I’m sure that most of us have received a decision from HMRC about tax that we feel is wrong. You may think that a similar business is paying less VAT, or you may disagree with HMRC’s interpretation of the rules; or in some cases you feel that they have just given you the wrong answer.  Over the years, I’ve seen or heard about a whole range of situations where HMRC’s decisions or assessments just seem to be wrong.

I’m sure that the majority of HMRC’s rulings and VAT assessments are technically correct. But today I wanted to consider some of those occasions when decisions are wrong, or seem to be unfair.
As a government department, HMRC should always apply the law correctly and ensure that all businesses are treated equally. However, that doesn’t always happen in practice.

The appeals system

Most businesses are aware that they have 30 days to lodge an appeal against a decision or an assessment issued by HMRC. HMRC sometimes will allow an extension of time to the 30 day limit, but please don’t rely on this.  However, smaller businesses in particular, are often not fully aware of this and assume that if they receive a ruling in a letter from HMRC, any appeal made against that ruling by HMRC is almost certainly a waste of time and the result will almost support the HMRC ruling.

The first stage of any appeal is to request a review by HMRC, which is carried out by an officer who has not previously been involved in the case.  In practice, I have seen some very positive decisions for the business from this process, but it is ultimately another decision by HMRC.  I have no idea what proportion of reviewed cases uphold the original ruling/assessment, but either way the business’ only option in this situation is to go through the formal appeals procedure and lodge an appeal with the Tax Tribunal.  I’ve explained a little more about this later.

The appeals process is supposed to be simple, but it’s a legal process, with deadlines and procedure. HMRC uses taxpayers’ money to fund their solicitors’ office and other legal and staff resources. Businesses have to fund their own costs, even if they eventually “win” their case against HMRC from their own resources. And you also need to add in the time, costs and stress for business owners.

I know that most businesses are doing their best to manage a very complicated tax. HMRC, on the other hand, as the tax collecting and managing department of government, is effectively the judge and jury of the whole system. There is very little excuse for them issuing incorrect assessments and rulings. I’ve set out below three different situations to illustrate this.

Property developer making taxable supplies but denied VAT registration

A property developer applied to register for VAT some 15 years ago, as a property developer. The company did most of the construction work in house, using only its own labour, so the initial VAT claim was for VAT on the cost of goods and materials.

The sale of the buildings concerned qualified for the zero rate. However the Company was told by the VAT registration unit that because it did not issue any invoices to customers for its construction work, it was not entitled to be registered for VAT. HMRC didn’t recognise that the taxable supplies were not construction services, but the zero-rated sales of the properties.

The company, like many small businesses, assumed that this decision was final and did not know about the appeals process.

Transactions between associated companies: insufficient evidence of services provided

Two associated companies were separately registered for VAT. Co A issued invoices for management charges to Co B each month. Co A was on quarterly returns, using the cash accounting scheme while Co B is on monthly returns.

In practice, the arrangements were intended to take advantage of the cashflow benefit, which in itself is not avoidance. However, there was little evidence to demonstrate that services described on the service had been provided and the actual extent of the services. The reviewing officer told me that while she accepted that Co A had provided the services concerned, there wasn’t sufficient information on the invoices to prove he extent of the services.

Non-residential conversions

In another property related case, a company applied to register for VAT on the basis that the company’s sales would qualify as zero-rated “non-residential conversions”.  The directors believed that all of the conditions set in VAT Notice 708, para 5 https://tinyurl.com/w5pagxm were met, including the evidence in the form of the limited information from local council record .

HMRC initially refused the application because they did not agree that the property met the criteria. The company asked for the decision to be reviewed and HMRC subsequently agreed in principle that the conversions were “non-residential conversions”.

However HMRC asked the company to provide additional evidence in addition to the normal council tax/electoral evidence mentioned in VAT Notice 708 para 5 https://tinyurl.com/w5pagxm.

The company has decided not to pursue the application because the VAT cost of the conversion is probably less than £20k, so it wasn’t cost-effective to register for VAT. So HMRC “won” a case when its initial ruling was technically incorrect. The business is left out of pocket, paying its own costs.

So is the system fair?

Many businesses don’t appeal because their owners are wary about challenging HMRC. Business owners are often very nervous about getting onto HMRC’s “blacklist”, even if their appeal is entirely justified. Many would rather pay a bit too much tax to avoid what can be a very stressful VAT review or investigation.

So what options do you have if you think HMRC’s decision is wrong?

The appeals process allows the business to request a review of the decision by an officer not previously involved in the case. If the review officer upholds the original decision, the business can then appeal to the Tax Tribunal.

And if the Tribunal upholds HMRC’s original decision, then the taxpayer’s only option is to appeal to the High Court and then the Court of Appeal .

In practice very few business owners are able to fund the cost of an appeal or willing to take on HMRC. The business is always left funding its way through the appeals process, even if HMRC’s ruling is eventually overturned.

So what this means in practice is that the Government benefits from the additional revenue from the business paying VAT even though HMRC’s decision is wrong. In the cases mentioned above the businesses couldn’t afford to take their appeals to the Tax Tribunal. So not only are the assessments wrong, but HMRC has a wealth of resources from public money to uphold their incorrect decisions through the appeals procedure.

Alternative dispute resolution (“ARM”)

One other approach before applying to the Tribunal is the Alternative dispute resolution scheme. This involves a meeting or meetings between the business and HMRC with the aim of resolving the differences in a less formal and less confrontational way. I haven’t been involved with an ARM, but I understand that it can be quite effective in certain situations; e.g. if there is a disagreement about facts. However ultimately it is still the taxpayer against HMRC, so you can understand why businesses are not particularly keen on this process.

Thinking outside the box…….

However, here are some alternative approaches you may wish to consider.

• Applying for a judicial review of HMRC’s actions. I understand this type of review is designed to deal with situations where a taxpayer challenges HMRC’s behaviour or handling of a case. It’s usually only used if the business has lost their appeal as a last resort action. You’d have to take legal advice if you think this could apply in your situation.

• if you are a member of a trade association or a professional body of some kind, find out if the issue has arisen with other members. The cost of a test case can then be shared by other members, so the financial drain for each taxpayer is significantly reduced. It also brings the subject to the attention of HMRC in a much more effective way.

• Finally, you could always ask your MP to intervene if you feel that HMRC are acting unreasonably. But you need to be careful with this and make sure you have the right information. On a couple of situations, I contacted a client’s mp, only to find out that in both cases the client had not given the correct information. That left me feeling rather embarrassed, as well as wasting a lot of my time (consultants can rarely collect much of their time cost in these situations) and the time of the MP and their staff in reviewing the issues.

So what do you do if you think that HMRC’s ruling or assessment is wrong? It seems that HMRC will always have the advantage even when they’ve given an incorrect ruling or assessment. There have been some very successful “test cases” where the costs have been shared among a group of businesses. This is a good way of ensuring that all businesses get equality of treatment and that HMRC’s application of the VAT legislation is correct.

But ultimately, we’re still left with a system where businesses end up paying too much VAT because they can’t afford the costs or time or hassle of appealing, even when HMRC have got it wrong.

September, 2020

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