The first tier tribunal (FTT) examined whether output tax could be reduced on the company’s VAT returns to reflect credit notes issued to customers. Neil Warren discusses the implications of the Tribunal’s decision.
Inventive Tax Strategies Ltd (TC06094) and three other companies were in administration or in the process of liquidation. They had all issued credit notes to customers who were entitled to a refund, but who would never receive any money because the company in question had no funds.
The administrators wanted to net-off the VAT shown on these credit notes against the VAT it had charged on invoices to customers
This group of companies had sold tax avoidance schemes, predominately to avoid SDLT, to over 3,000 customers and received advance fees for their services. All of the schemes failed for various reasons and most of the contracts said that if the schemes were unsuccessful, a full refund would be given to the customer.
Credit notes were issued to correct the original sales invoices but customers received no refund of money because all four companies went into either administration or liquidation.
The administrators and liquidators acting for the companies wanted to reduce the output tax payable in box 1 of the VAT return that was relevant to the date when the credit notes were issued.
Their argument was that the credit notes were correctly issued to reflect a “decrease in consideration” of the original invoices as a result of the scheme failures. This would be an “adjustment in the course of business”, as defined by the VAT Regulations 1995, reg 38 (SI 1995/2518).
The VAT adjustment, they said, should be based on the amount of money the customer was liable to pay (nil) rather than the actual payment (the original fee). HMRC’s main argument was that there could be no reduction in output tax because there had been no actual refunds given to the customers.
The tribunal concluded there needed to be “an actual repayment, as opposed to merely conferring an entitlement to one”. The case report added: “It follows that actual payment of a refund is required, in which case there will be a reduction in the price only to the extent of the amount actually refunded. It cannot be right that the appellants receive a repayment of 100% of the VAT where the customers receive a refund of less than 100% of the fees.”
The taxpayers’ appeal was dismissed.
It seems that the court took into the account the fact that the law needs to reflect a sense of fair play. Would it be playing the game with a straight bat if a business could charge £100 + VAT on an invoice and retain £120 with no VAT liability? That would have been the outcome if the credit notes were included on the company VAT returns.
The irony of this case is that the VAT rebates the companies were claiming from HMRC would probably have been the only source of potential refunds to the customers issued with the credit notes.
The tribunal report referred to “common sense and commercial reality.” A “decrease in consideration” only takes place when a customer either receives a refund or a credit against an outstanding payment.
The outcome of this case reminds me of the case of Simpson and Marwick v Revenue and Customs Commissioners ( CSIH 29) decided at the Scottish Court of Session.
The Court agreed with HMRC that the bad debt relief a company could claim on an unpaid VAT only invoice was 1/6 of the amount of the debt (i.e. based on the VAT fraction) rather than the full amount of VAT shown on the invoice.
In both the Simpson & Marwick, and Inventive Tax cases, the taxpayer was trying to achieve the outcome that payment had been received for making standard rated supplies without having an output tax liability on those monies.
In the case of Simpson & Marwick, the business usually invoiced an insurance company for the ‘net’ amount of its fees (which was paid) but the VAT element to the insured customer, who sometimes did not pay.
About Neil Warren
Neil Warren is an independent VAT consultant and author who worked for Customs and Excise for 14 years until 1997.