Tax: HMRC lose input VAT appeal
By Donald Drysdale for ICAS
30 January 2018
HMRC have lost £1 million to an Aberdeenshire farmer, but Donald Drysdale thinks that many other businesses might benefit from the judgment.
Introduction
A legal precedent was set in Edinburgh recently when the Inner House of the Court of Session rejected an appeal by HMRC and upheld a claim for repayment of VAT of over £1 million by an Aberdeenshire farming business.
VAT – a European tax
UK VAT law is governed strictly within parameters set by the EU – at least until Brexit. If and when the UK leaves the EU, we might even then remain a member of the single market and EU customs union with obligations to continue complying with EU VAT law.
Alternatively, on leaving the EU we may acquire new flexibility to change our VAT laws, but any such changes are likely to be gradual. VAT regimes exist in many countries, and are found to meet modern fiscal requirements – with most developed nations relying less on direct income taxes and more on indirect consumption taxes. UK VAT will stay with us in some form, and precedents already established may be relevant long into the future.
Single Farm Payment
The case of Frank A Smart & Sons Ltd [2017] CSIH 77, reported here, concerned VAT paid on purchases of units of Single Farm Payment Entitlement (‘SFPE’). These were units relating to subsidies under the EU’s Single Farm Payment (‘SFP’) scheme as it then applied
When the SFP scheme began in 2005 the taxpayer company received initial units of SFPE, without consideration, in respect of agricultural land which it leased. SFPE units were tradeable and a market in them developed.
To claim SFP, the farmer had to hold one hectare of eligible land for each unit and ensure that the land met specified agricultural and environmental conditions, though there was no requirement to cultivate it or stock it with animals. The company leased further land and, over a period of 4½ years, paid about £7.7 million for traded SFPE units, including the disputed input VAT.
During the period considered by the Court – the two years ended 30 September 2012 – the units yielded subsidies of £4.1 million in aggregate. The company’s intention in purchasing units was to obtain subsidies to repay its overdraft and develop its business operations. Since then it had actively investigated establishing a wind farm and constructing further farm buildings, and was contemplating the possible purchase of neighbouring farms.
The parties agreed on four fundamental points:
- the company was a taxable person carrying on an economic activity of farming and planning to diversify into the production of electricity by means of a wind farm;
- none of its activities or proposed activities constituted or would constitute an exempt supply;
- its purchase of SFPE units was a supply of services; and
- the receipt by the company of SFP subsidies was not an economic activity and did not constitute the making of supplies.
HMRC argued that, separately from its farming business, the company was trading in SFPE units and that this was not an economic activity for VAT purposes. They contended that the inputs incurred on acquiring SFPE units had a direct and immediate link with the taxpayer’s trade in SFPE units, not the farming business. As the SFPE units were outside the scope of VAT, it followed that the input tax was not deductible.
The taxpayer, on the other hand, maintained that the units were purchased to raise capital for its farming business (an economic activity for VAT purposes) and its future business of generating electricity (likewise an economic activity). The company claimed that raising capital in this way amounted to a general overhead of its business, linked to its total economic activity and forming a component part of the price of its products. It contended that the input tax paid on the units was deductible as a general overhead.
The Court of Session detailed the relevant Articles from the EU’s Principal VAT Directive and excerpts from the VAT Act 1994. It then cited key judgments of the European Court of Justice in which the basic principles of law applicable to the deductibility of input tax had been laid down.
One such case was Kretztechnik AG v Finanzamt Linz (Case C-465/03), reported here, in which the taxpayer had raised capital through a share issue. The ECJ had ruled that the share issue, falling outside the scope of VAT, was carried out by Kretztechnik to increase its capital for the benefit of its economic activity in general. As a result, the ECJ had held that the related costs formed part of its overheads and the related input VAT was deductible
In considering the circumstances of Frank A Smart & Sons Ltd, the Court of Session judgment recited what it saw as basic principles governing the recoverability of input tax and determined that the key test was how the income from the subsidies was to be used. The company had used the subsidies in its taxable business activities, including the construction of new farm buildings and the initial planning of wind turbines to generate electricity, so it was entitled to deduct its input VAT.
Other grants and subsidies
This decision is good news for farmers receiving subsidies. It may also have far-reaching consequences for organisations with any subsidies, grants or other income streams that fall outside the scope of VAT.
The Court of Session ruling demonstrates that, where costs are incurred in relation to income which is outside the scope of VAT, an understanding of how that income is applied may be crucial in establishing a right to deduct input VAT.
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