How many VAT inspections does it take for HMRC to find a mistake?

If your latest VAT inspection raised no significant issues, it’s easy to take VAT off your to do list until HMRC is due to call again. However, a High Court decision from earlier this summer has highlighted how a recent and/or uneventful HMRC inspection visit is no guarantee against unexpected VAT bills waiting around the corner.

The Realreed case

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 employees. A connected company provided guests with related services such as Wi-Fi, bed linen and housekeeping.

Since the business began in 1989, it treated these lets as an exempt rental of property, only charging VAT 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 the VAT it believed should have been accounted for over the previous four years. The company has appealed this decision and the First-tier Tax tribunal will address the question of whether the lettings are exempt or subject to VAT in a forthcoming hearing.

Was there a ‘legitimate expectation’?

In the meantime, the company has 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.

However, the High Court 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. Nevertheless, the High Court found it was more significant that the company had never asked HMRC for a formal ruling on this point and HMRC had never actually checked the VAT treatment of the rent nor told the company that it had done so. The mere fact that HMRC has not challenged the VAT treatment of a particular supply does not shift the burden of any error from the taxpayer to HMRC.

What does this mean for other businesses?

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, there now seems to be little or no scope for businesses to challenge a VAT bill solely because HMRC failed to query a disputed VAT treatment during previous inspections.

Realreed had applied a VAT exemption to the high value serviced accommodation lettings that were one of its principal sources of income, yet it took HMRC nearly 30 years to question the company’s stance. The fact that HMRC had clear sight of this VAT treatment and went along with it so many times before taking action shows that an uneventful HMRC inspection does not mean a clean bill of health for 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 issues.