Compound Interest From the Taxman

A company which mistakenly paid excessive tax to HM Revenue and Customs (HMRC) recently went to court to obtain interest on the overpaid tax – and won. HMRC had appealed against an earlier decision which ruled that the company was entitled to compound interest by way of compensation for the loss of the use of its money due to an error, which arose because of the premature payment of Advance Corporation Tax (now abolished). The claim was on the basis that HMRC had been ‘unjustly enriched’ by the use of the incorrectly received funds during the period that they held them.

HMRC claimed that the sum repayable should be calculated using simple interest, rather than compound interest, or if compound interest was appropriate, the rate should be based on the rate at which the Government could have borrowed the money (which is a very low rate) during the period in question. This argument was, in effect, that the interest should be based on the value of the use of the money to the Government, rather than the value lost by the company. HMRC based their argument largely on the fact that calculation of the ‘time value’ of the money received in error was extremely difficult to calculate. The company sought a commercial rate of interest.

The House of Lords ruled that proper restitution could only apply if the benefactor from the mistake (HMRC) repaid to the claimant company the sum due with compound interest. Passing the money to HMRC deprived the company of its right to use the money for its own enrichment.

As to the question of the rate of compound interest which should apply, the calculation had to be based on the value received by HMRC. The Lords accepted that HMRC had demonstrated that the applicable rate should be based on the terms of borrowing available to the Government. A claim for restitution in such circumstances must be based on actual benefit received by HMRC, not the commercial rate which would apply to the company.