Statutory Interest and Ex-gratia Payments

By David Thomas,2014-04-05 21:48
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Statutory Interest and Ex-gratia Payments

Statutory Interest and Ex-gratia Payments

1. Statutory interest

    1.1 In what circumstances and on what amount is statutory interest due?

    Section 78(1) requires the Commissioners to pay interest “where due to an

    error (on their part)....” a person has:

    (a) accounted for output tax which was not due (it would be

    most unusual to pay a claim under this section because

    of our policy of netting off output tax and input tax errors);


    (b) did not claim the correct credit for the purposes of section

    25 of the VAT Act (fairly common); or

    (c) paid VAT which was not due (section 80 of the VAT Act

    1994 - fairly common); or

    (d) suffered delay in receiving repayment of an amount due

    which is directly linked to VAT ( for example a DIY

    Builder’s claim).

    As you will see from the wording of this section it is not intended to pay SI where the trader makes an error. Section 78 provides for us to pay statutory interest only where an over payment of VAT has arisen as the result of official error. The law does not provide for us to pay statutory interest where for instance an overpayment is the result of an error by the trader or his accounting systems. Consequently, statutory interest is not due when the Commissioners made an error due to incorrect information being provided by the trader; but note the Bonanni case discussed in paragraph 1.2.

    Often officers are called on to make decisions on difficult areas of VAT, where guidance is deficient or there may be confusion over the issue at stake. Section 78 does not provide for us to take into account the complexity of an issue when determining whether or not statutory interest is applicable in a particular case. It is important to remember that our obligation is not dependent on whether or not an officer acted in good faith when making a particular ruling or decision. There will be circumstances when despite following all the correct procedures, an error may still be made because the guidance is deficient or policy advice given in good faith is later found to be incorrect.

    It is important to remember that by admitting we made an error and paying statutory interest does not necessarily mean that any particular individual is at fault.

    Having established that the overpayment was due to departmental error, it is not always clear on what “amount” statutory interest should be paid. As the

    purpose of SI is to represent commercial restitution - but at a rate which does not encourage traders to use Customs as a bank - we consider that it should only be calculated on the net amount of tax overpaid due to our error, so in

    the majority of cases the interest will be paid under subsections (1)(b) or 1(c). This is because it is the net amount of money which the claimant should have had the use of.

    This can be illustrated by two simple examples:

    (a) Due to our error a repayment trader accounted for output

    tax on a zero-rated supply. This resulted in the trader

    claiming a smaller VAT credit in Box 5 of its VAT return

    than it would have been entitled to had the supply been

    correctly zero-rated. In such cases a claim would be

    made under subsection 78(1)(b) and interest paid on the

    difference between the credit claimed and the credit that

    was properly due.

    (b) Due to our error a payment trader failed to recover input

    tax. This resulted in too much VAT being paid to the

    Commissioners in Box 5 of the VAT return. In such cases

    a claim would be made under s78(1)(c) and interest paid

    on the difference between the amount that was actually

    paid and the amount that should have been paid.

    Further support for this policy can be found in the Tribunal decision of North

    East Media Development Trust [1995] VATDR 240, where it was found that

    the amount upon which SI is payable should be calculated by reference to the net sum which the Commissioners were liable to repay. For example, in the case of sports clubs any overpayments of tax on exempt membership subscriptions must be netted-off against the input tax the club incorrectly recovered. The amount of tax paid in error is the difference and is covered by section 78(1)(a) and (b).

    Finally, section 78(5)(a) would appear to support this approach, as it applies “in [those] cases where an amount would have been due from the person by way of VAT ... had his input tax and output tax been as stated in that return...”.

    In summary, statutory interest is only due on the net amount the business has not had the benefit of, and then only if that amount can be connected to Commissioners’ error.

1.2 What is an error?

    There is no statutory definition of an error in section 78, therefore, the word takes on its natural and every day meaning; consequently it is usually quite clear whether Customs have made an error. However, the law does not make any provision for Customs to take into account errors on the part of both parties. In the case of Mr and Mrs P Bonanni and - C&E Commrs,

    LON/92/1485A (VTD 11823), the Tribunal commented that the fact that the

    error was not solely due to the Commissioners does not negate the fact that overpayments were also made due to an error on the part of the Commissioners. Therefore interest was properly due. (Nonetheless, SI was found not to be due in this case for other reasons).

    However, if the Commissioners made a decision, which later turns out to be wrong because the trader provided incorrect information, then we would contend that SI is not due as the error was due solely to the trader. In a recent case Avco Trust plc, (VTD 16251) the tribunal commented that

    “there is no duty upon the Commissioners to search for errors in a taxpayers

    affairs and advise him how to correct those errors. If they are asked for advice or a ruling then they are under a duty to give that advice; or if they offer advice having noticed a mistake then they are committed to that advice and if they are wrong there may be an error within the meaning of section 78”.

    Other cases which consider error are:

    Newton and Newton -and- C&E Commrs, MAN/92/1160 (VTD 11372). In

    this case the appellant failed to recover input tax on a number of leased machines. It was claimed that this was an error by the Commissioners because during previous enforcement action officers had been informed that the machines were subject to leasing agreements. On this basis, the appellant argued that Customs had been liable to look into the VAT position of those leases. Rejecting this contention the Tribunal stated that:

    “It has been said many times that VAT is a tax that requires the taxpayer to determine its liability to the Commissioners. The burden to determine the correct amount of tax to be paid or reclaimed is a burden borne by the taxpayer. The Commissioners officers are not conducting an audit of a taxpayers accounts when they carry out an inspection visit. Their function is to verify the returns submitted on the basis of the information supplied to them. They are not required to conduct an in-depth investigation. It is not unreasonable for a taxpayer to expect an investigating officer to give guidance when requested or when a problem is obvious to the officer. In this case the inspecting officers could not be expected to consider all the assets of the business and how they were being financed or provided. .... Those officers could not have been expected to have any knowledge of the returns submitted by the appellant or the way the figures had been calculated...”

American Express -and- C&E Commrs, LON/92/1165Z (VTD 9748). In this

    case statutory interest was refused on the basis that the company, although mentioning a potential claim for statutory interest, failed to submit it until a considerable period later. Although there were some misunderstandings between the parties this did not amount to an error by the Customs. As the Tribunal chairman made clear, it is up to the taxpayer to formulate and present his claim not for Customs to chase it up!

    Rogers Torbay Ltd -and- C&E Commrs, LON/93/835 (VTD 11389). During

    a control visit the appellant informed the visiting officer that it had underdeclared a sum of VAT and submitted a voluntary disclosure. However, following a later audit it transpired that no error had been made and the company sought SI on the refund.

    The Tribunal dismissed the claim on the basis that where an error has been made, the circumstances should be looked at subjectively rather than objectively and it should be determined “from what action did the confusion

    “directly flow””. In this case the appellant’s incorrect voluntary disclosure caused the confusion. The tribunal added that in the circumstances it would be “repugnant to common sense and to the intention of the legislation” to

    conclude that the over-payment was due to an error on the part of the Commissioners.

    J L Peart & PA Peart t/a the Border River -and- C&E Commrs,

    MAN/96/0433Y (VTD 14672). A grocer was visited by Customs in 1990. At

    the trader’s request the visiting officer examined his VAT records at his tax advisor’s premises. During the visit the control officer was informed that the business’s owners were considering running a cafe from the premises, although nothing was planned for a least 6 months. From the information provided at that stage, the officer was satisfied that the trader was correctly accounting for tax under Retail Scheme D. When the cafe business eventually started the owners did not account for the cafe’s taking under Retail Scheme

    D, although the Scheme was still used for the grocery takings. In September 1995 the trader submitted a refund claim on the basis of a retrospective change of Retail Scheme from D to F. The trader also requested statutory interest on the refund, on the basis that the visiting officer in 1990 had failed to point out that Scheme D could not be used where supplies of catering were made. On this basis the Commissioners had made an error for the purposes of section 78 VAT Act 1994.

    The Tribunal refused the claim on the grounds that:

    ; It is a trader’s responsibility to choose the scheme most

    suited to its business.

    ; After the cafe business was established the trader kept

    using Scheme D on the advice of its tax advisors.

    ; During the visit to the accountant’s premises, the officer

    was not told anything that would have caused him to

    decide that Scheme D was inappropriate at that time. The

    nature of the business changed after he had visited.

    Customs’ Public Notices made very clear that using Scheme D was inappropriate for supplies of catering.

    A similar decision was reached in RJN Creighton BEL/93/57.

    A decision that has further clarified what is meant by “error” is CGI Pension

    Trust Ltd MAN/98/85Z (VTD 15926). In reaching its conclusion the tribunal

    stated that two things must be shown (a) whether there had been an error, or errors, by the Commissioners within the meaning of section 78(1) of the 1994 Act, and, if so, whether it was due to the Commissioners that one of the four events as set out in section 78(1) applied to the trader.

    Only if the answer to both those questions is yes is statutory interest due. 1.3 How is statutory interest claimed? (see 7.3.8 for M&S ECJ related guidance)

    Sections 78(10) and (11) of the VAT Act 1994 require all claims for statutory interest to be made in writing and within three years from the date we authorised payment of the amount on which interest is being claimed. It is not

    related to the date the original refund was made, the date it should have been paid by us, or the due date of a particular return.

    For example, a repayment arising from an official error in respect of period 12/01 is made on 31 October 2004. The trader will have until 31 October 2007 in which to make a claim for statutory interest.

    Important: if it is local practice to pay some claims with statutory interest without checking, with the caveat that the claim will be checked at a later date, it is very important that all the necessary information is put in the trader’s folder at the time the claim is received. This may mean asking the claimant to send in the evidence he has. In this way if the claimant destroys his records eg because he has an agreement with us not to keep the records for the legally required period, we will have the necessary documentation to check the claim. If, subsequently, the trader’s file is put onto electronic folder the documentation from the claimant must not be destroyed, but it must also be scanned or stored separately.

    1.4 Is Interest payable when incorrectly levied penalties are repaid? Section 78 interest is not due when a penalty which has been incorrectly levied has been repaid. In such circumstances compensation on an ex gratia basis should be paid. The level of compensation should be calculated in the same way as statutory interest

    1.5 What happens when the claim contains a mixture of both

    departmental and trader error?

    Many claims may consist of a mixture of underdeclarations and

    overdeclarations due to departmental error and over and underdeclarations which are the fault of the trader. In such cases we must examine the claim on a period by period basis and rework those periods to show what the trader would have accounted for had the errors not taken place. However, if those periods still show that an overpayment took place on what amount is statutory interest calculated?

    In general, the rule is that we cannot reduce our liability to statutory interest by netting off amounts due to our errors first. We must assume that these sums are set off last. This can be illustrated by the following examples: 1.5.1 Example 1

    Trader under-declares ?100 output tax, over-declares ?100 output tax due to Commissioners’ error and ?100 due to its own error. In effect this means that the trader has overpaid ?100 tax. In such cases statutory interest will be payable on the ?100 overpayment.

    1.5.2 Example 2

    Trader under-declares ?50 output tax, over-declares ?100 output tax due to Commissioners’ error and ?100 due to its own error. In effect this means that the trader has overpaid ?150 tax. In such cases statutory interest will only be payable on ?100 of the overpayment. The remaining ?50 is attributable to the trader’s own error.

    1.5.3 Example 3

    Trader under-declares ?150 output tax, over-declares ?100 output tax due to Commissioners’ error and ?100 due to its own error. In effect this means that

    the trader has overpaid ?50 tax. In such cases statutory interest will only be payable on the ?50 overpayment.

    1.6 Is compound interest payable?

    The Tribunal has made clear that compound interest is not due, all interest is calculated on a simple basis. In National Council for YMCAs Inc -and- C&E

    Commrs [1993] VATTR 299 the Tribunal stated that there is no court

    decision “where reference to statutory interest has been interpreted by the courts as meaning compound interest”. In Peoples Bathgate and

    Livingstone Limited -and- C&E Commrs, (EDN/93/262) the Tribunal

    commented that:

    “if the exceptional course of allowing compound interest in the circumstances were envisaged ... the section should have so specified”. It added that “it appears to the Tribunal that compounding interest unless specifically sanctioned by Statute would be a most unusual course to follow.”

    Some advisors have also argued that by failing to pay compound interest the UK is in breach of its European obligations, as this is the normal method used by the banks and other financial institutions. However in the cases of Ansaldo

    Energia SpA, Marine Insurance Consultants Srl and GMB Srl and Others (Cases C-279/96, C-280/96 and C-281-96), which concerned an illegal

    charge levied by the Italian authorities, the ECJ stated that: “Community law does not preclude .... payment of interest calculated by methods less favourable than those applicable under ordinary rules governing actions for the recovery of sums paid but not due between private individuals ...”.

    On this basis the UK is entitled to operate the current method of calculating statutory interest.

    1.7 Is interest due on the late payment of interest?

    No. The provisions set out in Section 78 (1) and 1A exclude the payment of further interest on a delayed payment of interest. Section 78(1A) (b) states: The amounts referred to in paragraph (d) do not include any amount payable under this section (ie section 78).

    However, a number of tax advisors have argued that their clients are entitled to further interest on any interest payments, which were delayed in error by Customs. They rely on the North East Media Development Trust Ltd

    (NEMDT) [1995] VATDR 240 and MAN 95/2626 decisions.

    In the first NEMDT case, we argued that interest under section 78(1)(a) was not due as VAT had not been overpaid because of Commissioners error. The Tribunal disagreed and awarded interest. On the basis of that decision NEMDT then argued that interest was due on the late payment of section 78(1)(a) interest. This was on the basis that under section 78(1)(d) VAT Act 1994, it “suffered delay in receiving payment of an amount due ... in connection with VAT”. In other words because the Commissioners had

    incorrectly argued that statutory interest was not due, interest under section 78(1)(d) was due on the late payment of the s78(1)(a) interest. Although we argued that the “interest clock” had stopped running when the disputed sum had been repaid, the Tribunal found that section 78(1)(d) did apply. It said: “...that there is nothing offensive in the notion that the Commissioners should pay interest upon interest. ... once it is established that a sum of tax is repayable to a trader by reason of an error on the part of the Commissioners, an entitlement to interest crystallises when that repayment is authorised, ...”

    This meant that where we had incorrectly denied interest under section 78(a) to (c), further interest under section 78(1)(d) was due on that sum of interest. The trader then went back to tribunal for a third time and argued that a further amount of interest was due under section 78(1)(d) on the late payment of the initial interest under section 78(1)(d). This again was on the basis that the Commissioners had been wrong to refuse it. Again the tribunal agreed. Although we originally accepted the first two decisions NEMDT’s third argument was never envisaged. Subsequently section 78 was amended by S 44(1) FA 1997 by the addition of S 78(1A).

    (1A) In subsection (1) above-

    (a) references to an amount which the Commissioners are liable

    in consequence of any matter to pay or repay to any person are

    references, where a claim for the payment or repayment has to

    be made, to only so much of that amount as is the subject of a

    claim that the Commissioners are required to satisfy or have

    satisfied; and

    (b) The amounts referred to in paragraph (d) do not include any amount payable under this section.

This section has two effects:

    ; The purpose of subsection (a) is to limit interest solely to

    those sums which Customs are liable to repay to the

    trader, and which were overpaid because of an error by

    the Customs. This means that interest is not payable on

    sums which were paid in error, but which the

    Commissioners have capped under s80(4) VAT Act 1994.

    ; Subsection (b) addresses the NEMDT point and provides

    that where there is a delay in paying interest under

    section 78, further interest is not due under S 78(1)(d). S 44(1) Finance (No 1) Act 1997 added that this provision has always had effect.

    In simple terms, interest is not due on the late payment of the principal interest sum.

    1.8 Can SI be paid when repayment supplement is found to be due? Subsection 78(2) specifically excludes any liability to pay interest on an amount of VAT credit, which falls to be increased by repayment supplement, and, on the amount of the repayment supplement itself. Where a claim for statutory interest on a late payment of repayment supplement is received, it should therefore be refused.

    1.9 Rate of interest

    Statutory interest is payable at the rates set out in The Air Passenger Duty

    and Other Indirect taxes (Interest rate) Regulations 1998. The Regulations

    make provision for the interest rates to change on the sixth day of any month, in accordance with various specified formulas. The formulas are all based on the rounded average of the base lending rates of six clearing banks. Statutory interest is calculated to be 1% less than the rounded average. 1.10 On what period is interest due - the “applicable period”?

    Unlike Repayment Supplement there is nothing in s78 which allows Customs to deduct processing time, such as 30 days, from the statutory interest periods. If no queries are raised with the trader then no days should be deducted from the amount of interest payable. This will be discussed in more detail below.

    Subsections 78(4) to (7) define the period for which interest is applicable, the “applicable” period.

    1.10.1 Subsections 78(1)(a) and (b)

    Subsections 78(4) and (5) apply to subsections 78(1)(a) and (b) and define

    the “applicable” period as starting:

    (a) For a payment return: on the date on which the disputed

    amount was “paid”, ie the date we received payment.

    (b) For a repayment return: on the date the Commissioners

    authorised “payment” of that return. Remember,

    authorisation of repayment returns usually occurs within

    30 days. So SI, in these cases, would not necessarily

    start from the date the return was received!

    It ends in both cases from the date the Commissioners “authorised” repayment of the claim, not the date it was paid.

    We consider “authorised” to mean the date the countersigning officer signs the form that authorises repayment of the capital sum overpaid; ideally the trader should be written to at the same time. Section 78(12) adds that

    authorisation of payment” also occurs when the Commissioners set-off

    (under s81(3) VAT Act 1994 or some other procedure) a refund against any debt the trader may owe the Commissioners. It also mentions that for the purposes of this section “return” takes the meaning as defined by Paragraph

    2, Schedule 11 to the VAT Act 1994.

    Remember: If the trader has declared and overpaid output tax and you accept that SI is due, the interest should be calculated from the date he actually made the overpayment not the date we became aware of the error. We can’t simply argue that we are only in error from the time a tribunal or court decision goes against us. If we accept that we are in error the trader must be compensated from when he was financially disadvantaged because of that error.

    1.10.2 Section 78(1)(c)

    Where a claim falls within section 78(1)(c), subsection 78(6) defines the

    applicable period as starting from the date the payment was received up to the date repayment of the sum was authorised, not the date it was paid.

    1.10.3 s78(1)(d)

    For claims made under section 78(1)(d) the interest period starts from the

    date the Commissioners might reasonably have been expected to authorise repayment ending on the date when the payment was authorised, not the

    date it was paid.

    1.11 Is the interest calculated on an annual or daily basis? Statutory interest is calculated on a daily basis using calendar days (ie Saturday and Sunday are included in the calculation).

    1.12 Can unreasonable delay by the trader be excluded from the interest period?

    The general rule is to pay statutory interest from the date of the erroneous payment to the date we authorise repayment. However, section 78 (8) of the VAT Act 1994 provides that when determining the applicable period for statutory interest we can leave out of the calculation any period for which the claim was delayed by the conduct of the person making the claim. In other words we can exclude any delay caused by, in the words of the Act…. „any

    failure to provide the Commissioners with the requisite information to enable them to determine the claims (existence and amount)‟.

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