Tribunal dismisses appeal against 'restitution interest' tax charge

Various members of the British American Tobacco (BAT) corporate group, which had successfully recovered sums from HMRC based on a breach of EU law in the franked investment income group litigation (FII GLO), had challenged the legality of the charge suffered on the compound interest element of those sums. The government introduced the restitution interest tax charge in 2015, after the Court of Appeal ruled that catalogue company Littlewoods should be paid compound interest on refunded overpaid VAT.

The government claimed the charge was introduced to reflect the fact that corporation tax rates were historically much higher than they are now, so the interest would have been taxed at higher rates had it been paid in the periods to which it relates. The first-tier tribunal has now ruled that the charge does not deprive the BAT companies of an effective remedy for a breach of EU law by HMRC.

"There can be no doubt that, in an ordinary case, the incident of taxation on the profits arising from an award would not render the exercise by a claimant of its EU law right either virtually impossible or excessively difficult," said tribunal judge Roger Berner. "In such a circumstance, it is the vindication of the right itself which has given rise to the taxation of the profit, according to the ordinary corporation tax rules."

"That is not to say that there are no circumstances in which taxation of an award could breach the principle of effectiveness. If it were to be found that, although taking the form of taxation, the measure in question was in substance confiscatory, that in my judgment could equally be held to be in breach of the principle of effectiveness. But ... it is plain that the mere incidence of taxation in the ordinary course does not amount to a confiscatory measure," he said.

The judge went on to say that the test was whether the particular provision was "rational and proportionate as a taxation measure". It was not irrational for HMRC to come up with a standard charge which could be applied in these cases, especially following extensive modelling; and the figure at which it ultimately arrived was not disproportionate, he said.

"I consider that the process by which [the 45% charge] was arrived at was both logical and rational as were the underlying assumptions that underpinned the rate," he said. "It produced a rational basis of taxation, and not confiscation … It does not perpetuate the unlawful situation. It does not deprive BAT of an adequate remedy; it properly addresses a factor of the restitutionary award that would tend towards over-compensation."

Additionally, the way in which HMRC 'ring-fenced' the restitution interest, preventing the tax upon it from being offset by any tax reliefs or allowances, was a "natural, and logical, feature of any tax that is applied to present income or profit by reference to an assumed tax effect in earlier periods with a view to restoring the taxpayer to the position of a hypothetical taxpayer which paid tax in those earlier periods", the tribunal judge said.

"It is natural and logical in those circumstances because the effect would otherwise be to permit current reliefs effectively to be carried back, and would not replicate the position of the hypothetical taxpayer paying tax at the relevant times," he said. "The use of current reliefs would thus be objectionable irrespective of the approach taken to the ascertainment of the appropriate tax rate."

The judge also dismissed arguments by the BAT companies that the charge breached the EU principles of sincere cooperation, legal certainty and legitimate expectation. BAT is expected to seek permission to appeal due to the sums at stake, according to tax expert Jake Landman of Pinsent Masons, the law firm behind Out-Law.com.

Separately the Supreme Court began hearing arguments in HMRC's appeal against Littlewoods' claim for compound interest on its overpaid VAT repayment earlier this month. The case has now been adjourned while the Supreme Court decides whether a further referral to the Court of Justice of the European Union (CJEU) is required.

"We do not expect to hear anything further regarding the future steps in the Littlewoods v HMRC compound interest case until around October and possibly later," said Jake Landman.

The Supreme Court may need to consider the future availability of the reference procedure in light of the recent position papers released by both the UK and EU, which set out how each intends to approach ongoing judicial and administrative proceedings as the UK leaves the EU, he said.