V@ update - July 2022

Welcome to the July 2022 edition of RPC's V@, an update which provides analysis and news from the VAT world relevant to your business.

News

• HM Government has published an updated policy paper on proposed changes to the Northern Ireland Protocol. In relation to VAT, the government intends to maintain the existing arrangements in the Protocol on VAT and excise to support trade on the island of Ireland but will provide freedom for Ministers to adapt or disapply rules so that people in Northern Ireland can benefit from the same policies as those elsewhere in the UK.

• The VAT rate for energy-saving materials in residential buildings in Great Britain is now 0%: see the updated list of rates and classifications here.

• HMRC has updated its internal manual in relation to daycare services supplied by private bodies in England and Wales, following the Supreme Court's decision to refuse permission to appeal the Court of Appeal's judgment in LIFE Services Ltd and The Learning Centre (Romford) Ltd, which confirmed that providers must be charities, public bodies or regulated as a private welfare institution or agency by the relevant authority in the country concerned, in order to exempt their supply of services under Item 9, Group 7, Schedule 9, VATA 1994.

• HMRC has updated its guidance on applying for repayment of overpaid import duty and VAT. Businesses that are registered for VAT must not use form C285 to claim for repayment of overpaid VAT; any adjustment must be made through their VAT returns. Adjustments to a VAT return are subject to normal VAT rules. Businesses that are not VAT registered must continue to use form C285 to claim for a repayment.

Case reports

Sofology – FTT decides online advertising costs recoverable as no direct link to exempt insurance commissions

In Sofology Ltd and another v HMRC [2022] UKFTT 00153 (TC), the First-tier Tribunal (FTT) allowed the taxpayers' appeals against VAT assessments in respect of input tax on Google advertising costs.

Sofology Ltd and DFS Furniture Company Ltd (the Appellants) are retailers of sofas and other furniture. They also supply intermediary services for sofa insurance, which is provided by a third party to their customers. The supply of sofas and other furniture is taxable for VAT whilst the insurance intermediary services are exempt for VAT purposes.

The Appellants relied on an earlier decision of the FTT, in which it was held that DFS was entitled to recover input tax on certain types of advertising costs (such as TV and poster adverts and direct mailing). The Appellants had applied that decision to the considerable pay-per-click (PPC) advertising costs they had incurred and had accordingly deducted the input tax for those costs. HMRC considered that the input tax was not fully recoverable for those PPC advertising costs because the costs were directly attributable to both the taxable supplies of sofas and the exempt supplies of insurance intermediary services. HMRC's view was that the input tax was not recoverable insofar as it related to the exempt insurance intermediary services. HMRC raised assessments accordingly.

The FTT applied the "direct and immediate link" test to the facts and determined that the advertising costs only had a direct and immediate link to the supply of sofas, not to the supply of insurance intermediary services. The FTT also rejected HMRC's secondary argument that the PPC advertising costs should be treated as an 'overhead', which would have rendered the input tax only partially recoverable. Input tax on the PPC advertising costs could therefore be deducted in full.

Why it matters: This decision is a helpful illustration of the deductibility of input tax for online advertising costs (PPC advertising in particular) where taxpayers provide both taxable and exempt supplies. However, the question of whether costs have a direct and immediate link to the taxable supplies is still very much dependent on the particular facts of the case under consideration. The FTT in this case had the benefit of considerable witness evidence. Taxpayers will need to consider the facts of their own case carefully before deciding whether this decision is applicable to their own case.

The decision can be viewed here.

Northchurch Homes – FTT confirms building works did not involve construction of a new build but qualified for reduced rate on other grounds

In Northchurch Homes Ltd v HMRC [2022] UKFTT 00201 (TC), the FTT considered whether redevelopment works carried out on a home (the Property) amounted to the "construction of a building" for the purposes of section 35(1)(a), (Value Added Tax Act 1994).

Northchurch Homes Ltd (the Appellant) was contracted to implement a substantial programme of redevelopment works on the Property. The Appellant engaged a sub-contractor, Sword Logistics Ltd (Sword), who invoiced the Appellant for VAT on its services at the standard rate. The project was large and complex, and involved a protracted planning process that lasted from February 2016 until December 2018. Permission was granted subject to pre-commencement conditions including a structural engineer's report as to securing and retaining the existing front façade and the roof slope of the Property during the construction phase.

The Appellant engaged Sword to undertake works including underpinning and the excavation and construction of a basement and foundations. Substantial works were carried out at the Property, including the demolition of most of the interior. Sword had intimated to HMRC that its services should attract VAT at the reduced rate of 5% in accordance with Schedule 7A, Group 7, VATA 1994, because the Property had not been lived in for two years prior to the start of work, but subsequently suggested that the work should in fact be zero-rated. HMRC determined that VAT should be charged at the standard rate and advised that it intended to make adjustments to Sword's 10/19 and 01/20 VAT returns.

In challenging HMRC's decision, the Appellant contended that the works carried out on the Property amounted to the "construction of a building" for the purposes of section 35(1)(a) VATA 1994, such that Sword's services should be zero-rated. The FTT dismissed this aspect of the Appellant's appeal, and determined that the works did not involve the construction of a new build, but rather constituted an extensive building project preserving significant structural aspects of the old house. Having regard to Note 18(b) in Schedule 8, Group 5, VATA 1994, the FTT concluded that what remained of the Property as it stood on the eve of development could not fairly be said to be "no more than a single facade". The FTT held that the façade and the roof were not the same and were two different structures. The façade was the thing that faced the street while the roof, although visible from the street, did not face the street. As the works did not fall within Note 18(b), they were not zero-rated.

The FTT went on to consider the Appellant's subsidiary argument that, even if Sword's supply was not zero-rated, it should nonetheless be treated as subject to a reduced rate of 5% in accordance with Schedule 7A, Group 7, VATA 1994, on the basis the Property had not been lived in for a period of two years ending with the commencement of the relevant works. HMRC argued that it had made no decision in relation to a reduced rate, and therefore the FTT had no jurisdiction to consider this argument.

In upholding this aspect of the Appellant's appeal, the FTT determined that, while HMRC had not made any decision as to a reduced rate, it was not bound to find that the standard rate should apply. Rather, applying the guidance provided in HMRC v SDI (Brook EU) Ltd and another [2017] UKUT 0327 (TCC), the FTT was entitled to consider the correct rating if there was sufficient evidence before it to determine that issue. The FTT noted that the evidence of the Property owner was sufficient to determine that the Property had been unoccupied for over two years before the works started in June 2019. HMRC had chosen to simply argue that as there was no decision in relation to a reduced rate the FTT did not have jurisdiction. HMRC did not advance any other argument, either in writing or orally, as to why Schedule 7A, Group 7, VATA 1994 would not apply. Accordingly, the FTT was satisfied that the conditions in Schedule 7A, Group 7, VATA 1994, were satisfied, such that the supply by Sword to the Appellant qualified for a reduced rate.

Why it matters: This case provides some helpful guidance as to the approach the FTT is likely to take when construing the construction and renovation provisions in Schedules 7A and 8, VATA 1994, and confirms that the FTT's jurisdiction in respect of appeals under section 83(1)(b), VATA 1994, should be construed broadly so as to encompass any issue between a taxpayer and HMRC in respect of which HMRC has made a decision which is material to the chargeability of the taxpayer to VAT.

The decision can be viewed here.

Sheth and Ghazi – FTT quashes directors' personal liability notices as HMRC did not meet burden of proof

In Neegum Sheth and Sam Ghazi v HMRC [2022] UKFTT 00167 (TC), the FTT considered two appeals against personal liability notices (PLNs) which had been issued by HMRC under paragraph 19, Schedule 24, Finance Act 2007 (FA 2007).

Mr Sheth and Mr Ghazi (the Appellants) had been, respectively, a director and 'operations director' of Aircall International Ltd (AIL), a company that had claimed zero-rating in respect of 28 dispatches of mobile telephones. On 2 November 2015, HMRC notified AIL of assessments of output VAT under section 73, VATA 1994, totalling £2,959,239 plus interest. The following day, AIL entered creditors' voluntary liquidation. On 2 December 2015, AIL (by this point controlled by a liquidator) submitted a notice of appeal of the denial of zero-rating and assessment. In August 2016, the appeal was withdrawn by AIL due to lack of funds to pursue it. In July 2017, HMRC notified a penalty calculation summary to AIL, and in August 2017 notified it of a penalty assessment under paragraph 1, schedule 24, FA 2007 and issued a PLN to each Appellant.

The Appellants appealed the PLNs, on the grounds that they had neither knowledge of the fraudulent connection of AIL's transactions, nor the means to acquire such knowledge at the relevant time, their behaviour had not met the threshold for 'deliberate' behaviour and they had undertaken sufficient and reasonable due diligence. They put HMRC to proof in respect of their allegation of fraudulent evasion of VAT.

The appeal was allowed.

HMRC argued that the Appellants' case relating to the underlying assessments imposed on AIL should be struck out on the ground that the Appellants had previously had the opportunity (as director and operations director of AIL) to argue that the input tax was recoverable and as the appeal had been withdrawn it would be an abuse of process to allow them to take the point now. The FTT rejected this argument. HMRC had been on notice that the basis of the underlying denial of the zero-rating was challenged for at least two years and it was incumbent on it to apply for a strike-out explicitly, and at an earlier stage in the proceedings. Further, it was intrinsic to the consideration of the case for the FTT to consider the level of the Appellants' alleged knowledge and to what it related. It was not therefore in the interests of justice for the appeal to be struck out.

The FTT then considered the substantive issues, namely: (1) whether there was an inaccuracy in AIL's returns; and (2) if so, whether it was deliberate (which in turn was dependant on whether AIL, through its directors, knew that the relevant transactions related to a fraud and whether AIL took every reasonable step within its power to prevent its own participation in that fraud and whether AIL's conduct was properly attributable to each of the Appellants).

The FTT noted that it had been provided with more than 4,500 pages of evidence. Much of the evidence from HMRC related to other proceedings (which the FTT described as 'not a helpful way of presenting the case') and unsubstantiated assertions that provided 'little assistance' to the FTT in its fact-finding role.

The FTT concluded that this was insufficient to discharge the burden of proof, which rested with HMRC, to show that there were inaccuracies in the returns and the PLNs should therefore be cancelled.

Why it matters: The case highlights the importance of HMRC being able to provide conclusive evidence of fraud in order to justify the issuing of a penalty for deliberate behaviour. HMRC spent a great deal of time explaining the fraudulent behaviour of a third party overseas business in the supply chain, rather than concentrating on the actions of AIL and its directors. Ultimately, the FTT concluded that HMRC had not provided enough evidence to establish that the directors had deliberately underpaid VAT and therefore the PLNs had to be cancelled.

The decision can be viewed here.