UK: VAT: capped claims on input tax

It is said that there is a time for everything under the sun, a time to cry and a time to laugh. One taxpayer is currently laughing, because even if he did not get his timing right in making a VAT claim in time, the Court of Appeal has nevertheless allowed his claim even though it was made 10 years after he could have initially claimed and even though normally there is now a three year limitation period!

The taxpayer, Mr Fleming (t/a Bodycraft) traded in motorcars and when he bought three of them in 1990, he did not claim VAT input tax. He only did this in 2000. HM Customs refused his claim because Regulation 29(1A) of the Value Added Tax Regulations 1995/2518 blocks any claims made more than three years after the return in which he was originally eligible to claim. On the face of it he was 7 years too late.

Regulation 29 (1A) was introduced in 1997 (some 7 years after the right to deduct the input tax on the motor cars arose) and did not contain any transitional period during which a taxpayer would have the right to submit a claim outside the 3-year period. The Tribunal decided that EU law required that a transitional period should have been provided for in Regulation 29 (1A) following the decision in Marks and Spencer (C-62/00). In the Grundig case (C-255/00) that followed, the European Court of Justice held that a minimum 6-month transitional period was needed.

However, the taxpayer lost in the High Court, on the basis that after the introduction of Regulation 29(1A) there was a reasonable period of notice in which to make his claim. Now the Court of Appeal has unanimously found for Mr Fleming (see Fleming (t/a Bodycraft) v HMRC [2006] EWCA Civ 70).

Lady Justice Hallett and Lord Justice Ward decided that a transitional period needed to be enacted legislatively, and as it had not been, Regulation 29(1A) was invalid until a transitional period was introduced. Lady Arden concluded that a transitional period could be "read in" to Regulation 29(1A), but only from the date of the Marks and Spencer judgment in 2002, so Mr Fleming’s claim succeeded.

The Judgment is essentially a "Rule of Law" point. The tax system requires legal certainty and taxpayers are vested with rights as well being subject to obligations. They therefore have a "legitimate expectation" that those rights will not be removed without proper legislative notice so that they can order their affairs accordingly.

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It is said that there is a time for everything under the sun, a time to cry and a time to laugh. One taxpayer is currently laughing, because even if he did not get his timing right in making a VAT claim in time, the Court of Appeal has nevertheless allowed his claim even though it was made 10 years after he could have initially claimed and even though normally there is now a three year limitation period!

The taxpayer, Mr Fleming (t/a Bodycraft) traded in motorcars and when he bought three of them in 1990, he did not claim VAT input tax. He only did this in 2000. HM Customs refused his claim because Regulation 29(1A) of the Value Added Tax Regulations 1995/2518 blocks any claims made more than three years after the return in which he was originally eligible to claim. On the face of it he was 7 years too late.

Regulation 29 (1A) was introduced in 1997 (some 7 years after the right to deduct the input tax on the motor cars arose) and did not contain any transitional period during which a taxpayer would have the right to submit a claim outside the 3-year period. The Tribunal decided that EU law required that a transitional period should have been provided for in Regulation 29 (1A) following the decision in Marks and Spencer (C-62/00). In the Grundig case (C-255/00) that followed, the European Court of Justice held that a minimum 6-month transitional period was needed.

However, the taxpayer lost in the High Court, on the basis that after the introduction of Regulation 29(1A) there was a reasonable period of notice in which to make his claim. Now the Court of Appeal has unanimously found for Mr Fleming (see Fleming (t/a Bodycraft) v HMRC [2006] EWCA Civ 70).

Lady Justice Hallett and Lord Justice Ward decided that a transitional period needed to be enacted legislatively, and as it had not been, Regulation 29(1A) was invalid until a transitional period was introduced. Lady Arden concluded that a transitional period could be "read in" to Regulation 29(1A), but only from the date of the Marks and Spencer judgment in 2002, so Mr Fleming’s claim succeeded.

The Judgment is essentially a "Rule of Law" point. The tax system requires legal certainty and taxpayers are vested with rights as well being subject to obligations. They therefore have a "legitimate expectation" that those rights will not be removed without proper legislative notice so that they can order their affairs accordingly.

To find out how this decision may affect you and what you should do next, please see below.

HMRC has sought permission to appeal to the House of Lords although the grounds of appeal are unclear.

Taxpayers should examine their records for old INPUT tax claims, and consider submitting these to HMRC as protective claims, pending resolution of the Fleming case.

If the Court of Appeal is right, there is still technically no legislative transitional period for input tax claims, although this could be remedied very quickly (for example, in the Budget on 22 March), in which case a new 6 month transitional period will kick in.

These sectors have restricted their original input tax (for example, on capital goods claims) to claiming only that part referable to business use, under s 24(5) of the VAT Act 1994 and Regulation 100 of the VAT Regulations 1995/2518.

In our view this approach is incorrect in law and always has been, as taxpayers with some non-business use have under the so-called Lennartz mechanism, always been able to claim in full on purchases of goods and services, and then subsequently account for often varying levels of non-business use. While the Customs manual permits a backdating of a revised partial exemption method, HMRC would insist that Regulation 29(1A) must apply and only claims going back three years be permitted.

Taxpayers with non business activities who purchased large capital items more than three years ago and incurred VAT which was apportioned under the old rules should consider their position, and consider whether it is worthwhile making a full Lennartz claim on previously capped input tax.

They have an option to retain the business/non-business apportionment, or claim in full and account over a longer period of time for private/non-business use. The latter option may give rise to significant cash flow advantage.

This does have some advantages. For example, on a sale, tax is only due on the business part. For property the option to tax is never due on a separate residential element (for example, above a pub or shop) and for other items such as plant, tax would be on the sale price that has depreciated from the original cost, so the tax may not be substantial anyway.

For spend on capital assets used over a period of years (both goods and services), taxpayers should revisit their calculations.

Where input tax claims have been originally apportioned between business and non-business use, and only the business element is claimed, taxpayers should calculate the benefit of making further protective claims for the remaining full deduction, less any tax due on private use for the years so far.

For property, Business Brief 15/2005 permits a 20-year cycle of adjustment. So for a property bought 5 years ago where VAT was incurred and 50 % business use was claimed, there is a potential uncapped right to the balance of the input tax, less the private use on the whole building (50% less 5/20 output tax on the non business use of the building. Therefore, a further 37.5 % could be claimed). If the capping provisions are held to be unlawful then the taxpayer would repay the 37.5%, albeit over the remaining 15 years, thus giving the taxpayer a beneficial cash flow advantage. Tax may be due on the sale of the whole asset (business and non-business part) and this must be factored into the benefit of making such a claim.

For further information contact any of the following VAT/Tax contacts or your usual CMS contact

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 13/03/2006.