Three-year limit oversteps the mark

Richard Watson is VAT practice head at Price Waterhouse. His open letter sent this week to Customs & Excise VAT policy chief Martin.

Brown has focused the argument about misuse of the three-year rule by Customs and has received the whole-hearted support of the profession.

Dear Martin

‘We agreed that I would write to you to express some views about the detailed application of your new policy on limiting retrospective claims for VAT. My purpose here is not to question the basic policy – I and others have done that in other places – but to question certain administrative actions which are not actually in line with that policy.

As you have explained, ministers took the decision to limit to three years repayments of VAT because they were concerned about the impact on the revenue of the current legal provisions on refunds.

Draft amendments to the law have now been exposed, which concentrate on amending section 80 of the VAT Act and its associated interest provision (section 78). These amendments, however unwelcome, appear to achieve ministers’ intentions. They limit to three years the amount of VAT paid in error which can be repaid.

They also make certain administrative changes to that repayment regime and amend the effective impact of the unjust enrichment defence.

However, what the department has actually done in practice goes considerably further than this. It includes:

Refusing claims to include input VAT from periods of more than three years ago on the current VAT return – even when the invoice or evidence of input tax has only just been received. For example, when VAT on a supply such as a management charge is overlooked and Customs assess the supplier for output VAT more than three years later.

Assessing under-declarations of tax more than three-years old, while refusing to offset over-declarations from the same periods, whether related or not. However, you have now said that you will not use this to assess fully taxable traders for VAT on reverse charges or acquisitions.

Refusing adjustments of over and under-declarations from more than three years ago on the current VAT return when they net out to less than #2,000.

Refusing to accept VAT-only credit notes made to correct an over-declaration more than three years after the original over-declaration.

Refusing input tax claimed when opting to tax a building if the input tax was incurred more than three years previously.

Refusing claims for pre-registration input tax incurred more than three years before registration

Refusing bad debt relief for supplies made more than three years previously.

Without exception, these administrative arrangements are sanctioned by legislation other than section 80. Moreover, they do not necessarily reflect any change in the interpretation of the law. Rather, they reflect changes in the facts of the case.

Taking a simple example of a reverse charge on imported services, your original posture was that if a mistake had been made and the reverse charge had not been accounted for, an assessment would be raised for the appropriate period.

If that period was five years, for example, deduction of input tax would only be allowed for the last three years. You have now accepted that this would be wrong for a fully taxable trader, because it would result in additional tax being levied – tax which was never due and should not have been due. You have not, however, accepted the same point for partly exempt businesses, nor for the comparable circumstances of allowing deduction of input tax where the evidence has only just been provided.

An example of the latter is when one trader, who has made a mistake in his liability and is told that his supplies are standard-rated, issues a VAT-only tax invoice to another for a period of more than three years.

In both cases, the taxpayer has made a mistake of fact. He has not applied the law as it should have been applied. There is no dispute over a principle.

Most importantly, there is no precedent on which others can base a claim.

In these circumstances, it must be correct in law and equity that the department should receive only that tax which it should have received if the law had been correctly applied in the first place, with interest to make up for the fact that it did not receive the tax at the correct time.

To impose a three-year limit on such ‘repayments’ has the effect of creating a payment of tax where none should have existed. It is this inequality which is fuelling the debate – of six years for you, as opposed to three years for us.

I think you will find, on close examination, that all the examples I have given above fall into this category. They take away the taxpayers’ right to recover the correct amount of tax at a different time from that originally prescribed, but where there has been no change in law.

If you want to go down this road, you will need more extensive legislation than that so far exposed. Because, in these areas, there is no potential for large ‘band-wagon’ reclaims, I would hope that Parliament would firmly reject any proposal for retrospection.

I would suggest, therefore, that if the department’s actions actually mirrored the draft legislation already put forward, you would achieve ministers’ intentions, without upsetting a large part of the VAT collecting community.

As you know, many businessmen accept that they should not have a right to recover tax back to the start of the tax simply because someone else has won a tribunal case. That aspect of your proposals is much more acceptable to them than the rest of what you are doing.

I hope that you will accept this letter for what it is, based on discussions with our clients, to reach a position which will benefit business and the Department.’

Yours sincerely,

Richard Watson

Accountancy Age offered Brown right of reply, but he declined to comment.