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Partial Exemption (VAT Notice 706)
The above guidance has been updated and the option to send an email to get an approval for a partial exemption special method has been removed.
CASE REVIEW
CJEU
1. Recovery of input tax where VAT has been incorrectly charged
Michael Schutte is a farmer and forester. Between 2011 and 2013, Mr Schutte purchased timber, resold and delivered it to his customers as firewood. His suppliers charged and accounted for VAT at the standard rate of 19%; however, Mr Schutte charged and accounted for VAT at the reduced rate of 7%. Following an audit, the German tax authorities concluded that the sales should have been subject to VAT at 19% rather than 7%.
The Finance Court in Germany found that the sales were liable to VAT at 7% but also the purchases made by Mr Schutte should have been liable to VAT at 7%, not 19%. As a result of this judgment, the input tax reclaimed by Mr Schutte was reduced and the German tax authorities sought to recover the VAT overclaimed for the years 2011 to 2013, plus interest. Mr Schutte contacted his suppliers and asked them to correct the invoices which were issued to him and refund the difference.
The suppliers did not correct the invoices or refund the VAT overcharged and so Mr Schutte applied to the German tax authorities for discharge from the additional VAT recovery which had been sought as well as the interest. The German tax authorities rejected the application on the grounds that the applicant was responsible for the situation.
The question before the CJEU was whether the principle of fiscal neutrality and the principle of effectiveness require that the applicant has a right to claim reimbursement of the VAT overpaid by him to his suppliers, including interest, directly from the tax authorities, even though there is still a possibility that the suppliers will at a later point in time take action against the tax authorities on the basis of a correction of the invoices, and the tax authorities may then no longer have a right of recourse against the applicant, with the result that there is a risk that those authorities will have to reimburse the same VAT twice?
The CJEU ruled that a receiver of supplies of goods has a direct right to claim from the tax authorities the reimbursement of improperly invoiced VAT paid to his or her suppliers and paid by those suppliers to the tax authorities, together with related interest, in circumstances where that receiver can not be criticised for fraud, abuse or negligence but can not claim that reimbursement from those suppliers and there is a procedural possibility of those suppliers subsequently claiming reimbursement of the overpaid tax from the tax authorities after having adjusted the invoices that were issued initially to the receiver of those supplies. If the VAT improperly charged is not reimbursed by the tax authorities within a reasonable time, the damage suffered must be compensated by the payment of default interest.
Constable Comment: The right to deduction of VAT is an integral part of the VAT system and in principle should not be limited. The system is intended to relieve taxable persons entirely of the burden of VAT in the course of its taxable business activities. However, this case emphasises the importance of ensuring that the rate of VAT charged on invoices to customers is correct at the time the supply is made as it can cause a significant administrative burden on both the customer and supplier if VAT is overdeclared to HMRC.
Upper Tribunal
2. Disapplication of VAT registration: Facilitation of VAT fraud
This appeal concerned Impact Contracting Solutions Limited (ICSL) which operated in the labour provision market. ICSL’s customers were temporary work agencies, and its suppliers were approximately 3000 mini-umbrella companies (MUCs) which supplied labour. On 16 September 2019 HMRC cancelled ICSL’s VAT registration number with immediate effect. HMRC considered that ICSL was registered for VAT solely to abuse the VAT system by facilitating VAT fraud and therefore they were empowered by the principle established in the case of Ablessio to cancel the VAT registration. HMRC considered that the arrangements between ICSL and MUCs were contrived with the effect that the MUCs failed to properly account for VAT on their supplies to ICSL.
ICSL argued that they were entitled and required to be registered for VAT. HMRC are only able to cancel a VAT registration where they are satisfied that a registered person has ceased to be registerable. It is never permissible for HMRC to rely on the Ablessio principle where the person in question has taxable supplies unconnected with fraud which exceed the threshold for registration.
HMRC argued that the Ablessio principle does not require domestic legislation to apply in the UK and the application of the Ablessio principle was not against the law. Also, the EU abuse principle, including Ablessio, has a statutory basis in UK law and so is deemed to have always applied.
The UT concluded:
- The application by HMRC of the Ablessio principle is not against the law or otherwise prohibited by the VAT legislation where it is applied to deregister a taxpayer who has either fraudulently defaulted on its VAT obligations or facilitated the VAT fraud of another party and at the relevant time has also made taxable supplies unconnected with fraud which would result in a liability to be registered.
- The principle in Ablessio applies:
– to the deregistration for VAT purposes by HMRC of a person as well as to a refusal by HMRC to register a person.
– to enable the deregistration of a person for VAT purposes who has facilitated the VAT fraud of another, where the person to be deregistered knew or should have known that it was facilitating the VAT fraud of another.
– irrespective of whether the person whom HMRC seeks to deregister has also made taxable supplies unconnected with the facilitation of fraud and which would result in a liability to be registered.
The UT held that HMRC’s action was not disproportionate, and the appeal was dismissed in relation to the preliminary points raised.
Constable Comment: This case demonstrates the impact of EU cases on UK courts post Brexit. ICSL must now convince the FTT that HMRC’s deregistration was not appropriate based on its own facts.
First-Tier Tribunal
3. Error Correction: Tour Operators Margin Scheme
In this case, the appellant, Golf Holidays Worldwide Limited) (GHWL) filed an error correction notice (ECN) for the periods 03/17 to 03/21 on the basis that it had incorrectly accounted for VAT on its wholesale supplies within the Tour Operators Margin Scheme (TOMS). The ECN was filed to reverse that position but HMRC rejected it on the grounds that there had been no error made by GHWL. The question before the Tribunal was whether there had been an error which can be corrected by way of an ECN or whether GHWL’s original position was lawful which could not be reversed by way of an ECN.
In 2013, the ECJ ruled that wholesale supplies were within the scope of TOMS. Following this case HMRC issued Brief 05/2014 which stated there would be no changes to the operation of TOMS in the UK but UK businesses could choose to apply the direct effect of the EU law and treat wholesale supplies as within TOMS.
GHWL argued that the correct legal position is that UK law excludes wholesale supplies from TOMS and requires a taxable person to apply the normal VAT rules. Therefore, under UK law, TOMS was not applicable to GHWL’s wholesale supplies to non-UK customers and it had made an error that could be corrected by way of an ECN.
HMRC argued that there was no error made by GHWL when it chose to account for VAT under TOMS on its wholesale supplies as this was consistent with EU law and therefore GHWL had applied a VAT position which, although may not have been favourable, was lawfully available to them.
The Tribunal agreed with HMRC and confirmed that an incorrect assessment of the most advantageous position, which is within the law, is not an error of fact or law which could be corrected through the use of an ECN.
GHWL also argued that HMRC could not refuse to allow the error correction on the grounds that the VAT declared was in accordance with EU law because doing so would be an unauthorised imposition of direct effect. HMRC contended that it had not enforced or imposed direct effect on GHWL, because it was GHWL who decided to apply the EU rules to its supplies. HMRC have just acknowledged that GHWL made a lawful choice and refused to process the ECN accordingly.
The Tribunal concluded that GHWL had not made an error which was capable of being corrected by way of an ECN and the rejection of it by HMRC does not mean that they are enforcing direct effect. There was also no breach of fiscal neutrality as there was a choice of methods available to GHWL. The appeal was dismissed.
Constable Comment: In this case the appellant chose to account for VAT on wholesale supplies under the TOMS rather than applying the normal VAT accounting principles. It is important to ensure that all VAT treatments available are considered at the outset because, as this case showed, it is not necessarily possible to reverse a decision in the future by way of an error correction notice where a lawful but less advantageous option is chosen.
4. Hardship Application
This case concerns whether the appellant, Waynefleet, should be permitted to appeal without having to pay the VAT in question to HMRC. The appellant contended that they were unable to pay the VAT of £170,344.78 to HMRC; however, HMRC denied the application for hardship.
The main business activities of Waynefleet comprise journalism and writing, business management, marketing consultancy and the purchase of game shooting. Following an enquiry by HMRC, HMRC raised assessments covering the periods 03/18 to 09/21 in the sum of £161,012 on the basis that the supply of pheasant shooting was a commercial activity and subject to VAT.
HMRC issued a statement of the appellant’s VAT account showing tax due of £161,012 plus interest of £9,332.78 totalling £170,344.78. The appellant wrote to HMRC requesting that they apply the hardship provisions on the VAT assessment. HMRC requested the appellant to provide evidence in support of the application for hardship. The appellant responded stating that if the VAT had to be paid then the business would be inoperable. However, in the absence of financial records or information HMRC were not satisfied that the company would suffer hardship.
As part of the appeal process, the appellant provided a Statement of Facts, copy correspondence and a photocopy of a diary entry which related to HMRC’s enquiry. Copies of two bank statements were also lodged showing balances of £943.49 and £198.86, the total cash balance being £1,142.35, as well as a Balance Sheet as at 30 June 2022 and the company accounts to 20 June 2022.
The burden of proof in establishing hardship lies with the appellant. HMRC explained that the appellant was unable to trade because if it did so then it would be trading whilst insolvent. The appellant must show that, on the balance of probabilities, it would suffer hardship if it were required to pay the £161,012. The Tribunal found that the company had no immediately or readily available resources and that the appellant simply has nothing from which it can pay the VAT at stake in its appeal. The Tribunal concluded that the appellant would suffer hardship if it were required to pay the VAT and the appellants’ application for hardship was allowed.
Constable Comment: Where a company or an individual has received an assessment from HMRC for payment of tax and this is the subject of an appeal to the First Tier Tax Tribunal, HMRC can request that payment of the assessment be made in full prior to the Tribunal hearing the appeal. It is for the taxpayer to demonstrate that payment of the disputed tax would cause them to suffer financial hardship and each case should be considered on the basis of the facts. It is therefore important that sufficient information can be provided at the outset to avoid an unnecessary dispute ahead of any hearing on the disputed decision.
5. VAT registration: penalties
GB-Gadgets Ltd (GB Gadgets) appealed against a penalty totalling £46,726.79 for failing to notify an obligation to register for VAT. The penalty related to unpaid VAT in the period 1 September 2013 to 31 March 2018.
GB Gadgets imported goods for resale online and registered for VAT from 1 April 2018. In January 2020 HMRC began a VAT compliance check on GB Gadgets and requested certain information. HMRC requested further information in February 2020 which was not supplied by GB Gadgets so HMRC issued an information notice on 9 November 2020.
In September 2020 HMRC issued eBay with a joint and several liability notice relating to GB Gadgets. As a result of this, eBay blocked GB Gadgets from trading on its platform and GB Gadgets ceased trading entirely. In December 2021 HMRC issued a VAT assessment for £208,173 for the period 1 September 2013 to 31 March 2018 which was calculated on the basis of sales records supplied to HMRC including those from eBay.
The amount of the penalty applied by HMRC is a percentage of the potential lost revenue (PLR) which in these circumstances means the amount of VAT which GB Gadgets was liable to pay for the period beginning on the date when it was required to be registered until the date on which HMRC were notified of the liability to be registered.
Based on the limited evidence given to the Tribunal by both HMRC and GB Gadgets, the Tribunal concluded that it was more likely than not that GB Gadgets should have been registered for VAT from 1 September 2013 and that HMRC calculated the PLR on the basis of actual sales records. The Tribunal were also satisfied that the penalty was assessed within the time limit and was correctly notified.
GB Gadgets’ grounds of appeal were that the penalty should be reduced because there were special circumstances, being that GB Gadgets opened its first bank account in September 2016 and before this period the account was used by another individual and his company. The Tribunal found that the fact the company underwent a change in ownership at the end of 2017 did not remove its liability to the penalty as it was imposed on the company and not the individual.
The Tribunal ruled that there were no relevant factors which should be taken into account in determining whether there were special circumstances in this case. Therefore, the penalty was confirmed and the appeal was dismissed.
Constable Comment: In this case, the appellant failed to notify HMRC of their liability to be registered for VAT within the required statutory time limits which resulted in them being liable to penalties and as they did not successfully argue that they had special circumstances which applied, the full amount of the penalty was due. This demonstrates the importance of notifying HMRC within the required statutory time limits in order to avoid incurring unnecessary penalties.
6. DIY claim: Dwelling constructed for business purpose
This case concerned Mr Spani’s appeal against HMRC’s refusal of his claim for a repayment of input VAT incurred on the construction of a dwelling under the DIY Housebuilder Scheme. HMRC rejected the DIY claim on the grounds that the dwelling will be used for business purposes as the planning permission was granted for a holiday let.
The appellant argued that the property was made available for letting solely due to the fact that it falls within the Souths Down National Park and in order to obtain planning consent, it was required to be made available for letting, even though it was the appellants primary residence in the UK. The appellant did not actually let the property as these plans were frustrated by Covid, instead he used the property as his main residence in the UK. The appellant contended that merely listing it for letting falls short of HMRC’s position that the intention was to use it for wholly commercial purposes. If this was the case, the appellant could have registered for VAT and recovered the VAT incurred; however, he did not because the property was never intended to be a commercial endeavour.
HMRC’s position was that in order for a DIY claim to be refunded, the property must be used otherwise than in the course of furtherance of business. The planning permission granted permission for a holiday let because a residential home would not be permitted. A holiday let is classified as a business for VAT purposes and therefore not eligible for a refund under the DIY claim. The fact that the property is listed for lettings means it is capable of earning business income.
The Tribunal agreed with HMRC confirming that the appellant’s plan to live in the property does not alter the property into a dwelling that is eligible for a refund. The appeal was dismissed.
Constable Comment: This case reinforces that HMRC will not make a refund in relation to a commercial property, such as a holiday let, under a DIY claim. Taxpayers should consider alternative methods to recover VAT incurred on commercial properties such as VAT registration, option to tax etc. It is important to consider all rules in relation to a DIY claim before it is submitted to HMRC. Constable VAT has relevant experience and would be pleased to assist with DIY claims or any land and property related queries.
Please note that this newsletter is intended to provide a general overview of the subject. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this blog post. Specialist VAT advice should always be sought in relation to your particular circumstance.