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Secret VAT rule used against new traders

12th Jun 2015
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HMRC has changed its interpretation of a key VAT rule so that newly registered businesses are being denied VAT refunds.

What’s more HMRC hasn’t publically announced this change in practice, so tax advisers and taxpayers have been potentially over-claiming input VAT on new VAT registrations. 

So what’s changed?

When an established business registers for VAT it will already hold some stock and assets which will be used after the registration date in connection with its VATable sales. For the last 43 years, the trader has been able to reclaim all the input VAT paid on those goods, in his first VAT return, as long as these conditions are met:

  • the goods were acquired in the four years before the date of registration
  • the items are still held at the date of registration.

However, if you ring the VAT helpline you may now be told the trader can’t reclaim all of the input VAT paid on those goods. HMRC says the input VAT should be reduced to take into account the use that has been made of the goods before the VAT registration date. There has been no change in practice for VAT reclaims on services, which must be provided in the six months before registration.  

Example:

Ken has been a self-employed pest controller for many years. He registered for VAT with effect from 1 May 2015, at which point he held a van that cost him £24,000 on 1 May 2013, and equipment that he bought for £9,000 on 1 May 2012, both inclusive of VAT. He expects to use the van for eight years and the tools for five years.

Previously most VAT advisers would advise Ken to reclaim VAT of £4,000 in respect of the van and £1,500 paid on the equipment.

The new HMRC interpretation of EC VAT Directive 2006/112 article 289 (set out in VAT Input Tax Manual para 32000) is that as the van has been used for 2/8th of its life, just £3,000 (6/8 x 4000) of the input VAT can be reclaimed. For the equipment a similar calculation reduces the VAT reclaim to £600 (2/5 x1500).

Ken is obviously losing out by £,1900 of unrecoverable VAT.

Any taxpayer would be confused by the advice given by the VAT helpline, as that doesn’t agree with the guidance given in the public VAT Notices 700 (at section 11) and 700/1 (at para 5.2). AccountingWeb member Littlelow was certainly puzzled by advice he got from the VAT helpline a year ago when he called about a very similar problem.

So when did HMRC change their practice and why?

HMRC apparently changed their practice from 1 January 2011, but it is not possible to confirm this as the record of updates to the VAT input manual only goes back to February 2012.

The UK law is set out in VAT regulation (SI 1995/2518) reg. 111, which doesn’t mention the need to restrict input VAT in respect of the use assets have already been put at the registration date. However, Neil Warren writing in Taxation Magazine is convinced that the new HMRC practice is correct, when article 289 is considered.  

Other VAT experts are not swayed by HMRC’s reasoning. Wayne Neale head of VAT at Larking Gowen says: “This is taxation by reinterpretation.  In my view, HMRC has an extremely dubious reasoning for correcting a supposed 43 year error on pre-registration VAT.”

Wayne goes on to say "HMRC still require a taxpayer to declare full VAT on the sale of the assets which have been used for business and this quid pro quo has always been at the heart of the rules.”

So what has been your experience the VAT helpline advice on reclaiming pre-registration VAT? 

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Replies (23)

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By johnjenkins
15th Jun 2015 09:14

We have

not come across this as yet. However if we were challenged we would agree with Wayne Neale. I don't think the sale price has anything to do with it, as the value of the asset in the sale will reflect the use over the period it was used.

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By hedleyg
15th Jun 2015 10:27

What Happens Elsewhere?

Although, HMRC is applying dubious logic to these situations, it will have the effect of delaying major purchases until after registration - bad for the economy.

As VAT is an EU wide tax, what happens in other EU member states?

If normal practice is the same as it has been in the UK, I can only see challenges getting bogged down in the european courts.

Not exactly well thought out.

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By BKD
15th Jun 2015 11:22

John

You seem to be contradicting yourself - you say that you agree with Wayne, but that the sale price is irrelevant since that would reflect the use of the asset. Actually, there is very good logic in HMRC's treatment.

Take an asset that cost £20k plus £4k VAT. It is used for non-business purposes so that when it is introduced to the business it is worth only £10k. Under the 'old rules' the trader could claim VAT of £4k, use the asset for a couple of weeks and sell it for £10k plus £2k VAT. An immediate saving to him (loss to the Exchequer) of £2k. That strikes me as an unjust outcome.

Bearing in mind that for, eg capital allowance purposes, an asset introduced to the business will be treated as having been acquired at its then market value. Why should a similar provision not also apply for VAT?

Sometimes you just have to accept that HMRC are correct, even though their route to that correct treatment is questionable.

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By johnjenkins
15th Jun 2015 12:01

@BKD

I do agree with Wayne as far as "this is taxation by reinterpretaion". If you say that you can claim back the VAT of assets that you hold then that is the rule. The sale has got nothing to do with it. I do agree with the concept of a "revaluation" but after 43 years, come on. We all know the real reason for the sudden change. What if the asset was bought with starting a business in mind?

A lot of people tend to forget the concept of VAT is not a tax on registered business. It is a tax on the unregistered end user.

As far as your example is concern BKD, it is irrelevant. There is no loss to the Exchequer because the rule states quite clearly that the business can claim the VAT back. So now we will have arguements on what the asset will be worth.

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By AndrewV12
15th Jun 2015 12:05

Going back 4 years

I suppose going back 4 years was a bit over generous. 

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By gary_taylor
15th Jun 2015 12:25

Enquiries

Are we now to expect a series of enquiry letters which may result in assessments and penalties and interest? Should we be advising our newly registered clients to make a voluntary disclosure to minimise any penalties?

I personally understand the rationale but there needs to be proper disclosure of the change and notice that it is going to happen.

This is just a mess. 

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By Gordon Frew
15th Jun 2015 13:10

I had a case in point over 2 years ago. My client runs a furnished holiday lettings business and needed to register for VAT after 3 years trading.

VAT inspector required a useful life of everything purchased, even down to the bed linen, so that the pre & post registration periods could be pro-rated, ie the period pre-registration was not claimable but the post-registration remaining life of the asset was.

Bizarre but true.

 

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By Taxbreak
15th Jun 2015 13:26

What utter hogwash...
There is nothing in regulation 111 which requires an apportionment - it provides for a person to claim "VAT on the supply of goods..." - not a part or a portion or of some of the VAT on the supply.There appears to be some confusion in the thread above. The original article considers an established business trading below the VAT threshold which later registers for VAT. In such circumstances the use in the unregistered business does not constitute use for a non-business purpose. If an asset had been bought for a non-business purpose and then at a later date was introduced into the business, Reg 111 would not allow any VAT recovery - and it has always been thus.Article 289 deals with the rights/entitlements of an unregistered person - that person cannot recover input tax and cannot show VAT on their invoices. It is of no relevance to a person who is VAT registered - and Reg 111 applies to a VAT registered person and entitles him to make an exceptional claim for recovery of pre-registration input tax.HMRC's input tax manual at VIT32000 is confused and confusing. It says at one point: "The amount of tax that can be recovered is the amount that would have been deductible had the business been registered at the time the tax was incurred." The later comment that the VAT must be adjusted for the use made of the van in the intervening period is - in my humble opinion - hogwash. It neither accords with the statutory provisions of Reg 111 or with what is said in the remainder of HMRC's manual, in HMRC's notice or with HMRC policy. Reg 111(2)(a)(ii) provides for VAT on goods not to be treated as input tax to the extent that he goods have been "consumed". The VAT General Guide gives petrol, electricity and gas as such examples. A van cannot be said to have been consumed.What on earth do the rules for Capital Allowances have to do with VAT rules? They are separate and distinct and there is no read across."Sometimes you just have to accept HMRC are correct" - really? even when they are wrong? I think not. If they are correct, fine, but this looks to be one of those occasions when what is set out in the manual is plainly wrong. If they wish to change policy they must do so prospectively and must be sure that any policy accords with the legislation.We have the rogue sentence in VIT32000 but I have seen no examples of HMRC seeking to apply this "new policy" in practice and it is not clear from the article above or the other posts that anyone else has? If there is doubt, I would suggest one of the many rep bodies be asked to raise it at the next JVCC rather than allow the continuance of what would appear to be unnecessary scare mongering.

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By Taxbreak
15th Jun 2015 13:30

And for the avoidance of doubt...

... my comments above do not deal with the situation of items within the capital goods scheme, where the rules do differ.

If anyone has been required to apportion recovery of non-CGS goods, I would ask HMRC to revisit the matter with a view to obtaining payment of the balance of the VAT incurred.

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By Ian McTernan CTA
15th Jun 2015 14:21

This is why...

This is why I'm not a VAT expert.  HMRC insist on making rules within rules within rules and over complicating everything, then having different sets of rules for CT, CA's, VAT, IT, etc etc.

One day they will simplify it all- but probably not in my lifetime.

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7om
By Tom 7000
15th Jun 2015 14:37

Now this is important

so....We called HMRC VAT dept

We were put through to a Technical advisor ( 1st layer assistance said no change)

We told him to look at VIT 32000

He said the rules havent changed, any apportionment simply relates to if you were making exempt supplies and the rules as usual due to private use.

He confirmed Notice 700 hasn't changed and its part of the public record and thats what we shoud use.

So if HMRC have a change in policy they havent told their staff

We have a call reference no on it too....just in case :)

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By stephen_walton
15th Jun 2015 15:27

Its common sense by HMRC

Normally cant agree with HMRC but this time they are right and have commercial logic

If the same van was bought now it would never be worth the same as it was two years ago and to some extent they are being generous with the straight line application as depreciation is usually on a reducing balance basis

The overriding issue is the fairness here not which rule has been broken or avoided 

 

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By mojothethird
22nd Jun 2015 14:59

and fairness implies HMRC

deleted

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By mojothethird
22nd Jun 2015 14:58

fairness

stephen_walton wrote:

Normally cant agree with HMRC but this time they are right and have commercial logic

If the same van was bought now it would never be worth the same as it was two years ago and to some extent they are being generous with the straight line application as depreciation is usually on a reducing balance basis

The overriding issue is the fairness here not which rule has been broken or avoided 

 

well, fairness would be for the HMRC to announce policy change correctly.

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By DMGbus
15th Jun 2015 15:39

HMRC guidance - NO DEPRECIATION

The amount of tax that can be recovered is the amount that would have been deductible had the business been registered at the time the tax was incurred. You should consider partial exemption and non-business restrictions when you calculate the amount of tax to claim. Please note that the partial exemption de minimis limit does not apply to VAT incurred pre-registration.

Source: VIT32000 - How to treat input tax: pre-registration, preincorporation and post-deregistration claims to input tax under regulation 111

It will be noted that there is no reference to the alleged depreciation / reduction to be applied in respect of recoverable VAT.    There is however a reference to partial exemption which is a different thing altogether.

Going back to the date of change and a reference to January 2011, I see that there was some reference to pre-registration VAT in Januuary 2011, but it said the following:

Reclaiming VAT – what you can and cannot claim: paid
VAT before you registered?
HMRC issues a factsheet, VAT FS1 What you need to know about VAT to all newly VAT registered businesses. The factsheet states that ‘In some cases, you can reclaim VAT you paid on goods you bought up to three years before you registered’.
From 1 April 2009, the time limit was increased to four years. The factsheet will be updated as soon as possible. HMRC apologise for any confusion caused.

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By The VAT Doctor
16th Jun 2015 06:30

Litigation
Thanks for the mostly positive comments. I have done a reply to Neil Warren's article for Taxation explaining in a bit more detail why I think HMRC are wrong. I also hear there is pending litigation on this point.

Actually it seems that there's a new equally apt phrase - taxation by rumour!
Wayne Neale, aka The VAT Doctor

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Neil Warren
By Neil Warren
16th Jun 2015 07:48

HMRC policy should be communicated properly

I am really pleased that Accounting Web have followed up my Taxation article to cover this topic - it is very important because, as one respondent rightly said, HMRC have changed their view on something we have been happily adopting in practice for 43 years ! And the amounts of tax involved can be considerable. As a bit of further background, my first liaison with HMRC on this issue was about three months ago, to tell them there was a technical error in their guidance - I was very surprised when their policy section (via the press office) said that it wasn't an error and that was how they thought the rules applied - and our liaison developed from there. I think we are all agreed that if they do change their interpretation of any important legislation, then it should be properly communicated (and the reasons why) and not hidden away in the internal manuals............. Neil Warren

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By The VAT Doctor
16th Jun 2015 21:15

VPG
Not sure if you are a VPG member Neil or can access their page on LinkedIn- a good debate there too. There is litigation planned on this which is a good idea. I am convinced HMRC are wrong, certainly in their reading of Art 289. As a former officer too (ok over 20 years ago), I am embarrassed at the lack of information and taxation by rumour and policy. I was in the department and on the office helpline before Merseyside Cablevision and did not like telling people they could not get their VAT back. But I think that same mentality has never gone away in HMRC. They see this as a tax loss.

If I buy a widget machine and trade for 6 months before registering, my machine may knock out widgets for another 30 years and may still be worth a fair bit. That machine is a cost component of my sales of widgets and therefore, VAT is recoverable. This is distinguishable from widgets I have bought and sold - the VAT has been used up.

I have sent a response now to your article. I don't agree with the conclusion but this is a very rare event and I do hugely respect your views on VAT.
Wayne

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Neil Warren
By Neil Warren
17th Jun 2015 08:02

HMRC policy

Hello Wayne - thank you for this - I had heard there was litigation pending on this issue, which is good news to help clarify things - I also know that the topic is on the agenda for the next JVCC meeting. Regarding input tax, the recent case of Premier Foods (Holdings) Ltd was also very interesting, although I need to do more reading on it before I put pen to paper.          Neil Warren

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By johnjenkins
17th Jun 2015 09:21

We seem to

be missing the fact that there is (at the moment) a 4 year ruling. Have things changed in 43 years that this ruling should no longer be in force? There must have been a specific reason why the 4 year rule was created.

If you take the argument that a non registered self-employed person buys a van which includes vat. They don't claim the VAT back. After 12 months they set up a limited company and register for vat, The limited company buys the van with no vat and cannot claim vat back from the original invoice. So I really don't see why the 4 year rule is there.

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By robertt
17th Jun 2015 10:07

Services v goods

Watch out for HMRC challenging refunds on the "services v goods" basis particularly in relation to building works. HMRC are actively reviewing any building works required to enable a business to start trading that take place more than six months before registration and will seek to disallow anything that can be regarded as services rather than goods. you will need detailed invoice split between goods and services to support your claim even if the whole works have been capitalised.

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By Julian Stafford
18th Jun 2015 14:42

A further thought

I agree with what "Taxbreak" has to say.

As far as potential litigation is concerned, I can envisage one problem in that Regulation 111 says that HMRC "may" authorise someone to deduct VAT as if it were input tax. As various cases regarding CIS Gross Payment Status withdrawal have indicated, this implies a discretion on the part of HMRC. If they choose not to exercise that discretion, it is difficult to see what remedy the taxpayer would have other than an application to the High Court for Judicial Review of the reasonableness of the HMRC decision and/or the question of Legitimate Expectation if their publications are misleading. It is now fairly well established that the First Tier Tax Tribunal cannot look at the reasonableness of HMRC discretion unless there is a specific supervisory jurisdiction built into the relevant legislation. This is rarely the case (although it does apply if you have had your car impounded and fags[***] seized after a cross-channel shopping trip).

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By The VAT Doctor
24th Jun 2015 22:15

"May"

Hi Julian

The UK law does indeed say "may" and essentially says it is not input tax, but is allowed to be treated as such by HMRC at their discretion.

Unfortunately, like a few other bits of the UK law, this is just HMRC's twisted view of the world.

The UK definition of a taxable person is too restrictive and is non compliant with EU law. EU law says, if you make supplies of a business nature, you are a taxable person, but UK law says that you are one only when you are registered.  This leads to all sorts of issues and indeed HMRC's view of Reg 289 is influenced by this error.  HMRC accepted years ago they were wrong, but with a sense of dejavu, they are back again.  Years ago there was a case called Merseyside Cablevision, involving one of the early pioneers in cable TV.  They spent fortunes on cabling etc to get themselves up and running all before they had a customer (naturally).  Anyway, when they asked HMRC for a registration to claim this VAT back, HMRC said no, you are not a taxable person.  Thanks HMRC!! After litigation and a similar Belgian case, HMRC accepted they were wrong and preparatory activities are accepted as 'trading' for VAT and this classifies you a taxable person under EU law.  Hence 'intending' VAT registrations.

Anyway, where I am getting to is that the VAT incurred is incurred by a taxable person (EU definition) and therefore IS input tax, as an EU right, not by the gift of HMRC.  Reg 111 is not compatible with EU law.

There has been lots of reporting of this issue and seeming acceptance that HMRC are right.  I think it's nonsense and hopefully the planned litigation will prove me right. 

It's outrageous that HMRC has said nothing official, or announced via JVCC etc.  I think the reason is they know it is a try-on.

Finally, Stephen Walton, I respectfully don't agree.  Many assets can contribute towards taxable outputs for decades and the costs are cost-components of the outputs; it's a quid pro quo that if you want VAT on outputs, VAT on inputs should follow, leading to the value added being taxed.  Also, no proportionate output tax reduction on asset sales is mooted.  Some assets appreciate; not many, but some do - we have a client who uses and sells classic cars and these sometimes vastly appreciate.

 

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