Page last updated at 16:32 GMT, Thursday, 10 April 2008 17:32 UK

Teacake set to cost taxman 3.5m

A chocolate teacake
Chocolate teacakes were wrongly classed as a biscuit for two decades

The UK Treasury is facing a 3.5m bill, because of VAT wrongly imposed on a Marks and Spencer teacake, the European Court of Justice (ECJ) has ruled.

Customers paid VAT for 20 years before the authorities accepted the product was a cake, which does not command VAT.

The UK argued that paying back the total sum would "unjustly enrich" M&S as customers had paid the money.

The ECJ ruled that, in principle, VAT had to be repaid in full, but left the final decision to the British courts.

We are pleased with the outcome which endorses our position - we're optimistic that the House of Lords will now find in our favour
Marks and Spencer spokeswoman

That decision will be taken by the House of Lords and HM Revenue and Customs said it was too early to make a comment.

"This is a very complex judgment on which it would be premature to make any comment until the House of Lords has handed down its judgment," Revenue and Customs said in a statement.

Marks and Spencer welcomed the ruling.

"We are pleased with the outcome which endorses our position.

"We're optimistic that the House of Lords will now find in our favour and hope that this will conclude the matter and draw a line under this protracted litigation," a spokeswoman said.

Cake or biscuit

UK tax officials acknowledged that chocolate teacakes had been wrongly classed as biscuits in 1994, prompting M&S to launch a legal battle to have the wrongly-paid VAT returned.

Under UK tax rules, most traditional bakery products such as bread, cakes, flapjacks and Jaffa Cakes are free of VAT, but the tax is payable on cereal bars, shortbread and partly-coated or wholly-coated biscuits.

The complexity of the legal battle surrounds the difference made by the tax authorities between companies classed until 2005 as repayment and payment traders.

While M&S was classed as a payment trader which owed VAT to the government at the end of a financial quarter, it argues that the main supermarkets, which were owed VAT by the authorities, were treated differently on the issue of chocolate teacakes.

It complains that HM Revenue and Customs handed supermarkets back the VAT wrongly paid by customers on chocolate teacakes, while refusing to do the same for Marks and Spencer.

Unjust enrichment

Customs officials point to a ruling by the VAT and Duties Tribunal which said that M&S would not have made much more profit on the teacakes if VAT had been removed.

In the tribunal's opinion, compensation of more than 10% (350,000) would have amounted to unjust enrichment of the company.

But the European Court of Justice says the principle of "fiscal neutrality" means that tax authorities cannot make a distinction between different companies.

It says it is up to the House of Lords to decide whether such a distinction was made.


How various products are classifed by HM Revenue and Customs

Zero rated [no VAT] Standard rated [17.5% VAT]
Chocolate chip biscuits where the chips are either included in the dough or pressed into the surface before baking All wholly or partly coated biscuits including biscuits decorated in a pattern with chocolate or some similar product
Jaffa Cakes Gingerbread men decorated with chocolate unless this amounts to no more than a couple of dots for eyes
Bourbon and other biscuits where the chocolate or similar product forms a sandwich layer between two biscuit halves and is not continued on to the outer surface Chocolate shortbread
Marshmallow teacakes (with a crumb, biscuit or cake base topped with a dome of marshmallow coated in either chocolate, sugar strands or coconut) "Snowballs" without such a base are classed as confectionary
Caramel or "millionaire's" shortcake consisting of a base of shortbread topped with a layer or caramel and (usually) chocolate or carob Shortbread partly or wholly chocolate-covered
Flapjacks Cereal, muesli and similar bars with honey or other added sweetening matter

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