Showing that a valid business exists can be a challenge for VAT purposes, particularly for charities and not-for-profit organisations. Neil Warren reviews the tests to consider in areas of doubt.
The case of Pat Willis Eco Ltd (TC05972) provides a good illustration of what HMRC look for when determining whether a business exists. The company had claimed that its main business was that of a public relations (PR) agency.
HMRC accepted that the company traded as a taxi business, but saw no evidence that it also operated as a PR agent, finding deals for “household names” in the UK with clients in Nigeria, earning a commission for its services.
It had not secured a deal since 2011 when it first registered for VAT. HMRC, therefore, used its powers of “best judgment” (VATA 1994, s73) to disallow input tax of £20,679 claimed on expenses supposedly relevant to the PR business, which were mainly building materials and clothing. There was an absence of purchase invoices to support most claims.
Intention to trade
There is no problem with a business becoming VAT registered and claiming input tax if it has an “intention to make taxable sales” – this would be a voluntary registration, (VAT Notice 700/1, para 3.9).
But the taxpayer must be able to show tangible evidence of future trading plans, such as:
- a business plan with projected income and expenditure over a number of years;
- contracts and orders with potential suppliers and customers;
- how the business will be financed in the period with no income; and
- correspondence about future trading plans.
John has purchased a derelict public house for £300,000 + VAT (the seller charged VAT because he had opted to tax the property). John will spend 12 months renovating the pub with an anticipated spend of £200,000 + VAT into four luxury flats, which he will then sell on the open market with a 99-year lease for £200,000 each.
John’s sales will be zero-rated (VAT Notice 708, section 5), so he can register for VAT as an intending trader as soon as he buys the property to claim input tax on his expenses for the project. There is no time deadline as to when he must sell the flats – it is all about his “intention to make taxable sales”.
The tribunal received no evidence from the company or its director of any retainers, contracts, potential customers or correspondence to indicate there was a PR business in place. The tribunal supported HMRC’s assessment that no such business existed and dismissed the appeal. The judge commented: “There were no records at all to support the claim for input tax deduction in respect of the PR business”
What is a business?
VAT experts often recall the landmark case involving Lord Fisher (ref: QB  STC 238), which considered whether the income from shoots he organised with his friends, for which they paid a fee, was deemed to be business income.
This case led to the court establishing six business tests, which are summarised in the VAT business / non-business manual (para VBNB22000) as follows:
1.Is the activity a serious undertaking earnestly pursued?
2.Is the activity an occupation or function, which is actively pursued with reasonable or recognisable continuity?
3.Does the activity have a certain measure of substance in terms of the quarterly or annual value of taxable supplies made (bearing in mind that exempt supplies can also be business)?
4.Is the activity conducted in a regular manner and on sound and recognised business principles?
5.Is the activity predominately concerned with the making of taxable supplies for a consideration?
6.Are the taxable supplies that are being made of a kind which, subject to differences of detail, are commonly made by those who seek to profit from them?
It was always going to be difficult for Pat Willis Eco Ltd to prove the company had a PR business in place.
The director told HMRC that he could not produce purchase invoices to support his input tax claims because the information was on two laptops that had supposedly been lost. HMRC did not accept this argument.
Even if the laptops had been lost, there was still the opportunity for the taxpayer to get copies of major purchase invoices from his suppliers to support his input tax claims, an option he had not taken.
For a balanced view on this issue, see my article about the case of a recording studio - Gravel Road Records Ltd (TC05598): Business failure no bar to claim input tax. The company convinced the First-tier Tribunal that it had an intention to make taxable sales and was therefore entitled to reclaim input tax on its expenses.
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.