The recovery of taxes collected under a law which is ultra vires, or on the basis of an incorrect interpretation of law, is a highly debated topic in several jurisdictions. Requests for restitution or refund of such taxes have been deliberated by Courts on the basis of considerations which include mistake of law, chaos in public finances, unjust enrichment and refund being the discretion of the Revenue Department. Restitution claims are also thwarted by enactment of validating laws. At the core of this dispute lie the principles of fairness of the administration, and justice to the affected citizen who was made to pay taxes which were not legally payable. This article examines the legal position in India and other jurisdictions.
II. Illegal Taxes and Ultra vires Taxes
The power to levy taxes at the hands of monarchs was not limited. The importance of the power to levy is underscored by the fact that the Bill of Rights, 1689, provided that the Crown should not levy any tax without the consent of Parliament. The written Constitutions across the world also define taxing powers clearly so that the State will not exceed its power and the subjects will know their obligations.
The demand for payment of taxes could be tainted in two ways viz. (a) the demand is made without any authority, or in other words, the levy was ultra vires, or (b) the tax demanded is based on an incorrect interpretation of law. In the former case, there was no authority to demand tax to begin with, and the authority claimed is void ab initio. In the latter, the authority is valid, but the interpretation placed on the relevant provision of law for demanding the tax is incorrect, and thus the tax was found to not be payable by the subject from whom it was demanded.
III. Restitution or Refund of Illegal Taxes and Ultra vires Taxes
Simple logical reasoning demands that any tax collected without authority or by a wrong interpretation of the relevant provision of law should be returned to the tax payer. The Government has no right over such taxes. Only when a tax payer chooses to challenge a levy or demand for tax and succeeds, and is determined to take the next logical step of making the demand for refund, will he realise the barriers denying him of the chance to get his refund. Sometimes, the legislature also decides to throw in its weight by enacting validating laws, complicating the claim for refund. Some of the grounds on which such claims for refund could be denied are (a) payments made under a mistake of law on the part of the payer, (b) tax liability passed on, (c) chaos in public finances, and (d) the validating law has validated collection of the taxes.
There are rules regarding taxes. The Bilbie Rule or the “mistake of law” rule was propounded in Bilbie v. Lumley wherein the Court held that payments made under mistake of law are not recoverable. The Court based this proposition on the basis that every citizen is expected to be aware of his legal obligations, otherwise there is no saying to what extent the excuse of ignorance may be carried. This rule obtained almost universal recognition in that it was followed in Australia, Canada, New Zealand and many American States. Several authors have criticised this rule as unprincipled and unfair. Later the Bilbie Rule was abandoned in the United Kingdom, Canada and Australia.
In USA, the Supreme Court has held that a State must provide procedural safeguards against an unlawful tax exaction because such exaction constitutes a deprivation of property under the Due Process Clause.
In Air Canada v. R. (British Columbia), La Forest, J. rejected the mistake of law argument to deny the restitution. According to him, the rule was rejected as having been constructed on inadequate foundations as lacking in clarity and resulting in undue harshness. The development of the law of restitution had rendered otiose the distinction between mistakes of fact and mistakes of law.
In Woolwich Building Society v. IRC, Lord Goff, speaking for the House of Lords, rejected the mistake of law argument to deny the restitution and held that “In the end, logic appears to demand that the right of recovery should require neither mistake or compulsion, and that the simple fact that the tax was exacted unlawfully should prima facie be enough to require its repayment.”
The High Court of Australia also rejected the mistake of law rule in Commissioner of State Revenue (Victoria) v. Royal Insurance Australia Ltd.
In Mafatlal Industries Ltd v. Union of India, the Supreme Court of India referred to the above judgments mainly for the purpose of dealing with the claim for restitution under Section 72 of the Contract Act, 1872. The distinction between the payments made under the “mistake of law” and “mistake of fact” was not applied in Indian Law.
The “passed on” defence is sometimes called ‘unjust enrichment” or “windfall gain”. It must be understood that if the illegal tax or ultra vires tax collected is retained by the government, it is “unjust enrichment” on the part of the government. However, the phrase “unjust enrichment” is used in these discussions to indicate that if the assessee has shifted the economic burden to his customers, then granting refund would result in “unjust enrichment” at the hands of the assessee. Sometimes, it is described as “windfall gain” to the assessee as he has already “passed on” the tax burden to others.
In Air Canada, the airline argued that the “passed on” defence should be available only if it is shown that the tax was specifically charged to other identified parties, making them true tax payers. However, the majority held that even if the airlines could demonstrate that it did not pass on the tax, it would still be denied the recovery as it would create “fiscal chaos”. In his dissenting opinion, Wilson, J. rejected the “passed on” argument as a defence and held that merely because the person unjustly enriched is a government authority, different rules cannot be made for restitution.
In Australia, the legislature enacted the Franchise Fees Windfall Tax (Imposition) Act, 1997 to tax the receipt at the hands of the taxpayer who were entitled to receive refund from the Government after the judgment in Ha v. State of New South Wales. The windfall tax rate was 100% of the taxable amount. This rendered the refund claim virtually nugatory. However, in Royal Insurance the Australian High Court rejected the “passed on” argument. Mason, C.J. held that “As between the plaintiff and the defendant, the plaintiff having paid away its money by mistake in circumstances in which the defendant has no title to retain the moneys, the plaintiff has the superior claim. The plaintiff’s inability to distribute the proceeds to those who recoup the plaintiff was … an immaterial consideration ….”
In Mafatlal Industries, the Supreme Court upheld the validity of certain amendments made to the Central Excises and Salt Act, 1944 by which it was provided that refund of excise duty would be denied if the assessee had “passed on” such duty to any other person. By majority, the Court held that the requirement of “unjust enrichment” would apply to assessments “incorrectly made” and excess duty demanded, and also to erroneous assessments demanding duty on transactions that are not dutiable under the Act. The Court rejected the contention that the amendment was a mere device to retain illegally collected taxes. Sen, J. disagreed with the majority and held that the manufacturer from whom the duty was collected is entitled to receive the refund. Sen, J. agreed with the views of Mason, C.J. in Royal Insurance. Prior to Mafatlal Industries, the Court allowed refund without regard to unjust enrichment. The minority judgment in Mafatlal Industries, and many judgments prior to Mafatlal Industries are in line with the principles generally accepted in other jurisdictions and also have sound basis. In light of them, the majority view in Mafatlal Industries requires reconsideration.
The proposition of chaos in public finances was developed in Coleman v. Inland Gas Corp., in which the Court observed that “When the income is collected it is allocated to different funds……. no tax payer should have the right to disrupt the government by demanding a refund of his money, whether paid legally or otherwise ….” The majority in Air Canada rejected the chaos argument. In Ha, Brennan, C.J. rejected the chaos argument stating that the Court was conscious of the implications of its judgment over the revenues of the States. He also rejected the plea for overruling the previous cases prospectively and also to postpone the effect of the judgment in Ha by 12 months. Lord Goff in Woolwich agreed with the views of Wilson, J. in Air Canada that “Why should the individual taxpayer as opposed to taxpayers as a whole, bear the burden of Government’s mistake?” and held that taxes and levies paid pursuant to an ultra vires demand is prima facie recoverable as of right. Lord Keith, in his dissenting judgment in Woolwich expressed a similar view stating that when the plaintiff pays under protest, the defendant accepts the payment with the full knowledge that it may have to be repaid if the action resulted in favour of the plaintiff. In Mafatlal Industries it was stated that the financial chaos which would result in the administration of the State by allowing such claims is not an irrelevant consideration, and that in case of large claims, it may well result in financial chaos in the administration of the affairs of the State. If a levy is held to be invalid for any defect other than the power to impose such a levy, the defect can be cured by making an amendment, or enacting a new law curing the defect pointed out by the Courts. At the time of curing the defect, sometimes, the legislature also gives retrospective effect to such amendments, and provide that any levy collected prior to such an amendment, or the new law, would be treated as the levy charged and collected under the amended or new law, thus validating the levy collected earlier. Instead of curing the defect, if the amendment or the new law only seeks to invalidate the judgment which rendered the levy invalid, and provides for retention of the levies collected earlier, such a law will be invalid. In Rai Ramakrishna v. State of Bihar, the Supreme Court upheld the validating law. The Court also allowed collection of the past dues by reason of the retrospective effect given to the validating law. The Supreme Court also adopted prospective overruling in some cases and held that any taxes paid till its judgment would not be refunded. Validating laws are used by the legislature at the instance of the executive to defeat lawful claims of the tax payers, treating them as adversaries even after the tax payers had succeeded in Court. The time has come for the Courts to consider excluding such successful litigants from the effect of validating and retrospective levies.
IV. Conclusion and Suggestions
As rightly observed by Lord Goff in Woolwich, the tax payers are entitled, as a matter of right, to restitution of the taxes paid by them which are not due or payable. When a tax payer challenges a levy, he is acting in accordance with law and asking the Courts to determine if the levy is valid or not. In pursuing the litigation, the tax payer expends a substantial amount of money and effort. The government is also aware of the challenge to the levy and, like the tax payer, it also seeks legal advice and decides whether to contest the litigation or concede. If the Court grants the relief in favour of the tax payer, the least that he can expect from both the government and the Court is that he is granted restitution by refund of the taxes paid by him. Seeking restitution is not illegal. It is also not unfair. Denial of restitution would act as a disincentive to a potential litigant challenging the illegal levy. The tax payer is not interested in just settlement of jurisprudence. Exercise of executive or legislative power to deny such refund and restitution is unfair, particularly in the democratic set up where the executive and legislature are expected to act within their respective sphere for the benefit of the subjects and. The last layer of protection in our Constitution, the Courts, are expected to play a more constructive role in protecting the rights of citizens and they should bear in mind that managing the finances is the role of the executive and not the Courts.
*Research Scholar, VIT School of Law, VIT Chennai-600 127.
**Associate Professor & Head of the Department, VIT School of Law, VIT Chennai – 600 127.
Tax is a compulsory extraction of levy by a governmental authority from its subjects in order to support the activities of the government. Unlike fees or charges, in which there is a necessity of quid pro quo, taxes do not require anything in return.
“An Act Declaring the Rights and Liberties of the Subject and Settling the Succession of the Crown”, available at https://avalon.law.yale.edu/17th_century/england.asp last accessed on 2-1-2020.
See illustratively, Constitution of India, Commonwealth of Australia Constitution Act, Constitution of the United States of America.
 See State of Kerala v. K.P.Govindan, (1975) 1 SCC 281, where the Supreme Court upheld the order passed by the High Court granting refund of the illegally collected charges. See also CST v. Auraiya Chamber of Commerce, (1986) 3 SCC 50.
 (1802) 2 East 469 : 102 ER 448
G.E. Palmer, The Law of Restitution, Vol. 1 (Boston: Little Brown, 1978), cited in Frederic Bachand, “Restitution of Unlawfully Levied Taxes: Survey and Comparative Analysis of Developments in Canada, Australia, And England”, 38 Alta L Rev 960 (2001).
Id., fn. 38.
(1994) 126 ALR 1
In Salonah Tea Co. Ltd. v. Supt. Of Taxes, (1988) 1 SCC 401, the Supreme Court allowed refund of the taxes illegally collected stating that the State has a concomitant duty to refund. Followed in Union of India v ITC Ltd., 1993 Supp (4) SCC 326
Supra Note 9.
In Kingstreet Investments Ltd. v. Province of New Brunswick, 2007 SCC OnLine Can SC 1 :  1 SCR 3, the Supreme Court of Canada approved Wilson, J.’s arguments and rejected the observations of La Forest, J.
1997 HCA 34. In this decision, of the provisions of the Business Franchise Licences (Tobacco) Act, 1987 (NSW) were held to be invalid as imposing a duty or duties of excise within the meaning of Section 90 of the Constitution of Australia.
See Margaret Brook, “Restitution of Invalid Taxes, Principles and Policies”, 5 Deakin L Rev 127 (2000). When the legislature passed a law prohibiting recovery, it was held to be invalid in Commr. of Motor Transport v. Anthill Ranger & Co. Pty. Ltd., (1956) 94 CLR 177. However, if the prescribed a limitation period for seeking restitution, it was held to be valid in Burmah Construction Co. v. State of Orissa, 1962 Supp (1) SCR 242.
 Supra Note 12.
Ibid. See Peter Butler, “Restitution of Overpaid Taxes, Windfall Gains, and Unjust Enrichment: Commissioner of State Revenue v. Royal Insurance Australia Ltd.” 18 U. Queensland LJ 318 (1994-95)
Supra Note 13.
 Supra Note 12.
 Supra Note 13.
 Supra Note 13.
 Supra Note 9.
1997 HCA 34.
 Supra Note 11.
 Supra Note 9.
Supra Note 11.
 Supra Note 13.
D. Cawasji & Co. v. State of Mysore, 1984 Supp SCC 490. See Shri Prithvi Cotton Mills Ltd. v. Broach Borough Municipality, (1969) 2 SCC 283, where the validating law was held to be valid as the law cured the defect pointed out by the Court, and it was within the competence of the legislature.
See Somaiya Organics (India) Ltd. v. State of U.P., (2001) 5 SCC 519. Application of prospective overruling, particularly in tax matters, raises various jurisprudential questions which are not within the scope of this article. A casual survey of the number of validating and retrospective enactments made in India shows that this power is not used responsibly.
Synthetics and Chemicals Ltd. v. State of U.P., (1990) 1 SCC 109. The State Government understood that this would mean that it could collect any dues for the past period and that resulted in a fresh round litigation. Finally, in Somaiya Organics (India) Ltd. v. State of U.P., (2001) 5 SCC 519, the Court held that the Government cannot collect any past unpaid dues after its judgment declaring the levy to be illegal. See also Belsund Sugar Co. Ltd. v. State of Bihar, (1999) 9 SCC 620.
 Supra Note 11.