Revenue & Customs could be forced to repay “billions” of pounds in tax to UK businesses after suffering a devastating defeat in the House of Lords today.

In the latest in a series of test cases concerning the Government’s former advance corporation tax (ACT), which was declared illegal in a landmark European Court of Justice (ECJ) ruling in 2001, the UK’s highest court ruled that Sempra Metals should be compensated using compound rather than simple interest for historical ACT payments.

Last October, in another test case involving Deutsche Morgan Grenfell, the investment bank, the law lords ruled that the Revenue was liable to refund ACT repayments made from 1974 to 1998.

The Revenue argued that the back payments should be limited to six years, as is typical in tax disputes, but the law lords said that the unusual circumstances of the case meant that DMG and 60 other companies were entitled to full refunds for the entire period they paid the tax.

Today’s decision means that the Revenue will now have to calculate those back payments using compound rather than simple interest — which significantly increases its liability.

Sempra, formerly Metallgesellschaft, was the claimaint in the landmark ECJ judgment that initially ruled that the UK Government’s ACT regime breached certain aspects of the Treaty of Rome.

It was then appointed test claimant on the interest issue in the domestic courts and won its case in the High Court and Court of Appeal before the Revenue appealed to the Lords.

In his judgment, Lord Nicholls of Birkenhead, said: "We live in a world where interest payments for the use of money are calculated on a compound basis. Money is not available commercially on simple interest terms.

"This is the daily experience of everyone. If the law is to achieve a fair and just outcome when assessing financial loss it must recognise and give effect to this reality."

Sarah Lee, a litigation partner at Slaughter and May who won both the Sempra and DMG cases, said that the combined effects of the two rulings was “extremely significant”, but declined to name a specific figure for how much the Revenue stands to lose.

In a concession to the Revenue, the law lords ruled that interest should be calculated at Government borrowing rates, which are lower than commercial rates — a move that will reduce the impact of the judgment.

Sinead Hart, a tax lawyer at DLA Piper, said that this was “something of a silver lining for the Revenue” in an otherwise expensive ruling.

A Treasury spokesperson said: "The Government continues to examine this lengthy judgment carefully, but notes that the Lords have ruled that interest should be charged by reference to rates applicable to borrowing by Government, not at commercial interest rates. It is important to recognise that the amount of money at issue in this case is in the low tens of millions."

But tax experts have previously predicted that the effects of the DMG case would run into hundreds of millions of pounds and the addition of compound rather than simple interest would swell that figure further.

Lawyers said that the combined effect of the two judgments was potentially worth “billions”.

Clare Canning, the head of litigation at the solicitors Barlow, Lyde and Gilbert, said that the ruling was “another blow for the Revenue, following the Deutsche Morgan Grenfell decision last year”.

The decision “can only fuel the expectations of other group litigation claimants challenging the Government”, she added.

Jason Collins, head of tax litigation at McGrigors, said: "For too long it has been a win-win situation for the Revenue. It has charged penal rates of interest to taxpayers who pay late or pay the wrong amount of tax, but pays a derisory rate when it is the one that gets it wrong.

“The Lords have recognised that EU law requires compound interest to be paid where tax is collected prematurely. The Revenue must now recognise that it must provide full recompense in all areas when it has wrongly collected tax in breach of EU law.”

The Slaughter and May team, acting for Sempra, instructed Laurence Rabinowitz, QC, of One Essex Court.

Ian Glick, QC, also from One Essex Court, acted for the Revenue which used its internal lawyers.

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