In a recent decision, the Supreme Court held that claimants could not bring claims in unjust enrichment to recover compound interest on taxes paid under a mistake of law: Prudential Assurance Company Ltd v Commissioners for Her Majesty's Revenue and Customs  UKSC 39.
In doing so, the Supreme Court departed from the House of Lords decision in Sempra Metals Ltd v Inland Revenue Commissioners  UKHL 34, considered here, which held that such a claim was available. In the present case, the court disagreed with the view taken in Sempra Metals that the time value of money could be considered a separate benefit for the purposes of the law of restitution, in addition to the payment of the unlawfully levied tax. Accordingly, the Supreme Court held, there was no additional benefit to be reversed by the award of compound interest once the tax itself had been repaid. Instead, the court could award simple interest under section 35A of the Senior Courts Act 1981.
The Supreme Court noted that, in Sempra Metals, the House of Lords had also held that compound interest was available as damages, where it was the measure of the loss foreseeably suffered by a claimant from the loss of use of his funds. That point was not in issue in the present case and, the court said, nothing in its judgment was intended to question that aspect of the decision.
The decision is significant in clarifying the law on unjust enrichment, and in particular reversing the previous case law under which a claim for compound interest was available. However, it does not affect the question of whether and in what circumstances compound interest may be awarded as damages to compensate a claimant who is out of pocket as a result of a defendant's wrongdoing (such as a breach of contract, or the non-payment of a debt).
Julian Copeman and Ajay Malhotra, a partner and senior associate in our disputes team, consider the decision further below.
This is a test case brought as part of group litigation relating to the tax treatment of dividends received by UK resident companies from non-UK portfolio investments.
One of the issues considered by the Supreme Court is whether the claimant was entitled to compound interest in respect of tax levied in breach of EU law, on the basis that HMRC were unjustly enriched by the opportunity to use the money in question. All of the tax in question had ultimately been repaid by HMRC or set off against lawfully levied tax, and so the claim in restitution was solely for interest rather than the unlawfully levied tax itself.
HMRC submitted that only simple interest should be awarded, under section 35A of the Senior Courts Act 1981.
Although the difference between simple and compound interest is described as "modest" in the present case, the point arises in other cases pending against HMRC and is estimated to be worth around £4-5 billion.
At first instance, Henderson J held that compound interest should be awarded, following Sempra Metals. The Court of Appeal dismissed HMRC's appeal. HMRC brought a further appeal on the point to the Supreme Court.
The Supreme Court allowed the appeal, finding that a claim for compound interest did not lie in restitution.
The court summarised the judgment in Sempra Metals as finding, by a majority, that the court had jurisdiction to award, on the ground of unjust enrichment, the time value of money paid prematurely as a result of a mistake, on the basis that the recipient received a benefit from the claimant in the form of the time value of the money. That benefit should ordinarily be quantified as the market value of the use of the money – ie the cost of borrowing an equivalent amount in the market.
The court noted that the law had developed in a number of areas since Sempra Metals, including that the Supreme Court's decision in Littlewoods Ltd v Revenue and Customs Comrs  WLR 1401 had revealed a conflict between the decision in Sempra Metals and prior legislation. In particular section 78 of the Value Added Tax Act 1994, which provides for the payment of simple interest on overpaid VAT repaid by HMRC: entitlement under section 78 is subject to limitations which would be defeated if taxpayers could bring a common law claim for interest on mistaken payments. Until Sempra Metals, it had been settled law for about 200 years that no such claim could be brought, and that was the basis on which Parliament enacted section 78. In its decision in Sempra Metals, the House of Lords failed to have regard to that scheme, and other legislation providing for simple interest on overpaid tax.
The Supreme Court noted also that allowing recovery of payments made under a mistake of law creates potential difficulties under the law of limitation, since section 32(1)(c) of the Limitation Act 1980 enables claims to be brought within six years of the mistake being discovered, no matter how long in the past the payment was made. At the time of Sempra Metals, it was thought that this problem would not affect HMRC, due to legislation which provided that section 32(1)(c) should not apply in relation to payments of tax made under a mistake of law. However, Parliament's attempts to introduce a limitation period for such claims with retrospective effect have subsequently been held to be incompatible with EU law. This is another way in which the law had developed since Sempra Metals.
Further, the Supreme Court said, the law of unjust enrichment had developed in ways which could not easily be reconciled with the majority decision in Sempra Metals, most significantly as to the requirement for the defendant to be unjustly enriched "at the expense of" the claimant. In Investment Trust Companies v Revenue and Customs Cmrs  UKSC 29, Lord Reed explained that, as a general rule, a claim for unjust enrichment is only available in respect of a benefit which the claimant has provided directly to the defendant. A causal connection between the claimant incurring a loss and the defendant receiving a benefit is not enough.
When money is paid by mistake, a benefit is transferred directly to the recipient at the expense of the paying party. As such, an obligation arises immediately under the law of unjust enrichment to reverse the enrichment by repaying the money. The majority in Sempra Metals considered that there was an additional and simultaneous transfer of value comprising the opportunity to use the money, which also gave rise to a claim in unjust enrichment, but the Supreme Court in the present case found that reasoning to be flawed. It held that, in cases of mistaken payment, the recipient may receive the opportunity to use the money as a consequence of the transfer, but a causal link is not sufficient. There is no additional transfer of value comprising the opportunity to use the money. The only transfer of value needing to be reversed is the payment of the principal sum.
The claimant can, however, be awarded simple interest on the amount of the payment under section 35A of the 1981 Act. That is because the obligation to repay the amount of the mistaken payment creates a debt, and interest can normally be awarded on a debt under section 35A.
The Supreme Court noted that, on a literal reading, section 35A applies only where there are proceedings for recovery of a debt or damages, and so would not apply to the extent that unlawfully levied tax had been set off against lawfully levied tax before any proceedings were issued. However, an award of interest was nevertheless required by EU law, as otherwise there would be no effective remedy. The court said it was unnecessary to decide in this appeal how an award of interest should be made available in such circumstances, but there were a number of potential solutions.
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