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Type of interest due on overpaid tax is at discretion of national governments, ECJ says

It is for European member states to determine how interest should be calculated on repayments of overpaid tax, the European Court of Justice (ECJ) has ruled.

The ECJ referred a case involving the type of interest due on repayments of value added tax (VAT) to retailer Littlewoods back to the High Court for judgment. The company had argued that it should be entitled to compound interest on the overpaid tax, which had been charged in breach of EU law on commission.

"A taxable person who has overpaid value added tax which was collected by the Member State contrary to the requirements of European Union legislation on value added tax has a right to reimbursement of the tax collected in breach of European Union law and to the payment of interest on the amount of the latter," the ECJ said in its judgment. "It is for national law to determine, in compliance with the principles of effectiveness and equivalence, whether the principal sum must bear 'simple interest', 'compound interest' or another type of interest."

Tax law expert Ian Hyde accused the ECJ of "dodging" the issue, which could have cost the Treasury £1 billion if decided in favour of Littlewoods.

"Compound interest would represent a commercial restitution but it looks like HM Revenue and Customs (HMRC) will get away with not paying it," he said. "It is unlikely that the UK courts will force HMRC to pay compound interest when the potential liability for the many cases waiting for the outcome of this decision could run into billions of pounds – which the UK Government can ill afford to pay."

Simple interest is calculated only on the original or 'principal' amount, or on that portion of the principal amount that remains unpaid. Compound interest arises when interest is added to the principal amount, meaning from that moment on the interest that has been added also earns interest. UK law currently only awards interest on a simple basis.

Littlewoods had mistakenly overpaid VAT on sales dating back to when the tax was introduced in 1973 as it had not deducted the commission it paid to the agents who had collected sales from its customers from the value of those sales. Both EU and UK law provide that commission should be treated as a "discount against the consideration for past purchases or future purchases" rather than as "consideration for the services" provided by the agent to the company.

In an opinion advising ECJ judges in January, Advocate General Verica Trstenjack said that reimbursement with simple interest was compatible with EU law as it provided "adequate compensation" for the loss of the use of the money and because "no more generous remedy" was available in relation to overpayments of other taxes. She said that the type of interest added to the repayment was a question "to be determined by the Member States" providing that a taxpayer would not be treated differently elsewhere in the EU.

The ECJ added that national rules on the calculation of interest due should not "lead to depriving the taxpayer of an adequate indemnity for the loss occasioned through the undue payment of VAT". However, it was for the UK court to determine "whether that is so in the case at issue ... having regard to all the circumstances of the case".

It noted that Littlewoods had already received interest worth over £268 million from HMRC, an amount exceeding the overpaid VAT by more than 23%.

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