On 12 January 2012, Advocate General Trestenjak’s Opinion in Case C-591/10 Littlewoods Retail Ltd and Others was published. This represents the next phase in the VAT compound interest journey and, should the Court of Justice of the European Union (CJEU) to follow the Advocate General’s Opinion in its judgment, it is very unlikely that this trip to Luxembourg will be the end of the road.

Littlewoods is currently the lead VAT compound interest case, behind which virtually all other similar claims are stayed (one notable exception being Grattan Plc (No.2) v HMRC [2011] UKFTT 282 (TC), which has its own reference to the CJEU).

When overpayments of VAT are returned to a taxable person, they are only entitled to ‘simple’ interest under s.78 of the Value Added Tax Act 1994. Ultimately, the question for the UK courts, and the CJEU, is: does the limitation of s.78 to simple interest on repayments of VAT provide the taxable person with an effective remedy under EU law, where the directive did not require the relevant principal sum of VAT to be paid in the first place?

The facts of Littlewoods relate to the VAT treatment of commissions paid to Littlewoods' agents. It is common ground that the Revenue’s treatment of the agents’ commission payments had been defective between 1973 and 2004. Repayments of the principal sums with simple interest had been made to Littlewoods (as with most of compound interest claimants currently stood behind), however as David Anderson QC for Littlewoods put it to the CJEU: “…simple interest is not enough to restore Littlewoods to the position it would have been in had unlawful payments not been made. Nor more pertinently for the purposes of English law is it enough to remove the benefit the Government has had from using [that] money all those years…”

The questions referred to the CJEU by Mr. Justice Vos can be summarised as follows:

  1. If VAT is overpaid as a result of a breach of EU law by a Member State, is it sufficient for the Member States in order to comply with EU law that the VAT is returned together with simple interest (i.e. under section 78 VATA)? 
  2. If that is not a sufficient remedy, does EU law require compound interest to be paid? 
  3. If the answers to questions 1 and 2 are both in the negative, what other remedy is required by EU law? 
  4. If the answer to question 1 is in the negative, can a taxpayer choose its preferred common law remedy in mistake of law, thus benefiting from an extended limitation period, or is it for the national court to decide which remedy should be available?

The criticism levelled at s.78 is that simple interest is entirely arbitrary. It represents neither the extent of the taxpayer’s loss nor the UK Government’s gain. For the purposes of the English law of restitution, it is the latter measure which is important. This point was considered in the well known direct taxation case of Sempra Metals Ltd (formerly Metallgesellschaft Ltd) v Inland Revenue Commissioners [2007] UKHL 34; [2008] 1 AC 561, in which the House of Lords found that the correct measure of interest should reflect the UK Government’s cost of borrowing, which, along with any other type of commercial borrowing, is calculated at rate of interest which is compounded. As Lord Walker famously said in that case: “in modern economic conditions simple interest does not provide full compensation where unjust enrichment has lasted for a significant period”.

Littlewoods provided expert evidence to the CJEU from the economist John Kay to demonstrate this. He concluded that the interest provided to the claimants under s.78 represented only 20% of the benefit enjoyed by the UK Government by the use of the claimant’s money (and an even smaller fraction of the sum lost to Littlewoods, since its cost of borrowing would clearly have been greater than that of the UK Government). This, Littlewoods said, could in no way represent an effective remedy for the breach of EU law. In short, Littlewoods seeks what has become know as ‘full restitution’.

The UK, supported by submissions from the governments of France, Germany, Finland, Cyprus and the Netherlands (although only the UK attended the hearing), argued that because the rate of interest on repayments is not set down in the legislation of the EU (i.e. is not ‘harmonised’) the rate of interest to be paid is a question for Member States to decide on their own. The European Commission, while acknowledging that that an award of interest must be payable and that an amount representative of the erosion of the value of money though inflation would represent the “strictest minimum”, agreed with the UK that the matter should be left to the competency of individual Member States.

Unfortunately, the Opinion is largely inconclusive on the central question of whether taxpayers have an entitlement to compound interest under EU law. The first three questions were dealt with by the Advocate General together. She confirmed that where tax had been overpaid as a result of a breach of EU law by a Member State, EU law required that Member State to reimburse the principal sum levied and also to pay interest to compensate the taxpayer for the unavailability of the sums paid. The Advocate General, agreeing with the UK and the Commission, stated that it was up to Member States to determine the correct measure of interest on repayments of tax unlawfully levied, provided that the EU principles of effectiveness and equivalence were not infringed.

The principle of effectiveness requires that the exercise of rights conferred by EU law is not rendered “virtually impossible or excessively difficult” by Member States. The principle of equivalence prohibits more favourable rules from applying to similar domestic situations.

As to the principle of effectiveness, the Advocate General dealt with this rather briefly, stating that she considered the principle to be “clearly complied with” in this case. She said that a breach of this principle would arise only if “the interest was so low it largely deprived the interest claim stemming from EU law of substance”.

Of material relevance seemed to be the fact that the simple interest already repaid by HMRC to Littlewoods (£268m) exceeded the principal sums repaid (£204m) by 25%. It is difficult to reconcile this approach since self-evidently the sum of interest payable is directly referable (only) to the amount of time over which the principal sum has been outstanding. The fact that the amount of interest exceeded the principal sum in this case is only reflective of the long period of time over which the principal sums had been owing. It is unclear why or how this is relevant to the question of the effectiveness of the rate of interest itself. Would the outcome have been different, for instance, if the UK’s breach of EU law had only lasted from 1983 to 2004 rather than 1973 to 2004?

Having concluded on the principle of effectiveness, the remainder of the Opinion concerns only the question of equivalence. Of particular concern to the Advocate General was the question of whether the definition of a “similar domestic claim” would include all tax repayment claims (therefore including direct tax claims) or whether it would only include unlawfully levied indirect taxes other than VAT, or even just unlawfully levied domestic taxes comparable with VAT. Whilst reference was made to C-35/05 Reemtsma Cigarettenfabriken [2007] ECR I-2425, where the court concluded that the direct and indirect tax system were not related, AG Trestenjak opined this issue could not be considered by her “in abstracto”. Only the UK referring court had direct knowledge of the detailed rules governing interest on claims for reimbursement of tax and it was therefore for that national court to examine whether or not the rules governing the payment of interest on VAT collected in breach of EU law corresponded to rules governing similar domestic interest claims. The Advocate General went on to say, however, that the referring court should make a substantiated further request to the CJEU, by way of a fresh reference, for further clarification of this point.

She also noted that where there was a range of similar domestic interest claims, in respect of which different detailed rules are laid down, the principle of equivalence did not require the most favourable of those rules to be applied to interest from VAT overpayments.

The fourth question essentially springs from the fact that Littlewoods’ claim has been brought as a claim for mistake of law in the High Court (rather than as a statutory claim). The advantage of a High Court “mistake” claim is that the six year limitation period only starts to run from the date on which the mistake of law was discovered or could, with reasonable diligence, have been discovered. If successful, Littlewoods would therefore potentially be entitled to compound interest on the principal sums recovered on their Fleming claims right back to 1973, when VAT was introduced in the UK.

On the other hand, another type of common law claim (known as a “Woolwich” claim) would only allow the taxpayer to go back six years from the date of making the claim. HMRC will no doubt argue that this more limited remedy would be sufficient if compound interest is, in principle, payable. The question essentially is whether the taxpayer should, if s.78 is not sufficient to comply with EU law, be entitled to choose between the alternative “mistake” and “Woolwich” common law claims?
Since the Advocate General had already determined that s.78 provided an ‘effective’ remedy for EU law purposes, she restricted her answer to this question within the confines of the principle of equivalence and again opined that it was a matter for the national court. If taxpayers can choose their remedy in respect of similar domestic claims, they should be able to choose their remedy in respect of interest on VAT overpaid in breach of EU Law.

Importantly, however, the Advocate General reiterated that where there was a range of domestic remedies available, the principle of equivalence did not require Member States to extend their most favourable rules to similar claims concerning payment of interest on VAT collected in breach of EU law.

If the Advocate General’s opinion is followed by the CJEU, the case will then return to the High Court for determination of these various questions and possibly thereafter once more to the CJEU before we have finality on the question of compound interest in VAT claims. In the meantime, virtually all claims remain stayed pending the final determination in Littlewoods.