An unjust ruling.

If Customs & Excise was a commercial enterprise, no one would do business with it. In a bid to swell the Treasury coffers, it is refusing both to repay many companies the money it owes them and to allow credit for VAT paid more than three years ago. And this is even before the passing of any new law, for which Customs is lobbying hard – ‘in the national interest’ – to allow them to do so.

The biggest of many downsides of this blatant attempt at confiscation is that, whether legally or politically, it is doomed ultimately to fail.

In the meantime, Customs will lose control of the tax which it is their duty under Parliament to administer.

The proposed rules, introduced in the Budget but published in draft form in July, will stop businesses from recovering overpaid VAT dating from more than three years ago. But Customs will be able to collect underpaid VAT for up to six years. The law will be retrospective and thus nullify any existing repayment agreements. And it will be made deliberately difficult for businesses to recover a VAT overpayment even within the new three-year time limit and including cases in which Customs’ own instructions are responsible.

Unattractive proposals

There are several particularly unattractive aspects to these proposals.

Take a business which in each of the last six years has overpaid VAT of #15,000 and underpaid VAT #10,000: it is therefore owed net VAT of #30,000.

Under the proposed rules, it will be assessed for six years but can only reclaim for three. It will have to pay out #15,000 to Customs, plus, of course, interest and penalties. Even worse, if that were possible, the ‘six years for us, three years for you’ rule will apply in many cases where the VAT should effectively cancel itself out, as with a management charge. Similarly, VAT due under the reverse charge (where a business receives services from abroad, charges itself VAT and then takes an immediate deduction) will be caught if the business is partly exempt.

The ‘six years for us, three years for you’ rule creates a deliberate imbalance. There is injustice too in changing the rules for the past.

This is rightly unpopular and also disturbs the normal operation of law on which all civilised countries depend. Businesses currently in dispute with Customs over past VAT liability are finding that they won’t have all their money returned even if they win their case. If taxpayers cannot trust the administrators to apply the rules as they exist then the system cannot operate properly.

There have already been cases in the courts – reported in Accountancy Age – concerning Customs’ refusal to repay agreed overpayments. In the instance of the Royal College of Gynaecologists, the VAT Tribunal chairman described Customs’ legal arguments as ‘totally devoid of merit’. At a judicial review in the High Court involving a number of opticians and others on the same point, the judge found decisively against Customs, considering its actions to be both unfair and an abuse of process.

But that isn’t all. There are two options during a dispute: to go on paying the disputed tax or withhold it. If a business keeps back the tax and loses the argument, it will have to pay the debt plus interest. If it goes on paying but wins, Customs will refund with interest. It’s a fair system. But, under the proposals, while a victorious company can keep what they have withheld, any that do go on paying will only get cash back for the last three years. So much for the well-publicised Taxpayers’ Charter under which Customs promises to treat everyone the same.

The irony is that businesses will inevitably stop paying over VAT during a dispute even when it falls within the three years as there is no guarantee there won’t be yet another attempt to change the rules in the future to allow even less time to reclaim. A test case affecting many businesses could hit Customs hard financially. The Treasury will not have use of the disputed money and, over the years, will need to borrow more and more heavily.

Creating confrontation

These one-sided proposals create confrontation not agreement. The number of disputes going to court will rise and the present controversy will not be quickly forgotten as the imbalance can only create mounting injustice.

Irrespective of any legal actions, MPs’ postbags will be filled with letters of complaint from businesses in their constituencies.

Sadly, this is almost a straight re-run of Customs’ 1985 bungle when it took its usual heavy-handed approach and introduced draconian VAT penalties, punishing scores of businesses for innocent errors even where no tax was lost. At the time, the changes were officially described as ’tilting the balance in the taxpayers’ favour’ though they did the exact opposite.

The public outcry forced Customs to back down and, in successive years, to reduce the penalty regime to a more acceptable level (little consolation to businesses that had to pay up in the meantime). The same is going to happen again.

Cases are already going to court. They will last for years and Customs won’t be certain until they’re over whether the proposed policy will succeed in law or if it can keep the large contingent liability of unrepaid taxpayers’ money building up in the meantime. If Customs loses, the interest cost and legal fees will run into millions. Treasury forecasting will be very difficult.

How did we get into this mess in the first place? Customs now says it creates too much uncertainty in the national finances if taxpayers can claim VAT overpayments right back to 1973 (when it started). For businesses to plan and operate properly, there has to be the greatest possible certainty in tax. Many thoughtful practitioners have accepted the case for time limits, always stressing these should be balanced allowing the same time period to both parties. But Customs does not always find it easy to treat the taxpayer fairly and this is no exception.

It has lost a lot of court battles recently and clearly feared losing more. But in many instances the cases arose mainly from Customs’ own failure over several years to address distortions inherent in the UK VAT system.

This is designed to be a tax on final consumers not on the companies that levy it on the state’s behalf – acting as unpaid tax collectors, in effect.

Increasingly, however, Customs has tried to use the system to impose VAT costs on businesses and it is scarcely surprising they have begun to fight back. More and more, the courts are recognising the distortion too.

What should be done? The answer is twofold. Firstly, Customs should give up the attempt to introduce the ‘six years for us, three years for you’ rule.

It should also drop the general retrospective effect of the law on existing cases. If there is a really serious risk (which I doubt) that a few businesses will receive a true VAT windfall, then there could be specific legislation to deal with those exceptional cases. It is not the answer to take the unthinking blunderbuss approach, trying to confiscate the funds of all businesses owed money by Customs for more than three years.

Refuge of scoundrels

Over the next few months, Customs will be increasingly forced to defend the policy on grounds of national interest: it will argue that businesses should not receive a windfall from taxpayers and the money would be better spent on the country as a whole. What it will not say – particularly since it will have lost the case – is that the money does not belong to the public purse but to the businesses concerned. Customs should remember Dr Johnson’s words when it decides to confiscate what does not belong to it: ‘patriotism is the last refuge of the scoundrel’. One could use the same ‘public good’ argument to justify the confiscation and redistribution of assets owned by the ten richest people in the UK. Government bodies would be the first to step in if a commercial organisation tried to operate in such a manner.

Customs won’t listen. If it runs true to form, it will cite national interest to railroad the new rules through a Parliament kept deliberately uninformed, as in 1985, of the real issues. In its eyes the world will be a better and happier place. But will it?

John Arnold is director of European VAT Services at Moret Ernst & Young.