any drawbacks. Notably, can – and will – AI replace human-based compliance systems? Gruppetta’s speech suggests the FCA does not believe this to be the case. Rather, the FCA thinks AI will complement, but not replace human judgement in order to refine the decision-making model over time. The FSB’s report highlights the importance of appropriate risk management and oversight of AI, including adherence to data privacy and issues around cybersecurity. However, while AI may not fully replace human intervention, it may require tailor-made supervision by a new specialist regulatory body, as suggested by evidence given to the parliamentary Science and Technology Committee’s ‘Algorithms in decision-making’ inquiry.
Simon Whitehead, partner in the Joseph Hage Aaronson Contentious Tax team, is author of The Legal 500 and The In-House Lawyer Comparative Legal Guide to Tax in the United Kingdom.
The Guide is formatted as an easy-reference Q&A, and provides an overview of tax laws and regulations. The UK chapter provides an overview of areas including withholding tax, transfer pricing, the OECD model, GAAR, tax disputes and an overview of the jurisdictional regulatory authorities.
Advocate General (AG) Kokott has issued her Opinions on the interpretation of the beneficial owner concept in two sets of circumstances: under the Interest and Royalties Directive (IRD) (Joined Cases C-115/16, C-118/16 and C-119/16 N Luxembourg 1, X Denmark and C Danmark I, and C-299/16 Z Denmark) and under the Parent-Subsidiary Directive (PSD) (Joined Cases C-116/16 and C-117/16 T Danmark and Y Denmark).
The IRD cases involved Danish companies being given loans from and paying interest to companies based in other EU member states and ultimately owned by entities resident in third countries. Under the IRD, withholding tax is not chargeable on interest payments arising in an EU member state, so long as the beneficial owner of the payment is based in another member state. The PSD cases involved the payment of dividends from a Danish company to a company in another member state which was ultimately owned by a third country-based entity. Under the PSD, dividends from subsidiaries to parent companies are not subject to withholding tax, and there is no beneficial ownership requirement as with the IRD. In all cases the Danish tax authorities refused to grant an exemption from Danish withholding tax on the interest and dividend payments to the non-Danish, EU parent company. The Danish tax authorities interpreted the IRD and the PSD as meaning that the non-Danish, EU company in receipt of the income was a conduit and not the beneficial owner of the payment.
In the IRD cases, the AG took the view that the non-Danish, EU company receiving the interest was, in principle, the beneficial owner, as it was the entity entitled in law to demand payment of the interest. However, that company would not the beneficial owner where it was not acting in its own name and on its own account, but instead as a trustee for a third party. The AG listed some relevant aspects for the national court to consider when determining the existence or otherwise of a trust relationship. A refinancing agreement with another party on similar terms as the present case was not of itself conclusive of a trust. By contrast, arrangements such as identical refinancing interest rates and received interest rates, or the absence of costs for the parent company could indicate the existence of a trust.
With regard to the PSD cases, AG Kokott confirmed that the exemption to withholding tax under this Directive was not subject to a condition of beneficial ownership. Consequently, the next question was whether there was an abuse under EU law, namely a wholly artificial arrangement to escape national tax normally due on profits. The AG’s view was that a determination of abuse was a matter for the national court on the facts. In itself, the existence of a parent company in another member state so as to profit from that state’s tax legislation was not abusive, but abuse may exist if that company did not have the structure to achieve its purposes and generate an income.
This article appears in the JHA March 2018 Tax Newsletter, which also features:
This judgment relates to the proceedings between Volkswagen AG and the Finance Directorate of the Slovak Republic. The dispute arose after a partial refusal by the Finance Directorate of the Slovak Republic of an application for a refundof value added tax (‘VAT’), charged several years after the initial delivery of the supplied goods to Volkswagen AG.
The Slovak government argued that the 5 year limitation period (Law No 511/1992 on Tax Administration, ‘The Tax Code’), starting from the date of delivery of the goods, had already expired when the application for deduction was made on 1 July 2011.
The legal context asks whether the fixing of the starting date of the five year limitation period is compatible with EU law on the common system of value added tax. While current EU law on the common system of value added tax holds that the ‘right to deduct’ (Article 167 of Directive 2006/112) is an integral part of the VAT scheme, the ‘right to deduct’ is also subject to substantive requirements or conditions (judgment of 19 October 2017, Paper Consult, C-101/16, paragraph 38).
The CJEU found that EU law must be interpreted to preclude national legislation of a Member State in circumstances, such as the main proceedings, when the exercise of the right to claim a refund expired before the VAT tax was charged and an application for a refund was submitted.
This article appears in the JHA March 2018 Tax Newsletter, which also features:
The new Directive aims to amend Directive 2011/16/EU, which concerns administrative cooperation in the field of taxation. The proposed legislation places an obligation on intermediaries to report on potentially aggressive tax planning arrangements.
While the existing tax instruments at EU level do not contain explicit provisions requiring Member States to exchange information in the case of tax avoidance and/or evasion schemes, DAC contains a general obligation for the national tax authorities to spontaneously communicate information to the other tax authorities within the EU.
The new reporting requirements have an effective date of 1 July 2020, with EU Member States obliged to exchange information every three months after that. The first exchange will take place by 31 October 2020.
This article appears in the JHA March 2018 Tax Newsletter, which also features:
