Businesses no longer suffer 'unjust enrichment' discrimination from HM Revenue and Customs (HMRC)

How will the recent ruling in the Marks and Spencer case affect businesses who were previously considered ineligible to receive certain VAT refunds?

What has changed?

HMRC has reversed its position on a concept known as 'unjust enrichment' and has now stated that VAT claims made before 26 May 2005 will no longer be rejected on those grounds. Businesses that made claims prior to that date will now have them paid, subject to verification.

What is unjust enrichment?

The UK legislation states that where a person has paid an amount of VAT to HMRC which was not due to them, HMRC has to pay the amount back. However, the VAT does not have to be repaid if HMRC can prove that to do so would unjustly enrich the claimant. Unjust enrichment arises where, by meeting a claimant's VAT claim, they would be put in a better economic position than if they had not mistakenly accounted for the VAT, leading to the claimant receiving a windfall.

The teacake case

The change in policy arises as a result of a reclaim for VAT overpaid by Marks & Spencer (M&S) between 1973 and 1994 on the sale of chocolate covered teacakes. HMRC advised M&S to account for VAT at the standard rate on the teacakes for a number of years, but eventually acknowledged that they should have been classified as zero-rated. The case was reported in Tax Story of the Week dated 21 April 2008.

Even though HMRC accepted that M&S  should not have declared and paid VAT in the first place, its position was that the VAT had been 'passed on' to the customer and so M&S would obtain an unfair advantage if it received and retained the refund. HMRC therefore agreed to pay only 10% of the M&S claim.

However, other businesses in a similar position to M&S were paid by HMRC in full. This quirk in treatment between different businesses arose because the legislation distinguished between two different taxpaying groups and resulted in the unjust enrichment provisions only being applied to 'payment traders' and not to 'repayment traders'. Repayment traders are those businesses whose input tax generally exceeds their output tax, and payment traders were those whose output tax generally exceeds their input tax. M&S is a payment trader.  
The UK Government eventually recognised this deficiency and extended the legislation in 2005 to apply to both categories of business. However, HMRC still refused to repay the remainder of the claim to M&S on the basis that it had been made prior to the change in the law.

Change in policy

When its claim for a refund was still refused by HMRC, M&S took its case to the European Court of Justice (ECJ). M&S argued that it had been unfairly treated because the unjust enrichment legislation discriminated against net payers of VAT.

The ECJ and the House of Lords both agreed with M&S that there had been discrimination, and that has lead to HMRC announcing a policy change.

Karen Robb, VAT Partner at Grant Thornton says: "This change in policy can only be seen as good news by businesses. HMRC has finally conceded that the unjust enrichment rules cannot be used to discriminate between different categories of VAT registered businesses. Any retailers who have had claims denied on the grounds of unjust enrichment prior to the law change in May 2005 should review their position and take steps to seek repayment. It remains to be seen whether this is the end of the matter though. Businesses that could have submitted claims before the 26 May 2005 deadline but were advised not to because of the rules prevailing at the time will feel aggrieved. Those businesses should seek professional advice, and certainly before another change in the rules for claims comes into effect on 1 April 2009".

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