Two recent decisions of the Court of Appeal involved claims for restitution of tax which it was alleged had been levied in breach of EU law. The claim in Test Claimants in the Franked Investment Group Litigation v. Commissioners of the Inland Revenue [2010] EWCA Civ 103 (“FII”) was referred to the Court of Justice of the European Union to determine whether UK corporation tax rules did in fact breach EU law (a significant matter since up to £5 billion may have been overpaid), and whether the claim in F J Chalke Ltd v. The Commissioners for Her Majesty's Revenue and Customs [2010] EWCA Civ 313 (“Chalke”) was time-barred. But even though no order for restitution was made in either case, the Courts did consider issues relating to restitutionary relief and made significant, albeit somewhat elusive, observations concerning claims for the recovery of overpaid taxes.

On the assumption that all the tax receipts were unlawful, the Court in FII considered two claims which might be open to the claimant taxpayer. One was for compensatory damages for a serious breach of EU law. This claim was unavailable because the uncertainty as to whether the tax was due meant that, if EU law had been breached, the breach could not be regarded as serious. The other claim, which would be available on the facts, was for restitution under the “San Giorgio principle”, whereby each member state is required to provide an effective restitutionary remedy for the repayment of taxes paid in breach of EU law, whether that breach is serious or not.

The San Giorgio principle was relevant in Chalke, where a key question was whether the decision to award simple or compound interest fell within that principle, so that it was governed by EU law, or whether it was simply a matter for national law. The Court held that it would have referred this to the CJEU for resolution had it not decided that the claim was time-barred. Had this issue been referred, it is hoped that the CJEU would have concluded that the award of interest is an ancillary matter to be determined by national law.

The Court in FII went on to examine what was required of a restitutionary claim under English law to satisfy the San Giorgio principle. Two grounds of restitution are potentially available: one founded on mistake of law and the other founded on Woolwich Equitable Building Society v. IRC [1993] A.C. 70, whereby it is sufficient to establish that the receipt of the tax was unlawful. The trial judge ([2008] EWHC 2893(Ch)) had held that the Woolwich ground by itself did not satisfy the San Giorgio principle, because he assumed that that ground was only available where there had been a tax demand. The Court of Appeal disagreed, holding that a Woolwich claim was engaged without needing to prove a tax demand, it being sufficient that the taxpayer voluntarily complied with the legislative imposition of the tax. This is consistent with the essence of Woolwich. It followed that a Woolwich claim would satisfy the San Giorgio principle without needing to have recourse to a claim founded on mistake. This should not, however, exclude the possibility that a mistake claim will satisfy the San Giorgio principle. Indeed, this has proved to be significant for claims relating to taxes paid in breach of EU law which are brought outside the six year limitation period: Deutsche Morgan Grenfell v. IRC [2006] UKHL 49, [2007] 1 A.C. 558.

The Court did, however, recognise two restrictions on San Giorgio claims. The first is that restitution is unavailable where there is a lawful basis for the Revenue's receipt of the tax, this being the issue which was referred to the CJEU. The second restriction is that the taxpayer cannot claim for tax reliefs which it has utilised to reduce its liability to pay the unlawful tax, which would otherwise be available to reduce its liability to pay lawful tax. Two reasons for this restriction were identified. First, as previously recognised by the ECJ, the decision to utilise tax reliefs does not constitute an inevitable consequence of the unlawful levying of the tax, but arises from an independent commercial decision of the taxpayer. In other words, it is too remote from the unlawful levy. This is a very strict test of remoteness, which means that the taxpayer can only recover the amount of tax which has been unlawfully paid and other payments which relate directly to that tax, such as interest and penalties, even though the decision about the use of tax reliefs would clearly have been influenced by the imposition of the unlawful tax levy. An alternative, and preferable, reason was simply that the use of the reliefs did not benefit the Revenue and the restitutionary cause of action is only concerned with the defendant's gain and not the claimant's loss. Damages for loss should instead be claimed where there has been a serious breach of EU law.

Two defences to the restitutionary claims were potentially relevant in both cases. First, the claims appeared to be time-barred as they fell outside the normal six year limitation period. To escape this fate, the claimants relied on section 32(1)(c) of the Limitation Act 1980, which extends the limitation period in cases where the “action is for relief from the consequences of a mistake”. Where the section applies, the limitation clock does not start ticking until the claimant discovers, or could have discovered, the mistake. Unfortunately for the claimants in Chalke, even the extended limitation period had expired. But the FII claimants had a seemingly strong case: their payments were caused by a recently-discovered mistake as to the validity of the tax legislation. The Court of Appeal, however, interpreted section 32(1)(c) narrowly, holding that to fall within the section the mistake has to be an essential element of the cause of action and not just a causal reason for the overpayment. Hence, to benefit from the section, the claimant has to plead mistake as the unjust factor. It follows that, to the extent that claims are brought under Woolwich, the extended limitation period is unavailable. This narrow interpretation of section 32(1)(c) is generally to be welcomed. It provides clarity to a previously uncertain area of law (see e.g. the differing views in Deutsche Morgan Grenfell). Moreover, the decision is consistent with Parliament's general policy of curtailing the extended limitation period in the tax context (see e.g. Finance Act 2004, ss. 320–321). It should also be noted that this aspect of FII sounds a cautionary note for the recognition of absence of basis as the method for establishing the unjust factor in the law of unjust enrichment, since mistake would then never form a specific part of the claim and the extended limitation period would be wholly inapplicable, in all contexts.

The second possible defence was change of position, into which FII and Chalke offered the most tantalizing of glimpses of clarification of the law. Whether the Revenue can raise the defence against claims for repayment of unlawful taxes is a novel issue before the courts. Without deciding the point, the Court of Appeal in both cases recognised that its availability raises difficult constitutional and policy issues. In FII the Court recognised that the EU law principle of effectiveness precludes the application of the defence to San Giorgio claims, meaning that the defence is unavailable where the unlawful levy stems from a breach of EU law. The trial judge, however, considered whether the defence is available generally to claims brought under Woolwich. He concluded that the defence is unavailable because it cannot be relied on by a wrongdoer and claims brought under Woolwich fall into this category, being “founded on the unlawful levying of tax and therefore on the commission of a legal wrong” ([339]). Where, however, claims against the Revenue are founded on mistake, they are vulnerable to the defence. The trial judge's approach has the benefit of clarity, but it is questionable whether the Revenue commits a legal wrong when it collects tax in contravention of EU law. The decision of the Court of Appeal has not resolved this wider issue of the availability of the defence to Woolwich claims outside the EU context.

The implication of FII and Chalke is that the claimant tax payer has a difficult tactical choice to make as to which ground of restitution should be relied on against the Revenue, as each has its own advantages and pitfalls. Brought under Woolwich, the claim does not attract the extended limitation period because mistake is not an essential ingredient. However, the Woolwich claim has the advantage of disabling the change of position defence, if the trial judge's decision in FII remains good law. Conversely, a mistake claim enjoys the extended limitation period, but is liable to be defeated by change of position. The choice between the two claims might seem evenly balanced. However, recent legislation has removed the advantage of the extended limitation period in many tax cases, meaning that often the Woolwich claim is preferable.