VAT: HMRC assumption of missing sales was wrong

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Neil Warren reviews a case where HMRC concluded that the capital introduced to a business came from understated sales.

Dodgy curry

Going back about 30 years to my Customs and Excise days, I did an inspection on an Indian restaurant, where concerns had been raised about the total output tax being declared by the business on its VAT returns. The declared VAT seemed quite low compared to similar establishments in the area. So I put on my best Hercules Poirot hat and visited the premises to find out what was going on.

To cut to the chase, the director was suppressing about 50% of his sales from his VAT returns, but because this left the company with insufficient cash to pay its trading expenses, he brought the suppressed money back into the company as “capital introduced”. He admitted to his crime and I raised a big assessment and a separate penalty notice. He was lucky that this was in the days before Customs and Excise and the Inland Revenue talked to each other, otherwise he would have had a corporation tax problem as well!

Second-hand cars

Roll forward 30 years to the FTT case of Thomas O’Rouke T/A Southgates UK (TC06335): a business which bought and sold second-hand vehicles, and also did repair work. The facts followed the same story as my Indian restaurant investigation, but there was a happier ending for the taxpayer.

An HMRC assessment for £29,539 was raised using the VAT officer’s best judgment that there had been suppressed sales. That figure was based on the capital introduced figures shown in the annual accounts for years 31 July 2011 to 31 July 2014. The same accounts recorded accumulated trading losses of £164,000.

HMRC had evidence of 12 cars being purchased in periods March and June 2014, but with no evidence of the vehicles being sold. There were also instances of spare parts being purchased in December 2012 with no link to either a sold or repaired vehicle.

Best judgment?

The tribunal had to consider whether the officer had used his ‘best judgment’ in raising the assessment under s73(1), VATA 1994. It seemed that the officer had not taken into account the full facts about the apparent accounting anomalies.

For example, the taxpayer claimed that the capital introduced had mainly come from an increase in his mortgage (now standing at £101,000) plus other loans of £10,000. He also had rent arrears of £16,000 on his trading premises. The 12 vehicles missing from his records had never belonged to him but had been bought by a third party at an auction who did not hold an account at the auction in question.

The decision

The tribunal was in no position to establish the correct figure of any underpaid VAT, but it was not satisfied that HMRC had used ‘best judgment’ in raising its assessment and properly considered all relevant facts. So HMRC was asked to go away and recalculate the assessment based on the facts and information provided by the taxpayer. 

Judge Anne Fairpo commented: “As far as possible, our primary task is to find the correct amount of tax on the material available. However, we cannot determine whether the assessment should be quashed altogether or be assessed for a different amount as we were simply not provided with sufficient information even to determine whether there was any element of under-declaration, as submitted by HMRC, or of over-declaration, as apparently indicated by the appellant’s accountants’ analysis”.

Losses allowed

There is no crime in a business making a trading loss, and those losses can occur over many years in some cases (think of internet-based businesses!). However, it is important for advisers to consider two key issues, in order to be ready with answers should HMRC query the source of funds for the business or the owner.

  • Financing of losses: What are the sources of capital introduced to the business and is there documentary evidence of this introduction?
  • Personal expenses: In the absence of business profits, how is the business owner paying for his personal expenses including mortgage payments, domestic bills and food?

About Neil Warren

Neil Warren

Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.


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