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VAT: HMRC u-turns on pre-reg acquisitions

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10th Nov 2016
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Neil Warren explains the issues for businesses and asks if this is HMRC’s first Brexit VAT decision.

HMRC have confirmed that no prior-use adjustment needs to be made to input tax claimed by a business that relates to pre-registration expenditure.

A newly VAT registered business can claim input tax on its first VAT return in relation to certain expenditure paid before it was registered:

  • Services – for the six-month window before registration, as long as the service has not been supplied onwards before registration.
  • Goods – the window is four years, as long as the goods were wholly used in the business in the period before VAT registration, and are still owned by the business on its first date of VAT registration. The goods can be either business assets or stock.

Note that a business which uses the flat rate scheme can claim pre-registration input tax in the same way as a business that doesn’t use the flat rate scheme.

What was the problem?

HMRC amended their internal manual guidance in 2011 (VIT32000), to say they expected input tax claimed on goods to reflect wear and tear and use in the period before registration (see Example 1). However this policy change was kept secret from traders and the majority of HMRC staff, as there was  no public announcement, and no amendment was made to VAT Notice 700/1.

HMRC’s previous policy was that input tax claims would be based on the cost of the goods, i.e. as shown on purchase invoices. The amended internal guidance did not come to light until early 2015. In August 2015 I advised how traders could minimise the effect of this policy change.

Example 1

Dave bought a van to use in his decorating business on 1 October 2014 for £10,000 plus VAT. He registered for VAT on 1 October 2016.

Under HMRC’s revised interpretation implemented from 2011 to 2016, Dave should claim input tax on the market value of the van on the date of his VAT registration. If Dave applied an annual depreciation rate of 20% straight line basis to the value of his van, he would claim input tax of £1,200 on his first VAT return, rather than £2,000 (as shown on the invoice for the van).

U-turn

After a year-long review, HMRC have confirmed that their revised approach is not correct, as announced in Revenue and Customs Brief 16 (2016). Input tax claims for pre-registration expenditure should be based on the cost of goods as shown on purchase invoices. Any assessments raised by HMRC to reflect the incorrect policy will be reversed, so an appeal will be needed in many cases to bring the error to their attention.

Any business that has applied its own reduction, such as Dave in Example 1, can make an adjustment under the normal error correction rules. As the amount of tax underclaimed will almost certainly be less than £10,000 (the error correction limit) it can be corrected on the next VAT return.

Is this a Brexit concession?

When I wrote about this subject last year, I took the view that UK legislation did not create an issue with an input tax claim based on cost (SI 1995/2518, reg 111) but that Article 289 of the EC Directive 2006/112 (known as the Principal VAT Directive) created a problem. This was confirmed by the HMRC press office spokesman I liaised with at the time who said: “An adjustment does need to be made for pre-registration use of goods because EU law states that VAT on goods is only deductible in so far as the goods are used for the purpose of taxable transactions.” He also referred to an ECJ case Lennartz C97/90 to support his argument.

As a closing thought, does this welcome U-turn by HMRC’s policy team mean that the flexibility of UK law in regulation 111 has been recognised at the expense of the more specific wording in Article 289 – because the latter will be irrelevant after the UK leaves the European Union?

Is this HMRC’s first Brexit VAT decision? Let us know your views below. 

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