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Steve Allen of VAT Solutions (UK) Ltd reports on another chapter in the long-running VAT saga concerning chocolate teacakes.

Steve Allen

Long struggle

It has taken a 12-year struggle, but Marks & Spencer seems to have finally won its battle with HM Revenue & Customs to recover £3.5m in overpaid VAT on chocolate teacakes. The European Court of Justice has recently ruled in favour of M&S, saying that it should be allowed to claim the VAT back.

The fight started in 1994 when M&S made a claim for overpaid VAT on chocolate teacakes. Up to that point, HMRC had viewed these as a standard-rated biscuit and M&S had accounted for VAT on them from 1973 to 1994. In a letter dated 30 September 1994, the then HM Customs & Excise acknowledged their error, and agreed that the chocolate teacakes were indeed cakes and not biscuits, and therefore zero-rated.

In February 1995, M&S submitted a claim for overpaid VAT to the Commissioners for £3.5 million. That claim was accepted only to the extent of 10% of the amount (£350,000), since the Commissioners took the view that M&S had passed on 90% of the VAT paid by it to its customers. Consequently, the Commissioners invoked the defence of unjust enrichment under section 80(3) of the VAT Act 1994. The authorities also applied the then newly introduced three year capping provisions and said they were not obliged to repay any sum which had been paid to them more than three years prior to the submission of the claim for repayment. The amount which was finally paid to M&S on 4 April 1997 was therefore £88,440.

M&S appealed to the VAT and Duties Tribunal, and in 1998 it upheld the view taken by the Commissioners. M&S appealed to the High Court, which, in turn, dismissed the claim in December 1998. An appeal against that decision was made to the Court of Appeal which again dismissed M&S’s claim. However, in 1999, the Court of Appeal referred a question which related to a separate aspect of the proceedings (the taxation of gift vouchers sold by M&S) to the ECJ for a preliminary ruling on the compatibility of the retroactive introduction of a three year cap with the principles of effectiveness of Community law and of the protection of legitimate expectations. That question concerned the issue of whether an individual could derive rights directly from a Directive after it had been correctly transposed into national law, where the Member State had failed to take proper account of the scope of the Directive.

ECJ ruling

In Case C-62/00 Marks & Spencer [2002] ECR I-6325, the ECJ ruled that the principles of effectiveness and of the protection of legitimate expectations precluded national legislation such as the UK legislation in question. Following this decision, the Commissioners accepted that M&S’s claim should not be time barred, and accordingly repaid the sum claimed, up to the limit of 10% (£350,000), above which they maintained that there would be unjust enrichment. M&S appealed the High Court’s decision regarding unjust enrichment to the Court of Appeal, and in October 2003 it found against M&S, which again appealed the matter to the House of Lords. The House of Lords, in turn, referred the matter to the ECJ.

The complexity of the legal battle lay in the different treatment the Commissioners placed on businesses classed, until 2005, as ‘repayment' and ‘payment' traders. While M&S was classed as a ‘payment trader' which owed VAT to HMRC at the end of a financial quarter, it argued that the main supermarkets, which were owed VAT by HMRC, were treated differently on the issue of chocolate teacakes.

M&S argued that the defence of unjust enrichment was applied to its valid claim for wrongly paid tax, but the same defence was not applied to block comparable claims made by its competitors, contravening the European law principles of equal treatment and fiscal neutrality.

In January 2008 Advocate General Juliane Kokott backed M&S stating:

'The objection that Marks & Spencer has been enriched cannot be invoked as long as it offends the principle of equal treatment.'

The case then moved on the ECJ, and on April 10 2008, they released their decision stating firstly:

‘Member State has maintained in its national legislation an exemption with refund of input tax in respect of certain specified supplies but has misinterpreted its national legislation, with the result that certain supplies which should have benefited from exemption with refund of input tax under its national legislation have been subject to tax at the standard rate, the general principles of Community law, including that of fiscal neutrality, apply so as to give a trader who has made such supplies a right to recover the sums mistakenly charged in respect of them.'

The court went on to state:

‘the principle of fiscal neutrality precludes the prohibition of unjust enrichment from being applied only to taxable persons such as ‘payment traders' and not to taxable persons such as ‘repayment traders', in so far as those taxable persons have marketed similar goods. It will be for the national court to determine whether that is the position in the present case. Furthermore, the general principle of equal treatment, the infringement of which may be established, in matters relating to tax, by discrimination affecting traders who are not necessarily in competition with each other but are nevertheless in a similar situation in other respects, precludes discrimination between ‘payment traders' and ‘repayment traders' which is not objectively justified.'

And finally:

‘it is for the national court itself to draw any conclusions with respect to the past from the infringement of the principle of equal treatment'

End in Sight?

In summary, the ECJ ruled that, in principle, VAT had to be repaid in full, but left the final decision to the British courts. That final decision will be taken by the House of Lords, and HMRC said it was too early to make a comment. A spokesman said:

“This is a very complex judgment on which it would be premature to make any comment until the House of Lords has handed down its judgment.'

In contrast, M&S welcomed the ruling stating,

‘We are pleased with the outcome which endorses our position.

We’re optimistic that the House of Lords will now find in our favour and hope that this will conclude the matter and draw a line under this protracted litigation.'

Tony McClenaghan, head of indirect tax at Deloitte, which acted for M&S, described the ECJ decision as a “sweet victory". He said:

'Common sense has prevailed. It is unreasonable for different retailers to be treated differently in relation to similar transactions. The fact that the UK authorities changed the law in 2005 suggested that comparable situations had previously been treated differently,'

So, despite HMRC’s reticence it would appear likely that the never-ending saga of the chocolate teacakes, which seems to have run longer than ‘The Mousetrap' is finally near its end, and that M&S will get its £3.5 million refund (no doubt with a vast amount of interest). The details of the decision are very interesting, and the full decision is worth reading.