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Professor of Law, University College, Cork.
[email protected]

Copyright © Steve Hedley 2003
First published in Web Journal of Current Legal Issues

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It is clear law that tax paid after a wrongful demand may be recovered back by the taxpayer. The rule is sometimes loosely described as being about "mistaken" tax payments, but in fact it is available whether or not a mistake can be identified: it is enough that the demand had no valid legal basis. Deutsche Morgan Grenfell v IRC [2003] EWHC 1779 (Ch) raises the question whether, in a case where a mistake can be proved, there is an additional cause of action based on that mistake, subject not to the ordinary limitation period of six years, but to the more generous period available in actions "for relief from the consequences of a mistake" (Limitation Act 1980 s 32). Park J has now held that this additional cause of action is indeed available.

This note argues that this is an unnecessary and undesirable extension of the law, and that the standard limitation period should be enough. The special status which the earlier restitution case law gives to tax cases is designed to deal with a genuine difficulty, and it is undesirable to blur the line with ordinary "mistake" cases in this way.

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At the relevant times, dividends paid by one company to another were in general subject to Advance Corporation Tax (ACT) at 25%. There was an exception to this: if the two companies were in the same group, they could make a "group income election"; if the Revenue accepted this election as validly made, then ACT ceased to be payable. The legislation was explicit that such elections could only be made where the payee was resident in the UK (Income and Corporation Taxes Act 1988 s 247). However, this restriction was called into question by the CJEC in the Metallgesellschaft/ Hoechst case (C-410/98, [2001] STC 452), which held that the group income exemption could be claimed by payees resident anywhere in the EU. The issue in Deutsche Morgan Grenfell was whether sums paid as ACT could be recovered back, once it became clear that, under Metallgesellschaft/ Hoechst, they should never have been paid.

In principle there is not the slightest doubt that the sums were recoverable, both because the CJEC said so in Metallgesellschaft/ Hoechst, and under the Woolwich principle, that tax wrongly paid is recoverable from the tax authority (Woolwich Equitable BS v IRC [1993] AC 70). Two complications arose, however.

Firstly, the dispute was not really about restitution of the sums paid as such, but rather as to interest. There was no dispute that Corporation Tax was ultimately payable on the dividends; the Metallgesellschaft/ Hoechst case was about whether it was payable in advance, and the Deutsche Morgan Grenfell action concerned only the loss of interest attributable to having paid the tax early. This complication makes the case awkward to read, though it does not affect the restitutionary issues involved.

Secondly, the Woolwich principle could not carry the whole weight placed on it, for reasons of limitation some of the payments were made more than six years before the action was started, and so were caught by Limitation Act 1980 ss 2 and 5.

Accordingly, the issue in the case is whether a claimant who can sue under the Woolwich principle may additionally or alternatively sue for "mistake of law", invoking the principle of limitation recognised in Kleinwort Benson v Lincoln [1999] 2 AC 349, that the six years begins to run only from the time when "the plaintiff has discovered the ... mistake ... or could with reasonable diligence have discovered it" (Limitation Act 1980 s 32).

 

The law on transactions involving a mistake is rightly regarded as centrally important within restitution. However, as with so many restitutionary issues, it quickly reveals ambiguities and differences of approach. There seem to be at least two separate regimes or grounds of recovery existing side-by-side, under one of which "mistake" is of fundamental importance, under the other of which it is irrelevant. Yet, surprisingly, there is significant overlap between the two.

Behind the two regimes lies a serious disagreement as to their relative scope and utility. It seems to be widely accepted that there can be no question of allowing "mistake" free rein; security of transaction rightly demands that most possible pleas of "mistake" should be rejected. Recovery is therefore kept within narrow bounds. But there is a fundamental disagreement over how narrow. For some, the answer is a rigid and explicitly defined "mistake" doctrine. Claimants must specify a precise matter of fact on which they held an inaccurate belief; a mere false hope or mis-prediction of the future will not do; there must be proof that they would have acted differently had they known the truth; and a range of defences is available to the payee, such as if the payee had changed position on the strength of the payment. For others, however, this is not strict enough - partly because not all the defences asserted are clearly law - and the whole idea of "mistake" is misleading. Rather, relief is available only to claimants who did not get what they paid for. So an attempt to pay for goods which were not forthcoming, or to pay off a tax liability which was not due, will lead to liability; but other mistakes, however profound, will not. On this latter view, while most successful claimants will in fact have been making a serious mistake, "mistake" as such does not enter the legal analysis; mistake cases are better defined as cases of "failure/absence of consideration" or perhaps "failure of basis". These two approaches obviously differ substantially; there is a considerable literature on the choice to be made between the two (see eg Burrows 2002, ch 3; Hedley 2001a, ch 1).

Perhaps as a result, much of the "mistake" case law is curiously disjointed, with a variety of different regimes in play, which sometimes lead to the same result and sometimes not. In relation to wrongly paid tax, the Woolwich case plainly favours the second approach, based as it was either on absence of consideration or on the constitutional argument that there must be an effective remedy for tax wrongly demanded. However, some supporters of the first approach think that Woolwich should be reconsidered, not least because it was decided before the House of Lords had removed the "mistake of law" bar on the mistake-based approach. Plainly there is room for considerable debate here. However it is clear that Woolwich cannot be assimilated into a "mistake" regime. The Lords did not base themselves on mistake, and the tax payers in that case were not "mistaken" in any ordinary sense of the word - they knew from the first that the tax demand was erroneous, and made their payment only as part of a calculated litigation strategy.

The central issue in Deutsche Morgan Grenfell is therefore whether Woolwich should be taken as the final word on restitution of wrongly paid tax, despite the fundamental change to the area wrought by Kleinwort Benson; or whether, in addition to the Woolwich remedy, there is a liability on "mistake" principles. As to the authorities, Lord Goff's opinion in Kleinwort Benson is quite explicit: under the present law, there are "two separate and distinct regimes in respect of the repayment of money paid under a mistake of law", namely those concerned with wrongly-paid taxes and similar charges (where it is enough to show the invalidity of the demand), and other cases (where a mistake is needed) ([1999] 2 AC at 381-382). However, in Deutsche Morgan Grenfell Park J did not read this as precluding reference to "mistake" principles in tax cases. He took recovery for mistake to be the general principle, and finding nothing explicitly to the contrary in Lord Goff's opinion, he applied that supposed general principle to tax cases as well as others (para 17).

This is a surprising conclusion, and Park J's reasoning (at para 18) seems weak. Lord Goff was quite explicit on the point. Indeed, it is hard to see how he could have made it plainer that the two regimes were distinct, and that tax cases were to be resolved without applying directly any test of whether the payer was "mistaken". Park J noted that Lord Goff could not be read as saying that "although money paid under a mistake of law was generally recoverable, money paid in taxes under a mistake of tax law was not" (para 18(ii)). This is true, but no-one is trying to read him this way. It is uncontroversial that Woolwich affords a remedy in that case - the controversy is only as to the limitation period applicable. Similarly, it is trite but irrelevant that "I do not believe that Lord Goff was saying that there could never be a restitutionary claim for tax paid by mistake" (para 18(iii)). With respect, that is not the issue. The issue is whether in addition to the Woolwich remedy - which will in practice cover all mistaken tax payments, and more besides - the mistaken taxpayer also has a remedy under Kleinwort Benson, with the attendant advantages in the law of limitation. Whatever else Lord Goff was saying, he plainly intended that the legal regime applying to tax wrongly paid should be distinct from that applicable to the general run of cases. Yet this is the line that Park J has now blurred.

What is also true is that the issue whether the two regimes should be merged is a problem with many ramifications, perhaps not all of which have yet come to light. Lord Goff was not in the relevant passage concerned with the limitation issue, but rather with the issue whether a payment under a settled, but mistaken, view of the law was a defence - and the point he was trying to establish was that while such a defence was not available in the general run of cases, in tax cases it should be left open for now. And indeed Park J was forced to concede this, agreeing to allow the Attorney-General to reserve the point for a higher court (para 18(iv)). But this only emphasises the good sense behind the "two regimes" idea. Tax cases are special in a number of respects, which is precisely why rules designed for quite different contexts should not be blindly applied to them. On this point, therefore, it seems to me that Park J is simply wrong, and should be reversed by a higher court. Lord Goff plainly meant to subject tax cases to a distinct regime, and that is what Park J should have done.

One of the most glaring features of "mistake" in the modern case law, and a major argument for adopting a "failure of consideration" approach instead, is the sheer difficulty of identifying "mistakes" in practice. This seems to be a modern phenomenon. In earlier centuries, a claimant who had doubts whether they should pay was unlikely to be granted a remedy if they paid nonetheless. Indeed, the court of appeal in 1915 seemed to think it a bit of a stretch to grant a remedy in those circumstances even against the background of compelling threats of distraint (Maskell v Horner [1915] 3 KB 106). Now that a different attitude is taken, and it is recognised that there might be perfectly legitimate reasons why payment might be made despite doubts whether it was truly owing, a different sort of problem emerges. In any important and complicated dispute over liability, it will only be at the extreme end-points of the quarrel that either side will be completely mistaken or completely un-mistaken. In the middle, all will be doubt and confusion, and asking whether the claimant was at any one instant "mistaken" is extraordinarily difficult. So in most of the recent leading cases on "mistake", it is in fact very hard to say that the payers were "mistaken" in any ordinary sense. They will have had all sorts of doubts, but how many or how few doubts about the truth are enough to constitute a "mistake" (see Hedley 2001a pp 4-10)

(In parentheses, it is a pity that Park J, at para 15, summarised Kleinwort Benson as a case where the claimants - "in common with virtually everybody who had a view on the point at the time" - had made a mistake. This is tendentious at best. It was assumed in the course of that hearing that there was a mistake, the better to resolve certain preliminary issues. It is quite another matter whether it was actually true. It is hard to see how it could have been so, without much deliberate shutting of eyes on all sides. The limited financial powers of the local authorities were notorious, and there must be a suspicion that if all sides were ignorant of this, it can only have been through a deliberate failure to enquire. This is no doubt precisely why recovery was originally established on "failure of consideration" grounds, rather than "mistake" grounds - those claimants who were in a position to give the "mistake" point a wide berth did just that. See generally Birks and Rose, 2000; Hedley, 2001b ch 6; Krebs, 2001 chs 5 and 12.)

The difficulty in identifying a "mistake" was no less acute in Deutsche Morgan Grenfell. If the law as laid down in Metallgesellschaft/ Hoechst had been appreciated by all from the start, then no doubt the payments of ACT would never have been made. But when the court asked itself (as was inevitable in a limitation dispute) precisely when a mistake had been made, considerable difficulties emerged - not to mention doubts whether it could really be said that the ACT payers had been "mistaken" at all.

What, precisely, was the payers' mistake? A natural first assumption is that it was a mistaken belief that they were liable to ACT. If that is so, then the next step is to ask when they first appreciated, or could reasonably have appreciated, their error, for that will be the point at which time begins to run under Limitation Act 1980 s 32. But this leads to precisely the difficulties experienced in other cases. Any informed observer would always have known that the UK-oriented tax provisions were open to challenge at the European level, though no doubt different observers would have given different weights to that point. So did time run from the date of the payment, on the argument that all payers were taking a risk at the moment of the payment? Or did time only begin to run when it became clear that an actual claimant (Hoechst AG) was taking the point? Or when the Advocate-General accepted the point? Or when the CJEC accepted the Advocate-General's opinion? Each of these moments has arguments that can be made for it; it is far from obvious which is "the" moment at which the scales fell (or should have fallen) from the claimants' eyes. In the event, if forced to choose, Park J would have plumped for the date of the CJEC's ruling (para 30). Yet if he had anything by way of detailed legal justification to support this conclusion, he did not mention it; nor did he elaborate on an obvious difficulty with this ruling, namely that, if this is right, Deutsche Morgan Grenfell were still "mistaken" when they commenced proceedings to recover back their "mistakenly paid" money! This is all rather unsatisfactory, but it is not really Park J's fault; the question Park J thought he had to tackle does not appear to have any satisfactory answer.

However, Park J went on to reject this whole approach (rightly so in my view). Recall that a company claiming exemption from ACT needed to make an application, which would only be accepted if the Revenue thought it properly made. Unless or until that application was accepted, no valid election had been made, and the ACT remained payable. Accordingly, it is quite wrong to say that the payers made the "mistake" of thinking that they were liable to ACT. They were liable to ACT. Their mistake, if any, was in failing to appreciate that the UK group income provisions should have extended to cover them. But of course if they had applied to the Revenue on that basis, they would have been turned down, and so would have remained liable to pay ACT. It is therefore hard to see that a causally relevant mistake can be shown. If the payers had known at an early stage that the UK-oriented ACT provisions were contrary to EU law, they would still have had the problem that the Revenue would not have known it, or at least would not have accepted it without a ruling to that effect from the CJEC. Accordingly, they would have ended up paying ACT anyway, albeit perhaps (like the claimants in Woolwich) immediately instituting an action to recover their payments back (para 21).

Park J, having seen this point clearly, nonetheless thought he had found a way around it. It is true that if the payers and no-one else had known the truth, then the payments would still have been made. However, if everyone concerned, including the Revenue, had appreciated the truth, then a successful application for exemption would have been made, and no ACT would have been demanded or paid. In that carefully-defined sense, there was a causally relevant mistake. "Therefore the ACT which DMG in fact paid was paid under a mistake of law: if the mistake had not existed the ACT would not have been paid. It is, however, important to appreciate that the mistake was not directly a mistake about whether there was a liability to pay ACT" (para 25).

This is perfectly satisfactory so far as it goes; but it is not the criterion that has been applied in "mistake" cases up until now, which have asked rather what would have happened if the claimant had known the truth. Park J has manipulated the test's application in order to reach the desired consequence. It is not that the result is unfair. On the contrary, it emphasises how fairness in such a case demands the application of subtly different criteria from ordinary "mistake" cases, and hence the wisdom of insisting on a different regime in these cases, as Lord Goff insisted. The fact that the (private law) test can only reach the right (public law) result after rather delicate reformulation shows quite clearly that it is the wrong test.

It is surprising that Park J did so much in the case to favour a "mistake" approach, especially since he concluded that "this is not a result which I reach with much enthusiasm" (para 41). There seems to be no special reason why these claimants deserved a more generous limitation period beyond the normal six years; nor, as Park J pointed out, were they the sort of people Parliament was trying to help when the special "mistake" provisions were introduced. In a sense, Lord Browne-Wilkinson's dissent in Kleinwort Benson, which emphasised the mess that the majority's position made of limitation law, has done its job too well. It has convinced the lower judiciary that the law is beyond common law repair, and that they need not be held back from further extensions of liability by the argument that the limitation consequences are indefensible. Now that statutory reform of the law has failed to appear, we are left with a broad derogation from the ordinary period, which no-one defends but no-one is prepared to correct either. The separation of powers between judiciary and legislature has been interpreted so that this problem falls into the province of neither. It has fallen through the cracks of the constitution.

But the main criticism of the judgment must be on its central point - its rejection of the need for separate regimes for unlawful taxes, and other cases. It is not possible to apply the same rules to both, as has become clear at various points in the analysis. A strong line is needed to protect constitutional rights, such as the right not to be unlawfully taxed. In that context, the judges are right to sweep away technicalities such as to the precise nature of the mistake: to say that just as the tax payer should have no defence if the tax is rightly demanded, so the tax authorities should have no defence if it is not. But that is very different from private law "mistake" cases, where the claimant is typically asking to be relieved from a difficulty of their own making, which might with more care on their part have been avoided - a more delicate approach to the equities of the case is there required. There is good sense behind the "two regimes" approach, which is in danger of being lost.

This dispute is far from over. The government have announced that they will appeal from Park J's ruling. Various points have been reserved for challenge at the appellate level, so the argument may take a different shape before the court of appeal. And however that appeal may go, the government have stated their intention to avoid Park J's ruling for the future, by amendments to the Limitation Act (Inland Revenue 2003). Whether that legislation will be unopposed or whether arguments to the contrary will be raised, perhaps on human rights grounds, remains to be seen.

 

Birks, P and Rose, F (eds) (2000) Lessons of the swaps litigation (Oxford: Mansfield Press).

Burrows, A (2002) The law of restitution 2nd ed (London: Butterworths) ch 3.

Hedley, S (2001a) Restitution: Its division and ordering (London: Sweet and Maxwell) ch 1.

Hedley, S (2001b) A critical introduction to restitution (London: Butterworths) ch 6.

Inland Revenue (2003) "Tax overpaid in earlier years" News Release 78/03, 8 September

Krebs, T (2001) Restitution at the crossroads (London: Cavendish Publishing) chs 5 and 12.