Five law lords in London said yesterday that they would have to "reluctantly" ask the European Court of Justice (ECJ) to say whether the high street giant is entitled to repayment of VAT wrongly charged on its chocolate-covered teacakes.
The House of Lords held that an earlier decision by the ECJ had not clarified EU law sufficiently for them to decide whether M&S was entitled to repayment of £3.5m charged on its teacakes over two decades.
Under UK tax laws the supply of food, including some chocolate biscuits, is zero-rated for VAT. But biscuits wholly or partly covered in chocolate attract a standard VAT charge.
For many years, starting with the introduction of VAT in 1973, the commissioners of Customs and Excise took the view that M&S teacakes covered with chocolate were biscuits and therefore standard rated.
M&S accounted for VAT on that basis. But in 1994 the VAT authorities admitted they had been wrong. The "biscuits" were actually cakes and should have been zero-rated.
The company claimed repayment of all the VAT for which they had wrongly accounted over the years, totalling £3.5m.
But its argument has failed so far, despite a previous plea by the Court of Appeal for guidance from the ECJ on issues including whether the tax was recoverable in the light of M&S having passed 90 per cent of it on to its customers.
The high street chain claimed in 1995 that between April 1973 and October 1994 it had wrongly accounted for VAT on sales of its chocolate-covered teacakes (the sort with marshmallow inside) as a result of an error by its suppliers and faulty advice from the commissioners of Customs and Excise.
But because so much time had elapsed before the complaint was raised, the commissioners told M&S it could have only 10 per cent of the tax back - £88,440, capped for three years, plus interest. The commissioners claimed that to pay back more would be "unjust enrichment" for the retailer, because the shops would have recovered the excess tax in the prices charged to customers buying teacakes.
Lord Walker said yesterday that, in a case which had already gone on for 10 years, the law lords were "naturally very reluctant" to add further delay and expense by a second reference to the ECJ.
But he said that, having studied the earlier judgment of the ECJ, there was still real doubt as to the relevant principles of EC law and there was no alternative but to send the case back.
Lords Nicholls, Steyn, Hoffmann and Scott agreed.
A fine line: VAT and the law
* The great debate over whether Jaffa Cakes were a VAT-able chocolate-covered biscuit or a tax-free cake caused such disagreement that it went to a tribunal in 1991. McVitie's won its argument by baking a foot-wide Jaffa Cake and passing it around.
* Gingerbread men dipped in chocolate are subject to VAT at 17.5 per cent, but those covered with caramel are not. The chocolate makes it a sweet rather than a tax-free biscuit.
* Women used to pay £45m a year in VAT on tampons until Gordon Brown decided to treat them as a non-luxury item and lifted the tax four years ago.
* Women who buy size five or larger shoes have to pay VAT, whereas those with smaller feet qualify for children's tax exemptions.
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