Where domestic law charges VAT on a supply in breach of EU law, the taxable person has a claim for repayment subject to time limits and unjust enrichment rules. As Investment Trust Companies shows, a consumer may have a direct remedy against HMRC based on the domestic law of restitution and in EU law under Danfoss. But, as the Court of Appeal has now decided, this claim does not include netted-off input VAT, which must be claimed from the supplier. Difficulties and uncertainties remain.
Michael Conlon QC (Hogan Lovells) examines the Court of Appeal decision in ITC, and the uncertainties that remain.
The Court of Appeal decision in
Investment Trust Companies (in liquidation) v HMRC [2015] EWCA Civ 82 (reported in Tax Journal, 20 February 2015) is the latest battle in the war over rights and remedies for overpaid VAT.
The claimants were closed-end investment trusts which purchased investment management services. Contracts with the managers provided that fees were ‘plus VAT if applicable’. In breach of EU law, domestic law failed to exempt such services: see Claverhouse (C-363/05) [2008] STC 1180. The managers made claims under VATA 1994 s 80, which HMRC repaid and which the managers reimbursed to the trusts.
HMRC capped the claims at three years under s 80(4) but, following Marks & Spencer (C-62/00) [2002] STC 1036, HMRC made further repayments for periods prior to 4 December 1996 (the date the three year cap was introduced). However, HMRC refused claims for the period from 4 December 1996 to commencement of the ‘in-time’ claims (called ‘the dead period’). HMRC also reduced the claims by the amount of input VAT reclaimed by the managers, relying on ss 80(2A), 81(3) and (3A).
The position may be illustrated by assuming output VAT of 100 charged on a manager’s fee, against which a partly exempt manager was entitled to deducted input VAT of 25. The amount repaid by HMRC under s 80 and reimbursed to the trusts was the net amount of 75. Accordingly, the trusts remained out of pocket to the extent of 25 (or, where a trust was VAT registered, to the extent of its irrecoverable input VAT).
The trusts brought claims against HMRC, for restitution at common law and for repayment under directly effective EU law rights: see San Giorgio (C-199/82) [1983] ECR 3595. Three test claimants were selected: Kleinwort Trust and F&C Trust, making claims for the 100 in the dead period; and M&G, which was operating throughout, and therefore claimed 100 in the dead period and 25 in claim periods outside the dead period. Only Kleinwort Trust was VAT registered, with a recovery rate of about 58%.
In the High Court, the agreed issues raised questions of domestic law and EU law. As regards domestic law, Henderson J highlighted the four ingredients of a claim for restitution
(a) Has the defendant been enriched?
(b) Is this at the claimant’s expense?
(c) Was the enrichment unjust?
(d) Are there any defences?
See Lord Steyn in Banque Financière [1999] AC 221 at 227A-B. As to (a), there was no doubt that HMRC had been enriched to the extent of the 75. But what about the 25? The 25 represented output VAT payable to HMRC by the managers’ external suppliers. However, HMRC was under a liability to credit 25 as the managers’ input VAT. HMRC discharged that obligation using part of the 100 output VAT. Accordingly, the judge reasoned, HMRC was enriched to the full extent of the 100 in all periods. This was at the claimants’ expense: ingredient (b). Academic opinion and case law indicated enrichment could occur indirectly. Moreover, in the event of a restitutionary claim against the managers, they would have a ‘cast iron’ defence based on change of position.
The judge then explored the EU law principle of effectiveness and the developing jurisprudence. This requires a direct right of action against the tax authorities by a person who has borne the economic burden of the undue tax, where recovery from the supplier would be ‘impossible or excessively difficult’: see Danfoss (C-94/10) [2011] I-09963. The principle of effectiveness precluded HMRC from raising a defence of change of position. Prima facie, the claimants should succeed.
However, the judge addressed the interaction between EU law rights and domestic procedural rules. He ultimately concluded that Parliament had intended s 80 to be an exhaustive remedy for the recovery of overpaid VAT. Domestic law must be disapplied to the extent necessary to give effect to directly enforceable rights, but only to the extent required by the principle of effectiveness. Accordingly, the time limit applicable to a Danfoss-type claim should be fixed at three years, rather than by reference to the Limitation Act 1980 s 32(1)(c) (i.e. proceedings must be commenced within six years of the date on which the mistake was discovered or could with reasonable diligence have been discovered). Thus, the claimants should be in no better position than the managers whose claims fell under s 80.
Henderson J gave provisional judgment on 2 March 2012: [2012] STC 1150. In Test Claimants in the FII Group Litigation [2012] 2 AC 337, the Supreme Court held (and the CJEU confirmed) that where domestic law provides concurrent remedies, a claimant may rely on either or both. Following that decision, Henderson J gave final judgment. The claims for the 100 overpaid in the dead period were time-barred and therefore failed. M&G’s claim, for the 25 in periods outside the dead period, succeeded.
HMRC appealed against the 25 decision in favour of M&G. The claimants cross-appealed against dismissal of their claims for the 100 in the dead period. The Court of Appeal (Patten, Moore-Bick, Beatson LJJ) gave judgment on 12 February 2015. The judgment (delivered by Patten LJ) develops the law in three areas:
(a) unjust enrichment: see at paras 26 to 69;
(b) the construction of s 80: at paras 70 to 82; and
(c) the EU law remedy: at paras 83 to 107.
Unjust enrichment: The essence of the court’s decision is that Henderson J was wrong about HMRC being unjustly enriched by the 25, which had been credited to the managers as input VAT. The 25 was due to HMRC as output VAT on the external providers’ services to the managers. It did not follow, however, that the managers were entitled to a credit of 25. Such a dichotomy could arise from the operation of the VAT system. By making their s 80 claims, the managers had recharacterised their services to the trusts as VAT exempt; therefore, they had no entitlement to input VAT credit. It followed that, by retaining the value of the 25 credit, the managers and not HMRC were enriched at the claimants’ expense.
Section 80: The court also rejected Henderson J’s application of the s 80(4) time limit to the claims for the dead period. This turned on the true construction of s 80(7). When its predecessor section was enacted in 1989, the common law had not recognised the remedy of mistake-based restitution. It followed, therefore, that the statutory scheme did not impinge on such a remedy. Accordingly, s 32(1)(c) Limitation Act 1980 applied to the dead period claims, not s 80(4). The court agreed with Henderson J that, on the authorities, an indirect benefit may be sufficient to found a claim in restitution. The final consumer who pays the tax has a sufficient economic connection with HMRC to claim that HMRC has been enriched at his expense.
EU law: Could the Danfoss-type claim under EU law also be invoked against HMRC for the 25? The court concluded that on these facts it could not. The San Giorgio principle, as developed in Danfoss, permits domestic law to operate a two-stage procedure. The taxable person who has paid the undue tax has an EU law right to recover it from the authorities; and the consumer, who has borne the tax burden, must then seek recovery from the taxable person. It is only where the second stage is impossible or excessively difficult, that the principle of effectiveness confers on the consumer a direct right of recovery against the authorities. The claimants’ argument that the principle of effectiveness gave them a direct remedy for the 100 against HMRC was rejected. They could have no greater claim than for the 75 due to the managers.
The court allowed HMRC’s appeal, dismissing the claims for 25 in all periods. The claimants’ cross-appeal was allowed for the dead period, but limited to 75. In Kleinwort’s case the recoverable percentage of 58% was netted-off against the 75.
The dead period has been resuscitated, at least on these special facts. But the court’s decision has wider implications for current and future claims, with a potential overlapping of remedies but a mismatch of limitation periods. Where VAT has been overpaid, in practice the consumer will first seek repayment from its taxable supplier, triggering the s 80 claim by the supplier for the 75. The supplier’s s 80 claim is subject to the s 80(4) time limit (now four years). The supplier must reimburse the 75 to the consumer. According to the court, however, the consumer’s claim against the supplier at common law should be for 100, not 75. The extended time limit in s 32(1)(c) applies (and, in theory, a claim could go back to 1973). It may be, on the facts, that such a claim is precluded, or limited, by the contract and, as to the 75, by a change of position defence.
A claim in restitution may then lie against HMRC. There is also a direct right of action against HMRC where the Danfoss principle is engaged and it is ‘impossible or excessively difficult’ to recover from the supplier. The court’s decision implies this is a high hurdle. It is likely to be satisfied where the supplier is insolvent. Might it also be satisfied where, for example, the supply contract precludes or limits a claim or the supplier relies on change of position? In either case, contrary to Henderson J’s view, the s 32(1)(c) extended limitation period applies, with claims potentially going back to 1973. The principle of effectiveness is not infringed by requiring the consumer, in certain scenarios, to bring two sets of proceedings: a claim against the supplier for a period limited by the contract; and a Danfoss claim against HMRC outside that period. This highlights the need for care in formulating claims and in drafting supplier contracts.
Substantial sums are at stake in this litigation and in cases stood behind it. Further appeals and a possible reference to the CJEU are likely before the dead period can finally be laid to rest.
Where domestic law charges VAT on a supply in breach of EU law, the taxable person has a claim for repayment subject to time limits and unjust enrichment rules. As Investment Trust Companies shows, a consumer may have a direct remedy against HMRC based on the domestic law of restitution and in EU law under Danfoss. But, as the Court of Appeal has now decided, this claim does not include netted-off input VAT, which must be claimed from the supplier. Difficulties and uncertainties remain.
Michael Conlon QC (Hogan Lovells) examines the Court of Appeal decision in ITC, and the uncertainties that remain.
The Court of Appeal decision in
Investment Trust Companies (in liquidation) v HMRC [2015] EWCA Civ 82 (reported in Tax Journal, 20 February 2015) is the latest battle in the war over rights and remedies for overpaid VAT.
The claimants were closed-end investment trusts which purchased investment management services. Contracts with the managers provided that fees were ‘plus VAT if applicable’. In breach of EU law, domestic law failed to exempt such services: see Claverhouse (C-363/05) [2008] STC 1180. The managers made claims under VATA 1994 s 80, which HMRC repaid and which the managers reimbursed to the trusts.
HMRC capped the claims at three years under s 80(4) but, following Marks & Spencer (C-62/00) [2002] STC 1036, HMRC made further repayments for periods prior to 4 December 1996 (the date the three year cap was introduced). However, HMRC refused claims for the period from 4 December 1996 to commencement of the ‘in-time’ claims (called ‘the dead period’). HMRC also reduced the claims by the amount of input VAT reclaimed by the managers, relying on ss 80(2A), 81(3) and (3A).
The position may be illustrated by assuming output VAT of 100 charged on a manager’s fee, against which a partly exempt manager was entitled to deducted input VAT of 25. The amount repaid by HMRC under s 80 and reimbursed to the trusts was the net amount of 75. Accordingly, the trusts remained out of pocket to the extent of 25 (or, where a trust was VAT registered, to the extent of its irrecoverable input VAT).
The trusts brought claims against HMRC, for restitution at common law and for repayment under directly effective EU law rights: see San Giorgio (C-199/82) [1983] ECR 3595. Three test claimants were selected: Kleinwort Trust and F&C Trust, making claims for the 100 in the dead period; and M&G, which was operating throughout, and therefore claimed 100 in the dead period and 25 in claim periods outside the dead period. Only Kleinwort Trust was VAT registered, with a recovery rate of about 58%.
In the High Court, the agreed issues raised questions of domestic law and EU law. As regards domestic law, Henderson J highlighted the four ingredients of a claim for restitution
(a) Has the defendant been enriched?
(b) Is this at the claimant’s expense?
(c) Was the enrichment unjust?
(d) Are there any defences?
See Lord Steyn in Banque Financière [1999] AC 221 at 227A-B. As to (a), there was no doubt that HMRC had been enriched to the extent of the 75. But what about the 25? The 25 represented output VAT payable to HMRC by the managers’ external suppliers. However, HMRC was under a liability to credit 25 as the managers’ input VAT. HMRC discharged that obligation using part of the 100 output VAT. Accordingly, the judge reasoned, HMRC was enriched to the full extent of the 100 in all periods. This was at the claimants’ expense: ingredient (b). Academic opinion and case law indicated enrichment could occur indirectly. Moreover, in the event of a restitutionary claim against the managers, they would have a ‘cast iron’ defence based on change of position.
The judge then explored the EU law principle of effectiveness and the developing jurisprudence. This requires a direct right of action against the tax authorities by a person who has borne the economic burden of the undue tax, where recovery from the supplier would be ‘impossible or excessively difficult’: see Danfoss (C-94/10) [2011] I-09963. The principle of effectiveness precluded HMRC from raising a defence of change of position. Prima facie, the claimants should succeed.
However, the judge addressed the interaction between EU law rights and domestic procedural rules. He ultimately concluded that Parliament had intended s 80 to be an exhaustive remedy for the recovery of overpaid VAT. Domestic law must be disapplied to the extent necessary to give effect to directly enforceable rights, but only to the extent required by the principle of effectiveness. Accordingly, the time limit applicable to a Danfoss-type claim should be fixed at three years, rather than by reference to the Limitation Act 1980 s 32(1)(c) (i.e. proceedings must be commenced within six years of the date on which the mistake was discovered or could with reasonable diligence have been discovered). Thus, the claimants should be in no better position than the managers whose claims fell under s 80.
Henderson J gave provisional judgment on 2 March 2012: [2012] STC 1150. In Test Claimants in the FII Group Litigation [2012] 2 AC 337, the Supreme Court held (and the CJEU confirmed) that where domestic law provides concurrent remedies, a claimant may rely on either or both. Following that decision, Henderson J gave final judgment. The claims for the 100 overpaid in the dead period were time-barred and therefore failed. M&G’s claim, for the 25 in periods outside the dead period, succeeded.
HMRC appealed against the 25 decision in favour of M&G. The claimants cross-appealed against dismissal of their claims for the 100 in the dead period. The Court of Appeal (Patten, Moore-Bick, Beatson LJJ) gave judgment on 12 February 2015. The judgment (delivered by Patten LJ) develops the law in three areas:
(a) unjust enrichment: see at paras 26 to 69;
(b) the construction of s 80: at paras 70 to 82; and
(c) the EU law remedy: at paras 83 to 107.
Unjust enrichment: The essence of the court’s decision is that Henderson J was wrong about HMRC being unjustly enriched by the 25, which had been credited to the managers as input VAT. The 25 was due to HMRC as output VAT on the external providers’ services to the managers. It did not follow, however, that the managers were entitled to a credit of 25. Such a dichotomy could arise from the operation of the VAT system. By making their s 80 claims, the managers had recharacterised their services to the trusts as VAT exempt; therefore, they had no entitlement to input VAT credit. It followed that, by retaining the value of the 25 credit, the managers and not HMRC were enriched at the claimants’ expense.
Section 80: The court also rejected Henderson J’s application of the s 80(4) time limit to the claims for the dead period. This turned on the true construction of s 80(7). When its predecessor section was enacted in 1989, the common law had not recognised the remedy of mistake-based restitution. It followed, therefore, that the statutory scheme did not impinge on such a remedy. Accordingly, s 32(1)(c) Limitation Act 1980 applied to the dead period claims, not s 80(4). The court agreed with Henderson J that, on the authorities, an indirect benefit may be sufficient to found a claim in restitution. The final consumer who pays the tax has a sufficient economic connection with HMRC to claim that HMRC has been enriched at his expense.
EU law: Could the Danfoss-type claim under EU law also be invoked against HMRC for the 25? The court concluded that on these facts it could not. The San Giorgio principle, as developed in Danfoss, permits domestic law to operate a two-stage procedure. The taxable person who has paid the undue tax has an EU law right to recover it from the authorities; and the consumer, who has borne the tax burden, must then seek recovery from the taxable person. It is only where the second stage is impossible or excessively difficult, that the principle of effectiveness confers on the consumer a direct right of recovery against the authorities. The claimants’ argument that the principle of effectiveness gave them a direct remedy for the 100 against HMRC was rejected. They could have no greater claim than for the 75 due to the managers.
The court allowed HMRC’s appeal, dismissing the claims for 25 in all periods. The claimants’ cross-appeal was allowed for the dead period, but limited to 75. In Kleinwort’s case the recoverable percentage of 58% was netted-off against the 75.
The dead period has been resuscitated, at least on these special facts. But the court’s decision has wider implications for current and future claims, with a potential overlapping of remedies but a mismatch of limitation periods. Where VAT has been overpaid, in practice the consumer will first seek repayment from its taxable supplier, triggering the s 80 claim by the supplier for the 75. The supplier’s s 80 claim is subject to the s 80(4) time limit (now four years). The supplier must reimburse the 75 to the consumer. According to the court, however, the consumer’s claim against the supplier at common law should be for 100, not 75. The extended time limit in s 32(1)(c) applies (and, in theory, a claim could go back to 1973). It may be, on the facts, that such a claim is precluded, or limited, by the contract and, as to the 75, by a change of position defence.
A claim in restitution may then lie against HMRC. There is also a direct right of action against HMRC where the Danfoss principle is engaged and it is ‘impossible or excessively difficult’ to recover from the supplier. The court’s decision implies this is a high hurdle. It is likely to be satisfied where the supplier is insolvent. Might it also be satisfied where, for example, the supply contract precludes or limits a claim or the supplier relies on change of position? In either case, contrary to Henderson J’s view, the s 32(1)(c) extended limitation period applies, with claims potentially going back to 1973. The principle of effectiveness is not infringed by requiring the consumer, in certain scenarios, to bring two sets of proceedings: a claim against the supplier for a period limited by the contract; and a Danfoss claim against HMRC outside that period. This highlights the need for care in formulating claims and in drafting supplier contracts.
Substantial sums are at stake in this litigation and in cases stood behind it. Further appeals and a possible reference to the CJEU are likely before the dead period can finally be laid to rest.
