VAT and compound interest (again)

The Advocate General has again opened up the issue of whether compound interest is necessary in order to provide full or adequate compensation for the damage caused by demanding payment of VAT contrary to EU law: Joined Cases Sole-Mizo (Case C-13/18) and Dalmandi (Case C126/18).

The AG has opined that EU law will normally require full compensation to be made to a person who has suffered from a breach of EU law and that full compensation requires the payment of interest both at a commercial rate and which recognises the erosion to the value of money by the effluxion of time by providing some form of compounding.

It remains to be seen whether the ECJ will support the view of the AG, but if it does so then it may cast doubt on the decision of the Supreme Court in the Littlewoods case that simple interest was an “adequate indemnity” for overpayment of VAT over long periods.

Background

The issue of compound interest was considered by the ECJ and Supreme Court in the Littlewoods cases. Littlewoods had overpaid output VAT on supplies made in connection with its catalogue shopping business between 1973 and 2004. HMRC repaid over £200m of overpaid VAT together with interest of £268m calculated at a simple rate pursuant to VATA 1978 s.78.

Littlewoods complained 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).

In a somewhat ambiguous decision, 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" but that it was “for the internal legal order of each Member State to lay down the conditions in which such interest must be paid, particularly the rate of that interest and its method of calculation (simple or “compound” interest)”.

Back in the UK, the Supreme Court eventually held that EU law did not require UK law to provide for compound interest on repayments of overpaid VAT in order to provide the taxpayer with an “adequate indemnity”.

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. See “Compound interest and repayments of VAT”.

Joined Hungarian cases

The joined Hungarian cases concern provisions of Hungarian law that illegally restricted VAT deductions and led to taxpayers obtaining deductions for input VAT in a later period than should have been the case.

These provisions were held incompatible with EU law and the Hungarian tax authorities paid interest on the late deduction of the VAT calculated by reference to the base rate of the central bank (under provisions of domestic Hungarian law dealing with situations where a settled practice had been overturned).

The two Hungarian taxpayers in this new case submitted claims for compound interest on the input VAT which had been restricted.

The case raises a number of issues over the EU principles of effectiveness and equivalence, but the general issue of most interest is the question whether the simple rate of interest was sufficient to provide an “adequate indemnity”. The AG’s opinion on this was released on 11 September 2019.

The Advocate General noted that some earlier ECJ judgments referred to a taxpayer’s right to “full compensation” and in other judgments (particularly in tax matters where substantial amounts are at stake) reference is made to “adequate compensation”.

Despite the differences in wording, the AG suggests that there is no conflict in the two formulations. Rather the use of the term “adequate” indicates that in some circumstances the right to “full compensation” for damage caused by breach of EU law may have to be qualified in some instances due to considerations of “practicability and general expediency”.

Commenting specifically on the Littlewoods case, the AG states that “the intention of the Court was not to depart from the principle of full reparation, but rather to refer to the fact that the precise rate to be applied - the one amounting to full compensation - depends on the situation currently prevailing in each Member State”.

The AG suggests, however, that apart from in such situations, the grant of something at least close to full compensation is necessary to ensure the full effectiveness of EU law. In particular, the AG’s opinion goes on to suggest that basing the rate on that of the central bank would not comply with that requirement as that would not be a rate in practice available to an ordinary taxpayer to borrow the necessary funds to offset the late repayment of VAT.

Moreover, the AG goes on to say that compensating the taxpayer also required the tax authority to compensate for the “monetary erosion caused by the effluxion of time” by further interest.

In essence, therefore, the AG suggested that some form of compound interest is necessary to meet the requirements of EU law, though this should be one based on the rate of inflation (rather than a rate charged by a bank).

Comment

This is only an AG’s opinion, and one that does not fully set out the basis why the AG considered that the ECJ may have considered, as a departure from the general principle, simple interest acceptable in the Littlewoods case.

However, if followed by the ECJ, it will potentially shine the spotlight back on arguments for compound interest and potentially cast doubt on the Supreme Court judgment in Littlewoods.