Company receives VAT refund for using incorrect flat rate category
Businesses that choose the wrong trade sector category when using the VAT flat rate scheme (FRS), and thereby pay a lower rate of VAT, can be sure that HMRC will soon jump on them for doing so and claim the underpaid amounts of VAT in the process. What if the boot is on the other foot, ie a business that overpays VAT due to using a wrong trade classification? Needless to say, HMRC are not so quick to act and indeed are not particularly forthcoming in handing out VAT repayments.
In a recent First Tier Tax Tribunal case, JJK Engineering Ltd (JJK) won its appeal to have four years overpaid VAT refunded following its decision to reclassify its FRS trade sector.
What is the FRS?
The FRS is a scheme available only to businesses whose turnover is below £150,000. It allows traders to account for VAT on a fixed percentage of their VAT inclusive turnover but with no deduction for VAT the business pays on goods and services etc. The percentage to be applied varies according to which of the statutory trade sectors the business falls into; the sectors being listed in a table of regulations together with the appropriate percentage to be used.
Background
JJK applied to join the FRS in June 2008 but no trade sector category existed for its main business activity of project management, so it agreed to use the 12.5% rate associated with ‘Architect, civil or structural engineer’ (ACSE). This trade sector described the business activity of engineering consultants and designers. This still did not adequately describe JJK’s business so it could have opted for ‘any other activity not listed elsewhere’ (OANLE).
VAT returns were filed, using this category from 2008 until October 2015, at which point JJK’s accountants wrote to HMRC’s VAT Registration Service explaining their client should have originally registered under the OANLE category and therefore should pay VAT at the rate of 12% not 14.5% (the rates having increased since the time of original registration). The accountants asked for any VAT overpaid for the last four years, that being the time limit for correcting errors on past VAT returns, as a consequence of using the wrong trade category, to be repaid.
HMRC responded in November 2015 saying:
“I have updated your record to show you will be using 12% from September 2015.
We will not change your choice of sector retrospectively as long as your original choice was reasonable……
Note: Some businesses can reasonably fit into more than one sector. So changing your sector does not automatically make your original choice unreasonable.
Having looked at your records I will accept the change of trade sector from 1st September but I do not consider your original choice of trade sector to be unreasonable……..
As the FRS is self-assessing it is ultimately up to the trader to make an informed choice, as to which trade sector percentage they apply to their business, and they will be held accountable if the choice isn’t correct.”
Despite HMRC’s offer of an internal review of their decision being accepted by JJK, HMRC simply ignored the request and so an appeal was made to the Tribunal.
The hearing
Mr Ward, the principal of JJK, is a Chartered Engineer and Fellow of the Institute of Mechanical Engineers and virtually all of his work has been to do with plant and equipment as a Technical Project Manager, Installation Manager and, in one instance, Senior Engineer. From the evidence given by Mr Ward the Tribunal was convinced that he was not, in any sense, an architect, structural or a civil engineer.
JJK contended that HMRC’s decision not to backdate the use of the lower VAT percentage should be quashed on the basis that it:
- gave a windfall to HMRC
- gave no explanation why it was reasonable for JJK to have chosen ACSE in the light of advice contained in VAT Notice 733
- did not refer at all to the legislation and so ignored that the effect of regulation 55H(1) of the VAT Regulations 1995 was to make mandatory use of the correct percentage
- failed to address points raised in relation to the Tax Tribunal decision in Idess Ltd v HMRC
- referred to a wholly irrelevant reason why retrospection was not allowed
In Idess Ltd v HMRC (2014) and, most recently, in SLL Subsea Engineering Ltd v HMRC (2015), the First Tier Tax Tribunal agreed that mechanical engineers should be correctly classified as ‘business services not listed elsewhere’. Mechanical engineers working on plant and machinery were not the same as civil or structural engineers who were working on projects involving land and buildings.
HMRC said that their policy, as set out in VAT 733, was that backdating would not be allowed if the original choice was reasonable.
In reaching his decision the Tribunal judge explained that he had to decide whether JJK choosing ACSE was reasonable and not necessarily whether it was correct. It was not a reasonable choice because it did not describe the business that JJK actually carried on. Furthermore, the element of choice was minimal.
The Tribunal also saw no reason for JJK to seek HMRC’s approval to change its rate as this is not a requirement laid down by the VAT Regulations. Legislation only requires a business to notify a future change of trade category.
Concluding, the judge said, “I cannot therefore see where there is the source of HMRC’s power to deny, or for that matter agree to, backdating a change of percentage, except by assessing.”
In light of this decision, those contractors who feel they may have chosen the wrong FRS category and overpaid VAT may wish to consider making a correction for the last four years.
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