No direct right in restitution against HMRC for investment trust companies, rules Supreme Court

The managers had accounted for VAT on supplies of investment management services under the UK law in force at the time, even though these supplies should have been exempt from VAT under the relevant EU VAT Directive. At the same time, the managers had deducted the input tax incurred on costs made in the course of their business, as their VAT taxable supplies of management services were considered to create a right to recover input tax. Therefore, the net amount of VAT was paid out to HMRC.

After it became clear that UK law was not in line with the EU VAT Directive, the managers were refunded the VAT paid and passed this VAT on to the ITCs under the statutory reimbursement arrangements. However, the ITCs were only refunded the net VAT amount that HMRC received from the managers, and not the total amount of VAT that they had paid to the managers.

A number of the managers' claims were also time barred under section 80 of the 1994 VAT Act. The three-year limitation period in this scheme has already been found to be compatible with EU law, on the grounds that it is necessary to avoid the disruption of public finances.

The ITCs claimed, based on unjust enrichment or direct rights under EU law, directly from HMRC the difference between the VAT amount received from the managers under the statutory scheme and the VAT amount paid to the managers. The ITCs also claimed the VAT amounts the managers were not entitled to claim because they were time barred under the statutory scheme.

There was no dispute between the parties that HMRC had been enriched by the net VAT amount accounted for by the managers. The ITCs had attempted to argue that HMRC had been enriched by the full amount of output tax accounted for by the managers; an argument that was accepted by the original judge in the case but rejected by the Court of Appeal. To succeed, the ITCs also needed to establish that HMRC had been enriched at their expense.

The Supreme Court partially agreed with the Court of Appeal, in a unanimous judgment given by Lord Reed.

"There is no doubt that, in economic terms, [HMRC was] enriched at the expense of the [ITCs]," the judge said in his judgment. "The net result of the mistake was that the [ITCs] were worse off by the amount of the Managers' output tax, and [HMRC was] better off to the extent that the amount exceeded the Managers' input tax."

However, the purpose of a restitution claim was "not to compensate for loss, but to reverse the defective transfer", the judge said. For this reason, the court could not simply look to see which party had suffered the economic loss, he said.

"There was a transfer of value … from the [ITCs] to the Managers, under the contract between them," he said. "It was defective, because it was made in performance of a contractual obligation which was mistakenly believed to be owed. There was a subsequent transfer of value ... from the Managers to [HMRC]. It was also defective, because it was made in compliance with a statutory obligation which was inapplicable because it was incompatible with EU law. These two transfers cannot be collapsed into a single transfer of value from the [ITCs] to [HMRC]."

Therefore, the ITCs did not have a direct right in restitution against HMRC. The route available to the ITCs is indirectly through a section 80 claim against HMRC, which is submitted by the managers and this route removes the need for the ITCs to have a direct remedy against HMRC, the court concluded. Even though, the section 80 claim is limited for the net VAT amount paid by the managers to HMRC and subject to time limitations. However, the ITCs may still be able to bring a claim based on equivalence principles in EU law if the indirect route should prove impossible or excessively difficult.

"Parliament cannot sensibly be taken to have intended, when it created this scheme for the reimbursement of suppliers (with provision for them in turn to reimburse their customers), subject to strict time limits, that it should exist concurrently with non-statutory liabilities towards suppliers and their customers which were potentially wider in scope and were subject to a longer and less certain limitation period," the judge said.

Litigation law expert Craig Connal QC of Pinsent Masons, the law firm behind Out-Law.com, said that Lord Reed's "detailed analysis" of the law of unjust enrichment would be of wider interest, beyond VAT repayment claims.

"Much of the underlying message amounts to the sounding of a cautionary note against treating unjust enrichment as creating 'a judicial licence to meet the perceived requirements of fairness on a case by case basis'," he said. "The rules of unjust enrichment should be ascertainable and consistently applied."

"Here, the defendant had to receive a benefit from the claimant, but the claimant also had to suffer a loss through his provision of the benefit. The relationship had to be direct, other than in cases of sham steps in a transaction or what might be regarded as 'mere agents'. Discussion of 'economic reality', described as a 'somewhat fuzzy concept', should be approached with care," he said.

"The law of restitution continues to emerge on a step by step basis. However, this latest judgement is likely to be of concern to fund managers who are likely to feel that they bear the risk for HMRC's erroneous application of the VAT exemption," said Darren Mellor-Clark, tax expert at Pinsent Masons.