Constable VAT Focus 27 January 2023


Insurance sector partial exemption framework
HMRC has released new guidance for those dealing with partial exemption for insurers, including businesses and HMRC when discussing how partial exemption applies in practice for an insurer. The guidance is intended to help insurers gain approval for a fair and reasonable partial exemption special method (PESM) with minimum cost and delay.

HMRC confirmed that the guidance is neither mandatory nor binding and HMRC will consider whether to approve any PESM that an insurer declares fair and reasonable.

Repayment interest on VAT credits or overpayments
The above guidance provides information on repayment interest. HMRC updated the guidance to confirm when a person is not eligible for repayment interest. In addition, HMRC has now clarified the end date for repayment interest.

The second hand motor vehicle payment scheme

The second hand motor vehicle payment scheme is a new scheme that is being introduced from 1 May 2023. The scheme will allow taxpayers to claim a VAT related payment if you buy an eligible second hand motor vehicle in Great Britain and:

HMRC also released brand new guidance on how to check if the motor vehicles are eligible for the second hand motor vehicle payment scheme. In addition, new guidance was released on how to work out the value of a vehicle when calculating a payment using the scheme.

There is also new guidance to confirm which records should be retained for second hand vehicles exported to the EU for resale, and also the records required for vehicles moved to Northern Ireland for resale.

HMRC has confirmed that until the new scheme is introduced, on 1 May 2023, taxpayers should continue to follow the existing guidance.


Upper Tribunal

1. Organix and Nakd bars: Zero rated or confectionery ?

This case concerned Morrison’s appeal against the First Tier Tribunal’s (FTT) decision which rejected Morrison’s argument that certain products (Organix and Nakd bars) were zero rated food items. As Morrison accounted for VAT at 20% on the sales, it sought a repayment from HMRC; however, this was rejected on the grounds that the products fell within the exception from zero rating as they were ‘confectionery’. The FTT upheld this decision.

Morrisons has appealed to the Upper Tribunal (UT) on two grounds. Firstly, it argued that the FTT erred in law excluding from its analysis of whether the products were confectionery, relevant considerations such as the actual or perceived ‘healthiness’ of the products and/or the marketing of the products as ‘healthy’ products. HMRC referred to various points the FTT raised around the healthiness of the products and argued it did not err in law. However, the UT rejected HMRC’s submission that the FTT did take into account healthiness and perceived healthiness in the way suggested.

Secondly, Morrisons argued that the FTT erred in law in failing to consider that the absence of ingredients associated with traditional confectionery (cane sugar, butter or flour) was a relevant factor. The FTT concluded that the absence of such ingredients is not a factor pointing to the products falling outside the meaning of confectionery. The UT disagreed stating that whilst there will no doubt be examples of confectionery which do not contain such ingredients, but are nevertheless confectionery, it does not mean that the consideration of ingredients, and the absence of such, will not add to the overall picture of a product’s classification. As a result, the UT concluded that the FTT also erred in law on this point.

For both points, HMRC argued neither outweighs the cumulative weight of all the other factors and submitted that the result would therefore be no different. The UT stated that the ‘would have been different’ test is the wrong approach, and the question is whether the decision ‘might have been different’ which it was satisfied to be the case here. The FTT’s decision was set aside and the case was remitted back to the FTT to take place before a new panel.

Constable Comment: In this case, the UT remitted the case back to the FTT for another hearing. It will be interesting to see the outcome as the UT took the view if the arguments raised by Morrisons were considered as relevant by the FTT, the decision ‘might have been different’. Nevertheless, this case highlights the importance of seeking professional advice regarding uncertain VAT liabilities of food items from the outset. If you or your business have any related queries, Constable VAT has experience in this area and would be pleased to assist.

2. Bad Debt Relief: Interest on historic claims

This case concerned HBOS and Lloyds Banking Group (“the appellants”) and HMRC’s liability for interest in respect of bad debt relief claims made in relation to car hire purchase supplies made by the appellants between 1989 and 1997. HMRC is liable to pay a person interest where “due to an error on the part of the Commissioners… a person has suffered delay in receiving payment of an amount due to him from them in connection with VAT..”. Historically, to claim bad debt relief on a supply of goods, property in the goods must have passed, which prevented the appellants making bad debt relief claims as title was retained by the appellants under the hire purchase agreements where customers defaulted on hire charges. However, this condition was held to be unlawful under EU law in 2016. The appellants made bad debt relief claims in 2007. HMRC accepted and paid these claims in 2019 in addition to interest in the sum of £872,147 for the period from 2007 to 2019.

The appellants argued that interest is due from an earlier date, being the date that all conditions for a bad debt relief claim were satisfied, other than the unlawful property condition. HMRC rejected this claim and the FTT upheld their decision on the grounds that the enactment of the property condition was not an ‘error on the part of the Commissioners’, and the reason the appellants did not make an earlier claim was their belief that the property condition was legally valid.

The Upper Tribunal (UT) held that VAT is within the collection and management powers of HMRC, as the relevant responsible State Body, and behaviour of HMRC that is derived from an erroneous statutory provision will clearly be something capable of fitting with the words ‘error on the part of the Commissioners’. The UT therefore overturned the FTT’s decision and concluded that the appellants are entitled to claim interest with effect from the date at which all conditions for a bad debt relief claim were satisfied. The appeal was allowed.

Constable Comment: In this case the appellants have successfully argued that if not for an error, on the part of HMRC, within UK legislation, they would have made claims at the earlier dates, therefore they are entitled to interest from such dates. The ultimate quantum of the interest claim based on the earlier dates is still to be determined between the parties; however, the estimate for the total disputed period is estimated at £9 million.


3. Tour Operators Margin Scheme: Negative margin

This case concerned The Limited (TSL)’s calculations performed under the Tour Operators Margin Scheme (TOMS) and whether the TOMS operated in such a way as to permit a negative calculation resulting in a repayment to TSL. TOMS is a simplification measure and applies to supplies of designated travel services. VAT is accounted for on the margin between the selling and purchase price of the supply and input VAT is precluded on supplies bought in for onward supply under TOMS.

TSL provides serviced accommodation which it leases for extended periods from predominately non-VAT registered owners. In the period in question, TSL bought in (leased) accommodation which it could not supply profitably (“inventory sold at a loss”) or in some cases at all (“unsold inventory”). TSL contended that TOMS should provide a similar result to normal VAT accounting such that where input VAT exceeds output VAT, HMRC should repay the VAT cost of the negative margin and there is nothing within the terms of TOMS that precludes a negative margin scheme calculation.

HMRC contended that there is no basis for calculation of negative output VAT under TOMS and the scheme should be applied only to the extent necessary to achieve its aims. A taxable person rendering conventional VAT returns may be in a repayment position because their input tax exceeds their output tax, but output tax is always a positive amount.

The Tribunal agreed with HMRC and upheld that there has been a supply made by TSL, in return for consideration, and it is the taxable amount of that supply which is to be determined. A negative taxable amount is conceptual impossibility.

The Tribunal considered the application of inventory sold at a loss and concluded that where a supply is sold at a loss, the taxable value under TOMS will be £0. However, when the annual calculation is performed, the full purchase cost of a specific transaction would be permitted to be included, and to that extent permitting the use of a negative margin, as long as the overall calculation results in a positive taxable amount. If the overall result of the annual calculation is a negative margin, the sum due by way of output tax would be £0. The annual sum due under TOMS cannot be a repayment.

With regards to unsold inventory, the Tribunal noted that only input VAT incurred for the re-supply of a travel service is excluded from recovery. Therefore, VAT borne on inventory bought in, but unsold, would not be excluded from recovery. However, in this case, whilst the Tribunal considered that identified costs incurred in buying in goods and services which are not subject to onward supply should be excluded, costs associated with block booking of accommodation should be included. Where such costs exceed the value obtained for onward supply the negative margin forms part of the annual calculation; however, where the global calculation results in a negative margin, again, the tax due under the TOMS is £0 and there is no basis for a repayment to TSL.

Constable Comment: In this case, the Tribunal confirmed that a taxpayer operating TOMS is not entitled to a repayment as a result of the supplies not being profitable.  It was stated that a negative margin can arise as a consequence of lack of profitability, but VAT is a transaction tax and not a profit tax.

4. Input VAT recovery on fundraising

This case concerned Ince Gordon Dadds LLP appealing HMRC’s decision to disallow input VAT in the sum of £73,238. The input VAT denied related to Project Kappa, being the flotation of Gordon Dadds Group Limited (previously known as and referred to a Culver) on the Alternative Investment Market (AIM) and the raising of £20million. The flotation was affected as part of a reverse takeover in which Works Group Plc (WG) acquired Culver. WG joined the Culver Holdings VAT group the same day that the takeover took effect.

WG incurred input VAT on services in relation to the takeover and sought to recover this via the VAT group representative member, Culver. HMRC took the view that WG did not make or intend to make supplies within the scope of VAT and therefore the input VAT is not recoverable.

WG contended that the services are treated as made to the representative member (Culver) which carried on the taxable activities of the group as a whole, and as the cost of the supplies formed part of the overheads of Culver, the input VAT incurred is recoverable, even considering the position prior to the takeover.

Alternatively, WG argued that input VAT was incurred by WG in fundraising to further downstream economic activity of WG, being the activity of Culver which is owned by WG. WG acquired these supplies in order to raise capital to support and fund the expansion of the taxable activities of the VAT group it intended to join and did join upon acquisition.

HMRC disagreed and stated that merely joining a VAT group does not give rise to an entitlement to recover VAT. It cannot change a non-economic activity into an economic activity, nor does it automatically create a direct and immediate link between all input costs of a holding company and the taxable outputs of other VAT group members.

The Tribunal considered the principles from Frank Smart and BAA to determine whether input VAT is recoverable and dismissed the appeal. Whilst the Tribunal accepted that WG had an intention to join the VAT group and its intention was fundraising, there was no evidence to prove that funds were intended to or had actually been used as working capital (to fund ‘downstream’ operations). Instead, the money from the fundraising was used to acquire other businesses that became customers of Culver’s management services. The Tribunal stated that this finding was fatal to the appeal as such use of funds is not within the reasoning of Frank Smart principles, and as a result it was concluded that input VAT incurred by WG on Project Kappa is not recoverable.

Constable Comment: This case highlights the importance of considering input VAT recovery rules prior to takeovers. There are complex rules around takeovers, holding companies and VAT groups and it is important that professional advice is sought in advance.

5. Car available for private use

This case concerned the recovery of VAT incurred by  London Drylining Ltd (LDL) in relation to an Audi Q5 motor vehicle, which was purchased exclusively for business purposes. HMRC took the view that there was nothing preventing private use of the vehicle, therefore input VAT is blocked. As a result, HMRC raised a VAT assessment of £9,052.00 and penalty for a careless error of £1,357.80.

The appellant contended that the vehicle was used exclusively for business purposes. Whilst there is nothing that prevented the director of LDL from using the vehicle for personal reasons, the vehicle has only been used for business purposes. The director had access to other vehicles for private use and the appellant also provided a mileage log which accurately matched the vehicle’s mileage on the odometer.

The Tribunal highlighted that input VAT is blocked if the vehicle is available for private use, rather than if the vehicle was actually used privately. The Tribunal stated that there was nothing preventing the appellant from using the vehicle for personal reasons. The insurance of the vehicle permitted use of the car as ‘social, domestic, pleasure and commuting’ without any reference to business use. The Tribunal accepted the mileage log; however, the fact remains that the vehicle was available for private use and therefore input VAT is blocked. As a result, whilst HMRC agreed to suspend the penalty, the VAT assessment was upheld and the appeal was dismissed.

Constable Comment: This case highlights that even if a vehicle is not used for private purposes, but is available for such use, the input VAT is not recoverable. It is difficult to prove that a vehicle is not available for private use and HMRC recommends taking steps such as insuring the vehicle for business use only and agreeing to restrict the vehicle use by employees or directors to business use only.

Please note that this newsletter is intended to provide a general overview of the subject. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this blog post. Specialist VAT advice should always be sought in relation to your particular circumstance.