VAT man to pay back pounds 5 billion

Big high street chains and department stores are looking forward to a pounds 5bn windfall after a landmark court ruling yesterday which threatens the Government's tax-cutting plans.

News of the bonanza follows a Court of Appeal ruling that Customs and Excise had been wrong in charging value-added tax on "interest-free" credit deals since the tax was introduced in 1973.

The ruling could put at risk the plans of the Chancellor, Kenneth Clarke, to cut taxes in the next Budget. The estimated pounds 5bn in tax and interest that the Government would have to repay in the worst case is the equivalent of 2.5p off the basic rate of income tax. It could also mean the loss of several hundred million pounds a year from future revenues.

Companies that may benefit from the ruling include Dixons and Currys, leading department stores, such as the John Lewis Partnership, and major car dealers.

David Heathcoat-Amory, the Paymaster General, said Customs would "vigorously contest" the judgment in the House of Lords - but warned that if that case was lost, "there will be implications for other taxpayers". He said the figure of pounds 5bn was ''wildly exaggerated".

The blow to public finances comes at a time when there is already a serious shortfall in VAT revenues, which stand at about pounds 43bn a year. In the financial year just ended they were almost pounds 6bn lower than Treasury estimates, and pounds 750m below the estimate in last November's Budget.

The new gap in the revenues comes on top of an extra pounds 300m that the Government will have to pay in compensation for the BSE scare. Moreover, another case concerning VAT on cars which is to come before the courts shortly may cost Customs and Excise as much as pounds 25bn.

City experts last night said the Government's finances were looking increasingly precarious. "If this ruling is upheld, to cut taxes the Chancellor would have to argue that a one-off impact would have no implications for ongoing tax plans," said Adam Cole, of the brokers James Capel.

The court decision is as much of a headache for Gordon Brown, the shadow Chancellor, because the appeal to the House of Lords could take up to a year, which means any impact on public finances would not be felt until well after the general election.

The only silver lining for the Government is that shops will be able to pass on the benefits of the ruling to their customers, helping to reduce prices. The types of goods often sold with interest-free credit account for 10 per cent of the retail price index, so lifting VAT on the loans would reduce inflation a little.

The decision by Lord Justices Stuart-Smith and Hutchison reverses earlier VAT Commission and High Court rulings. The court granted Customs leave to appeal to the House of Lords. VAT experts described the decision as a significant defeat for the Customs. It follows last week's loss in a VAT tribunal case brought by BT over VAT paid on the delivery charges for company cars. Customs is appealing against the decision in the High Court.

A further and potentially more damaging case involves the litigation brought in the name of the former drinks company, Allied-Lyons.

Peter Jenkins, a VAT specialist with accountants Ernst & Young, which advised BT, said Allied-Lyons was challenging a Customs "blocking order" to prevent British companies reclaiming VAT on their cars in the way the tax on other goods and services can be reclaimed under the European VAT directive. If it is successful, the cost to Customs could range from pounds 15bn to pounds 25bn.

It also points out that it will only have to meet the estimated pounds 6m claim from the furniture company which brought the test case before the outcome of the House of Lords hearing is known.

However, advisers are suggesting that companies should be preparing to make claims for repayment. How much they can seek will depend on how far back their records stretch. But Mr Jenkins suggested the records need not be too detailed, so long as they contained evidence of sales and financing arrangements.

The Kingsway Furniture Group, parent to Primback, the liquidated company at the centre of the case that came to the High Court in July 1994, estimates it could be in a position to claim back about pounds 6m. Although the size of repayments will depend on the amount of "interest-free" credit business, the extensive use of such deals to increase sales during the recession means all kinds of companies will be able to bring claims if the Customs and Excise fails in its appeal.

Clare Mainprice, of Mainprice and Co, the firm that represented Primback, said: "This is going to mean refunds, with interest, for many large and small companies. The major high street stores have used interest-free credit deals as a major selling tool during the recession. Because the big chains have done it, small retailers have had no choice but to do the same in order to compete."