HMRC is not missing a trick. Historic approval may not let you off the hook. We offer advice on how to protect your business from a nasty shock.
A VAT-registered company that regularly reclaims, and receives, refunds from HMRC for input VAT incurred on its expenditure unchallenged, might assume its historic input VAT refunds are secure. Unfortunately, this is not the case.
Since the change in Government, a reinvigorated HMRC is now reviewing VAT returns filed in the past four years. Many of these inspections arise from a pre-credibility check of the most recent return that claimed a refund of VAT.
Until HMRC’s enquiries are resolved, it holds on to the input VAT refund claimed, as well as other input VAT refunds claimed in the meantime. This is to offset any historic monies identified as owed to HMRC, against the most recent claims for input VAT refunds. So, from a cash flow perspective, it’s in the interest of the business to resolve HMRC’s enquiries as quickly as possible.
The power to review
Let’s take a scenario where HMRC issues an assessment to claw back previously made input VAT refunds plus interest (currently 8%) and, potentially, also a ‘careless error’ penalty of up to 30% of the amount of VAT clawed back.
The business may try to argue that HMRC’s previous willingness to make VAT refunds without challenge should make a difference. That it should somehow stop it from retrospectively applying its current view on how the business should correctly account for VAT on its transactions. But this is incorrect.
Where HMRC has merely processed filed VAT returns without query, it has no knowledge of how the figures reported have been calculated. But the VAT Act gives HMRC the power to review, and challenge where necessary, the underlying VAT return workings going back up to four years.
Not a full audit
Where a business points out a previous four-year VAT inspection, or a pre-credibility check of one VAT return, on which HMRC did not carry out a VAT assessment in respect of the accounting error that it is currently identifying, the business may try to argue that HMRC approved its VAT accounting during those previous interactions.
But be warned: when it concludes a pre-credibility check of a single VAT return, HMRC says the following in the closing communication to the business:
“It is important that you understand that this check is not a full audit of your VAT declarations. If we consider that a more detailed check of the same period is appropriate we may carry out a further review at a later date.”
False sense of security
So, input VAT refunds received following a ‘successful’ pre-credibility check of a single VAT return are, as far as HMRC is concerned, provisional and subject to future enquiries as part of any future in-depth four-year VAT inspection.
Where HMRC has previously carried out a four-year VAT inspection without challenging the business’s VAT accounting, the business may feel it has stronger grounds to rebuff any retrospective VAT assessments issued now.
But the courts have confirmed this is not the case on several occasions. The most recent was Realreed Ltd t/a Chelsea Cloisters, where the taxpayer lost its judicial review High Court case against HMRC’s retrospective four-year VAT assessment issued – even though several previous VAT inspections had passed without incident.
The Court ruled that a taxpayer can only defend against retrospective VAT assessment action where HMRC has done or said something positively, during a previous inspection, about the taxpayer’s VAT accounting. In other words, HMRC clearly states in writing that it agrees with the taxpayer’s VAT accounting – rather than just not taking issue with it by issuing a VAT assessment.
What is ‘reasonable care’?
The same taxpayer also lost its argument, in the First-tier Tribunal, that HMRC should not have levied a ‘careless error’ penalty, on top of the retrospective four-year assessment for VAT and interest. HMRC considered that the taxpayer had not taken ‘reasonable care’ in its VAT accounting. The Tribunal provided these reasons for its view:
- The taxpayer did not take considered professional advice about its VAT accounting from a specialist VAT adviser, nor on whether HMRC’s conduct following previous VAT inspections (when no assessments were issued) gave the taxpayer a ‘legitimate expectation’ that HMRC had effectively approved the taxpayer’s VAT accounting.
- When he arrived at the business, the taxpayer’s current finance director did not investigate (internally or externally) the taxpayer’s VAT accounting – he just accepted that it was correct.
- HMRC offer a VAT ruling service – the taxpayer did not use this to try to obtain positive written confirmation from HMRC that it agreed with its VAT accounting.
How should a business protect itself?
Obtain VAT advice from a specialist VAT adviser. Even if HMRC disagrees with the VAT accounting used, it shouldn’t levy ‘careless error’ penalties on top where a competent adviser has provided an arguable view that the taxpayer’s accounting is correct, based on full knowledge of all of the relevant facts.
Where there is a risk that HMRC may seek to claw back previous VAT refunds (plus interest), then consider one or more of the following actions:
- Earmark funds to cover any potential future VAT assessments.
- Where the total potential amount at stake is greater than £1m, consider taking out tax exposure insurance
- Where possible, follow the advice given by the specialist VAT adviser and change contractual and commercial arrangements to support the VAT accounting method currently used.
For further guidance on any issues raised in this article, please contact Mark Ellis.
