Have Customs Reduced the VAT Rate?

Have Customs Reduced the VAT Rate?

GLYN EDWARDS AIIT considers a slightly confusing Customs Business Brief.

CAN TAXPAYERS TRUST information published by H M Customs and Excise? Several times a month, Customs issue Business Briefs with the promise to taxpayers 'to advise them of the latest changes and developments to taxes, duties and other Customs and Excise procedures'. This is a laudable aim, albeit that most tax advisers regard the official line with a healthy degree of sceptism, given that Business Briefs are often used to downplay important decisions of the tribunals and higher courts, whenever Customs suffer an unexpected defeat.

However, information in Business Brief 22/03 issued in November 2003 presents a more fundamental problem than the usual issue of propaganda and opinion. In a throwaway comment, Customs appear to have overturned settled European case law and more unusually they have overturned it in the taxpayers' favour!

Business Brief 22/03 concerned the VAT treatment of supplies of goods and services used by taxable persons for both business and non-business use. It explained how Customs intended to implement and limit the effects of the decisions of the European Court of Justice in Lennartz v Finanzamt München III [1995] STC 514 and the later case of Wolfgang Seeling v Finanzamt Starnberg [2003] STC 805. As readers will recall, these cases confirmed the right of deduction, in full, on goods and services purchased for mixed use, but with the proviso that taxpayers who took this option must account for VAT on private use in each subsequent VAT return period.

Before these cases, Customs had always insisted that taxpayers should apportion VAT incurred on purchases which were not exclusively for the purpose of the business. Thus, for example, if an asset was to be used 80 per cent of the time for private purposes and 20 per cent for the business, only 20 per cent of the VAT incurred on the purchase of the asset could be treated as input VAT.

The mischief in Business Brief 22/03 can be found in the final paragraph where it deals with the treatment of goods at sale or deregistration. Customs rightly point out that taxpayers who take advantage of the Lennartz mechanism, and recover VAT in full on their purchase, 'should bear in mind that ... on sale of the goods or deregistration of the taxpayer … VAT will be due on their full selling price'. There is nothing controversial in this; it is just a simple case of not having your cake and eating it, or what the courts might more formally describe as not being entitled to the benefit without also suffering the burden. And, of course, taxpayers and practitioners should be aware that the VAT burden may increase if the asset itself increases in value during the period of business use.

Customs then go on to make the following assertion.

'However, where apportionment is applied at purchase, VAT need only be accounted for in such circumstances on the proportion treated as business.'

The phrase 'in such circumstances' must mean that Customs are referring to the treatment of goods at sale or deregistration (which is the title of the paragraph). If this is the case, then if a taxpayer recovers only 20 per cent of the VAT he incurs on, say, the purchase of a motorbike he needs to account for VAT only on 20 per cent of the sale price. As shown in the Example below, the happy purchaser of the motorbike would be presented with an invoice, which appeared to charge VAT at a rate of 3.5 per cent, rather than the 17.5 per cent he was expecting.

Customs' message has the added attraction of its apparent fairness; i.e. why should a taxpayer be obliged to account for VAT on the full selling price of an item, if his recovery of input tax was restricted to 20 per cent? But is Business Brief 22/03 correct?

There are two relevant cases in the European Court of Justice which provide the answer. In Finanzamt Ülzen v Armbrecht [1995] STC 997, the Court ruled that an hotelier was not liable to VAT on the whole proceeds of the sale of his property, where part of that property had always been reserved for private use. Whilst this initially appears to support Customs' stance, it specifically related to property, where it was possible to identify discrete parts as wholly business or wholly private.

Of more relevance is Bakcsi v Finanzamt Fürstenfeldbruck [2002] STC 802. This concerned the sale of a car, which a German taxpayer had used for both business and private purposes. The decision of the court was categoric:

'A taxable person who sold a business asset was acting in a business capacity and therefore as a taxable person. Consequently, where a taxable person had chosen to incorporate wholly into his business assets a capital item which he used for both business and private purposes, the sale of that item was subject in full to VAT.' [My italics.]

Two tribunal decisions also confirm the same point. In David Seward (14706), VAT was found to be due on the full selling price of a yacht, notwithstanding that Customs had permitted recovery of only 45 per cent of VAT incurred on its construction.

Similarly, in D A Smith (t/a Varcom Sailplane Computers) (14196) the taxpayer was found to be liable to VAT on the full sales proceeds from a glider, even though he had only recovered 80 per cent of the VAT incurred on its purchase. In each case, Customs pointed out, and the tribunal accepted, that there is no provision in United Kingdom law that allows for a reduction in output tax by reference to the proportion of input tax claimed.

So why have Customs apparently changed their stance and what are the implications for taxpayers who cheerfully follow the 'new' policy?

Customs have been questioned on the first point and it appears that any suggestion that VAT would be due only on part of the sales price of an asset was a slip of the pen! They confirmed that they will, by concession, allow a taxpayer who deregisters, to account for VAT on a deemed supply of assets on hand only to the extent that he was initially able to recover input VAT on its purchase. However, there is no such concession for the sale of goods.

Taxpayers who are misled into accounting for less VAT on sales of mixed-use assets cannot rely on a tribunal siding with them if Customs raise an assessment. The tribunal can only apply the law, as it actually is. Any disputes arising from the application of the guidance in Business Brief 22/03 will therefore have to be settled by the Adjudicator or possibly through judicial review.

We must hope that Customs publish a clarification and that they will not penalise anyone who has been misled into the wrong VAT treatment by the department's error.

Glyn Edwards is a VAT consultant with IRPC Taxation Services and can be contacted on 07970 149834.

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