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Audit Scotland resisting £4.1m VAT claim

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15th Oct 2013
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Audit Scotland is fighting a £4.1m claim from HMRC for VAT the tax department says was wrongfully recovered on subcontracted local government audit work carried out accountancy firms.

In a letter to the Scottish Commission for Public Audit (SCPA), a committee of the Scottish Parliament that oversees the public sector audit watchdog, auditor general for Scotland Caroline Gardner explained, “Since 2006 the Accounts Commission has had an agreement with HMRC that allows it to recover input VAT on local authority work.

“The agreement recognises the Accounts Commission as [a] body similar to a local authority. Audit Scotland administers this VAT recovery on behalf of the Accounts Commission and in the past two weeks HMRC has now challenged the agreement suggesting that the input tax recovered since the start of the agreement (£4.1m) should be repaid.”

The dispute goes back to when Audit Scotland was created through a merger of the former Accounts Commission for Scotland with the National Audit Office’s operations north of the border. The Accounts Commission enjoyed a VAT exemption through its “section 33 status” and Audit Scotland negotiated to continue that arrangement with the Inland Revenue, Gardner told MSPs at a hearing last week, The Scotsman reported.

Gardner said Audit Scotland had acted in accordance with HMRC’s instructions since 2006 and intends to challenge the £4.1m claim “robustly”.

Audit Scotland has also made a provision in its 2013-14 accounts for a further £160,000 to fund VAT liabilities that are likely to crystalise in the next year. This smaller sum concerns interest and penalties liable on income earned by contracting staff to other public bodies, Gardner and her colleagues explained.

If HMRC persists with its stance, Audit Scotland will either have to ask the SCPA for extra funding or recover the sums paid in VAT and penalties by raising fees for local government audits by 4-5% - “neither of which is palatable”, Gardner said.

HMRC would not comment on an individual company, but referred readers to its VAT manual for its current procedure on section 33 bodies. Section 33 of the VAT Act 1994 allowed listed bodies to recover VAT incurred on non-business activities so that the additional taxes would not create an additional burden for councils and ratepayers. The bodies listed include police, local authorities, port and transport authorities, development agencies, the BBC and other more obscure public sector bodies. It also states that the Treasury can designate an authority to be included in the list.

The HMRC manual is not a legally binding document, but highlights the legal requirement that the supply should not be for "for the purpose of any business carried on by the body". The criteria for requesting an s33 listing, meanwhile, emphasise that the body should undertake a function ordinarily carried on by local government, and have the power to draw funding directly from local taxation - neither of which appears to apply for Audit Scotland, which has to rely instead on an understanding going back several years.

Now that the matter has surfaced at the public SCAP hearings the Scottish Office or Treasury could act to resolve the impasse - or stay out of the picture and leave HMRC to deal with a potential legal tussle with major ramifications for next year's independence vote.

When the tax department highlighted some of the possible problems of independence in 2012 and stated it was under no obligation to collect any additional Scottish levies, Scottish Nationalist finance minister John Swinney responded by saying an independent Scotland would set up its own national tax agency.

A separate Revenue Scotland “would serve the needs of the people of Scotland at a lower cost than the UK set up”, Swinney said.

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