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The House of Lords has upheld the claims for VAT refund of tax made by two taxpayers, Condé Nast Publications Limited and Michael Fleming t/a Bodycraft.

The tax was overpaid in periods running from 1973 (when VAT was introduced) to 1996 (when claim time bars were tightened).  Equivalent claims by thousands of other taxpayers big and small – together with contingent fees payable to advisers who helped compile claims – had been riding on the outcome of these two test cases.  The decision also has ramifications for HMRC's attempt to cap refund claims made by multinationals in respect of corporation and other direct taxes wrongly paid since the UK joined the EU.

However, it is not all bad news for HMRC.  The House of Lords declined to uphold elements of an earlier decision of the Court of Appeal which had left HMRC liable to refund even greater amounts of tax.  Some estimates had put the worst case liability for HMRC for all VAT claims at £1bn.

Commenting on the decision, Jason Collins, Partner in McGrigors Tax Litigation team said:

"This is mixed news for the Chancellor of the Exchequer.  Whilst hoping that all types of claim would be defeated, he will breathe a sigh of relief that the worst case scenario has not come home to roost.  Many taxpayers who had asked for their claims to be honoured after the Court of Appeal decision will now have to return the tax.  The other, successful taxpayers awaiting this decision will now be pressing HMRC to pay out their claims if they have not already done so.  The fight may not, however, end here – many taxpayers will look to be compensated with full commercial rates of interest calculated on a compound basis, rather than the low simple rate of interest provided for under statute.  Given the age of the claims, compounding could result in an interest award more than five times greater than the tax itself." 

 He went on to say:

"This litigation has been running for many years.  The decision will be welcomed by the many professional advisers who took a stake in the outcome of the case by agreeing contingency fees for processing taxpayers' claims.  This fee income will provide a welcome windfall at a time when the prospects for professional services in the short term are looking uncertain."

The decision also has consequences beyond VAT.  Similar capping legislation was introduced without transitional arrangements by the then Inland Revenue in 2004 and HMRC in 2007 to limit direct refund claims, in the form of section 320, Finance Act 2004 and Section 106 Finance Act 2007.  These measures were introduced to minimise the fall out from the EU discrimination claims brought by hundreds of multinationals seeking refunds of tax wrongly collected from them since the UK joined the EU.

Rupert Shiers, Partner, McGrigors, said:

"The Inland Revenue was widely criticised for not having consulted properly with HM Customs & Excise on the lessons that could have been learned from trying to shorten time limits for tax claims.  Their worst fears have been realised – not only is it clear that a transitional period is required, but the House of Lords have found that HMRC cannot be saved by reading in a transitional period based on developments in case law, and only clear publication of the start and stop times for the transitional period will do."

Technical Note

This decision is the culmination of 12 years of litigation which began in 1996 when HMRC (at that time HM Customs & Excise) reduced, with immediate effect, the time limits for making claims for repayment of VAT from a practically unlimited period of time to three years from the date which the claim was made.

In 2002, the European Court of Justice held in the case of Marks and Spencer v HM Customs & Excise (C-62/00) that the capping legislation contravened Community law, for failing to have an adequate transitional period before becoming effective.  In response, HMRC sought to give effect to the need for a transitional period by issuing two "Business Briefs" inviting taxpayers, for a limited period of time, to make claims that could have been made back in 1996.

Conde Nast and Fleming commenced proceedings because it was unclear whether the Business Briefs applied to input tax, as opposed to output tax claims.  HMRC argued that a transitional period could be "read in" by the Courts so the absence of the claims from the clear scope of the Business Briefs was not fatal.  In a step which surprised many commentators, the Court of Appeal upheld the taxpayers' claims, and went so far as to hold that all claims, whenever made, stood to be honoured unless and until a proper transitional period was provided through legislation; the Business Briefs were not enough.  The effect of this was that all claims, not just input tax claims, for tax paid between 1973 and 1996 were still in time, leaving it open to taxpayers who had not made a claim within the window provided for in the Business Briefs, or who made claims which had been rejected for not complying with the formal conditions in the Briefs, to come forward and make a claim.  HMRC appealed the Court of Appeal's decision to the House of Lords.

Overruling the Court of Appeal's decision, but finding for the taxpayer nonetheless, the House of Lords held, by a majority of four to one, that it was open for a late transitional period to be given effect by way of an administrative act of the Commissioners, as opposed to legislation.  A minority of two held that an administrative act was not a pre-requisite and a transitional period could start from the release of Court decisions clarifying the need for the transitional period.  Taken together this means that, because the Business Briefs did not deal with input tax claims, no transitional period had begun to run and there was therefore no time bar on making the input tax claims.

Effect on output tax claims

Whilst the House of Lords accepted that the Business Briefs were an effective way of remedying the absence of a transitional period in the capping legislation, some judges touched on the need for the Business Brief conditions to be themselves lawful.  The Briefs included a condition that the taxpayer prove that he could and would have made the claim in 1996 had there been a transitional period at that time.  For example, HMRC would not accept a claim for tax overpaid between, say, 1973 and 1996 if it only became clear from case law in, say, 1999 that the tax in question was not lawfully due.  In other words, claimants had effectively to go back in time to establish the type of claim they would have made based on the things they knew in 1996, and not things that they learned subsequent to that.  There is commentary to the effect that this condition was unlawful.  The consequence of this appears to be that any taxpayers who either made claims but failed this condition, or did not make claims because they feared they would fail the condition, may still be in time to claim.  No doubt HMRC will resist such claims.

Taxpayers will now seek to settle input tax claims which have been made but not yet honoured or will come forward and make claims whilst waiting for HMRC to issue a new Business Brief to provide a transitional period for claims.  They will be entitled to statutory interest on the amounts repaid.  The rate provided is significantly lower than base rate and is calculated on a simple basis.  Many taxpayers will believe that they are entitled under EU law to interest at commercial rates and calculated on a compound basis.  This can have the effect of dramatically increasing the pay-out.  Litigation around this matter issue has already begun.

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