Will HMRC allow colleges to have their cake and eat it?

The background

Depending how long you’ve been working in the sector, you may remember what is commonly referred to as the ‘Lennartz’ VAT accounting principle. HMRC’s original view was that under Lennartz, instead of apportioning VAT recovery on capital assets up front, colleges and other entities could instead reclaim all VAT costs incurred in full at that time, and then account for output VAT to HMRC for any ‘deemed’ supply of the non-business use over the life of the asset.

Colleges often adopted Lennartz accounting for capital projects as it afforded a significant cash flow advantage. Furthermore, HMRC could not levy interest on the output tax payable on non-business use over the asset’s deemed life.

Unsurprisingly, HMRC was never particularly reconciled with colleges and other taxpayers adopting use of the scheme for capital assets. When, in 2009, a subsequent decision in the European Courts (C-515/07 - VNLTO) ruled that the Lennartz approach should never have been allowable in respect of an organisation’s non-business activities, but only on the private use of an asset, the availability of Lennartz was strictly limited to a mix of taxable and private use. In January 2010, HMRC changed its policy and guidance to stop future use of the Lennartz principle for non-business use.

Subsequent to this change, HMRC sought the written agreement of those colleges that had adopted use of Lennartz accounting to honour the ongoing commitment to account for output tax on the non-business use of the asset. It would raise assessments where a college etc failed to do so.

Where are we now?

An appeal in relation to the application of the Lennartz principle was recently heard last year before the tax tribunal and we currently await the outcome. This is a complex case, the general argument being that, as VAT was never legally reclaimable so payment of output VAT in relation to non-business cannot be enforced. Notwithstanding this, the previously reclaimed VAT would now generally be out of time for HMRC to insist on any clawback. To summarise, whilst VAT was originally recovered in full, and output VAT has subsequently been accounted for on non-business use, there could be an argument that any output VAT payable over the remaining term is not legally required.

We are aware of a number of colleges that have appeals standing behind the lead case, who may have also been actively encouraged to stop accounting for Lennartz output VAT in their payments to HMRC. Whilst there may be an argument to do so, there are also many factors which suggest that such action may be inappropriate, particularly where the taxpayer has provided written confirmation that it would continue to adhere to an agreement to honour previous commitments. Anyone in the VAT sector knows that there is no sure thing when it comes to complex VAT litigation.

What should you do?

Colleges that decide to stop accounting for output tax payable to HMRC for continued non-business use of an asset would certainly be at risk should the appeal ultimately fail. HMRC could potentially levy penalties plus interest to the withheld output VAT due.

Objectively, Lennartz accounting only concerned the accounting option, as opposed to agreeing eligible/non-eligible VAT recovery or the correct rate of VAT due and payable. To stop accounting for output VAT which may be due could be seen by some as akin to finding a legal loophole. For this reason, there is also a public perception reputational risk to consider.

Our advice would be to await the outcome from the pending appeal. In the event the case succeeds, and HMRC policy changes, then you may be able to make a protective claim for VAT overpaid. You would have then have had your cake plus have had a less contentious nibble.