Sempra Metals (1): restitution revised

In his restatement of the law of restitution in Woolwich Building Society v Inland Revenue Commissioners [1992] 3 All ER 737 Lord Goff left the passing remark that 'at a time when Community law is becoming increasingly important, it would be strange if the right of the citizen to recover overpaid charges were to be more restricted under domestic law than it is under Community law'.

It may have taken 15 years to get there but with the Lords' judgment in Sempra Metals v Inland Revenue Commissioners [2007] UKHL 34 English law appears to have achieved that goal, leaving in its wake improved rights to the recovery of interest in a range of actions beyond the context of overpaid charges and European Community rights.

Group litigation orders

Sempra Metals represents a significant step in a series of decisions arising from litigation co-ordinated under some six group litigation orders where corporate taxpayers challenged the imposition of various taxes on the grounds that they offend European Community rights or obligations under other international treaties. Starting with the ACT Group Litigation in late 2001, those cases have since 2005 led to five House of Lords decisions and three rulings of the European Court of Justice (ECJ) '“ each significant and with more to follow. However, to avoid descending into the complexities of cross-border international tax perhaps the following two simplified examples might help illustrate the issue addressed in Sempra Metals and the implications for common law restitution claims more generally.

In the first example, assume that UK provisions required the UK subsidiary of a non- resident parent company to pay a portion of its corporation tax earlier than the UK subsidiary of a UK resident parent company and that this different treatment was contrary to the prohibition in the EC Treaty against national laws which inhibit the free establishment of enterprises anywhere in the Community (article 43 EC (formerly 52)). These are in essence the circumstances with which Sempra Metals was principally concerned and the conclusion reached by the ECJ in C-397/98 Metallgesellschaft Ltd and Ors, C-410/98 Hoechst AG and Hoechst (UK) Ltd v Commissioners of Inland Revenue and HM Attorney General from which much of this litigation derives.

What then has been the result of the breach of Community law in this context? The imposition of tax on the UK subsidiary is not, in this simplified model, unlawful. It always had to pay its tax bill. The incompatibility with Community law arises rather because UK law required that tax bill to be paid too early. The taxpayer has lost the benefit of retaining the cash for the period between the early payment and when that payment should have been due. Conversely the state has obtained not an excess of tax revenue but the advantage of receiving cash on a date earlier than it was due.

Paying unlawful tax demands

In our second example, assume a UK company is subject to a tax charge of £1,000 which is incompatible with Community law because it is only imposed on income received from other EU member states and not upon identical income received from within the UK. Unlike the company in the first example which paid a tax bill it was always due to pay but earlier than it needed to, this company should never have been due to pay the tax at all. Yet at the time the tax was charged the taxpayer was unaware that a charge which the law clearly said it was due to pay, could not be imposed on it without offending overriding Community rights.

It was not until several years after the charge was due to be paid that decisions of the ECJ revealed this reality. By then the charge had been long since satisfied.

All in the timing

Yet tax rules of course provide not only for the imposition of tax but also for reliefs (such as unexpended losses from prior years) and deductions (for example, interest payments) which can be used to reduce a taxpayer's tax liability. In this example rather than paying the unlawful tax of £1,000 in cash the taxpayer used its available reliefs to offset that liability. Thus while it never paid the (unlawful) tax, it expended reliefs which would have been available to reduce its other (lawful) tax liabilities.

Assume then in this example that in the following two years the taxpayer incurred lawful tax liabilities of £1,000 in each year. Its available reliefs having been expended in the previous year it was obliged to pay £1,000 in cash tax in the second and again in the third years.

This hypothetical situation is one of the many circumstances encountered in other decisions in this same stable of cases as Sempra Metals, namely the ECJ's decisions in the cases C-446/04 FII Group Litigation and C-524/04 Thin Cap Group Litigation v Commissioners of Inland Revenue.

Now, what has arisen from the breach of Community law in this second example? Distinct from the former where tax was just paid too early, here the tax imposition which breached Community law should never have arisen at all. But the taxpayer never paid it. Rather it has used a deduction which could have been carried forward into the following year to offset that liability. Had it known that the impost was unlawful what would have happened? Obviously the relief of £1,000 would not have been used up in the first year. There would have been no charge to apply it against. The taxpayer would instead have applied the relief against the next year's lawful tax bill of £1,000 to shelter it from paying tax in the second year. The taxpayer then does not have to put its hand in its pocket until the third year when, all reliefs now gone, it hands over £1,000 for the lawful liability then incurred.

The outcome then seems rather similar to the first example. The breach of Community law has caused the taxpayer to pay £1,000 in the second year which, absent the imposition of a tax in breach of community law in the previous year, it would not have paid until the third year. The taxpayer has paid tax earlier than it should. The state has benefited from its operation of a tax system in breach of Community law by receiving cash earlier than it should have been entitled.

Of course these examples are over simplifications of the relevant provisions and cases. They are intended as illustrations of the issues without the complexity introduced by reality.

The point then is one of timing. If a court concludes that the payee is liable to the payer (here on the grounds of a breach of Community law) how then does the calculation of compensation take into account the fact that what the payer has suffered is not the loss of money itself but rather the loss of use of its money and that what the payee has gained is its early receipt? This is the fundamental issue in Sempra Metals.

Revisiting common law

The common law principle, last considered by the House of Lords in President of India v La Pintada Compania Navigacion SA [1984] 2 All ER 773, prohibited an action for the recovery of interest where the principal sum had been repaid before the claim was issued. In the two examples above unless the breach of Community law was swiftly discovered no action would therefore perhaps arise, the mischief being not the loss of money but the loss of its use during the period of its premature payment. Bound by this precedent the High Court and Court of Appeal in Sempra addressed the matter from a Community law perspective. Whatever English law might exclude from recovery, the requirement of an effective remedy at Community law obliged the national court to fashion a remedy to provide full compensation for the taxpayer's loss of use of the money.

As commercially where interest is unpaid it compounds, the correct measure of the loss must be to assess its value at a commercial interest rate compounded at rests which would be observed commercially.

Left there we would be presented with precisely the oddity with which Lord Goff was concerned in his passing remark in the Woolwich case. Community law would indeed give recovery where English law could not do so on its own. Thus a claimant could recover the loss of use of money in the first example, where tax was paid too early in breach of Community law, but maybe not in the second where breach of Community law caused the early payment of a lawful tax? Perhaps not at all where the tax did not breach Community law but was rather raised ultra vires in breach of domestic law?

Precedent over-ruled

That outcome has been avoided by the judgment of the House of Lords in Sempra Metals. Pintada has been clearly and explicitly overruled. To Lord Nicholls the concept that there is no claim at common law for the loss of use of money upon a late paid principle is outdated and illogical. The majority then identify three co-existent claims at common law available to Sempra Metals. The first is a damages claim for breach of statutory duty (namely the duty to apply legislation compatibly with community law: s2 European Communities Act 1972). Here the taxpayer should receive the proper measure of its loss: interest at a commercial rate on a compound basis.

The second is restitution for payment under an unlawful demand and the third for restitution for payments made under a mistake of law. These differ in regard to the available limitation period. Here the calculation is not of the loss to the payer of the use of its money but of the benefit to the recipient from the use it did or could have made from the money. Use of money has a value. It can be invested or used to reduce borrowings. Normally that value is calculated as interest at a commercial rate and on a compound basis unless the payee could show particular circumstances which suggest that it did not receive the value to its use which would normally be expected. In the current circumstances the majority of the House of Lords believed that HM Revenue and Customs were able to show that they were in such an unusual position as the state can borrow money at less than a commercial rate. Interest therefore while compound should be calculated at the interest rate on the state's borrowings.

Significant developments

What is produced for claimants generally (not just taxpayers pursuing the state) are three significant developments. The first is the acknowledgement of a common law action to recover damages, whether at contract or tort or in restitution, for loss of use of money as a viable claim in itself. The use of money has a value independent of the money itself. Breach of a contract by late payment for example would seem as capable of founding an action in damages for the loss of use of the money as its non payment.

The second is the acknowledgement that compound interest is recoverable in normal commercial circumstances at common law whether as claims in damages or for restitution. The distinction will lie in the focus of the enquiry the former looking to the loss to the claimant and the later to the benefit which should have fallen to the defendant. It is likely this will come to the same thing save in quite exceptional cases (such as proceedings against the state).

The third is the consummation of Lord Goff's idea left stranded in Woolwich that a better deal should not be available under the exercise of Community rights than English law.

To the Court of Appeal the limits of compensation at English law required remedies to be fashioned to provide for effective compensation at Community law. To the House of Lords this seemed rather an invitation to remove those limitations for domestic actions as well. Indeed as the various cases in these group litigation actions continue on their path through the courts we may well now find that a better deal has become available at English law than the Community lawyers could offer.