After losing a number of court cases in recent years, HMRC now has to repay compound interest to companies that were unlawfully required to pay VAT under a 'mistake of law'. However, the Department has now announced that these repayments will be subject to corporation tax at 45 per cent. Cue a storm of outrage from the companies involved…
One of the issues we have been following in Weekly Tax Brief over the years is the huge amount of VAT which HMRC has to repay to companies who were unlawfully required to pay the tax under a 'mistake of law'.
As the companies won their cases in the courts, it became clear that very substantial amounts of interest could be payable on the tax refunds they were entitled to receive. This would not be ordinary statutory interest calculated on a simple basis, but 'restitution interest' calculated on a compound basis which requires HMRC to give up the financial benefits they received because of the overpayment of tax.
HMRC has announced that these payments of restitution interest will be subject to corporation tax at the new rate of 45 per cent. In view of the size of the repayments and the substantial amounts of restitution interest, it’s perhaps not surprising that HMRC is attempting in its own words “to reduce losses from litigation if HMRC were to be unsuccessful”. HMRC will publish its estimates of the amount of corporation tax this will yield with the Autumn Statement on Wednesday 25th November.
Predictably, the announcement has caused quite a storm:
Why should HMRC tax the interest at all? After all, restitution interest was intended to remove from HMRC all of the benefits it had received through the overpayment of tax. Many think that it is a bit rich for HMRC to try to claw 45 per cent of that back now.
And why 45 per cent? In the normal way, restitution interest would be taxable at no more than the prevailing rate of corporation tax, currently 20 per cent. In the early 1970s, when the tax problem began, the corporation tax rate was as high as 52 per cent. That subsequently fell with many claims relating to periods when the tax rate was no more than 34 per cent.
Advisers to affected companies are already talking about mounting a legal challenge to the latest changes. But here too the HMRC is one step ahead of them: from 26 October 2015 any payments of restitution interest made by HMRC to the companies will have the tax deducted at source. Once again, the companies will find themselves arguing with HMRC to get back tax securely locked away in HMRC’s coffers. Restitution interest on restitution interest, anybody?