Compound interest and repayments of overpaid VAT

The Supreme Court has held that the jurisprudence of the European Court of Justice (ECJ) does not require UK law to provide for compound interest on repayments of overpaid VAT in order to provide the taxpayer with an “adequate indemnity”: Littlewoods Ltd v HMRC [2017] UKSC 70. Overturning the judgments of the High Court and Court of Appeal, the Supreme Court considered that, read as a whole, the ECJ had not indicated that a full indemnity for the loss of the use of money over time was a necessary component of an “effective remedy” and, as such, the exclusive statutory right to simple interest in UK law was compliant with EU law.

As a result, the UK Exchequer may be saved some £17bn in claims that are apparently standing behind the Littlewoods claim and many existing claims which were stood behind will need to be amended or withdrawn. The extent to which these large amounts at stake may have weighed on the decision of the Supreme Court will remain a matter of conjecture.

Background

Littlewoods overpaid output VAT on supplies made in connection with its catalogue shopping business between 1973 and 2004. HM Revenue & Customs (HMRC) duly repaid some £204m of overpaid VAT together with interest of £268m calculated pursuant to VATA 1978 section 78.

Littlewoods complained however that the interest payable under section 78 was only simple interest and that an effective remedy for EU law purposes for the overpayment of VAT required the payment of compound interest (ie interest under which interest payments themselves are capitalised for the purposes of calculating later interest payments). This dispute reached the High Court, which referred the matter to the ECJ.

The somewhat ambiguous decision of the ECJ is reported at “VAT repayments and compound interest”, where the ECJ held that, as regards the calculation of interest, domestic rules "should not lead to depriving the taxpayer of an adequate indemnity for the loss occasioned through the undue payment of VAT".

When the case returned to the High Court, Henderson J held that an adequate indemnity for Littlewoods’ loss in this case would necessitate payment of compound interest. The Court of Appeal agreed with Henderson J in concluding that the reference to an “adequate indemnity” meant that the taxpayer must be indemnified for its loss of the use of money overpaid and that an “adequate” indemnity is one that one that is at least broadly commensurate with the loss of the use value of the overpaid money in the hands of the taxpayer. Simple interest would not meet that requirement in this case.

Supreme Court

The judgment of the Supreme Court (a joint judgment of Lords Reed and Hodge, with whom the remaining members agreed) in essence centres on the questions: (1) does section 78 provide for an exclusive regime for the payment of interest on overpaid VAT, excluding an alternative UK remedy in restitution and (b) if so, is that exclusion contrary to EU law.

Exclusive remedy?

As regards the question whether section 78 provided an exclusive remedy for payment of interest on overpaid VAT, Littlewoods pointed out that section 78 only provided for interest “if and to the extent that [HMRC] would not be liable to do so apart from this section”. Littlewoods contended that HMRC were, in any event, obliged to pay compound interest by way of restitutionary remedy under English law and that overrode the section 78 provision for simple interest.

The Supreme Court (like the courts below) rejected this argument. The Court considered that, viewed as a whole, the statutory scheme for the repayment of overpaid VAT under VATA 994 section 80 and interest under section 78 was clearly intended to provide an exclusive statutory remedy. But what of the fact that section 78 (unlike section 80) did not expressly exclude other remedies (and in fact expressly contemplated them). Looking back at the history of the legislation, the Court noted that the common law remedy of restitution for the use value of money by which a defendant had been unjustly enriched was not recognised until the decision in Sempra Metals which post-dated section 78. As such, Parliament could not have been contemplating such a right when it suggested the existence of other forms of right to interest in section 78. Moreover, to concede that section 78 had to give way to the common law principle in Sempra Metals would, in effect, render the limitation in section 78 redundant.

Read as a whole, it was clear that section 78 was intended to create an exclusive statutory scheme for interest payments. It must therefore be interpreted as impliedly excluding common law claims. The reservation for other forms of interest must be read as referring only to other forms of statutory interest which might be available. So construed, section 78 impliedly excludes claims for compound interest based on restitutionary principles.

Is the limitation in section 78 contrary to EU law?

The Court noted that it is quite clear from the jurisprudence of the ECJ that reimbursement of overpaid tax must be accompanied by interest and that is the case whether tax is simply overpaid or whether it was levied incorrectly. Thus the right to a payment of interest is, in itself, a Community law right and that right is on a par with the right to the repayment of the tax overpaid.

In the Littlewoods case, the ECJ had not stated whether simple interest or compound interest is required. Instead, the ECJ held that it was for each Member State to determine the conditions for payment of interest, subject to compliance with the principles of equivalence and effectiveness. This means that the terms must not be less favourable than those concerning similar claims under national law, nor must they make the exercise of EU rights practically impossible. In particular, the ECJ held that a Member State in receipt of overpaid tax must, in addition to reimbursing the sums overpaid, provide an “adequate indemnity” by way of interest to a taxpayer.

The crucial question, therefore, is whether simple interest can amount to an “adequate indemnity”. On this point, the Supreme Court departed from the courts below.

In particular, the Court considered that Henderson J and the Court of Appeal had been misled by references to a need for “reimbursement” and “indemnity” to consider that the ECJ were suggesting that the taxpayer must be fully compensated for the loss of the use of the monies. A reading of the judgment as a whole led the Supreme Court to a different conclusion for three reasons.

Firstly, the structure of the ECJ’s judgment suggested that an “adequate indemnity” in this context meant nothing more than reasonable redress for the taxpayer’s loss. Indeed, “adequate indemnity” as a phrase has a much less definitive meaning than “full reimbursement” or “full compensation”. Moreover, in suggesting that the referring court might consider that interest which was over 125% of the amount of the principal sum might be such a reasonable redress, the ECJ had given the UK courts a clear steer.

Secondly, given that almost all EU Member States provided only for repayments of simple interest on overpaid tax, the Supreme Court noted that they would have expected the ECJ to have been much clearer if they were seeking to render illegal such a widespread practice.

Thirdly, the Supreme Court looked at the subsequent caselaw of the ECJ following the Littlewoods judgment and found no inconsistency between its interpretation and those later cases.

Accordingly, the Supreme Court concluded that there is no requirement for UK law to provide for compound interest and that the exclusive statutory remedy in section 78 was compliant with EU law.

Comment

The judiciary are, of course, an impartial and independent body of the Executive. Still, it is perhaps fair to wonder whether the judgment may not have been influenced, if only subconsciously, by the amounts at stake in this case. £17bn is a lot of taxes, especially at a time of increasing economic uncertainty. Certainly, there are indications that the Court had little sympathy for Littlewoods’ plight as evidenced by the following quotation:

“Littlewoods have already recovered overpaid tax, and interest on that amount, going back several decades. The size of that recovery reflects a combination of circumstances which could not have occurred in most of the other EU member states: the retroactive nature of a major development of the common law by the courts, so as to allow for the first time the recovery of money paid under a mistake in law, and the inability of the legislature to respond to that development, under EU law, by retroactively altering the law of limitation so as to protect public finances. The resultant payment of interest cannot realistically be regarded as having deprived Littlewoods of an adequate indemnity, in the sense in which that expression should be interpreted.”

On the other hand, the decision has the benefit of simplicity. The decision of the Court of Appeal potentially raised the problem that, in the absence of any bright line between cases where statutory (simple) interest is an “adequate indemnity” and where it is not (requiring some other measure, such as compound interest), this left open the prospect for much future litigation.