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HMRC to charge 45% tax on restitution interest

The UK's HM Revenue and Customs (HMRC) will charge corporation tax at a special rate of 45% on any interest it is required to pay to taxpayers who overpaid tax under 'a mistake of law'.28 Oct 2015

The move comes in response to a Court of Appeal judgment in May that said compound interest should be paid to catalogue company Littlewoods on overpaid VAT.

Littlewoods had mistakenly overpaid VAT on sales dating back to 1973, when VAT was introduced, because it did not deduct the commission it paid to agents who collected sales from its customers from the value of those sales. HMRC has already repaid the VAT together with simple interest.

In 2012 the Court of Justice of the European Union said that under EU law a taxpayer was entitled to receive 'adequate indemnity' and that it was for national law to decide "in compliance with the principles of effectiveness and equivalence, whether the principal sum must bear 'simple interest', 'compound interest' or another type of interest."

The new measure does not apply to tax refunds and statutory interest repayments, which are only liable to corporation tax at the prevailing rate, currently 20%. It applies in circumstances where a taxpayer was unlawfully required to pay tax under a 'mistake of law' and is entitled to compensation or restitution for that overpayment.  HMRC said that the new 45% rate "reflects both the rates of corporation tax over the period to which typical awards relate, and the effect of compounding interest not taxed in the year to which it relates".

"This is a unique set of circumstances and this measure ensures that recipients of such restitution interest payments do not enjoy an unfair tax advantage at the expense of the public purse," HMRC said.

Tax disputes expert Stuart Walsh of Pinsent Masons, the law firm behind Out-Law.com said: "HMRC is readying itself for the prospect of having to make substantial payments of restitution interest to a large number of taxpayers who overpaid VAT for many years."

"Given the value of the claims, coupled with recent judgments that statutory interest payments on overpaid VAT are subject to corporation tax, the chancellor’s announcement is perhaps not that surprising. Left unchallenged, it serves to immediately and significantly reduce the value of all open claims that are awaiting the final Littlewoods decision," Walsh said.

"However, there are clear grounds to challenge the proposed measure. It is arguable that restitution interest should not be liable to corporation tax at all. In any event, the special rate certainly looks vulnerable to challenge," he said. "HMRC justifies the 45% rate by claiming that it reflects, in part, the corporation tax rates applicable over the period to which 'typical awards' relate."

"It is true that many of the claims do include periods extending back to the 1970s and mid-1980s when the rate of corporation tax was 52%. But not all claims fall within this definition. For example, there are many claims that are limited to periods from the early 1990s, when the corporation tax rate peaked at 34% and it has been falling ever since," he said.

"The blanket rate makes no allowance for these distinctions and therefore it is difficult to see how, in every case, the proposed measure could possibly result in HMRC giving up all of the benefit it has gained through the overpayment of tax, as they are required to do, or the taxpayers receiving the 'adequate indemnity' to which they are entitled. If the measure is retained in its current form, then a challenge is inevitable," Walsh said.