Latest from the courts

In the Homsub Ltd case the issue was the apportionment of values when a supply comprises goods at different VAT rates.

Further to the M & S case here is another First Tier Tribunal (FTT) case on the value of food and drink in meal deals. It also considered whether HMRC exercised ‘best judgement’ when it carried out an invigilation exercise to establish the percentage split between supplies subject to VAT and those which were not.

Background

Homsub is a franchisee in respect of Subway products, essentially being hot and cold food, which can be consumed either on or off their premises.

HMRC had concerns that the correct amount of output tax was being declared on sales. Consequently, it carried out an invigilation exercise as follows: The invigilators recorded, in respect of each of the five outlets, each sale made and annotated it with whether it was eat in or take out. A record was also made as to whether the food was hot or cold. Those differences needed to be recorded because of the different VAT treatment in respect of hot food and cold food on the one hand and eat in and take out food on the other. All eat in food is taxable, while some takeaways are zero rated. Further information here.

Contentions

Homsub complained that the methodology adopted by HMRC was flawed as it was not sufficiently refined to give rise to a reasonably reliable overall picture. It was argued that the exercise should have been undertaken by reference to transaction values, rather than the number of transactions. That is – HMRC should have looked at the value of supplies made which did attract VAT as compared to the value of supplies made which did not attract VAT.

The court identified that the true area of concern on the part of the respondents was that Subway sometimes had promotions called “Meal Deals” whereby several products would be bundled together for a single headline price.

Homsub contended that a meal deal offer was available to customers whereby for the all in price of £3 a customer could purchase a sandwich (hot or cold) and a drink (which could be a fizzy drink or hot beverage upon which VAT would be due). If the meal deal involved hot food, then it would be subject to VAT.

HMRC’s issue was that because of the way in which the appellant’s till was set up, it treated £2.99 of each meal deal as attributable to the sandwich (VAT free if cold) and only 1p to the accompanying drink which, if subject to VAT, would mean that the VAT would be one fifth of one penny.

Outcomes

Homsub stated that it is entitled to run its business as it sees fit and to make such commercial decisions as best suit its business. The appellant said that it is entitled to sell loss leaders, as do many major retailers, or to sell stock at less than cost price if that somehow serves the best overall commercial interests of the business.

The court ruled that this was not a true loss leader situation. This was a transaction were goods are packaged together to be sold at a single price. What must be done is to look at the reality of the transaction when apportioning the part of the money paid by the customer between the various components within the package of goods sold. Consequently, Homsub needed to apportion the sales value in a different way. This would not necessarily be on the basis of the relevant retail prices. This is because accurate apportionment is difficult, especially as, as Homsub explained, that labour is by far the largest cost component within the cost of a sandwich and the overall meal deal package, that is; much more staff labour was devoted to preparing sandwiches than serving drinks.

If the case stopped there, there would be additional output tax for Homsub to pay. However…

Methodology and best judgement

The court decided that the assessment methodology adopted by HMRC was significantly flawed and potentially misleading. A simple count of transactions that did attract VAT and those which did not attract VAT might be capable of being appropriate in certain kinds of business, but not in this case. Further, a statistician or forensic accountant would be ‘alarmed to find that the methodology used by HMRC was considered to be either acceptable or such as to give rise to a reasonably reliable result’. In court, the representative of HMRC was forced to agree with this interpretation- which must have caused embarrassment. The court also said that it was not its function to go on to undertake any kind of assessment to ascertain what, if any, additional VAT might be due.

Decision

In the court’s judgement the methodology was flawed to such an extent that it would be wholly unreasonable, and unfair to the appellant, to base a best judgement assessment thereon. The appeal was therefore allowed.

Commentary

Always have assessments of this sort reviewed. There is significant case law on ‘best judgement’ most salient being: Van Boeckel v C&E [1981] and Rahman v HMRC. Additionally, HMRC often make certain assumptions on assessments based on invigilation and mark up exercises. These can be challenged, as can the methodology. As examples, HMRC need to recognise, inter alia;

• seasonal trade variations
• discounts
• customer preferences (in this case, Homsub explained that at some of its shops’ locations a lot of customers were students and preferred to take away rather than eating in)
• representative periods
• sales/special offers
• the times invigilations were carried out (were they representative of all trade?)
• the number of invigilations and ‘test meals’ – were they sufficient to establish a fair overall picture of the business?
• own and staff use
• business promotions
• loss of goods (destroyed, waste, stolen etc)
• gross/net
• gifts to customers
• alternative methods
• HMRC staff experience etc

All of these and other situations can affect expected sale values.

I have further set out how HMRC operate in these situations here.

I have a success rate of over 90% in getting these types of assessments reduced or completely withdrawn. Please do not simply accept HMRC’s decision, nor the, increasingly, bullying stance they can adopt. Always challenge!