Supreme Court restricts limitation period for mistake of law claims

The Supreme Court has, by a majority of 4 to 3, upheld the principle first established in Kleinwort Benson that the Limitation Act applies to claims for restitution of monies paid under a mistake of law. The majority decision of the Court has held that the six year period allowed under s.32(1)(c) of the Limitation Act applicable to claims for relief from the consequences of a mistake, and which does not start to run until the claimant has discovered the mistake (or could have reasonably discovered it) does apply to claims based on a mistake of law: Test Claimants in the Franked Investment Income Group Litigation v HMRC [2020] UKSC 47 (the FII GLO case).

However, the Court has held that the House of Lords decision in Deutsche Morgan Grenfell (DMG) that a claimant should not be treated as having discovered their mistake, where that mistake is based on a new judicial decision, until that decision is handed down, was incorrect. Instead, the correct approach is to enquire when the claimant could, with reasonable diligence, have discovered that it had a "worthwhile claim" sufficient to merit obtaining legal advice and taking action to issue a claim. 

Background

The FII GLO is concerned with the UK's historical tax treatment of dividends paid by foreign subsidiaries to UK parents and, in particular, the failure of the UK to extend exempt tax treatment to such dividends. The case also covers the discriminatory treatment of portfolio dividends, as well as the UK's ACT regime. The numerous claims covered by the GLO have resulted in several linked cases with references of issues to the ECJ on three occasions. These referrals have covered both the substantive issues around the compatibility of the UK tax rules but also the remedies available to the claimants and the legitimacy of the UK governments attempts to restrict these remedies. One such referral was specifically directed at the question whether the introduction of restrictions on the time limits for the mistake based remedy for tax claims was contrary to EU law.

The importance of s.32(1)(c) to the claims in this (and other cases) cannot be overstated. As a result of the application of the fundamental EU freedoms, UK tax rules have been found to be contrary to EU law on many occasions. As with the FII GLO case, taxpayers have discovered that they have been making payments (or failing to obtain reliefs) to HMRC over very many years which have subsequently been found to be contrary to EU law. This is the case with, for example, overpayments of tax made by taxpayers in receipt of foreign dividends which have historically been taxed less favourably (subject to a tax credit) than UK dividends (tax exempt). Very broadly, the normal limitation period for claims would be six years, but taxpayers have relied upon s.32(1)(c) to argue (successfully) that the six year period for such claims did not start to run until they did (or should) have discovered their mistake. In the case of claims based on ECJ jurisprudence, this would often have been many years after the relevant payments were made. As a result, claims have been made going back to the time of the UK joining the EU in 1973 based on the fact that the mistake in making those payments could not have been discovered until many years later.

For example, the DMG case concerned the UK's advance corporation tax (ACT) regime which existed until 1999 and required a company paying a dividend to make a payment of ACT which could later be set against its mainstream corporation tax liability. In Hoechst [2001] the ECJ held that the legislation was incompatible with EU law in so far as it denied to the subsidiaries of non-UK resident parents the ability to make a group income election. The House of Lords in DMG held that for the purposes of s.32(1) of the Limitation Act, the claimants could not reasonably have discovered the mistake until the time of the Hoechst judgment. This allowed claims to be brought within six years of that judgment stretching back as far as 1973.

As a result of these decisions, the UK government sought to restrict the ability of taxpayers to make a DMG claim for repayment of taxes based on mistake, first by section 320 FA 2004 (which limited the application of section 32(1)(c) to tax claims made before September 2003) and then by section 107 FA 2007 (which retrospectively removed the right to existing actions which had commenced before September 2003, unless there was a relevant House of Lords judgment in existence by December 2006). However, the Supreme Court unanimously held that the retrospective restriction of DMG claims by section 107 FA 2007 was clearly contrary to EU law. However, the court was divided 5-2 on the question of whether the restriction introduced by section 320 FA 2004 was referred the matter back to the ECJ, which confirmed the majority view that the introduction of section 320 FA 2004 was in breach of EU law and that the UK was required to ensure that the DMG remedy was an effective remedy.

In the context of what has gone before, the most recent decision of the Supreme Court, which is fundamental to the available remedies to taxpayers in this case and the application of the limitation period, therefore appears to be somewhat late to the show to say the least!

Kleinwort Benson

In the latest iteration of the FII GLO, HMRC argued that the original 1999 decision of the House of Lords in Kleinwort Benson was, in part, incorrect. In that case, the House of Lords held for the first time that a restitutionary right to claim repayment of monies paid under a mistake of law (as opposed to a mistake of fact) existed. The Court went on to decide that the extended limitation period provided for in s.32(1) of the Limitation Act applied to claims made under mistake of law as well as to mistakes of act. Section 32(1)(c) applies to an "action for relief from the consequences of a mistake", and postpones the commencement of the limitation period "until the plaintiff has discovered the ... mistake ... or could with reasonable diligence have discovered it."

In particular, HMRC pointed out that when s.32(1)(c) (and its precursors) were enacted by Parliament, the law did not recognise any claim repayment based on a mistake of law. The law only recognised claims based on a mistake of fact, until the decision in Kleinwort Benson. As such, HMRC argued that s.32(1) should not be construed as extending to claims based on a mistake of law. That could not have been Parliament's intention when enacting s.32(1). In addition, the nature of a change of law (or a development of the law) based on judicial decision, is that it will often overturn a long history of legal understanding. In those circumstances, it can be argued that to apply section 32(1)(c) to mistakes of law undermines the basic purpose of limitation statutes, namely "putting a certain end to litigation and ... preventing the resurrection of old claims".

Against that were the arguments that the a claim based on mistake of law clearly fell within the language of s.32(1) if it were given its ordinary meaning. In addition, an application of the "always speaking" doctrine would support the view that s.32(1) should apply to such claims even though they were not recognised at the time it was enacted.

The Supreme Court was split four to three on this issue. The majority (including Lords Hodge and Reed who delivered a joint leading judgment) held that on balance s.32(1) should be construed in line with its ordinary meaning. This was despite recognising "the undeniable force" of the opposing argument. In large part, the decision appears to have been based on a great reluctance to overturn an earlier House of Lords decision which has stood for over 20 years and in so doing upset the legal certainty. The minority dissenting Law Lords preferred the argument that it would not have been the intention of Parliament to apply s.32(1) to mistake of law based claims when (at the time the section was passed) no such right existed.

However, the majority decision is also predicated on their decision that another House of Lords decision (that in DMG) was in part incorrect. Only in determining that the DMG decision was incorrect could the majority of the Law Lords conclude that the damage to the nature of the limitation defence could be sufficiently limited so as to allow the Kleinwort Benson decision to stand.

DMG

The majority of the Law Lords held that the approach taken by the House of Lords in DMG to the determination of the point of time at which the clock starts to run under s.32(1) for mistake based claims was incorrect. In DMG, in essence, the House of Lords held that a mistake of law in the context of a judicial decision could not be discovered until that decision was handed down. As such, the six year period under s.32(1) did not start to run until the time of the relevant judgment which gave rise to the claim.

The majority of the Law Lords in the FII GLO, however, pointed out that the this approach involved a logical paradox. In particular, it was illogical to suggest that a claimant (who successfully makes a claim) does not discover their mistake until their claim has been successfully pursued through the courts to its end, long after their claim was made. This was as a result of the courts applying "a different approach to the accrual of a cause of action based on mistake, on the one hand, and the approach to the limitation period applicable to that cause of action, on the other hand". In essence, whereas the change of law is treated as taking place when the payment is made for the purposes of the law of mistake, it is not so treated as taking place for the purposes of the discoverability of that mistake.

In DMG, a dissenting judgment had been delivered by Lord Brown in which he took the view that DMG discovered the mistake, within the meaning of section 32, when it first became aware of the Hoechst proceedings and recognised that there was a serious challenge to the legality of the ACT regime under EU law. In contrast to the decision of the majority in DMG, Lord Brown would have held that a mistake is discovered when the claimant recognises that a worthwhile claim arises. In the FII GLO judgment, the majority have held that Lord Brown was in essence correct.

"The purpose of the postponement effected by section 32(1) is to ensure that a claimant is not disadvantaged, so far as limitation is concerned, by reason of being unaware of the circumstances giving rise to his cause of action as a result of fraud, concealment or mistake. That purpose is achieved, where the ingredients of the cause of action include his having made a mistake of law, if time runs from the point in time when he knows, or could with reasonable diligence know, that he made such a mistake with sufficient confidence to justify embarking on the preliminaries to the issue of a writ, such as submitting a claim to the proposed defendant, taking advice and collecting evidence".

The majority rejected arguments that the approach they put forward was not practical. The decision recognises that the application of the approach will depend on the circumstances of the case. "For example, in cases where the claimant has made a payment on the basis of a mistaken understanding of the law which has resulted from ignorance, the mistake will normally have been discoverable immediately, by seeking legal advice". Section 32(1) only has effect where a mistake could not have been discovered at the time of the payment with the exercise of reasonable diligence. "On the other hand, where the payment was made in reliance on a precedent that was subsequently overruled, or an understanding of the law that was later altered by a judicial decision, the question will be whether the claim was brought within the prescribed period beginning on the date when it was discoverable by the exercise of reasonable diligence that the basis of the payment was legally questionable, so as to give rise to a worthwhile claim to restitution. Depending on the circumstances, it may be difficult to identify a specific date, but doubtful cases can be resolved by bearing in mind that the burden of proof lies on the claimant to prove that his claim was brought within the prescribed limitation period."

Therefore, so far as the House of Lords in DMG held that a claimant could not be regarded as discovering their mistake for the purposes of s.32(1) until the decision of the ECJ, the Supreme Court has held that the decision was incorrect. 

In relation to the FII GLO cases, the Court of Appeal had decided that the discovery date was 12 December 2006 (the date of the first ECJ judgment).  Although that position was initially accepted by HMRC, they subsequently sought to reopen the question and have now succeeded in part. This will affect the ability of claimants with open claims to recover overpaid tax. However, further cases will now be needed to determine the correct point in time when claimants should be regarded as having reached the point where they could, with reasonable diligence, have discovered their mistake.

Comment

The test put forward by the Supreme Court is much more uncertain than the definitive test in DMG was based simply on the date a court delivered its judgement on the law.  It would appear to require a difficult balancing of both the development of the law and professional opinion among practitioners at the time. As such, there will be much uncertainty around the actual date when the limitation period in s.32(1) starts to run.

In a tax context, the decision now appears to be largely of historical interest only since the scope of the s.32(1) six year rule has been restricted to claims brought before September 2003. However, from the perspective of the general application of the Limitation Act to restitutionary claims for repayments of monies paid under a mistake of law, it will have importance going forwards.