Les Howard explains how a tiny charity defeated HMRC at the tax tribunal over the method it uses to calculate the amount of input VAT it could reclaim.
The privately funded charity (Will Woodlands) was involved in forestry. It acquired parcels of land to establish woodlands. Its objectives are described as “conserving, restoring and establishing plants and all forms of wildlife in the United Kingdom and securing and enhancing public enjoyment of the natural environment in the United Kingdom.”
The First-tier Tribunal (TC06021) held that the charity’s primary objective is to establish and protect woodlands. This became a significant point in the arguments before the FTT, as the charity’s primary income source was not income directly generated by forestry activities.
The charity was registered for VAT in 1994. In due course, it agreed separate business: non-business (BNB) and partial exemption special method (PESM) calculations. These calculations were based on areas under business use. This seems sensible, since the stated activity was that of a “taxable forestry business”.
The charity’s accounts indicate substantial investment and grant income, outweighing specifically forestry income significantly. This is to be expected during the early years of forestry activities.
In 2013, HMRC decided to challenge the BNB method used by Will Woodlands. The HMRC officer wrote: “I am concerned that the method agreed does not produce a fair and reasonable apportionment of VAT on taxable goods and services supplied.”
Although he accepted that a significant proportion of the trees grown would ultimately be harvested which would generate taxable supplies, this would not be for some time, i.e. over 100 years.
More seriously, he opined that the forestry business (production and sale of timber) was not a primary objective of the charity, but merely a consequence arising from its charitable activities. Its main purpose, he said, was “charitable environmental work”, and noted that the main income was investment (43.2%) and grants (46.3%). He concluded that the land area basis for the BNB method was inappropriate, and invited the charity to propose a revised method.
The officer, in response to a question from the tribunal, stated that he thought the apportionment did not give a fair result “because it allowed them too much input tax credit.” Of course he did.
The officer further commented that the land was not used entirely for taxable purposes, as there were pathways, water, grasses and other plants, which would not be harvested. He also said that the trees were not used entirely for business purposes, they were also to be used for charitable, heritage and environmental purposes.
In my option these reasons are, quite frankly, ridiculous. Why would a forest not also contain other plants? Why would trees not be environmentally friendly?
Correspondence followed between the parties, leading to VAT assessments covering 19 months for a total of £75,000 in disallowed input tax. HMRC’s calculation was based on income, which is always their default position. The disagreement proceeded to the appeal before the FTT.
In reaching its conclusion, the tribunal indicated that there were two questions to be determined:
- whether the BNB method operated by the charity was fair and reasonable; and
- a more detailed question about the attribution of certain costs.
The FTT stated that the partial exemption method was not at issue, although HMRC had queried this. No assessment in relation to partial exemption had been raised.
Fair and reasonable
In addressing this test, the tribunal commented that, although the burden of proof normally lies with the taxpayer, in this case, HMRC had to demonstrate that its own method was preferable to the method previously agreed with them by the charity. It noted that the previously agreed BNB method had been operated for many years.
Evidence was given that income from the woodland would be generated for up to 150 years. But the levels of income, from thinning, and then from felling and the sale of timber was not readily predictable, although some income estimates in relation to thinning were provided. During the earlier years little taxable business income was generated, as you would expect, but HMRC don’t seem to have taken this into account. The tribunal held that HMRC’s income-based method was unreasonable.
In agreeing with the charity’s land area calculation, the tribunal held that there was “no dual use” of the land. Land-related costs were attributable solely to taxable business supplies. Thus, the charity’s BNB method was fair and reasonable.