Input VAT recovery in the absence of VAT invoices

The High Court has upheld an application for judicial review in connection with HMRC's refusal to allow a taxpayer to rely on alternative evidence to substantiate input VAT recovery claims in the absence of VAT invoices: R (on the application of Hotelbeds UK Ltd) v HMRC [2025] EWHC 2312. In this case, HMRC had rejected the claim without proper consideration and on the basis of HMRC guidance which the Court criticised as inconsistent and ambiguous and, in any event, not directly applicable to the facts of this case. The Court was satisfied that, in all the circumstances, the decision to reject the taxpayer's request was "unfair, unreasonable and unsustainable in public law terms".

Ultimately, the decision emphasises the importance of the principle of neutrality in the VAT system, which encompasses a taxpayer's right to recover input VAT connected to taxable outputs. Whilst the right to recover input VAT automatically depends on the existence of a valid VAT invoice, it is not the case that without an invoice there is no right at all. That is the purpose of HMRC's discretion to allow input VAT claims in the absence of a valid VAT invoice and that discretion must be exercised in a way that is reasonable in all the circumstances.

Background

Hotelbeds (HB) operated a business of making wholesale supplies of hotel rooms, purchasing hotel accommodation from UK VAT registered hotels and selling this to other suppliers of hotel accommodation, for example UK tour operators, events companies. In this, it acted as principal. Both the supplies to and by Hotelbeds were standard rated. Under general principles, therefore, where Hotelbeds paid VAT on the purchase of UK hotel rooms, it was recoverable because it was incurred for the purpose of making onward taxable supplies of hotel accommodation.

The method of payment adopted by HB was via the use of a virtual credit card or other instant payment method when the hotel guest checked in or out of the hotel, and not following the issue of a VAT invoice to them from the hotels. Although legally obliged to issue a VAT invoice, in many cases the hotels did not as there was no commercial incentive on the hotels to do so. Hotelbeds explained that it had continuously chased the hotels for valid invoices, but were often unsuccessful.

In these circumstances, HB asked HMRC to use its discretion to allow input VAT recovery under regulation 29 of the VAT Regulations 1995 (SI 1995/2518). This provides that HMRC may allow the recovery of input VAT in the absence of a valid VAT invoice provided that "a Claimant shall hold... such other ... evidence of the charge to VAT as the Commissioners may direct." HMRC, with some initial reluctance and caveats, initially allowed claims to recover input VAT made by the taxpayer through Error Correction Notices (ECNs) on two occasions. However, HMRC then refused two further applications to recover input VAT not evidenced by VAT invoices, taking the view that they did not accept HB had acted sufficiently diligently or reasonably. In particular, HMRC referred to VAT Notice 700 paragraph 16.8 which includes the statement: "Where it's satisfied that the business has taken reasonable steps to comply with the legislation, and that the supply has taken place, HMRC may consider exercising its discretion. But, where a business has systematically failed to obtain a valid VAT invoice HMRC will not consider exercising its discretion." HMRC considered that HB had systematically failed to obtain invoices such that its application should be refused. HB sought judicial review of that decision by HMRC not to exercise its discretion to allow input VAT recovery in the absence of a valid VAT invoice on the basis HMRC had failed to apply their own public Guidance on the subject, or alternatively, that HB had a legitimate expectation that HMRC would accept the two additional ECNs in the basis that HMRC had accepted two earlier ECNs on effectively identical facts.

High Court decision

The High Court judge in this case considered the various HMRC guidance on recovery of input VAT and HMRC's approach to the use of its discretion to accept alternative evidence in the absence of a valid VAT invoice. These included guidance in VAT Notice 700, in MHRC manuals at VIT31200 and Statement of Practice "VAT Strategy: Input VAT deduction without a valid VAT invoice". The judge concluded that none of this guidance had been produced with the scenario in mind where a taxpayer holds no invoice (as opposed to an invalid invoice). "There is no reference directly to "the position where no invoice is held" and thus no written policy Guidance that pertains directly to present circumstances... Furthermore, such guidance as there is, even if indirectly perhaps of assistance, is inconsistent, ambiguous and, in my judgement, difficult for a decision-maker to navigate. An element of sympathy must extend to the officer who was tasked with the decision-making in the present case."

As a result, the judge noted that the "policy documents give no warrant for HMRC declining to consider materials seeking to show that the right to deduct is evidenced by documents other than one called an invoice. While it is the case that to exercise automatically the right to deduct, a valid invoice must be held, it is not the case that without an invoice there is no right at all". Furthermore, in relying upon "the written policy contained in Notice 700 HMRC has misconstrued and/or misapplied its own policy. The decision as currently explained does not suggest a coherent understanding or consistent application of policy. Indeed, as stated, there was in my view no precise written policy that dealt with the approach to take where no invoice was held."

Moreover, the judge criticised HMRC's reliance on "systematic" failure in this case, noting that it seems to have simply been interpreted as "repeated". Whilst the term was "unhelpful and unexplained", it clearly meant something more than "repeated". The judge considered that "systematic" has to mean a threat to the recovery of VAT emerging from a planned system. "A systematic failure, without more, cannot be just the repeated failure - that is not what the word means." HMRC had been wrong to apply that guidance in this case, therefore.

It was incumbent on HMRC to consider the application of their discretion in this case, rather than simply refusing to do so.

The judge noted that HMRC policy in this area appeared to be informed by the following principles:

• The protection of the revenue -- that is to say the necessary drive to recover taxes due, and this includes as a very important factor the minimisation of the risk of fraud;
• The recognition of the central importance of the right to deduct, which is connected to the recognition of the neutrality of VAT;
• The observation of a proportionate/reasonable approach to procedural requirements, which is connected to the need to discourage arrangements that undermine the evidentiary basis and structure of the taxation system, and hinder the efficient management of the tax.

In this case there had been no serious suggestion of any fraud and HB had since changed its method of accounting for VAT to fall under the TOMS scheme (hence simply accounting for VAT on its margin and meaning there was no threat to the future system of input tax deduction). HMRC had erred in law by failing to give proper weight to the central importance of the right to deduct input VAT and the obstacles concerning documentation and proof placed in the way of recovery of the later ECNs were not reasonable. "They produced a refusal that was unfair and unreasonable, and unsustainable in public law terms."

As a result, the Court held that, in these circumstances, aside from HMRC's misunderstanding and therefore misapplication of policy, the decision to withhold repayment of the later ECNs was unreasonable in the sense that it was outside the band of reasonable decisions open to HMRC and upheld the application for judicial review. Indeed, the Court held that it was clear that the only lawful decision open to HMRC on the facts of this case was to allow payment of the later ECNs.

Comment

It may be unusual for a taxpayer to succeed on a judicial review claim, however this case appears largely to fall under the situation of HMRC failing to consider the exercise of its discretion at all on the incorrect basis (from its own guidance) that the taxpayer's failure to obtain invoices was "systematic". It may be more surprising that the Court felt able to conclude that the only reasonable decision available to HMRC had been to exercise its discretion to allow the claim in all the circumstances. This was based on a wide range of factors, including the absence of any serious allegation of fraud, the importance of the principles of neutrality and effectiveness and HMRC's payment of the previous ECNs. This last factor is maybe (again) a little surprising as the Court ultimately did not consider the taxpayer's alternative argument of legitimate expectation (based on the earlier repayments).

Ultimately, the decision emphasises the importance of the principle of neutrality in this context. "The purpose of the discretion is to recognise, necessarily, that the neutrality of the tax is important. Failure to recover input tax is non-neutral. In the same way as over-recovery of input tax harms the revenue and depletes the public purse, the retention of moneys properly recoverable is equally wrong and unfair. The tension between protection of the revenue and recognition of the neutrality of the tax and therefore the right to deduct is central."