The changes will come into effect on:
The press release is available here.
If you buy a flapjack* from a vending machine in the corridor at work it is VAT free. However, if you buy the same product from a machine in the staff canteen it will be standard rated.
* Of course, zero rating only applies to a “traditional” flapjack and not cereal or energy/sports nutrition bars…
HMRC’s manual VAT Assessments and Error Correction was updated on 15 October 2024.
This internal guidance is for HMRC inspectors (but is equally useful for advisers) covers assessments and error correction. The amendments apply mainly to General assessment procedures: Importance of avoiding delay.
The manual covers:
It also refers to for the most up-to-date guidance on reasonable excuse CH160000.as a defence against penalties and interest.
More on:
Disclosure of Avoidance Schemes – new rules
New HMRC guidance on error reporting
New online service for error correction
Error Disclosure under £10,000 – Draft Letter To HMRC
Latest from the courts
The second-hands of time.
In the First-tier Tribunal (FTT) case, the issue was whether the second-hand goods margin scheme (margin scheme) was applicable and whether HMRC’s assessments for £5,474,249 (later reduced to £5,004,595) of underdeclared of output tax were issued in best judgement.
Background
The Ancient & Modern Jewellers Limited (A&M) sold second-hand wristwatches with the majority of the sales properly accounted for via the margin scheme. However, from information obtained from Italian tax authorities in respect of supply chain fraud, HMRC issued the assessments on the basis that supplies of certain goods did not meet the conditions of the margin scheme so that output tax was due on the full value of the watches rather than the difference between the purchase and sale values. HMRC decided to penalise A&M because the errors were deliberate and prompted and subsequently to issue a PLN on the basis that such conduct was attributable to the director. A&M is a “High Value Dealer” for anti-money laundering purposes.
Contentions
Appellant
The appellant claimed that HMRC did not use best judgement on the grounds that:
so the assessments and penalties were invalid.
Whilst accepting that a best judgment challenge is a high bar A&M contended that the conduct and mindset of HMRC’s investigating and assessing officer was so unreasonable that it vitiated the whole assessment.
Respondent
HMRC contended that the assessments were based on best judgement and that its focus was not on the supply chain fraud claims (as claimed by A&M). Additionally, a previous inspection in 2014 had raised prior concerns which provided adequate grounds for the assessments. Moreover, A&M was aware of the terms of operation of the second-hand margin scheme and considered that A&M had wilfully misused the scheme in several regards. The scheme had been incorrectly used for goods purchased by way of intracommunity supplies – which had been imported with the appellant claiming input tax on the imports and then including them in the margin scheme. A&M wilfully failed to carry out due diligence on its suppliers.
Best Judgement
It may be helpful if we consider what the words “best judgement” mean. This was best described by Woolf J in Van Boeckel v CEC [1981] STC 290
“What the words ‘best of their judgement’ envisage, in my view, is that the commissioners will fairly consider all material before them and, on that material, come to a decision which is one which is reasonable and not arbitrary as to the amount of tax which is due. As long as there is some material on which the commissioners can reasonably act, then they are not required to carry out investigations which may or may not result in further material being placed before them.”
Technical
The second-hand margin scheme is provided for under The VAT Act 1994, Section 50A, The Value Added Tax (Special Provisions) Order 1995 and certain paragraphs of VAT Notice 718 which have force of law.
Decision
The appeal was dismissed. It was found that A&M deliberately rendered inaccurate VAT returns. The director of the company was aware both of how the margin scheme worked and that the terms of the scheme had to be complied with if a supply was to be taxed under the it. A&M was found to have acted deliberately in misusing the scheme by including ineligible supplies. A&M had been lax in the completion of its stock book, and it had not met the record-keeping requirements necessary to use the scheme for the relevant transactions. Additionally, some of its EU suppliers were not registered for VAT, a fact A&M did not take steps to discover, and so related purchases could not qualify for the scheme. Also, it was likely that some of the purchases were of new watches which made them ineligible for the margin scheme.
Re, evidence; the FTT found much of the A&M director’s evidence to have been self-serving and, in parts, evasive and that it did not consider that the integrity of HMRC could be impugned. The court determined that; the inspector was diligent and thorough, HMRC had legitimate concerns regarding A&M’s use of the margin scheme generally and specifically and there was a wider concern that the company was a participant in fraudulent supply chains. The FTT considered that the investigation was proportionately carried out considering these concerns and the assessments raised in exercise of best judgment.
Penalties and PLN
The case further considered penalties: whether the appellant’s conduct was deliberate (yes – appeal dismissed). Whether the Personal Liability Notice (PLN) [Finance Act 2007, Schedule 24, 19(1)] was appropriate for the conduct attributed to the director – whether his conduct led to penalty (yes – appeal dismissed).
Commentary
This case is a long read, but worthwhile for comments on; the margin scheme use, HMRC’s inspection methods, best judgement, evidence and MTIC amongst other matters.
Latest from the courts
In the Lycamobile UK Ltd First-Tier Tribunal (FTT) case, the issue was whether VAT was chargeable on the supply of a “Plan Bundle” at the time when it was sold and by reference to the whole of the consideration that was paid for it, or whether VAT was instead chargeable only when, and only to the extent that, the allowances in the Plan Bundle were actually used. The time of supply (tax point) was important because not only would it dictate when output tax was due, but more importantly here, if the appeal succeeded, there would be no supply of the element of the bundle which was not used, so no output tax would be due on it.
Background
The Plan Bundles comprised rights to future telecommunication services; telephone calls, text messages and data (together, “Allowances”). There were hundreds of different Plan Bundles sold by the Appellant and the precise composition of those Plan Bundles varied.
Contentions
Lycamobile considered that that the services contained within each Plan Bundle were supplied only as and when the Allowances were used, so that the consideration which was received for each Plan Bundle would be recognised for VAT purposes only to the extent that the Plan Bundle was actually used. In the alternative, these supplies could be considered as multi-purpose vouchers such that output tax was not due when they were issued, but when the service was used. Very briefly, the contention was that it was possible that not all of the use would be standard rated in the UK.
Unsurprisingly, HMRC argued that that those services were supplied when the relevant Plan Bundle was sold (up-front) and output tax was due on the amount paid, regardless of usage.
Decision
The Tribunal placed emphasis on “the legal and economic context” and “the purpose of the customers in paying their consideration”.
It decided that the terms of the Plan Bundle created a legal relationship between Lycamobile and the customer. The Bundle was itself the provision of telecommunication services when sold. The customers were aware that they were entitled to use their Allowances and could decide whether to, or not. As a consequence, consumption was aligned with payment and created a tax point at the time of that payment. There was a direct link between those services and the consideration paid by the customer.
The Tribunal also considered the vouchers point. There were significant changes to the rules for Face Value Vouchers on 1 January 2019 (the supplies spanned this date), but the FTT found that the Plan Bundles were not monetary entitlements for future services under either set of rules, so the tax point rules for vouchers did not apply here.
The appeal was dismissed and HMRC assessments totalling over £51 million were upheld.
Commentary
Not an unexpected result, but an illustration of the importance of; tax points, legal and economic realities, and what customers think they are paying for. All important aspects in analysing what is being provided, and when.
An easy yes or no question one would think, however, this being VAT, the answer is; it depends. Typically, management charges represent a charge by a holding company to its subsidiaries of; a share of overhead costs, the provision of actual management/advisory services or office facilities or similar (the list can obviously be quite extensive).
Consideration for a supply
The starting point is; is something (goods or services) supplied in return for the payment? If the answer is no, then no VAT will be due. However, this may impact on the ability to recover input tax in the hands of the entity making the charge. It is often the case that a management charge is used as a mechanism for transferring “value” from one company to another. If it is done in an arbitrary manner with no written agreement in place, and nothing identifiable is provided, and VAT is charged, HMRC may challenge the VAT treatment and any input recovery of the company making the payment.
Composite of separate supply?
This is a complex area of the tax and is perpetually the subject of a considerable amount of case law. This has been so since the early days of VAT and there appears no signs of disputes slowing down. I have written about such cases here here here here and here
“Usually” if a combination of goods or services are supplied it is considered as a single supply and is subject to the standard rate. However, case law insists that sometimes different supplies need to be divided and a different rate of VAT applied to each separate supply. This may be the case for instance, when an exempt supply of non-opted property (eg; a designated office with an exclusive right to occupy) is provided alongside standard rated advice.
Approach
What is important is not how a management charge is calculated, but what the supply actually is (if it is one). The calculation, whether based on a simple pro-rata amount between separate subsidiaries, or via a complex mechanism set out in a written agreement has no impact on the VAT treatment. As always in VAT, the basic question is: what is actually provided?
Can the VAT treatment of a supply change when recharged?
Simply put; yes. For example, if the holding company pays insurance (VAT free) and charges it on as part of a composite supply, then VAT will be added to an original non-VAT bearing cost. It may also occur when staff are employed (no VAT on salaries paid) but the staff are supplied to a subsidiary company and VAT is added (but see below).
Staff
The provision of staff is usually a standard rated supply. However, there are two points to consider. One is joint contracts of employment which I look at below, the other is the actual definition of the provision of staff. Care must be taken when analysing what is being provided. The question here is; are staff being provided, or; is the supply the services that those staff carry out? This is relevant, say, if the services the staff carry out are exempt. There are a number of tests here, but the main issue is; which entity directs and manages the staff?
Directors
There can be different rules for directors compared to staff.
If a holding company provides a subsidiary company with a director to serve as such, the normal rules relating to supplies of staff apply and VAT applies.
However, there are different rules for common directors. An individual may act as a director of a number of companies. There may be an arrangement where a holding company pays the director’s fees and then recover appropriate proportions from subsidiaries. In such circumstances, the individual’s services are supplied by the individual to the companies of which (s)he a director. The services are supplied directly to the relevant businesses by the individual and not from one company to another. Therefore, there is no supply between the companies and so no VAT is due on the share of money recovered from each subsidiary.
Accounting adjustments
Just because no “cash” changes hands, this does not mean there is no supply. Inter-company recharges may involve the netting off of supplies so that no cash settlement is made. However, consideration is passing in both directions, so, prima facie, supplies have been made. This applies when there are accounting adjustments in both parties’ accounts.
Inter-company loans
The making of any advance or the granting of any credit is exempt via The VAT Act 1994, Schedule 9, Group 5, item 2. This exemption covers most normal types of credit, eg; loans and overdrafts.
Planning
Planning may be required if;
Specific planning
VAT grouping
If commercially acceptable, the holding company and subsidiary companies may form a VAT group. By doing so any charges made between VAT group members are disregarded and no VAT is chargeable on them.
There are pros and cons in forming a VAT group and a brief overview is provided here
A specific development in case law does mean care must be taken when considering input tax recovery in holdco, details here
Joint contracts of employment
If members of staff are employed via joint contracts or employment no VAT is applicable to any charges made between the two (or more) employers. In addition, where each of a number of associated companies employs its own staff, but one company (the paymaster) pays salaries behalf of the others who then pay their share of the costs to the paymaster the recovery of monies paid out by the paymaster is VAT free as it is treated as a disbursement.
Disbursements
Looking at disbursements is a whole article in itself, and in fact there is a helpful one here
But, briefly, if a charge qualifies as a disbursement, then the costs is passed on “in the same state” so if it is VAT free, the onward charge is also VAT free, as opposed to perhaps changing the VAT liability as set out above. It is important to understand the differences between a disbursement and a recharge as a VAT saving may be obtained.
Overseas
The above considers management charges within the UK. There are different rules for making or receiving management charges to/from overseas businesses. These charges are usually, but not always, VAT free (an example is the renal of opted office space which is land related, so is always standard rated) and it is worth checking the VAT treatment before these are made/received. VAT free services received from overseas may be liable to the reverse charge.
Same legal entity
There is no supply if management charges are made between branches of the same legal entity.
Charities
There may be more planning for charities and NFP entities via cost-sharing arrangements, but this is outside the scope of this article.
Summary
As may be seen, the answer to a simple question may be complex and the answer dependent upon the precise facts of the case. It is unusual to have two scenarios that precisely mirror each other, so each structure needs to be reviewed individually. Inter-company management charges must be recognised, especially if the recipient is partly exempt. Please contact us if you have any queries or would like more information on any of the above.
An in-depth article on the DIY Housebuilders’ Scheme here
It is also possible to claim VAT on the construction of a new charity building, for a charitable or relevant residential purpose.
The following are bullet points to bear in mind if you are building your own house, or advising someone who is:
Budgeting plays an important part in any building project. Whether VAT you incur may be reclaimed is an important element. In order to establish this, it is essential that your plans meet the definitions for ‘new residential dwelling’ or ‘qualifying conversion’. This will help ensure that your planning application provides the best position for a successful claim. One point to bear in mind, is the requirement for the development to be capable of separate (from an existing property) disposal.
You are permitted to build the property for another relative to live in. The key point is that it will become someone’s home and not sold or rented to a third party. Therefore, you can complete the build and obtain invoices in your name, even if the property is for your elderly mother to live in. However, it is not possible to claim on a granny annexe built in your garden (as above, they are usually not capable of being disposed of independently to the house).
Despite the name of the scheme, you are able to use contractors to undertake the work for you. The only difference here will be the VAT rate on their services will vary depending on the nature of the works and materials provided.
A valid claim can be made on any building materials you purchase and use on the build project. Also, services of conversion charged at the reduced rate can be recovered. However, input tax on professional services such as architect’s fees cannot be reclaimed.
It is crucial to receive goods and services at the correct rate of VAT. Services provided on a new construction of a new dwelling will qualify for the zero rate, whereas the reduced rate of 5% will apply for qualifying conversions. If your contractor has charged you 20% where the reduced rate should have been applied, HMRC refuse to refund the VAT and will advise you go back to your supplier to get the error corrected. This is sometimes a problem if your contractor has gone ‘bust’ in the meantime or becomes belligerent. Best to agree the correct VAT treatment up front.
If you wish to purchase goods yourself, it will be beneficial to ask your contractor to buy the goods and combine the value of these with his services of construction. In this way, standard rated goods become zero rated in a new build. If you incur the VAT on goods, you will have to wait until the end of the project to claim it from HMRC.
The claim form must be submitted within six months of completion of the build, usually this is when the certificate of practical completion is issued, or the building is inhabited. although it can be earlier if the certificate is delayed. More details of when a building is complete here. Recent changes to the scheme here.
HMRC publish the forms on their website.
Using the correct forms will help avoid delays and errors. Claims can now be made online.
You are required to send original invoices with the claim. Therefore, take copies of all documents and send the claim by recorded delivery. Unfortunately, experience insists that documents are lost…
If you are in any doubt, please contact me. Mistakes can be costly, and you only get one chance to make the claim. Oh, and don’t forget that this is VAT, so any errors in a claim may be liable to penalties.
More on the DIY Housebuilders’ Scheme here, here, here, and here and Tribunal cases on claims here, here, and here
HMRC has updated its guidance on when repayment interest is due.
If a business has claimed more input tax than it has declared output tax (a repayment return) HMRC will repay the difference by making a VAT repayment. HMRC will also repay any VAT that has been overpaid in error. Repayments are usually made within 30 days. The 30 days starts from the day HMRC receives the VAT Return and ends the day your repayment is approved (not the day it is received). HMRC does not count days taken to check the return is accurate and legitimate, and to correct any errors or omissions, as part of this 30-day period.
If HMRC is late in paying, a business may be entitled to repayment interest on any VAT that it is owed. For accounting periods starting on or after 1 January 2023, repayment interest replaces the repayment supplement.
A business, or its agent can track a VAT repayment online.
Update
Information on eligibility criteria for repayment interest on overpayments and start dates when VAT is not paid to HMRC has been amended. Information on repayment interest end dates when HMRC sets it off against your debts has also been updated.
An annual adjustment is a method used by a business to determine how much input tax it may reclaim.
Even though a partly exempt business must undertake a partial exemption calculation each quarter or month, once a year it will have to make an annual adjustment as well.
An annual adjustment is needed because each tax period can be affected by factors such as seasonal variations either in the value supplies made or in the amount of input tax incurred.
The adjustment has two purposes:
An explanation of the Value Added Tax Partial Exemption rules is available here
Throughout the year
When a business makes exempt supplies it will be carrying out a partial exemption calculation at the end of each VAT period. Some periods it may be within the de minimis limits and, therefore, able to claim back all of its VAT and in others there may be some restriction in the amount of VAT that can be reclaimed. Once a year the business will also have to recalculate the figures to see if it has claimed back too much or too little VAT overall. This is known as the partial exemption annual adjustment. Legally, the quarterly/monthly partial exemption calculations are only provisional, and do not crystallise the final VAT liability. That is done via the annual adjustment.
The first stage in the process of recovering input tax is to directly attribute the costs associated with making taxable and exempt supplies as far as possible. The VAT associated with making taxable supplies can be recovered in the normal way while there is no automatic right of deduction for any VAT attributable to making exempt supplies.
The balance of the input tax cannot normally be directly attributed, and so will be the subject of the partial exemption calculation. This will include general overheads such as heating, lighting and telephone and also items such as building maintenance and refurbishments.
The calculation
Using the partial exemption standard method the calculation is based on the formula:
Total taxable supplies (excluding VAT) / Total taxable (excluding VAT) and exempt supplies x 100 = %
This gives the percentage of non-attributable input VAT that can be recovered. The figure calculated is always rounded up to the nearest whole percentage, so, for example, 49.1 becomes 50%. This percentage is then applied to the non-attributable input VAT to give the actual amount that can be recovered.
Once a year
Depending on a businesses’ VAT return quarters, its partial exemption year ends in either March, April, or May. The business has to recalculate the figures during the VAT period following the end of its partial exemption year and any adjustment goes on the return for that period. So, the adjustment will appear on the returns ending in either June, July, or August. If a business is newly registered for VAT its partial exemption “year” runs from when it is first registered to either March, April or May depending on its quarter ends.
Special methods
The majority of businesses use what is known as “the standard method”. However, use of the standard method is not mandatory and a business can use a “special method” that suits a business’ activities better. Any special method has to be “fair and reasonable” and it has to be agreed with HMRC in advance. When using a special method no rounding of the percentage is permitted and it has to be applied to two decimal places.
Commonly used special methods include those based on staff numbers, floor space, purchases or transaction counts, or a combination of these or other methods.
However, even if a business uses a special method it will still have to undertake an annual adjustment calculation once a year using its agreed special method.
De minimis limits
If a business incurs exempt input tax within certain limits it can be treated as fully taxable and all of its VAT can be recovered. If it exceeds these limits none of its exempt input tax can be recovered. The limits are:
The partial exemption annual adjustments are not errors and so do not have to be disclosed under the voluntary disclosure procedure. They are just another entry for the VAT return to be made in the appropriate VAT period.
Conclusion
If a business fails to carry out its partial exemption annual adjustment it may be losing out on some input VAT that it could have claimed. Conversely, it may also show that it has over-claimed input tax. When an HMRC inspector comes to visit he will check that a business has completed the annual adjustment. If it hasn’t, and this has resulted in an over-claim of input VAT, (s)he will assess for the error, charge interest, and if appropriate, raise a penalty. It is fair to say that partly exempt businesses tend to receive more inspections than fully taxable businesses.
If HMRC carry out an inspection and decide that VAT has been underdeclared (eg: either by understating sales, applying the incorrect VAT rate, or overclaiming input tax) an inspector has the power to issue an assessment to recover VAT that it is considered underdeclared. This is set out in The VAT Act 73(1)
“Where a person has failed to make any returns … or where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT from him to the best of their judgment and notify it to him”.
So, the law requires that when an inspector makes an assessment (s)he must ensure that the assessment is made to the best of their judgement, otherwise it is invalid and will not stand.
Guidance to surviving a VAT inspection here.
HMRC’s methods of assessing cash businesses here.
Definition of best judgment
Per Van Boeckel vs HMCE (1981) the judge set out three tests:
If any of these three tests are failed, then best judgement has not been employed. However, the onus is on the appellant to disprove the assessment.
There were further comments on the matter:
“There are…obligations placed on the Commissioners to properly come to a view on the amount of tax that was due to the best of their judgement. In particular:
This means that the assessing inspector must fairly consider all material placed before them and, on that material, come to a decision that is reasonable and not arbitrary, taking into account the circumstances of the business. In some cases, some “guesswork” may be required, but it should be honestly made based on the information available and should not be spurious, but HMRC must be permitted a margin of discretion.
Experience insists that it is usually more successful if the quantum of a best judgement assessment is challenged.
Where a business successfully disputes the amount of an assessment and the assessment is reduced, it will rarely fail the best judgement test.
In the case of MH Rahman (Khayam Restaurant) CO 2329/97 the High Court recognised the practice whereby the tribunal adopts a two-step approach, looking initially at the question of best judgement and then at the amount of the assessment. The message of the High Court appeared to be that the Tribunal should concern itself more with the amount of an assessment rather than best judgement.
Arguments which may be employed to reduce a best judgement assessment are, inter alia:
HMRC’s guidance to its own officers states that: Any assessments made must satisfy the best judgement criteria. This means that given a set of conditions or circumstances, “you must take any necessary action and produce a result that is deemed to be reasonable and not arbitrary”.
In other words, best judgement is not the equivalent of the best result or the most favourable conclusion. It is a reasonable process by which an assessment is successfully reached.
In the case of CA McCourtie LON/92/191 the Tribunal considered the principles set out in Van Boeckel and put forward three further propositions:
Tribunals will not treat an assessment as invalid merely because they disagree as to how the judgement should have been exercised. It is possible that a Tribunal may substitute its own judgement for HMRC’s in respect of the amount of the assessment. However, this does not necessarily mean that because a different quantum for the assessment was arrived at that the assessment failed the best judgement test.
Further, it is not the function of the Tribunal to engage in a process that looks afresh at the totality of the evidential material before it (M & A Georgiou t/a Mario’s Chippery, QB October 1995 [1995] STC 1101).
It should be also noted that even if one aspect of an assessment is found not to be made to best judgement this should not automatically invalidate the whole assessment – Pegasus Birds [2004] EWCA Civ1015.
Summary
There are significant difficulties in arguing that an inspector did not use best judgement and it is a high bar to get over.
In order to succeed on appeal, it would be required to be demonstrated, to the judge’s satisfaction, that the assessment was raised:
and that this action applies to the assessment in its entirety.