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VAT and look back in anger

Posted: July 1, 2015

For some time now it has been clear that HMRC are striving to close the perceived VAT ‘gap’ that exists between the amount the Exchequer expects to receive and the actual amount they get. Alongside this is an underlying move to try and get more tax into the coffers to help offset the impact of the financial squeeze felt by so many. A relatively recent example of this is the stance taken by HMRC on the recovery of VAT incurred prior to VAT registration.

When a business registers for VAT it does so either because it has already exceeded the VAT threshold in place at the time, it knows it is going to exceed that threshold in the near future or it is already making or will be making some kind of VATable supply and chooses to register. At the time that it registers it is able to look back to expenditure incurred prior to the registration date and recover any VAT on that expenditure; for goods and assets on hand at the date of registration it can look back 4 years, for services incurred leading up to registration it can look back 6 months.

HMRC have previously allowed all of the VAT incurred to be recovered as input tax, as long as the conditions for recovery were met (time limits, documentation, etc.) From some time in 2011 it appears that they have been taking a harder line, and instead of allowing all of the VAT incurred to be recovered they are expecting some kind of depreciation to be applied.

For example, A & B Removals have been in business for 10 years and have just tripped the registration limit and registered for VAT. They bought a new van for £18,000 + VAT three years ago. Under the ‘old’ rules the whole of the £3,600 VAT would be recoverable on the first VAT return.

Under the new interpretation by HMRC some element of depreciation has to be applied, and therefore the amount of VAT allowed to be recovered would be reduced, but the guidance is not particularly forthcoming on how much depreciation to apply.

Equally the legitimacy of the new treatment by HMRC has been brought into question, as their own internal guidance (VIT 32000) states: “The amount of tax that can be recovered is the amount that would have been deductible had the business been registered at the time the tax was incurred,” which would seem to clearly allow full recovery, but is followed shortly afterwards by “You must also take into account any use that has been made of the goods or services prior to registration”

So there are a couple of important points to consider here:

– is the move taken by HMRC legitimate? There is a VAT Tribunal case pending on this issue, so further information will become available in due course.

– if it is legitimate, how was the change in policy notified to business and the professions? It certainly seems to have many VAT professionals scratching their head, and the vast majority continue to advise clients to recover all pre-registration VAT without any depreciation.

– if it is legitimate, why does the general VAT guidance (VAT Notice 700 para 11.2) still imply that all pre-registration VAT (within the time limits and conditions) can be recovered, with no mention of depreciation?

Those of a cynical persuasion might suggest that HMRC have made an internal decision to restrict VAT recovery, but have avoided the legal niceties of letting people know, and applying the VAT law as it was written.