A customer purchases services from a supplier to which VAT at the applicable rate is added but VAT was not actually due. Is the customer able to recover these payments by bringing an unjust enrichment claim against the Revenue and Customs Commissioners? “Yes”, answered the Court of Appeal, on the basis that as a matter of “economic reality” the Commissioners were enriched at the expense of the customers, and that such an enrichment was unjust because VAT was not actually due. Lord Reed, giving the unanimous judgment of the Supreme Court, reversed that decision: Investment Trust Companies (In Liquidation) v Revenue and Customs Commissioners [2017] UKSC 29; [2017] 2 W.L.R. 1200. The customers did not have an unjust enrichment claim against the Commissioners because their enrichment was not “at the expense of” the customers.
There have been two theories about what should satisfy the “at the expense of” requirement. One requires a direct dealing between the claimant and the defendant. The other merely requires a “but for” connection between the defendant's gain and the claimant's loss. Proponents of both theories recognised that they should be subject to exceptions and the case law took a via media by endorsing the direct dealing rule but subject to wide-ranging exceptions.
Lord Reed settled this debate by endorsing the direct dealing rule but subject to more limited exceptions: (1) agency, (2) assignment, (3) tracing, (4) ignoring shams, (5) treating co-ordinated transactions as one and (6) the discharge of debts. The first five are not real exceptions: they merely apply general rules of law; the agent slips out of a transaction, the assignee stands in the shoes of the assignor, traceable assets are treated as if they were the original asset, the law ignores shams and treats co-ordinated transactions as one. The sixth is the only true exception.
In addition, Lord Reed rejected two expansions of the direct dealing rule which the courts below had added. The first was the “economic reality” test which the courts below had used to establish whether an enrichment was at the claimant's expense, which was rejected for two reasons. First, it was practically unworkable to identify who bore the economic burden of a set of transaction (at [59]). It is not necessarily true that a reduction in VAT would be passed on to the customer. Secondly, the purpose of unjust enrichment is “not to compensate for loss, but to reverse [a] defective transfer” (at [60]). But the fact that a loss and a gain are causally connected does not mean that there was any transfer of value. So there is nothing to reverse.
Lord Reed further constrained recovery by reinstating the “incidental benefit bar”, which the Court of Appeal had removed in TFL Management Services Ltd. v Lloyds TSB Bank plc [2013] EWCA Civ 1415; [2014] 1 W.L.R. 2006. According to Lord Reed there could be no recovery if the provision of the benefit “was merely an incidental or collateral result of [the claimant's] expenditure” (at [52]). This was the case for two reasons. First, the claimant would typically have received the consideration he bargained for as the counterpart for his expenditure, and so would not have suffered a loss. Secondly, the defendant's benefit is a mere side-effect of the claimant's expenditure. So, for example, if by litigating a matter the claimant settles a point of law which is advantageous to a third party, then the claimant has not directly benefited that third party and so there can be no restitution (cf. TFL).
The adoption of a tight direct dealing rule is a welcome development. It clears up an area that created considerable uncertainty and it is also in line with the purpose of unjust enrichment, reversing normatively defective transfers of values. This requires identifying a transfer of value, but without direct dealing between the parties there cannot be such a transfer. Hence, a “but for” test or wide exceptions to the direct dealing rule did not fit within the scope of the unjust enrichment's purpose.
Multiple transactions will count as a single transaction if considering each transaction individually would be unrealistic (at [61]). Lord Reed explained Banque Financiere de la Cité v Parc [1999] 1 A.C. 221 on that basis. In that case, the House of Lords disregarded an artificial transaction that was added for the sole purpose of avoiding regulatory requirements. The recent Supreme Court decision in Menelaou v Bank of Cyprus [2015] UKSC 66; [2016] A.C. 176 was also explained as a co-ordinated transaction. The parents of the defendant had agreed with the claimant bank that their house over which the bank had a charge would be sold, that the proceeds would be used to purchase a second property to be registered in the name of the defendant, and that the bank would obtain an equivalent charge over the second property. Unfortunately, the charge was not properly executed and so the bank sought a charge on the second property to remedy the unjust enrichment. The Supreme Court in Menelaou held that there had been a transfer of value between the bank and the defendant. Lord Reed, in ITC, explained this on the basis that the two transactions should be looked at as one single scheme (at [65]) so that the defendant was directly enriched at the expense of the bank.
In ITC, Lord Reed held that there was no transfer of value between the customers and the Commissioners in that case. The supplier was not the Commissioners agent's, nor was it possible to trace the customers’ payments to the Commissioners, and the transactions did not involve a sham or an artificial step. Nor did they comprise a single scheme (at [72]), because the first transfer from the customer to the suppliers did not even cause the second transfer to the Commissioners. It is the supply itself which causes the suppliers to be liable to the Commissioners. Hence, even if the customers had not reimbursed VAT to the suppliers, they would still have had to pay it to the Commissioners.
That the first transfer must cause the second certainly seems to be a necessary connection for them to count as a co-ordinated transaction, but it cannot be a sufficient connection otherwise Lord Reed would just have accepted the “but for” test. The precise requirements for co-ordinated transactions will have to be worked out in subsequent cases but the courts should be able to rely on the approach that the law has taken in other areas, such as tax avoidance.
ITC has wider implications for unjust enrichment. The discharge of debts is the only genuine exception to the direct dealing rule. Can such an exception be justified? If A and B are liable to C and A discharges the whole debt, then (subject to certain conditions) A will be able to recover from B if B bore the primary liability. Such recovery is thought to be part of unjust enrichment. However, this seems anomalous, as it is inconsistent with the direct dealing rule as A did not deal with B directly, C is not B’s agent, there is no sham nor is there any co-ordinated transaction. Furthermore, recovery in such a case is also inconsistent with the incidental benefit rule. A does not suffer any loss from the payment as he gets what he bargained for (the discharge of his debt) and B’s discharge is just incidental to that. Yet, there is recovery on A’s part.
For this to fit within unjust enrichment, Lord Reed said that it was an exception to the direct dealing rule; B’s enrichment will be deemed to be at A’s expense. Whilst recovery in such cases has long been recognised, it is not obvious that this should form part of the law of unjust enrichment (see Hilliard [2002] C.L.J. 551). If, as Lord Reed says, unjust enrichment is about reversing defective transfer of values, it is hard to see what is defective about the transfer here. Of course, there ought to be recovery but this does not fit within a transactional understanding of unjust enrichment. Instead, such recovery is probably best explained by the principle that he who receives the benefit of something should bear the burden thereof (Dering v Earl of Winchelsea (1787) 2 Bos. & Pul. 270). This would still fit within the “Aristotelian conception of justice as the restoration of a balance or equilibrium which has been disturbed” (at [41]), but outwith the law of unjust enrichment.
The scope and nature of the exceptions to the direct dealing rule will need to be worked out by the courts, but ITC brings much certainty to the law by affirming the direct dealing rule subject to narrow exceptions. It ensures that unjust enrichment performs its proper function of reversing defective transactions and is not used to do “whatever may seem fair between the parties” (at [39]). As for those who overpaid, a narrower statutory claim against the Commissioners is available. Unjust enrichment should not be stretched to provide an additional remedy.
