A Case of Little Interest? The Supreme Court’s Judgment in Littlewoods

The Supreme Court (‘SC’) on 1 November 2017 handed down judgment in Littlewoods Ltd and others v. HMRC [2017] UKSC 70. In a judgment of Lords Reed and Hodge (with whom Lords Neuberger, Clarke and Carnwath) agreed, the SC has unanimously allowed HMRC’s appeal against the decisions below of both Henderson J and the Court of Appeal (Arden, Patten and Floyd LJJ). The headline grabbing outcome is that approximately £17 billion of compound interest does not have to be paid by the Revenue to taxpayers who overpaid VAT and made Fleming claims for recovery. But the SC’s reasoning is of much wider interest.

The background to the appeal lies in the ill-judged decision of Parliament to enact section 47 of the Finance Act 1997. That section reduced the time limits for claims for repayment of VAT to three years from six, without putting in place any transitional provisions. As the SC’s judgment notes at [19], the Court of Justice of the European Union (‘CJEU’) in Case C-62/00 Marks & Spencer plc v. HMRC [2003] QB 866 ruled that such a legislative change infringed the EU law principle of legal certainty and was unlawful.

The House of Lords in Fleming (t/a Bodycraft) v. HMRC [2008] UKHL 2; [2008] 1 WLR 195 subsequently rejected various, more or less creative attempts by HMRC to rescue the position. The House of Lords ruled that the reduced limitation period had to be disapplied in respect of rights which accrued before section 47 FA 1997 entered into force. Parliament responded by introducing section 121 of the Finance Act 2008. This excluded the application of the new time limit in section 80(4) of the Value Added Tax Act 1994 (‘VATA 1994’) to all claims in respect of amounts paid before 4 December 1996,  provided that the claim was made before 1 April 2009. In other words, taxpayers were given a window within which to bring claims for repayment which had accrued before 4 December 1996.

The sting in the tail for HMRC was that this claim could be brought even if the statutory limitation period of six years which had formerly applied had expired.  The previous limitation period could not simply be resurrected through the process of “disapplication.” The upshot for HMRC was that they were obliged to pay Fleming claims made before 1 April 2009, but going back in some cases to the introduction of VAT in 1973. It is fair to say that the introduction of section 47 FA 1997 has proved to be a very expensive mistake.

Littlewoods is the latest example of a number of cases in which the Courts have nonetheless been prepared to limit the financial consequences of that mistake. Section 78 VATA 1994 permits statutory interest to be paid on VAT repayments. But only on a simple, not a compound basis. Having received repayment of VAT in the sum of about £205 million, together with simple interest of £268 million, Littlewoods contended that it was entitled to additional interest of £1.25 billion interest on a compound basis. This was principally on the basis that EU law required it to have effective protection for its right to repayment. Littlewoods contended that effective protection meant full compensation. Adequate reparation for its loss of the use of the money was said to be the “time value” of money, which mandated an award of compound interest.

Henderson J at first instance had referred to the CJEU the question of whether EU law required compound interest to be paid. There were certainly indications in earlier case law which suggested it might do so. The answer from the CJEU in Case C-519/10 Littlewoods [2012] ECLI:EU:C:2012:478 was considered by Henderson J and the Court of Appeal to be somewhat Delphic. The CJEU had clearly ruled that the obligation to repay overpaid VAT carried with it an obligation to pay interest on the sums repaid. But, subject to the twin EU law principles of equivalence and effectiveness, it was for the national legal regime to state whether the interest should be paid on a simple or compound basis.

At [29], the CJEU recognised that the rules governing the payment of interest should not deprive the taxpayer of an “adequate indemnity” for the loss occasioned by the undue payment of VAT. But at [30], it left it squarely for the national court to determine whether an adequate indemnity was available under the UK’s domestic legal system. The CJEU noted that section 78 VATA 1994 provided for simple interest to be paid and that HMRC had in fact paid out £268 million to Littlewoods by way of interest on its VAT repayment claim of £205 million.

The SC, overturning the contrary decisions of Henderson J and the Court of Appeal, has concluded that EU law does not require compound interest to be awarded to taxpayers on VAT repayment claims. HMRC is accordingly entitled to pay statutory interest on a simple basis only, in accordance with section 78 VATA 1994. The essential reasoning of Lords Reed and Hodge was as follows. The expression “adequate indemnity” did not connote a requirement to give full compensation for any loss, but rather gave Member States’ courts a discretion to provide reasonable redress in the form of the interest to be paid.

The SC emphasised three points. First, the structure of the CJEU’s judgment in Littlewoods did not suggest that that it was defining compound interest as part of the “full compensation” which had to be given in restitution. In circumstances where the principal sum of the tax had been repaid, that would amount to full compensation and the question of interest then had to be determined as an additional matter. Interest was compensation for a taxpayer being kept out of his money. The CJEU recognised interest had to be paid as a matter of principle. But when it came to analyse the form that the interest should take, the CJEU clarified that it was for national law, not EU law, to take the lead in this unharmonised area.

In doing so, the CJEU was following a well-trodden path. In Case C-295/04 Manfredi [2006] ECR I-6619, for example, the CJEU recognised that damages for competition law infringements must comply with the twin principles of effectiveness and equivalence. At [62] it stated: “In the absence of Community rules governing the matter, it is for the domestic legal system of each Member State to designate the courts and tribunals having jurisdiction and to lay down the detailed procedural rules governing actions for safeguarding rights which individuals derive directly from Community law, provided that such rules are not less favourable than those governing similar domestic actions (principle of equivalence) and that they do not render practically impossible or excessively difficult the exercise of rights conferred by Community law (principle of effectiveness).” In that case, at [95] to [100], the CJEU ruled that a claim for breach of competition law must be capable of generating compensation not only for sustained pecuniary loss but also for loss of profit, together with interest. Other matters, such as whether punitive damages would be awarded, would be for the national legal regime to determine, subject only to the principle of equivalence.

The SC found no warrant in other language versions of the Littlewoods CJEU judgment to construe “adequate indemnity” as requiring full compensation for loss. In addition, the SC noted that it was very difficult to construe the CJEU’s judgment at [30] as backing any requirement to pay interest on a compound basis since it left it for the referring Court to make the final assessment, despite having noted that only simple interest had been paid in this case. The CJEU must therefore have contemplated the possibility that simple interest could be an adequate indemnity for the loss of use of the money. The SC considered that the “steer” given by the CJEU in [30] was more by way of support for the position which the Advocate General had adopted, namely that simple interest by itself was capable of complying with the requirement of effectiveness.

Secondly, the SC also noted at [60] that 12 other Member States also provided that any interest on VAT repayments would be paid on a simple basis only. The SC noted that the practice of Member States in awarding interest varied, with many only awarding interest on a simple basis. It was not therefore possible to construe the CJEU’s judgment in Littlewoods as requiring all Member States to pay interest on a compound basis. Such a radical intrusion into State practice would have merited express words in the CJEU’s judgment.

Thirdly, there was nothing in previous or subsequent CJEU decisions to suggest that there was a formal requirement under EU law to pay compound interest. It was therefore for the internal legal order of the Member State to regulate the basis upon which interest would be paid, subject only to the general principles of effectiveness and equivalence. Since national law here provides for simple interest, that was sufficient to determine the issue in HMRC’s favour. The CJEU had not said the award of simple interest alone would breach the principle of effectiveness and the SC accordingly concluded that it was open to Parliament to legislate to constrain the basis upon which interest would be paid. The SC observed at [71] that the CJEU itself had noted that the interest paid to the taxpayer exceeded the principal sum repaid by 23%.

Perhaps more surprising, however, was the SC’s treatment of equivalence. The SC simply stated at [71] that “no issue of equivalence arises.” This was seemingly on the basis that the statutory regime for the payment of interest on VAT repayments was a distinct regime by itself. No other claims were within its ambit. The SC has implicitly rejected any cross-reference to any other statutory or common law systems of compensation which might require payment of interest on a compounded basis.

There are, in addition, a couple of significant practical points for taxpayers and their customers arising from this decision. First, Lords Reed and Hodge cited with approval a recent decision of the SC in Investment Trust Companies v. HMRC [2017] UKSC 29; [2017] 2 W.L.R. 1200. Section 80 VATA 1994 has been construed as excluding non-statutory claims by customers. This has significant ramifications for customers of VAT registered suppliers who wish to challenge the requirement imposed on the supplier to charge VAT.

It has long been a salutary practice of the VAT Tribunal (and now the First Tier Tribunal (Tax Chamber) or FTT) that the recipient of a supply may appeal against the HMRC decision which rules that VAT is due on a particular supply. The Scottish Upper Tribunal in HMRC v. Earlsferry Thistle Golf Club [2014] UKUT 250 (TCC), per Lord Tyre at [19], held that:

“It was not disputed by Mr Artis, who appeared on behalf of HMRC, that there are circumstances in which an appeal may competently be made to the FTT by the recipient of a supply of goods or services. This seems to me to be clear from the observations of Simon Brown LJ in C&E Commrs v Cresta Holidays Ltd [2001] STC 386 at paragraphs 9 and 10 where he declined to interpret certain statutory provisions as overturning two “longstanding Tribunal decisions” to that effect. Indeed, Canterbury Hockey is an example of an appeal under section 83(1)(b) by a recipient rather than by a supplier.”

At [7] of his judgment in HMRC v Cresta Holidays Ltd [2001] STC 386, CA, Simon Brown LJ recorded that the upshot of the William & Glynn’s Bank line of cases was that the Tribunal had ruled that HMRC was “bound to give effect to the Tribunal’s decision by repaying the tax to the (non-appellant) supplier (or allowing the supplier to take credit for it in his next tax return) whereupon the supplier would hold the monies so repaid or credited as constructive trustee for the appellant recipients.” That approach was endorsed at [12] of the judgment.

However, it would now appear to be well open to HMRC to decline to give effect to that custom by insisting that any claim for repayment of VAT is made only by the registered supplier, and not by the customer. The impact of the ITC and Littlewoods judgments of the SC would appear to be that customers will need to protect themselves if they dispute a VAT payment by: (i) appealing against any liability ruling or similar decision (as a recipient of the supply); and (ii) simultaneously suing the supplier for repayment of the overpaid VAT. That latter course of action was the route by which the SC in ITC suggested a customer would be able to vindicate its EU law rights.

This of course assumes that the customer cannot persuade the supplier to challenge the VAT liability on its behalf. But that is not an unrealistic assumption, particularly for a VAT payment trader who is able to recover input tax on its expenses and who simply passes on the VAT charge in full to its customer. There is nothing in it for the supplier to encourage it to do so. The customer must therefore incur the expense of this bifurcated legal route in order to challenge the imposition of VAT in principle (before the FTT). That is necessary in order to avoid a defence which the supplier would otherwise advance that the VAT was lawfully due and there had been no decision overturning HMRC’s ruling on liability. But the customer cannot simply rely upon HMRC permitting a repayment claim to be made directly to it, in the light of the construction of section 80 VATA 1994 adopted by the SC in ITC and Littlewoods. So it must also sue the supplier to protect its position and to generate the means by which its eventual right to repayment will be vindicated in English law.

The SC does not yet seem to have been addressed on whether or not the additional expense of a bifurcated procedure is itself compatible with the EU law principle of effectiveness. In Case C-268/06 Impact [2006] ECR I-2483, the CJEU at [50]-[55] cast some doubt on whether a national legal system which required EU law rights to be vindicated before multiple domestic fora would be compatible with EU law.

Secondly, the position is not entirely rosy for suppliers either. It is conceivable, following ITC, that more customers will opt to sue their suppliers for the return of overpaid VAT rather than engaging directly with HMRC. For suppliers who are still within the four year period for recovery of overpaid VAT under the amended terms of section 80 VATA 1994, they may simply respond by claiming the same sums back from HMRC. HMRC may insist on reimbursement arrangements being put in place to ensure that the tax finds its way back to the ultimate customer. But the supplier should not otherwise be out of pocket.

What happens though, where the four year limitation period for claims for VAT has expired? Following ITC, it is still open to customers to sue their suppliers to recover the overpaid VAT. For a simple claim in contract, section 5 of the Limitation Act 1980 would give them an additional two years within which to do so. A civil court could, in principle, still rule that no VAT was payable as a matter of law and that EU law accordingly required the customer to be reimbursed. The supplier would then have to repay the VAT levied, but would not be able to reclaim the overpayment back from HMRC. The supplier’s claim would by then be capped.

Thirdly, even where a supplier is not caught by the two year gap between the different, statutory limitation regimes, there is now the question of interest. A commercial customer suing a commercial supplier for the return of overpaid VAT would have a reasonable chance of being able to establish an entitlement to payment of interest on a compound basis. But the SC’s ruling in Littlewoods means that the supplier could itself only recover the VAT from HMRC on a simple interest basis. Over a period of four years, the differential may be substantial.

Despite saving the public purse £17 billion, the SC’s decision in Littlewoods will therefore be of significant interest to taxpayers and their advisers in the years to come.