Claim for overpaid VAT held not to be abusive

30 August 2012. Published by Adam Craggs, Partner

In St Martins Medical Services Limited v HMRC [2012] UK FTT 485 (TC), the First-tier Tribunal (‘FTT’) has recently allowed a claim for overpaid VAT made by a taxpayer,...

…despite HMRC arguing that the claim should be denied on the grounds of being an abuse of rights by the taxpayer.

The facts

In December 1997, St Martin’s Healthcare Limited (‘Healthcare’) set up a subsidiary company in anticipation of a change in the law on 1 January 1998. The new subsidiary, St Martin’s Medical Services Limited (‘Services’), then invoiced medical supplies to Healthcare for £10 million. Services duly paid the relevant output tax to HMRC. Healthcare’s intention, by making the payment to Services before the law changed on 1 January 1998, was to recover the VAT on Services’ supplies as input tax. This was because, at the date of supply by Services, Healthcare’s onward supplies to patients benefitted from zero-rating which allowed for input tax recovery. Such a recovery was not, however, possible after 1 January 1998. Services, having made a taxable supply, would also be able to recover input VAT that it incurred on purchasing supplies to fulfil the contract with Healthcare.

Full disclosure

Healthcare wrote to HMRC and explained the details of the scheme. This lead to an HMRC visit and the HMRC officer involved duly wrote a report identifying what he perceived to be the weaknesses of the scheme. Despite this, and with full knowledge that a VAT avoidance scheme was in operation, HMRC repaid to Healthcare the full amount of the input tax which it had incurred on the December 1997 payment.

In December 2000 HMRC finally decided to challenge the effectiveness of the scheme put in place by Healthcare and issued an assessment to recover the input tax. HMRC considered that the scheme did not work. HMRC suggested, presumably in an attempt to be helpful, that Services could make a claim for the overpaid VAT which would result if HMRC was correct in asserting that the arrangements did not work. Services duly made a protective claim for overpayment of VAT.

All parties then waited for the decision of the European Court of Justice (‘ECJ’) in Bupa Hospitals Limited and another v HMRC (Case C-419/02). In their decision, the ECJ ruled that payments on account of supplies that have not yet been clearly identified cannot be subject to VAT. The result of the ECJ’s decision was that the Healthcare scheme was rendered ineffective.

The problem for HMRC was that the December 2000 assessment had been made late and the VAT Tribunal therefore allowed Healthcare’s appeal, holding that the assessment was out of time because all relevant facts were known to HMRC, so that an assessment could have been issued within the normal time limit which expired on 31 December 1999.

HMRC’s attack

As a result of its inability to recover the input tax from Healthcare, HMRC sought to block Services’ claim for overpaid VAT, arguing that it was an abuse of rights for Services to claim the repayment of overpaid VAT relating to the assumed supplies to Healthcare.

The FTT, however, was not sympathetic to HMRC’s arguments. In the FTT’s view, the effect of the Bupa decision was that the assumed supplies by Services to Healthcare were in fact not services. Accordingly, to obtain fiscal neutrality, HMRC should have obtained a repayment of the input tax refunded originally to Healthcare and Services should be permitted to recover the overpaid VAT. In the FTT’s view, the fact that the Healthcare scheme was artificial and designed to obtain unintended tax advantages was of no continuing relevance once it had failed and all steps to reverse it were taken. The failure to achieve fiscal neutrality resulted solely from HMRC’s neglect in failing to make timeous assessment against Healthcare. HMRC were now barred by the procedural time limits and Services’ claim was properly made.


This case demonstrates the extreme lengths that HMRC are prepared to go to in order to retrieve an adverse situation that arose as a result of their own neglect. As the FTT pointed out in its decision, Services had made the claim for overpaid VAT at HMRC’s instigation. There was nothing abusive about the claim. HMRC had caused the breach of fiscal neutrality and not Services and their attempt to prevent Services’ claim was an attempt to make up for their own neglect in failing to raise timeous assessments to recover the input tax.

It cannot be good practice for HMRC to encourage the taxpayer to make a claim on the one hand, and then seek to deny it, and by so doing put the taxpayer to the time and trouble of a contested hearing. This conduct is rendered even less attractive when the motives involved were to make up for an earlier act of neglect on HMRC’s part. It is to be hoped that HMRC will learn appropriate lessons from this case and act accordingly in the future.

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