V@ update - October 2022

Welcome to the October 2022 edition of RPC's V@, an update which provides analysis and news from the VAT world relevant to your business.

News

• In our last update, we noted that while speculation about a possible cut to VAT rates as part of the 'mini-budget' held on Friday 23 September had proven to be misplaced, a VAT-free shopping scheme was to be launched for visitors to the UK. Following the fiscal announcement on 17 October, this will not now take place.
• The European Commission has announced a wide-ranging review of the VAT rules applicable to the travel and tourism sector. More details can be found in its recently published working document here.
• From 1 November 2022, VAT-registered businesses must use software compatible with Making Tax Digital to file their VAT returns, unless they are subject to insolvency procedures or otherwise exempt from filing VAT returns online. More details can be found here.
• HMRC has updated its guidance relating to the domestic reverse charge to remove advice relating to the Reverse Charge Sales List and to remove supplies for final consumption from the list of supplies excluded from the reverse charge.
• HMRC has updated its guidance on VAT and duty deferments, adding information about deferring import VAT through a taxpayer's VAT account.

Case reports

Hedge Fund Investment Management Ltd v HMRC [2022] UKFTT 340 (TC)

Input VAT recovery – whether taxpayer carried on a business or economic activity

Hedge Fund Investment Management Ltd (HFIM) had, since 2006, been authorised by the Financial Conduct Authority to carry out regulated activities including fund management and research, advisory, and introductory services. Having prepared a 'prospectus' to pursue its fund management activities, HFIM suspended this part of its business pending the outcome of ongoing litigation in the Seychelles. It claimed input tax both on legal fees incurred in relation to the litigation in the Seychelles and in relation to other expenditure. HMRC considered that HFIM did not carry on a business or economic activity during the relevant period and that there was no direct and immediate link between the inputs and outputs and it therefore issued decisions and assessments disallowing the input tax claimed. HMRC also imposed penalties on the basis that HFIM had carelessly submitted inaccurate VAT returns.

HFIM appealed to the First-tier Tribunal (FTT) against HMRC's decisions and assessments in relation to the principal sums and the penalties.

The FTT found that at the relevant time, HFIM intended to make taxable supplies in the future and HFIM was carrying out other research advisory and introduction activities during the relevant period. The FTT decided that the input tax on invoices for legal fees had a direct and immediate link to a later invoice made out to a company in the Seychelles relating to the litigation and HFIM could recover that input tax. Regarding input tax on the other expenditure, the FTT directed the parties to review the inputs claimed and seek agreement as to the extent to which they were directly attributable to HFIM's intending trade, or whether they comprised overhead costs. The FTT allowed HFIM's appeal against HMRC's penalty assessments as it followed from its decision that HFIM was an intending trader during the relevant period and had not been careless.

Why it matters:

This decision adds to the discussion on the interpretation of the 'direct and immediate link' and the 'economic activity' tests for input tax recovery. It is also notable that the FTT requested written submissions from the parties on certain case law that had not been addressed at the hearing, and directed the parties to review the position and to seek to reach agreement on certain expenditure as there was not sufficient evidence before it in relation to that expenditure.

The decision can be viewed here.

Innovative Bites Ltd v HMRC [2022] UKFTT 00352 (TC)

Zero rating – whether giant marshmallows are 'confectionery' and therefore standard-rated

Innovative Bites Ltd (IBL), a wholesaler of American sweets and treats, manufactured and sold 'Mega Marshmallows' (the product). IBL treated the product as zero-rated for VAT purposes under Group 1, Schedule 8, Value Added Tax Act 1994 (VATA 1994).

While there is no set definition of 'confectionery', the legal framework from Note 5, Group 1, provides the following explanation: "'confectionery' includes chocolates, sweets and biscuits; drained, glacé or crystallised fruits; and any item of sweetened prepared food which is normally eaten with the fingers".

In HMRC's view, the product should have been classified as 'confectionery' by IBL and should therefore have been standard rated rather than zero-rated. HMRC issued assessments to IBL for £472,928, relating to periods between June 2015 and June 2019.

IBL appealed the assessments to the FTT. Its main argument was that the product was designed to be cooked or roasted before being consumed. It was intended to be used as a key ingredient in a particular snack called a 's'more', a traditional American campfire snack which consists of roasted marshmallows and chocolate that is layered between biscuits. It was on this basis that IBL argued that the product should not be classified as 'confectionery' and should be zero-rated for VAT purposes.

The FTT allowed the appeal. It held that the product was not 'confectionery' for the purposes of Excepted Item 2, Group 1, Schedule 8, VATA 1994. In its view, the term 'confectionery' would not be expected to include products that were intended to be 'subjected to another cooking process before being eaten'. In arriving at its decision, the FTT also considered the packaging and design of the product and its marketing and placement in supermarkets. The FTT concluded that the product was sold and purchased as a product specifically for roasting and could not therefore be classified as 'confectionery'.

Why it matters:

While it might feel intuitively that marshmallows of any variety are confectionery (and indeed the FTT noted that marshmallows were a 'confection'), the FTT took into consideration a wider range of factors, including the intended preparation and consumption of the product and its packaging and design.

The decision can be viewed here.

DCM (Optical Holdings) Ltd v HMRC [2022] UKSC 26

HMRC's best-judgment assessment not time-barred; HMRC has power to refuse to make VAT repayments pending verification

DCM (Optical Holdings) Ltd (DCM) was a VAT-registered business which sold dispensed spectacles and laser eye surgery. In common with many optical businesses, it made both taxable and exempt supplies and therefore was partially exempt. It operated as a repayment trader.

HMRC discovered on a VAT visit that DCM had not adopted the method of apportionment of input tax between taxable and exempt supplies that its accountants had represented would be used following the settlement of a previous dispute in relation to DCM's partial exemption method. It had also not adopted an acceptable method of charging output tax. HMRC issued a best-judgment assessment in relation to both output and input tax.

The output element of the assessment was appealed to the FTT and then, via the Inner House of the Court of Session, to the Supreme Court, on the basis that HMRC had been in a position to issue the assessment at an earlier point in time and therefore it was time-barred by operation of section 73(6)(b), VATA 1994, which empowers HMRC to make an assessment of VAT no later than the later of: (a) two years following the end of the relevant accounting period; or (b) one year after evidence sufficient to justify making an assessment comes to the knowledge of HMRC.

DCM also appealed the input element of the assessment on the basis that section 25(3), VATA 1994, required HMRC to apply the VAT credits claimed and that it did not therefore have the power to refuse to pay the sums claimed in the relevant repayment returns (the vires challenge). Section 25(3) provides that if there is no output VAT, or if the input VAT exceeds the amount of output VAT, the amount of the excess is to be paid to the taxable person making the return as a VAT credit.

In relation to the time-bar challenge (relevant to the output tax), the Supreme Court held that 'knowledge' meant actual knowledge rather than constructive knowledge. It therefore fell to the court to decide which facts justified making the assessment, and then decide when the last of those facts was communicated to HMRC. In this case, the last piece of factual evidence relevant to the assessment, made in October 2005, came to HMRC's actual knowledge on 31 August and 1 September 2005. The assessment was therefore in time and the appeal on the time-bar challenge was dismissed.

In relation to the vires challenge (relevant to the input tax), the Court held that there was no express power to refuse to pay a claim, so if such power existed it would arise by implication. The parties agreed that HMRC had both the power and duty (implicit in section 25, VATA 1994) to conduct a reasonable and proportionate investigation into the validity of a claim for repayment, and that HMRC could take a reasonable time to investigate a claim. This implied power was consistent with the purpose of ensuring that taxable persons paid the right amount of VAT or received appropriate VAT credits, and with the principle of fiscal neutrality. If HMRC did not verify traders' claims and refuse to pay sums that were not due, an unwarranted cashflow advantage would be provided to repayment traders. The vires challenge was therefore also dismissed.

Why it matters:

This decision provides important and authoritative commentary on the time limits set out in section 73, VATA 1994, as to which there has been some dispute. The Supreme Court's comments on the doctrine of fiscal neutrality, which underpins the operation of the VAT system, are also particularly interesting in light of the decreasing extent to which UK courts are able to take account of future CJEU jurisprudence.

The decision can be viewed here.