BIM40164 - Specific receipts: refunds of sums paid as VAT: the starting point for the direct tax analysis

This is direct tax guidance; for indirect tax guidance, refer to VAT Guidance.

Refunds of sums originally paid as VAT are not ‘windfall’ amounts; they are non-gratuitous sums paid by HMRC as a result of a claim. The right to a refund typically arises following a change of view as to the legal obligation to pay a sum in the past. Whether the change of view arises from a Court decision or for some other reason does not alter the treatment of the refund for direct tax purposes.

The Upper Tribunal recently heard a case where the point at issue was the taxation of refunds of sums paid as VAT and the related interest (Shop Direct Group v HMRC [2013] UKUT 0189 (TCC)). In her judgment, Asplin J upheld the First-tier Tribunal’s decision, which had adopted a similar approach to the taxation of refunds of sums paid as VAT as set out in the following guidance. At paragraph 63 Asplin J confirmed that the refunds arose from the original trading transactions:

The [First-tier Tribunal] in my judgment were right to conclude that [S80 Value Added Tax Act 1994] was merely the legal machinery by which the payment was made and that the underlying source of the payment is to be determined by asking what in substance the payment was for. I also agree with its conclusion that the source of the repayments is the original trades by which the overpayments of VAT were generated being paid either to the supplier or the successor to the trade.

The starting point in computing the taxable profits of a trade are the accounts prepared in accordance with GAAP - see BIM30510. Tax law then provides for various adjustments to that figure. If tax law does not remove a particular item from the GAAP profits, then that item is taxable.

The accountancy treatment of VAT is considered in BIM31525. Address any questions about whether the accounts are or are not completed in accordance with GAAP to a HMRC Advisory Accountant.

The accounts are for the entity, rather than just the trade, so one question is whether the refund is a trade receipt. The answer is that it is a trade receipt because the operation of the VAT system is an integral part of carrying on the trade. It is for this reason that the professional fees incurred in connection with a dispute about the amount of VAT payable may be allowed as a deduction in computing profits. Such fees having been incurred wholly and exclusively for the purposes of the trade where there is a dispute over whether particular goods or services on revenue account are liable to VAT (see BIM46455).

Some agents have claimed that refunds of sums paid as VAT are not taxable on the basis of the decision in the case of Morley v Messrs Tattersall [1938] 22TC51. This case involved sums that were deposited with Tattersall on very specific and unusual terms. As noted in BIM40250, these sums were never the property of Tattersall and were never recognised as the income of the trade in its accounts. So Tattersall is not an authority for excluding the refunds from taxation.

The refunds of sums originally paid as VAT differ from the client monies held in Tattersall:

  • first, because the refunds are received in the course of trade;
  • second, because the refunds are the property of the trader and have been recognised as the income of the trader in their accounts.

Arnold J confirmed that this is the correct view in the recent case of Pertemps Recruitment Partnership Ltd v HMRC FTC/65/2010, where he distinguished between cases where the money belonged to the taxpayer (subject to any claim) and the situation in Morley v Messrs Tattersall where the money belonged at all times to the client (see BIM40240).

Morley v Messrs Tattersall has also been cited as authority for the idea that the nature of a receipt is fixed for ever more at the point of receipt. Again this point was considered by Arnold J in Pertemps where (at Paragraph 30) he concluded that:

…there can be circumstances in which money which is not a trading receipt at the time of receipt subsequently becomes a trading receipt because something occurs which changes its character.

The principles described in the following sections are of wide application. They apply not only to refunds of sums paid as VAT, for example in respect of fixed odds betting machines, but also to refunds of other duties such as air passenger duty or landfill tax. In addition they are relevant in circumstances where overpaid trade expenses are refunded; such as the discovery that for many years an electricity meter has been incorrectly read to the detriment of the customer.

The handling of refunds when

  • the trade continues, or when
  • the trade has passed to a new owner, or when
  • the trade has ceased

mirrors the tax analysis described in the following guidance.

The direct tax analysis is explained in more detail on the following pages:

BIM40166 Refund of output tax
BIM40168 input tax
BIM40170 Refund received by the trader or successor
BIM40172 VAT groups
BIM40176 Refund accounted for by someone other than the trader who made the overpayment: introduction
BIM40178 Refund accounted for by someone other than the trader who made the overpayment: payment for services
BIM40180 Refund accounted for by someone other than the trader who made the overpayment: post-cessation receipts
BIM40182 Refund accounted for by someone other than the trader who made the overpayment: miscellaneous income
BIM40186 Passing on the refund to original customer