The coffers of Gordon Brown's Treasury could be boosted by hundreds of millions of pounds of extra VAT, following a landmark ruling over the charging of "card handling" fees by department stores.

The Court of Appeal in London has ruled in favour of HM Revenue and Customs against privately owned Debenhams, which had won a High Court ruling last year supporting its contention that the 2.5 per cent charge represented a service charge for using the facility of a credit card.

Banking services are exempted from value-added taxes under European law.

With such service being not subject to VAT, it meant that while the end price paid by customers was unaltered, it meant Debenhams only accounted for VAT on 97.5 per cent of the goods' price.

But Lord Justice Mummery, Lord Justice Mance and Sir Peter Gibson reinstated the original VAT Tribunal decision in the Debenhams test case.

Lord Justice Mance said the Customs appeal should be allowed because Debenhams Retail is responsible for 100 per cent of any money paid by a customer.

He said the creation of a subsidiary for handling the card purchases was for no other reason than for creating a tax advantage. Any suggestion that the extra costs of handling card transactions justified the tax advantage was undermined by the fact that customers were charged the same for cash or card transactions and the 2.5 per cent paid to the subsidiary company by Debenhams Retail was five times in excess of the amount needed to cover any costs.

Debenhams is one of around 70 retailers, including Marks & Spencer , Boots , WH Smith , Tesco and J Sainsbury, running similar schemes. Most ordinary goods in Britain are subject to VAT at 17.5 per cent.

Customs officials argued that the scheme amounted to tax avoidance. "This was one of the most blatantly abusive avoidance scams of recent years, and the court’s decision to quash it is very welcome. It gave no benefit to consumers, who have been paying exactly the same price for goods regardless of the scheme," a Treasury official told Reuters.

"It was giving the large chains and department stores operating these schemes an unfair advantage over small retail firms. And if unchecked, it would have cost our public services at least £300 million per year."

Martin Sharratt, VAT director at Smith & Williamson, the accountancy and financial advisory group, said: "Customs will be delighted with the outcome, because they were worried that if the principle were to be accepted, retailers could well have increased the card-handling service to 5 per cent or more, increasing the tax loss to billions of pounds.

"Given the amounts involved, Debenhams may be prepared to appeal to the House of Lords, or the European Court of Justice."

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