This article first appeared in Bloomberg BNA in December 2017.
The UK Supreme Court, overturning decisions of the High Court and Court of Appeal, has unanimously held that the retailer Littlewoods is not entitled to compound interest on overpaid value added tax (“VAT”).
Littlewoods, a retailer, mistakenly made overpayments of VAT on commission paid to catalog sales agents between 1973 and 2004. Littlewoods made claims for repayment under the statutory regime for recovery of overpaid VAT in the Value Added Tax Act 1994 (“VATA”). Between 2005 and 2008, HM Revenue and Customs (“HMRC”) repaid the principal amount overpaid of 205 million pounds (approx. $271 million) together with interest of 268 million pounds. The interest was calculated on a simple basis in accordance with Section 78 VATA.
As more than 40 years had passed since the first overpayment, the issue of whether compound interest was also payable made an enormous difference to the value of the claim. In 2007, Littlewoods issued a claim in the High Court seeking recovery of compound interest on the basis of restitution, a common law claim. Littlewoods argued that HMRC had been unjustly enriched by the overpayments and was liable to make restitution for the time value of money. The claim was valued at £1.25 billion.
At the time of the Supreme Court hearing, HMRC was facing a further 5,000 claims for compound interest in connection with VAT or other taxes. The total amounts claimed in relation to VAT alone was estimated by HMRC at £17bn, making this decision of great significance to the UK government.
Two Issues Considered by Supreme Court
The Supreme Court considered two key issues:
- Was Littlewoods’ common law claim for compound interest excluded by the statutory regime for VAT overpayments (specifically sections 78 and 80 VATA) as a matter of English law (without reference to European Union (“EU”) law)?
- If so, was that exclusion contrary to EU law, in particular the principle of effectiveness?
On the first issue, the Supreme Court found, as had the lower courts, that Littlewoods’ claim was excluded by the provisions in VATA as a matter of English law.
There was no express provision in VATA excluding common law claims. However, the key factor for the Court on this first issue was that Parliament, in bringing in the statutory provisions, would not have intended them to have been capable of circumvention by the making of a concurrent common law claim. The Court noted that the statutory regime at sections 78 and 80 VATA imposes a number of limitations on HMRC’s liability which would be made ineffective if the taxpayer could simply recover compound interest by a common law claim. The fact that sections 78 and 80 VATA did not contain an express exclusion was explained by the fact that the type of claim made by Littlewoods (relying on the 2007 Sempra Metals case) was not contemplated at the time Parliament enacted the legislation in 1994.
The second issue, whether EU law required the payment of compound interest, is where the Supreme Court’s decision diverges from that of the lower courts. In a judgment released in July 2012, the Court of Justice of the European Union (“CJEU”) held that under EU law, the taxpayer was entitled to an “adequate indemnity” for its loss sustained by the overpayment of tax. However, the CJEU did not explain whether “adequate indemnity” actually required payment of compound interest. The High Court and Court of Appeal found that it did. Here the Supreme Court disagreed with the lower courts’ finding that this did not require “full reimbursement” to compensate for the non-availability of funds: the lower courts had formed too narrow a view of what might constitute “an adequate remedy.”
Three Reasons for Court’s Conclusion
The Court set out three reasons for this conclusion.
- The first reason was that the 2012 CJEU judgment established three principles. The first principle was that there is an general entitlement to interest on tax levied in breach of EU law. Secondly, the Member State is given discretion both as to the interest rate and method of calculation. That discretion is qualified by general EU principles of equivalence and effectiveness. The second of these is in issue as it sets the context for the scope of what constitutes “adequate indemnity.” This is not the same as a “full reimbursement.” Here the Court noted that the term “adequate indemnity” or “reasonable redress” supported a range of meanings which did not require full compensation for time value of money. The third point made was that the CJEU judgment, noting that Littlewoods had already received interest of more than 125 percent of the principal sum, suggested that where such a significant payment of interest is made in a claim for repayment which stretches back many years, it could constitute reasonable redress. The Supreme Court interpreted this as suggesting that the CJEU considered that the simple interest paid might constitute reasonable redress.
- The second reason given was that there is a widespread practice of simple interest being paid both on repayments to taxpayers and on late paid taxes. (In its submissions to the CJEU the UK had noted that having examined the legislation in 13 Member States, simple interest was awarded in all but Sweden.) If the CJEU had been looking to outlaw the use of simple interest they would have done so clearly.
- The third was that the Court’s interpretation of the CJEU’s judgment was consistent with the CJEU’s prior and subsequent case law which has left questions of the rate and method of calculation to be determined as a matter of national law.
The Supreme Court also concluded that a second reference to the CJEU was not necessary.
Effect of the Court’s Decision
The practical effect of the Supreme Court’s decision is that claims for compound interest on overpaid VAT will effectively be precluded, resulting in a substantial saving for the UK government.
In terms of its wider application, Littlewoods represents a step back from Sempra Metals, where the House of Lords recognized that in commercial terms, the value of money is measured on a compound basis and found that compound interest was a remedy available to the taxpayer. However, in Littlewoods the Supreme Court did not overrule Sempra Metals, but rather confirmed it was unavailable on overpayments of VAT. It remains to be seen whether all avenues available to the taxpayer to recover compound interest on overpaid taxes have been closed. The position is likely to be clearer in 2018, when the Supreme Court will hear the Prudential case (the test case in long-running litigation concerning the taxation of portfolio dividends), which is expected to address compound interest under English law.