House of Lords rule on VAT "capping"

Tax Archive 04/02/2008

The recent decision of the House of Lords on the validity of the "three year cap" could affect any business that has underclaimed or overpaid VAT. What was the decision in the case and what should affected businesses do now?

What was the case about?

The ruling in the cases of Fleming (t/a Bodycraft) and Conde Nast Publications Limited v HM Revenue & Customs [2008] UKHL 2 (which were heard together) is the latest instalment in a complex VAT issue that has been running for 11 years.

The cases relate to whether the reduced time limit of three years for VAT input tax claims was introduced correctly. In particular, whether there was an acceptable transitional period for the new rules and whether the change was communicated to taxpayers correctly.

What was the decision by the Court?

The House of Lords concluded that time limits or changes to them must be fixed in advance. Furthermore, if a retrospective time limit is introduced (as was the case with the three year cap) the legislation must include a 'reasonable' transitional period. The absence of such a period when the cap was introduced was found to be incompatible with EU law and therefore the limit must be disapplied in respect of input tax accrued before the date of introduction.

Who will be affected by this decision?

The decisions in these cases represent a significant win for the taxpayer and mean that all businesses with claims for input tax amounts pre-dating 1 May 1997 are now effectively uncapped. There is now no reason for HM Revenue & Customs (HMRC) to defer the settlement of outstanding claims (subject to agreement on quantum etc). This applies irrespective of when the claims were submitted. New input tax claims for periods prior to 1 May 1997 should also be uncapped until such time as a new transitional period has been introduced (and run its course).

Although the status of claims for output tax was not covered explicitly in the judgment, any such claims made prior to 30 June 2003 should now also be released. Whilst it may take yet further litigation to clarify the position after that date, protective claims submitted now will be worthwhile where the amounts are sufficiently material.

Karen Robb, a VAT partner at Grant Thornton says: "There are many areas where the VAT rules have changed since 1973 and claims may therefore be possible going back a number of years. Some issues such as staff entertaining, business mileage and bad debt relief are likely to affect a large number of businesses. However opportunities may also arise, for example, in respect of share issue and foreign exchange costs.

HMRC will now be looking to introduce revised legislation and therefore businesses who believe that they may be affected should take advice as soon as possible to determine whether they should be making a claim. This may be one of the last chances for recovering "old VAT".

It is also worth remembering that if the findings in the Sempra (direct tax) case are ultimately held to apply to VAT, the overall value of the claim may be increased substantially through the compounding of compensatory interest."

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