In two recent decisions, Lady & Kid Case C-398/09 and Accor Case C-310/09, the ECJ has sent a clear message that defences to the repayment of taxes levied in breach of EU law are restricted solely to the circumstances where the taxpayer has directly passed on that unlawful charge to its customers by increasing prices. It has rejected the defence that a company might be unjustly enriched by the return of an unlawful tax where it had passed on those unlawful taxes by reducing the value of its dividends to its shareholders. It is also difficult to see how defences recently developed in the English Courts such as change of position could now survive where EU protections are engaged.
In two judgments delivered this September the ECJ has sent a message to Member States regarding the defences it will permit to the claims for the repayment of tax levied contrary to community law.
The message is a re-statement of the Court’s case law on the defence of unjust enrichment in uncharacteristically unequivocal terms for the Court in recent years and it stands to relegate to history a number of defences which have been developing to protect Member States from repaying taxes levied in breach of EU law.
Where a tax paid is subsequently found to contradict EU rights, it is axiomatic that the taxpayers are entitled, as a matter of principle, to a refund of those charges (San Giorgio Case C-199/92 [1983] ECR 3595).
As an exception to that principle, the repayment of a tax wrongly paid can be refused where it would entail the unjust enrichment of the person concerned, that is where the burden of the tax has been passed on by the taxpayer to a third party.
However, the English Courts recently have been asked whether other exceptions might exist to restrain the obligation to repay wrongly levied taxes.
Two emerged in the context of the FII Group Litigation ([2009] STC 254).
One, the change of position defence, represented the deployment of a defence already known to the English law of restitution but in a tax context.
This defence contends that where a defendant had received a benefit to which it was not entitled, but had altered its position in reliance upon that receipt then, in the absence of wrongdoing by the defendant, it should not be obliged to restore that benefit to the claimant.
HMRC had argued that it was in a like position where tax income it had obtained without appreciating that it was levied in breach of EU law had been expended on the general public purposes for which it was raised.
In the FII case however, this defence was recognised as having very limited utility as HMRC accepted that it could not apply to claims protected by EU law.
The other defence which emerged from the FII case was dubbed the ‘fiscal chaos’ defence.
This argument contended that HMRC should not be obliged to repay taxes levied in breach of community law where the sum involved was sufficiently large as to cause a disruption to the annual national budgeting process.
Again this defence had limited utility because it was always subject to the implicit admission that HMRC was at least liable to repay an amount just short of one which would cause budgetary meltdown.
In the FII case Henderson J dismissed the argument as an attempt to rerun a request for a temporal limitation on the effects of a judgment which the UK had sought before the ECJ in that case and had been refused.
A bolder approach was adopted by HMRC in the Littlewoods case [2010] STC 2072.
Not only did HMRC now contend that the change of position defence could be deployed against EU claims but it expanded it into what Mr Justice Vos described as the ‘exhaustion of benefits’ defence.
It runs like this. The objective of setting the annual national budget is to match income with expenditure.
That process may produce a deficit or a surplus, but over only a short period of time it is clear that no surplus would remain.
The process of restitution is not to recover for the claimant its loss from making payments it was not due to make, but rather to strip from the defendant the benefits it has obtained from those unlawful payments.
The UK has therefore retained no benefit beyond at best, the year in which the unlawful payment was paid and therefore has no benefit to return.
As the claimants in Littlewoods are after only compound interest on payments which have now been returned, they get nothing.
Mr Justice Vos accepted that the change of position defence could be deployed in this way, but identified a critical flaw in it.
Where the tax payments concerned have been made over an extended period it is difficult to say that the UK ever made any budgetary decisions (and hence ‘changed its position’) on the basis of any particular payment.
However Vos J was much more upbeat regarding the exhaustion of benefits leg of the argument.
It is in the light of these arguments before the UK Courts that the ECJ’s September decisions are prescient.
The first of these decisions, Lady & Kid Case C-398/09 delivered on 6 September, concerns a nice development of the concept of unjust enrichment by the Danish Revenue.
Prior to 1988 Denmark levied a tax for social security purposes on employers, based on the number of employees.
Regarding this as a disincentive to employment, Denmark abolished that tax and replaced it with a surcharge on the first sale in Denmark of imported goods.
The surcharge remained in place until 1991 when it was declared to be in breach of the Sixth VAT Directive in Denkavit Case C-200/90 [1992] ECR I-2217.
However, when Danish retailers sought the repayment of those unlawful surcharges they were met with the defence that, as employers, the abolition of the equivalent NIC charge had created a greater saving, in most cases, than the unlawful surcharge which had replaced it.
They were in fact better off by reason of the wrongful tax.
One would have thought that a rather obvious answer to the Danish government’s defence is that not paying a tax that did not exist could hardly be called a benefit.
Yet the Court chose to hear the case in the Grand Chamber of 13 judges – a sign that it intended to use the case to make an important statement.
That statement is to restrict unjust enrichment arguments purely to the circumstance of an increase in the price of goods to customers to accommodate the tax charge:
‘20 ... the passing on of the tax wrongly levied on the purchaser constitutes the sole exception to the right to reimbursement of tax levied in breach of European Union law.’
‘Sole exception’ does certainly suggest that no other form of defence (such as ‘change of position’ or ‘exhaustion of benefits’) other than passing on through an increase in the sale price exists to the repayment of a wrongfully levied tax.
That the Court intends this message to mean what it says is supported by what follows.
The Court then accepts that in previous cases it had not ruled out that the national court, applying its national law, could take into consideration possible methods of refusing reimbursement of an unlawful tax other than passing on, but that
‘(25) ... it must be noted that the court, in paragraph 20 of the present judgment, states that the direct passing of the tax wrongly levied to the purchaser constitutes the sole exception to the right to reimbursement of tax levied in breach of European Union law.’
So there we have it. Passing on of the unlawful tax via an increase in prices is the only defence to an EU law claim for repayment of that tax.
Yet perhaps this was only intended to apply to indirect taxes. Not so.
Any such suspicion was dispelled in Accor Case C-310/09 which followed a week later. The Accor case concerned the French précompte system.
In very broad terms, as in the FII case, a resident company in receipt of dividend income from a resident subsidiary need not pay précompte on the onward distribution of those profits because it would receive an imputation credit for the tax paid by the resident subsidiary.
Conversely it would pay précompte on distributing profits from non-resident dividends because they carried no such imputation credit even though the profits had been taxed elsewhere.
Among the questions addressed to the court was a particular defence run by the French government.
The effect of précompte, it contended, was simply to reduce the reserves that the French company had to distribute to its shareholders.
The company therefore had not suffered from the payment of précompte.
The actual victims were the shareholders who had received smaller dividends than they ought.
Interestingly, the Advocate General in the Accor case had concluded that theoretically it would be possible to run such a passing on defence in a direct tax action, but had found in the circumstances in Accor that the defence did not apply.
The court did not follow its Advocate General’s lead.
Rather it refers repeatedly to the judgment in Lady & Kid (see paras 72, 73 and 74) concluding that an advance payment of tax made by a parent company when distributing dividends does not amount to a charge levied on the sale of goods so that it cannot lead to a passing on defence (see para 75).
That Accor and Lady & Kid were intended by the Court to be read together as a firm statement that defences to the repayment of any tax, direct or indirect, levied in breach of EU law are restricted to passing on by an increase in prices is suggested not just by the timing and cross-referencing of the judgments but also by the personnel.
Three of the judges on the bench for Lady & Kid, including its judge rapporteur, also appeared in Accor.
If this is the right message to read then it follows that novel defences such as change of position, fiscal chaos and exhaustion of benefits which are now being considered in the English Courts have no place as a restriction to the repayment of tax levied under EU law.
The requirement that the tax be directly passed on also makes it difficult to conceive of situations where this might arise outside a VAT setting.
Of course the ECJ message merely restricts efforts of Member States to expand the concepts of passing on and unjust enrichment as defences to repayment claims.
There is nothing to stop Member States relying upon properly introduced and reasonable time limits to restrict claims and other procedural bars.
There also remains the argument, to be explored by the Supreme Court in the FII case next year, as to when claims for the repayment of taxes levied in breach of EU law are no longer protected by EU principles such as that expressed in Lady & Kid and made more vulnerable to broader defences available to national law.
For now it seems that Lady & Kid will give us another one of those boilerplate paragraphs which will appear repeated in ECJ judgments to come.
Simon Whitehead, Partner, Dorsey & Whitney (Europe) LLP
