HMRC Reliance on Guidance Not Justified

The various VAT 'flat-rate' schemes were originally set up with the ostensible purpose of simplifying the VAT process for those using them, while being essentially revenue neutral for HM Revenue and Customs (HMRC).

A recent case dealt with a situation in which HMRC sought to remove the right of a farming partnership to use the flat-rate scheme on the ground that it had saved nearly £50,000 a year by doing so. The partnership farms livestock, which is then sold to local abattoirs.

Flat-rate schemes operate by allowing the user to pay a low rate of VAT on sales (in the case of an agricultural business this is 4 per cent) even though its customers are charged at the normal rate. The customers can recover the input VAT. The user of the scheme is not allowed to recover any input VAT they incur.

HMRC's decision to revoke the farmers' use of the flat-rate scheme was appealed to the First-tier Tribunal, which upheld HMRC's revocation, and then to the Upper Tribunal, which decided to refer the argument to the Court of Justice of the European Union (CJEU). The directive underpinning the scheme permits the taxation authorities to exclude from the scheme 'certain categories of farmers …for whom the application of the normal VAT arrangements…is not likely to give rise to administrative difficulties'. One question put before the CJEU was whether this entitles HMRC to exclude businesses from the scheme.

The CJEU found that the idea of revenue neutrality was one which should apply in the broad sense, not on a 'business by business' basis. In addition, the exclusion principles were not sufficiently clear and precise to enable the effect to be determined in advance, and thus undermined HMRC's argument.

HMRC's guidance on flat-rate schemes does state that businesses can be excluded from their use if they will do 'substantially better' by scheme use, but the CJEU ruling means that this cannot be justified. It should be remembered that HMRC's guidance does not have legal effect.

It is to be expected that HMRC will seek to revamp flat-rate schemes in the light of the decision.

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