VAT Director Rayner Essex
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VAT: Burning question of input tax

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A Northern Irish VAT case considered the trader’s ability to reclaim input tax when a large proportion of his income was from the Renewable Heat Incentive (RHI), rather from taxable sales. 

16th Jul 2021
VAT Director Rayner Essex
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The right to reclaim VAT exists where there is a direct link between the input tax (purchases) and the taxable business activities of the business (sales). For the most part, this direct link is obvious and uncontentious.

Colin Newell (TC08149) was a sole trader whose taxable activities involved generating heat, which was used to dry wood. Newell burned wood chips to generate the heat and he operated six boilers to perform these activities. 

The business received substantial funding via the RHI for Northern Ireland whilst Newell only made taxable sales of hot air, offering drying services to other businesses.

Facts

HMRC’s stance was that the business made both taxable sales and also outside the scope of VAT sales (the RHI funding). Therefore, its input tax should be restricted to only that directly related to its physical taxable sales. In effect the input tax reclaimed should be restricted by the percentage:

Taxable sales

Newell argued that the RHI funding was a subsidy and that as he did not make any exempt sales, only taxable sales, a claim for the full input tax should be permitted.

HMRC argument

HMRC’s focus was on restricting the input tax because VAT is only recoverable when it is directly linked to the activities of the business; the RHI subsidy was not directly linked. HMRC also argued that a charity receiving grants or subsidies would have to exclude such income when performing a partial exemption calculation.

The tribunal, quite rightly, saw it differently. With regard to the charities example, charities often make exempt sales, and the legislation is clear; where a business makes exempt and taxable sales, it must restrict its input tax to only those purchases related to the taxable activity, in effect, a partial exemption calculation.

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Replies (10)

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By Hugo Fair
16th Jul 2021 19:29

Interesting. On a quasi philosophical point ... why is HMRC allowed to pick example scenarios where they feel a 'win' will give them access to lots of revenue from similar scenarios (in this case including farmers and those producing electricity or ecological products according to Jason)?

I'm not sure I've expressed that well, but it feels wrong that an individual company has to fight (and pay for that fight) when patently operating within the current legislation - whilst HMRC pours the taxpayers' money into the endless maw of grateful lawyers.

In this type of situation, wouldn't their time (and our money) be better spent trying to convince those responsible that a change in law is needed (without trampling on individual businesses)?

Thanks (3)
Replying to Hugo Fair:
Jason Croke
By Jason Croke
19th Jul 2021 13:39

Its always been the case that HMRC get on the offensive where they think there is a potential exploit, the thing is, HMRC are so paranoid they think there is a potential exploit everywhere.

This case was fascinating, HMRC effectively inventing new rules where one did not exist, perhaps they were worried that this could open the floodgates for similar structures?

HMRC have in the last 18 months been doing a lot of inventing new rules where they don't exist, loan charge being a classic example. For VAT, HMRC have attempted to argue their guidance was always clear on disbursements and compensation for cancelled contracts and this caused uproar as their guidance didn't say what they think it said but had they got away with it would have allowed HMRC to make back claims from legitimate businesses simply following the rules.

Thanks (1)
RLI
By lionofludesch
19th Jul 2021 07:43

There's an interesting comparison here to the MOT garage. I've never come across any suggestion that input tax should be apportioned between taxable sales and outside the scope MOT test fees.

Why should Mr Newell's case be different?

Thanks (0)
Replying to lionofludesch:
Jason Croke
By Jason Croke
19th Jul 2021 13:46

HMRC's arguments were weak, they took a specific rule that denies input tax relating to not-for-profit entities and tried to argue that Mr Newells business was akin to a not for profit business on the basis had it not received the grants/ it would have made a loss.

As you posted, MOT's are outside the scope of VAT and the law clearly states you can reclaim input tax on purchases that relate to outside the scope of VAT supplies as long as those suppliers would have been taxable, which sale of heat/drying is.

I suspect HMRC are worried about all these other businesses who receive substantial grants, whether for electricity generation or something else - which can be treated as outside the scope of VAT without restriction on input tax.

For example, SEISS grants are outside the scope of VAT/not a supply for VAT purposes, so does that mean a business that say receives £100k of grants with a total turnover of say £200k in the year means they can only reclaim half their input tax?

Thanks (0)
Replying to Jason Croke:
RLI
By lionofludesch
19th Jul 2021 13:59

Yeah, but, Jason, this isn't a new thing. MOTs have been outside the scope of VAT since 1973 and we've not heard a peep out of HMRC about it.

Why would they be worried about RHI - or SEISS for that matter - but not MOTs ? Having established a near fifty year track record of the principles ?

If HMRC want to change the law and treat RHI differently to MOTs, it's perfectly within their remit to lobby their MP. And I suspect that they'd have a much greater chance of success with that than Joe Public.

Thanks (1)
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By Steve99
20th Jul 2021 00:48

Mot's I seem to remember that garages that only did mot's were not able to register for vat. A normal garage was not entitled to recover vat on direct costs ie new machines relatingto the mot's, but there was no attribution of costs between the taxable and o/scope income. But it's been a while and my retired brain is starting to get a bit fuzzy...

Thanks (0)
Replying to Steve99:
Quack
By Constantly Confused
20th Jul 2021 15:37

If you just have taxable and exempt supplies, no brainer, partially exempt, 3 pots, de-minimis, the whole nine yards.

If you add OS to the mix... I have never taken that into account on a partial exemption calc - I'm confident that that is correct when it comes to the pot, I'm now doubting myself as to items specifically attributable to OS supplies. So the electric I would split between taxable and exempt, but a part for a machine that literally only relates to the OS side of things (I'm not mechanical, so not sure of an example........ the... rubber stamp they use to say 'MOT'd'!), would I block recovery as it doesn't relate to a taxable supply?

Hmmmm

I know if you make B2B services outside the UK it is outside scope but with recovery for directly attributable items, but that's because the service would have been taxable in the UK. MOTs aren't, so does that prevent recovery?

Certainly I don't agree with HMRC in the above case as the partial exemption rules don't mention outside scope anyway!

That was a bit stream of consciousness due to the heat, so apologies if I have rambled or talked nonsense...

#Edit#
Meant to say - if a client only made OS supplies I would tell them they couldn't register for VAT, as they have no taxable supplies.

But if they only had taxable and OS supplies i would consider them fully taxable.

Rightly or wrongly :)

Thanks (1)
Replying to Constantly Confused:
RLI
By lionofludesch
20th Jul 2021 16:17

You'd be right.

Outside the scope of VAT means exactly that.

Thanks (0)
Replying to Constantly Confused:
Jason Croke
By Jason Croke
23rd Jul 2021 15:37

Outside the scope of VAT is weird (like everything else in VAT).

In your example a client who only made OS supplies, well, they can actually voluntarily register for VAT in certain circumstances.

If the supplies the business make would have been VATable in the UK, but because of the place of supply rules, the supply takes place outside of the UK, then the business can register for VAT and reclaim its input tax.

You see this often with a one-man consultancy business, they have one business client, not in the UK (say USA), say they supply IT services, these would be standard rated in the UK but if his only customer is in USA, the place of supply shifts to where the customer is, so IT guy makes an outside the scope of VAT supply because of the place of supply rules.

But had he made that supply in the UK, it would have been VATable and so IT guy can register for UK VAT, reclaim his input tax and nil output tax.
https://www.gov.uk/hmrc-internal-manuals/vat-registration-manual/vatreg2...

Thanks (0)
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By Steve99
21st Jul 2021 01:07

Where you have exempt and o/scope income you obviously do the p/e calculation first with the usual de minimis rules, then you do a non business calculation on what's left, ie direct attribution then you work on the pot after any adjustment re p/e if any.
It has been 25 years since I did a garages vat, but I'm pretty certain it was only directly attributed vat was disallowed, and doing a calculation on the pot was ignored, but as I said earlier I've slept a lot since then and my brain gets a bit fuzzy these days.

Thanks (0)