HMRC inspections and legitimate expectation

The High Court has held that HMRC inspections into a taxpayer over many years that failed to pick up any failure to account for VAT on supplies did not give rise to a legitimate expectation that HMRC would not assess the taxpayer to VAT on the correct basis: R (on the application of Realreed Ltd) v HMRC [2023] EWHC 1572.

Although the decision is highly fact specific, it does indicate that something much more than a “negative proposition” is required on the part of HMRC to provide any protection to a taxpayer. Not only would a claim of legitimate expectation require that HMRC had done something to positively indicate that they approve the VAT treatment, even so it would also be necessary to show that there had been detrimental reliance by the taxpayer on that assurance – and that was lacking in this case.

Indeed, the Court has stressed that judicial review should not be used reverse the burden on the taxpayer to get the VAT treatment of its supplies correct simply on the basis that HMRC had failed to challenge that treatment at an earlier stage.

Background

The claimant, Realreed, owned the freehold of Chelsea Cloisters, a block of over 600 flats. Most of these were let on long leases, but 200 were let as serviced accommodation. The claimant treated these as exempt supplies, but following an inspection in 2017, HMRC took the view that these were actually taxable supplies of accommodation. The claimant appealed that decision.

In addition to appealing the decision, the claimant brought judicial review proceedings to challenge the decision to raise assessments for VAT. It contended that, even if the supplies of the serviced accommodation was subject to VAT, the decision to assess that VAT retrospectively was unreasonable, conspicuously unfair and/or vitiated by the unlawful frustration of a legitimate expectation of the claimant. As a result, the formal VAT appeal was put on hold until determination of the judicial review.

In particular, the claimant pointed to a history of VAT and tax inspections carried out by HMRC over a long period of time, none of which had questioned the VAT treatment of the flats. The claimants’ offices had been subject to inspections in 1992, 1993, 1995, 2005 and 2014 without anyone from HMRC suggesting that its VAT treatment of the flats was incorrect. This, in particular, was the basis of the arguments in favour of setting aside HMRC’s decision to assess the supplies as subject to VAT.

Decision of the High Court

Firstly, the Court rejected the argument that there was any administrative basis for setting aside an administrative decision of HMRC simply on the basis that is was unfair or conspicuously unfair. Reviewing the case law on judicial review and in particular the decision in R (Gallaher Group) v Competition and Markets Authority [2019] AC 96, the Court noted that judicial review is only available as a remedy for conduct which is ultra vires or unlawful, not for acts done lawfully but which are complained of as being unfair.

Accordingly, the main basis for the challenge was that the claimant had a legitimate expectation that HMRC would continue to treat the relevant supplies as exempt from VAT (at least until 2019) and would not retrospectively seek to impose VAT. The claimant submitted that HMRC had confirmed that the supplies were exempt and had raised assessments on that basis.

HMRC argued that it had not made any representation as to the correct VAT treatment which the claimant could rely on. In any event, HMRC argued that the claimant had not “put all its cards face up on the table” and that there had been material changes to the claimant’s business over the period covered. In addition, even if it had made a representation, the claimant had not relied on it to its detriment and it would not be unfair for HMRC to depart from any legitimate expectation that had arisen.

The Court reviewed the evidence of the HMRC visits to the claimant over the period of time concerned, including notes made by HMRC officers. The Court considered that these inspections were of limited, if any, significance. They may have contributed to HMRC’s understanding of the claimant’s business but they did not involve any representation that could be relied on by the claimant. There was no evidence that the claimant had asked for any assurance as to the correct VAT treatment of the disputed supplies and did not expressly state that they had considered whether the supplies were exempt.

Whilst the Court considered that HMRC’s officers should have questioned the correct treatment of the supplies during those visits, there was simply no evidence that they had done so.

In addition, the Court considered that this was a case where (even if HMRC’s conduct had given rise to a legitimate expectation), HMRC would only have been bound by it if the claimants had relied on it to their detriment. Whilst the Court accepted that there can be cases where a claimant can enforce a legitimate expectation on which it has not relied to its detriment, this was not one of those cases. It was clear from the case law that reliance and detriment are significant features and the Court also noted that (unlike in some cases not involving detrimental reliance), this was not a case where HMRC had made an unequivocal promise as to its intended course of action.

On the facts, the Court considered that there had been no detrimental reliance. Indeed, the Court considered that there had not even been any reliance. The onus was on the claimants to determine the correct VAT treatment of its supplies and there was no indication that the claimant did anything different as a result of the inspections. If there had been no VAT inspections, it would have continued to treat the supplies as VAT exempt. Indeed, the Court has pointed out that any reliance was “on the negative proposition that [HMRC] did not say that the Relevant Supplies were subject to VAT. The courts should not use the jurisprudence of legitimate expectation to reverse the burden created by the VAT Act. It is for the taxpayer to determine the correct treatment of its supplies. As a general rule, the fact that [HMRC] do not challenge the taxpayer’s treatment of a particular supply on a particular occasion or occasions is not to be treated as shifting the burden from the taxpayer to [HMRC].”

Legitimate expectation: a practical problem

The Court also pointed out a practical problem that potentially arose in this case concerning the interaction of the claim for judicial review and the normal VAT appeal process (which had been deferred behind the judicial review).

HMRC argued that the claimant had not put it’s card face up on the table and that the taxpayer had changed its business model over the period. The Court had been asked to decide the judicial review case on the basis that the supplies were taxable, but without there being any agreement as to why they were taxable. In particular, it could be that there had been no change of business model and they had always been taxable. Alternatively, it could be that they were correctly exempt initially but then became taxable later. According to the Court, these were matters for the FTT to determine as part of the normal VAT appeal and had they been necessary to the Court’s decision it would have postponed its decision until the FTT had made its decision on liability.

However, as a result of the Court’s conclusion that there was no representation given to the claimant that could form the basis of any legitimate expectation, it was unnecessary for the Court do consider those aspects.

Comment

Although the decision is highly fact specific, it does highlights that a mere failure by HMRC to pick up on the taxpayer’s incorrect tax treatment of supplies is highly unlikely to give rise to a legitimate expectation. Something much more concrete is required from HMRC to affirm the taxpayer’s treatment of its supplies. Even then, it is highly likely that the taxpayer will need to show detrimental reliance in order to prevent HMRC raising an assessment to cover earlier years.

As such, the mere fact that HMRC may have inspected a taxpayer is unlikely to protect a taxpayer from future assessments on the basis that its tax treatment had been approved by HMRC.