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ITEM PF14

PENSION FUND COMMITTEE – 26 MAY 2006

GROUP ACTION CLAIM FOR RECOVERY OF OVERSEAS TAX

Report by the Head of Finance & Procurement

1. This report provides the Committee with details of a legal action which KPMG and McGrigors are progressing on behalf of a number of pension schemes and seeks member approval to Oxfordshire Pension Fund joining this action. The report sets out the background to the action, indicates the potential benefit to the Fund and seeks member approval to the costs of involvement.

Background

2. KPMG corporate tax advisors briefed council officers at the beginning of March about a legal action they and McGrigors (a firm of solicitors) are supporting on behalf of a number of private and public sector pension funds. A number of direct tax cases has been taken to the European Court by individuals and companies from member states on the basis that certain tax legislation of those member states is discriminatory under European Union (EU) principles and results in the taxpayer suffering a loss. The claims on behalf of pension funds are being co-ordinated through a test case pursued on behalf of the British Telecom pension scheme (BTPS) and cover the period 1993/94 – 1997/98 (at which point the UK tax regime was changed).
3. Based on existing claims by funds with a current value of between £1.5bn and £2bn, KPMG have noted that claims are between £2.5m and £4m plus interest. Whilst these are ‘ball park’ figures, the scale of the potential benefit required officers to respond to this with some urgency. The Oxfordshire pension fund has a current value of some £900m.

Basis for legal action

4. On joining the EU, member states sign up to the European Treaty, which recognises European Law as the highest law in each member state. Under the European Commission (EC) treaty there is a right to the free movement of goods, people, capital and services within the EU. Consequently, the European Court of Justice has held that, whilst member states are responsible for their own tax policy, they must nevertheless act within the parameters set by the EC – in particular, they must respect the basic treaty freedoms. Member states’ tax regimes, which act to discriminate against the free flow of capital, are therefore contrary to EU law.
5. There are two components to the legal action – the Foreign Income Dividends (FIDs) claim and the ‘Manninen’ claim – both of which revolve around discriminatory treatment of tax credits on dividends. The FIDs claim relates to UK companies electing to distribute dividends from profits arising overseas on which no tax credits were allowed compared to their UK distributions, which attracted tax credits. The implication of the Manninen claim pointed to the fact that the UK tax credit system gave tax credits to pension funds receiving dividends from UK investments up to July 1997 whereas overseas dividends did not carry a similar tax credit that could be reclaimed.
6. The test case for FIDs and Manninen is being pursued on behalf of British Telecom (BT) but a number of private and public sector pension schemes have joined in a group litigation order (GLO) since their claims are identical to those in the BT test case. If the BT test case were to be successful, the court’s ruling would then be applied to the GLO claims. Private sector pension schemes, which have joined the GLO, include British Coal, British Gas, British Steel and Shell. Five public sector pension funds have signed up to the GLO and a further 27 (including Oxfordshire – see paragraph 7 below) have filed claims at the High Court to facilitate their joining the GLO. A full list of these public sector pension funds is included at Appendix A.
7. McGrigors expect the test case to progress via the High Court to the European Court of Justice by the end of 2006 / beginning of 2007 and a ruling in 2008.

Timelines

8. For the period in question (1993/94–1997/98), a UK pension fund receiving UK dividends had a period of roughly six years following the end of each tax year in which to make a claim to HM Revenue & Customs (HMRC) for tax credits on UK dividends received in that tax year (i.e. for tax year 1993/94 a pension fund could make a claim to HMRC for tax credits up to 5 April 2000). Therefore, on the face of it, the ability for pension funds to make claims via their tax returns is now out of time. The Limitation Act 1980 then applies to open the door to extend claims beyond the deadlines set in the tax statute. This statute allows claims to be brought in the High Court for a period of six years following a "cause of action" arising. KPMG and McGrigors are arguing that the cause of action arose on the date when it was no longer possible to make a statutory claim for the tax credits. Therefore, they are suggesting, looking at the statutory time limits and the Limitation Act combined, a claim can be made at the High Court up to 12 years after the end of the tax year in which the dividends were received (for the tax year 1993/94 that 12 year period expired on 5 April 2006 – see paragraph 11 below).

Implications for Oxfordshire Pension Fund

9. Given the urgency already described, the principle of joining the GLO appeared attractive, particularly given the opportunity that the GLO offered to share costs and risks. The immediate priority for officers was to determine whether evidence could be assembled for the period in question to support a claim and whether the scale of the claim justified the cost. The basic information required was a listing of overseas dividend income received for the period of the claim, split between EU sourced dividend income and non-EU sourced dividend income.
10. An early approach to the pension fund’s past fund managers drew a blank, since the timelines involved were outside of their retention policies. A subsequent search of the Council’s own electronic archives revealed full income statements for the 3-year period 1995/96 – 1997/98 which contained all of the details required for a claim – but not for the earlier years 1993/94 – 1994/95. However, officers have located valuation reports for this period in the Council’s archives and the work of reconstructing the fund portfolios for the two-year period is planned for two weeks at the end of May.
11. Once the dividend income data is assembled for the 5-year period, officers plan to arrange for KPMG to complete a quantification exercise and negotiations are currently underway with KPMG to confirm the likely cost of this. The quantification exercise will put a value on Oxfordshire’s Pension Fund potential claim, at which point officers will determine whether to join the GLO formally or to withdraw altogether.
12. Given the issue of timing detailed in paragraph 7 above, the 5 April 2006 was an important deadline and, with advice from McGrigors, officers sought to protect the pension fund’s interests by lodging a protective claim in the High Court before the end of the tax year. This kept open the option of claiming back 12 years to 1993/94 - if officers had waited for the results of the quantification exercise and lodged a claim after the 5 April 2006 deadline, this would have restricted the claim to 1994/95 onwards – i.e. 12 years back from the 2006/07 tax year. The fund has 4 months from 4 April to submit evidence to substantiate the claim lodged with the High Court at which point it will be served on HMRC. Officers are currently discussing with KPMG the respective workloads of assembling the dividend details on the one hand, and quantification on the other hand, to plan out the timeline to 4 August 2006.

Costs of participation

13. The cost of lodging the provisional claim with the High Court amounted to £12,700 (McGrigors fees of £8,500 plus Court fees of £4,200) and this has been funded from the 2005/06 investment management consultancy fee budget.
14. The cost of the KPMG quantification exercise is currently under discussion and will be reported orally to members on 26 May.
15. If the Oxfordshire pension fund were to join the GLO, KPMG will charge a flat fee of £40,000. For other local authority pension funds KPMG have proposed a flat fee of £20,000 plus 2% of any repayment received, capped at £150k. However, KPMG are also the pension fund’s auditors and the Audit Commission will not accept contingent arrangements in these circumstances – hence the flat fee proposal.
16. For McGrigors, the further work of serving the claim on HMRC and linking it into the GLO will cost £8,000. The Oxfordshire pension fund will also be liable for a share of the common costs incurred in relation to both the FIDs issue and the Manninen issue by the test claimant BTPS, under a cost-sharing agreement which will limit costs to the lower of:

• An equal share of the total costs of both cases estimated to be between £650,000 and £750,000: – on the basis of 20 participants, for example, this would equate to a maximum of £37,500; or
• The value of repayments received multiplied by ¾% - for example if the fund secured repayment of £1m the share of costs would be £7,500.

17. Should the test case be lost and costs of HMRC be awarded against the test claimant, then these additional costs will be shared under the cost sharing agreements and will also be subject to the agreed capping mechanism. Until the quantification exercise is complete, the scale of possible costs will not be evident, but the capping mechanism provides a substantial comfort factor and reflects the fact that BTPS were committed to this legal action before the GLO was set up and are taking on the bulk of the risk themselves.
18. The potential financial perspective around this action is summarised in the table below:

		£	£	£
OCC pension fund claim - assume		-1,000,000	-1,500,000	-1,800,000
KPMG:	Quantification exercise (est)	5,000	5,000	5,000
	Flat fee	40,000	40,000	40,000
McGrigors:	Lodging provisional claim	12,700	12,700	12,700
	Serving claim / GLO	8,000	8,000	8,000
	Share of common costs	7,500	11,250	13,500
Sub-total: Professional & court costs		73,200	76,950	79,200
Net value of successful claim		-926,800	-1,423,050	-1,720,800

19. The implication of joining the GLO would be to incur costs – from the illustrative range above – of between £73,200 and £79,200, the exact amount to be determined when the claim is quantified. As the McGrigor’s cost of lodging the provisional claim of £12,700 has been charged to 2005/06, this would leave an indicative balance of between £60,500 and £66,500 to be met for which there is no budget provision in the 2006/07 estimates. All of these costs would be attributable to 2006/07.
20. It would be preferable to provide the Committee with a detailed perspective when the Oxfordshire Pension Fund claim has been finally quantified and it is clear whether joining the GLO is worthwhile; unfortunately the timing of the next Pension Fund Committee meeting - the 26 August - does not provide for that option. A decision needs to be made prior to 4 August 2006, for the reasons detailed above and the recommendations address this requirement.

RECOMMENDATIONS

21. The Committee is RECOMMENDED to:

1. delegate to the Head of Finance & Procurement and the County Solicitor the decision as to whether to join the GLO on the basis of the quantification exercise to be completed with KPMG;
   
   
2. authorise the defrayment of the costs of the action as estimated in the report, in the event of a decision to join the GLO.

SUE SCANE
Head of Finance & Procurement

Background Papers: Nil

Contact Officer: Ken Bell, Interim Assistant Head of Finance. Tel (01865) 815411

May 2006.

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