VAT assessment upheld despite HMRC not challenging VAT treatment on previous inspections

When a VAT inspection passes without incident, it may be easy for businesses to assume their VAT strategy is correct and let VAT planning and compliance projects slip down the list of priorities for a while. However, recent decisions from the courts and tribunals have shown how a recent and/or uneventful HMRC visit is no guarantee against unexpected VAT bills waiting around the corner.   

Case #1 – Realreed 

Realreed, a property company let out 200 flats located in London as serviced accommodation, either to private leisure travellers or to businesses seeking temporary accommodation for their employees. A connected company provided guests with related services such as Wi-Fi, bed linen and housekeeping.

From the time the business began in 1989, it treated these lets as an exempt rental of property, with VAT only charged by the connected company on the related services. However, in 2019, HMRC formed the view that the lettings were in fact subject to VAT and assessed the company for £4.8m to cover VAT it believed should have been accounted for over the previous four years. The company has appealed against this decision and the First-tier Tribunal (FTT) will address the question of whether the lettings are exempt or subject to VAT in a forthcoming hearing.

In the meantime, however, the company brought separate legal proceedings against HMRC in the High Court concerning HMRC’s failure to raise this as an issue in the 11 VAT inspections it had conducted on the two companies over the years. Not only had HMRC never questioned the exemption, it had even raised small assessments in the past on related VAT issues that were based on the assumption that the rentals were exempt from VAT. Overall, the company felt that HMRC’s conduct gave it a ‘legitimate expectation’ that its position had been correct, which would mean that HMRC could only apply VAT to its property lettings prospectively.   

Despite its conduct in these inspections, the High Court has upheld HMRC’s right to assess in these circumstances. The judge accepted that HMRC was clearly aware that the company was treating its lettings as VAT exempt and agreed that HMRC probably should have reviewed this VAT treatment at an earlier stage. However, the High Court found it was more significant that the company had never asked HMRC for a formal ruling on this point and that HMRC had never actually checked the VAT treatment of the rent nor told the company that it had done so. In coming to its decision, the court mentioned that the fact that HMRC had not challenged the VAT treatment of a particular supply did not shift the burden of any error from the taxpayer to HMRC.

Case #2 – UK Funerals Online

A company that provided the service of repatriating deceased persons from the UK to another country treated its services as the zero-rated transportation service of an export of ‘goods’ from the UK, meaning that it was entitled to recover VAT on related costs. However, HMRC challenged this VAT treatment, arguing that it had instead made an exempt supply of ‘making arrangements in connection with the disposal of the remains of the dead’ on which its entitlement to recovery of VAT on related costs would be restricted.

At the FTT hearing, the company’s managing director noted that HMRC had not objected to its declared VAT treatment on two previous VAT inspections and argued that it had been unfair for HMRC to pursue this case now, when there had been no relevant change in the law or to the company’s activities since those inspections were held. 

The FTT has found in favour of the company, deciding that its services did fall within the scope of the zero-rate, so the appeal succeeded on that ground. However, the judge also commented that the tribunal did not have any power to deal with complaints concerning what HMRC may have accepted or agreed to in the past.

What does this mean for other businesses? 

Both cases concerned disputes over the VAT treatment of a business’s main source of income, which they might have understandably assumed had been checked by HMRC on previous inspections. Their outcomes demonstrate two important points, being that:

• HMRC is prepared to assess retrospectively to correct an ‘error’, even when it appears to have tacitly accepted a fully disclosed VAT treatment on numerous occasions in the past, possibly over a prolonged period. 
• there seems to be little or no legal scope for businesses to contest a VAT bill solely because HMRC failed to review or challenge a disputed VAT treatment during previous inspections. 

What happens next?

Realreed is now seeking permission to take its legitimate expectation case further to the Court of Appeal. But, unless and until the company successfully persuades the courts to overturn the High Court’s decision, other businesses should be aware that an uneventful HMRC inspection does not mean a clean bill of health for VAT (or other tax) purposes. Instead, it’s essential to keep your VAT strategy under review and to always ask HMRC in writing for a ruling on any difficult and risky VAT issues.

For more information, please get in touch with Ian Carpenter or your usual RSM contact.