Claiming pre-registration input VAT

When I mention my days as a VAT officer with HM Customs and Excise, my children roll their eyes and say ‘back when the dinosaurs roamed the earth’. They do, to some extent, have a point; those days were nearly 30 years ago.

 

However, in the context of this article, the experience has come in handy. As a young officer, I carried out mainly ‘000’ visits. For readers not familiar with this term, these were visits to newly registered businesses and took place between 12 and 18 months of registration. Pre-registration input VAT was, therefore, one of the areas that I frequently checked. I can clearly remember my training and the public and internal guidance available on the matter.

 

So why this trip along memory lane? It seems that the position on pre-registration input VAT – as I and others believed it to be – has changed recently. The change was not publicised and there was no transitional phasing in. HMRC is now instructing officers to apportion the VAT according to the use before and after registration. But is this within the law?

 

Under the existing rules, a number of conditions must be met in order for pre-registration VAT to be eligible for reclaim; and the rules are different for goods and for services. Goods must be on hand at the date of registration and must have been purchased in the preceding four years; while for services, the time limit is six months. For both goods and services, the VAT must not be ‘blocked’ elsewhere (e.g. input VAT on cars and business entertaining). If all of these conditions were met, and assuming that a business is fully taxable, most advisors used to be of the view that the VAT was reclaimable in full. In cases where the business was partly exempt or had non-business activities, it may have been necessary to restrict recovery under a partial exemption/non-business method.

 

 

This adviser view is reflected in VAT Notice 700, para 11.1, which states: 

 

 

VAT Notice 700 paras 11.2 and 11.3 go on to explain the criteria for claiming the VAT, so it looks like this supports full VAT recovery. This would be the guidance that a taxpayer would turn to when deciding whether or not the VAT is recoverable.

 

In addition, the section on the front page of HMRC’s VAT website says: 

 

 

Again, there is no hint that the VAT may not be recoverable in full. 

 

However, contrast this with HMRC’s guidance in its VAT Input Tax Manual at VIT32000, which officers are now following and using to issue assessments to restrict the VAT recoverable on pre-registration costs:

 

 

It goes on to state:

 

 

This guidance itself seems to be contradictory. It states that the taxpayer should be put in the same position as if it had been registered when the VAT was incurred, taking into account non-business and exempt supplies. However, the subsequent paragraphs state that only the proportion of VAT relating to the taxable supplies post registration is recoverable, which seems at odds with this concept.

 

 

What does reg 111 of the VAT Regulations, SI 1995/2518, say?

 

 

There is no mention in reg 111 of an apportionment of the VAT between the period prior to registration and the period after. Rather this confirms the position that the taxpayer is entitled to recover the VAT to the extent that they would have been entitled to, if they had been registered at the time the cost was incurred.

 

I raised this with the Joint VAT Consultative Committee (JVCC) earlier this year. Its response was that reg 111 was based on art 289 of Directive 2006/112/EC, the Principle VAT Directive (PVD). Article 289 says: 

 

 

In fact, HMRC seems to be relying on art 286, as well. This refers to a taxpayer being exempt if it is trading under the VAT threshold in a member state. It seems that HMRC is using the term ‘exempt’ to mean that a taxpayer is making exempt supplies when trading under the threshold; and, therefore, the VAT incurred should be apportioned to reflect this.

 

However, this does not stack up. VATA 1994 Sch 1 para 1 refers to the taxpayer’s ‘taxable supplies’ exceeding the VAT threshold. If HMRC’s argument is to be believed, the taxpayer is making exempt supplies at this point and would not be required to register for VAT. Following that logic, there would never be a requirement to register for VAT, as a person only making exempt supplies cannot do so. 

 

HMRC cannot have it both ways.

 

Although the interpretation of arts 282 and 289 is quite literal, it does not seem to be within the spirit of the law. Article 286 is a simplification for the purposes of small businesses and art 289 refers to the non-deductibility of input tax relating to exempt supplies in general.

 

 

What does case law have to say on the matter? In the case of Denise Jerzynek v HMRC (2004) VTD 18767, the tribunal was quite clear that no apportionment was allowed under reg 111. HMRC’s internal policy at the time was referred to and no apportionment was mentioned in the guidance. 

 

In the more recent case of Earl Redway v HMRC [2015] UKFTT 418 (TC), there was no dispute over the VAT that was allowed on the goods on hand at the time. One can only assume that there had been no disallowance of VAT in this case, as the taxpayer had no argument with this amount.

 

 

So, where does this tie in with the time of the dinosaurs? Well, at the most recent JVCC meeting, the HMRC policy unit stated that the apportionment had been the policy for the last 25 to 30 years. In an ‘I am Spartacus’ moment, I and several others responded that we had been officers or advisers at that time and it was not the case. 

 

HMRC’s view is quite obviously flawed. It may be a literal view of the EU law, but is it necessarily correct? The apportionment is neither reflected in the UK legislation nor in case law. Therefore, should any such assessment be received, it should be challenged vigorously. There is a case going through the tribunal system at the moment; it is not due to be heard in the near future, but it will give a case that any appeal could be stood behind.

 

In the meantime, we need to keep chipping away at the dinosaur that is HMRC’s policy. I shall be raising it again at the JVCC. The policy is flawed and unlawful.

 

The views expressed in this article are those of the author and not necessarily those of Grant Thornton UK LLP.