Historical VAT reclaims and appropriate evidence

The Supreme Court has reinforced the principle that it is for the taxpayer to meet the burden of proof over the amount of input VAT it is entitled to recover, even in relation to historical Fleming claims: HMRC v NHS Lothian Health Board [2022] UKSC 28. It was for the taxpayer to show that they had incurred input VAT that was in principle recoverable and that included quantification of the amount of that input VAT.

The decision does leave open the possibility that State culpability that leads to the taxpayer not having sufficient records to prove a claim may be relevant in principle, but that was not a factor in this case.

Background

The case concerned a claim for the repayment of input VAT for the period from 1974 to 1997. The taxpayer had operated laboratories which were used mainly for NHS work (non-business) but partly for taxable non-NHS work (business activity). However, input VAT attributable to this business activity was not reclaimed under the general practice at that time. Following the Fleming case, the Board sought to recover that historical VAT. Since there were no actual records for the period, the Board had essentially sought to demonstrate the relevant percentage of business to non-business expenditure for 2006/7 (as the first year in which suitable accounts were available) and apply that percentage to the whole of the period from 1974 to 1997. Whilst it was essentially accepted that the Board had had a right to recover input VAT, HMRC rejected the claim on the basis that there was insufficient evidence as to the correct amount of recoverable input VAT. Both the FTT and UT accepted HMRC’s argument.

On appeal to the Inner House of the Court of Session, it was held that EU principles of effectiveness and proportionality require the UK tax tribunals to take a flexible approach to the requirement that a taxpayer must provide evidence of the amount of a VAT reclaim in historical cases and the Court decided to remit the case. In historical claims, where much of the evidence is inevitably lacking, the FTT should proceed on the basis of the evidence that is available, adopting a flexible approach. The critical question is whether, on the basis of that evidence, it is possible to hold that the taxpayer has proved its calculation of unrecovered input tax on a balance of probabilities – in other words, whether the taxpayer’s calculation is, at a general level, more likely than the contention that no unrecovered input tax, or a much lesser amount of such tax, is due.

HMRC appealed the decision of the Court of Session on a number of grounds, including that its approach to the standard of proof in late VAT input claims was incorrect and that it was also wrong in its application of the EU principle of effectiveness.

Decision of the Supreme Court

The Supreme Court has now overturned the decision of the Court of Session, emphasising the fundamental principle that a taxpayer must make out its claim remains the same even in such historical claims.

Firstly, the Supreme Court noted that the Court of Session had been incorrect in reading the FTT’s finding as indicating that the historical claim would have been “essentially the same” as that for 2006/7. The FTT’s findings were that (a) the nature of the business activity remained the same; and (b) therefore the inputs remained the same. The FTT’s finding as to the balance between business activity and non-business activity over the claim period was that there was not enough evidence to establish what this was or whether and how it had changed over the claim period or between the end of the claim period and the year 2006/7.

The Court of Session approach the case on the basis that it was one simply of quantification of an admitted claim. In fact, HMRC did not accept that the Board had actually established any entitlement to input VAT recovery for the claim period. The Supreme Court held that the Court of Session had been wrong to regard the establishment of a right to deduct some input tax as separate from the obligation on the taxpayer to quantify the amount it is entitled to recover. This error led the Court of Session to adopt the wrong approach to that quantification exercise. The taxpayer’s obligation is to prove how much it is entitled to claim, not merely that it must have incurred some input tax in the course of its business activity.

The Supreme Court pointed to the CJEU’s decisions in Vadan (Case C-664/16) and Zipvit (Case C-156/20) to reinforce the importance of the ability of the taxpayer to substantiate a claim for input VAT. It was simply not enough in this case for the taxpayer to show that it had engaged in business activity and had bought supplies for which it was charged VAT.

As regards the principle of effectiveness, the Supreme Court held that the decision of the Court of Session greatly extended that principle beyond what was required under EU law. It was clear that a Member State can apply a framework of conditions for claims and in this case that framework was HMRC’s discretion as to what information they required in the absence of VAT invoices. The principle of effectiveness was designed to remove hurdles to claims such as unreasonably short limitation periods or bans on the use of certain evidence. It was wrong to paraphrase the principle as requiring that the quantification of a historic claim should be possible in all but exceptional circumstances. In all cases, the standard of proof remained the balance of probabilities and that applied to historic claims also.

In fact, the Supreme Court noted that HMRC had been particularly flexible in its approach in this case, being willing to accept estimated claims provided that the assumptions on which the estimates had been made were reasonable and sustainable. However, both HMRC and the FTT rightly required that there be some way of establishing that the ratio during the claim period was likely to have been the same as it was in 2006/7. It was this step that the taxpayer had been unable to meet, either on the basis of documentary evidence or on the basis of oral evidence from those who worked in the laboratories over the period.

Finally, the Supreme Court rejected the argument that the failure of the State in this case had been the cause of the failure of the taxpayer to hold appropriate evidence. In fact, the Court noted that the UK rules had been unduly generous as regards input VAT recovery historically as opposed to there being a failure to implement a right to input VAT recovery. Equally, it was not a failure of the State that HMRC may have destroyed historical records relating to the taxpayer for the periods before 1997 in 2010. The obligation to keep proper accounting records is an obligation placed firmly on the taxpayer by article 242 of the PVD and regulation 31 of the VAT Regulations. It is not part of HMRC’s role to keep any copies of those records they may hold in case a taxpayer belatedly decides to recover input tax.

The Supreme Court noted that the question whether conduct on the part of the State other than setting procedural conditions for the exercise of the right can be relevant to the application of the principle of effectiveness is an interesting question – but it was one which does not arise on the facts
of this case.

Comment

There remain many unresolved cases of historical Fleming-style input VAT reclaims. Many are unresolved due to similar problems with proof and evidence. This decision will be disappointing to many of those taxpayers. However, the case leaves open the possibility that the principle of effectiveness or other EU principles may be of more assistance in cases where HMRC practice or the UK VAT rules were at fault at the relevant time and, in practice, led to the failure of the taxpayer to hold appropriate records.