VRM7000 - What must be set-off in a claim
Introduction
Where a person makes a claim, the appropriate setoffs under VAT Act 1994 must be made before HMRC pays or repays that claim.
We also have a discretion to take account of any taxpayer liabilities in other regimes HMRC administers such as corporation tax or excise duty.
Inherent Setoff – Section 80(2A) and Regulation 29 VAT Regulations 1995
HMRC’s liability is for the net amount of VAT due to a claimant having taken account of both Output and Input Tax errors for the periods claimed
For example, if a person incorrectly treated an exempt supply as standard rated, they cannot receive the gross amount of Output Tax overpaid for an accounting period, where the error had led to that person deducting Input Tax incorrectly in the same period. HMRC’s liability is to credit or repay any amount that remains due to the claimant after netting off the Input Tax. Similarly, late claims for Input Tax under Regulation 29 must take account of any Output Tax underdeclared in the same period(s).
Section 80(2A) acts to set-off any sums due to HMRC under or by virtue of VAT Act 1994 against a claim. This includes the inherent setoff of Output and Input Tax in section 25. It is ‘inherent’ because the VAT system treats the payment of Output Tax and deduction of Input Tax in the same period as an inseparable whole.
Regulation 29 claims allow a person to deduct Input Tax under section 25(2), which specifically sets off any credit against the Output Tax due.
Setoff under section 81(3)
HMRC is only liable to pay a claim after setting off any VAT, penalties, interest or surcharge owed to us.
This setoff under section 81(3) is mandatory and applies to the current liabilities of the taxpayer, regardless of the period incurred, provided those liabilities arose from VAT Act 1994. This provision does not allow HMRC to raise any new assessments or penalties outside of normal time limits (but see section 81(3A) below).
Setoff under section 81(3A)
Section 81(3A) is a special provision which requires us to set any ‘liabilities’ that would otherwise be out-of-time to assess, against any amounts for which we are liable under a claim. It does this by disregarding the assessment time limit, to undo all the consequences of a mistake. It is not limited to particular accounting periods, but any adjustment must derive from the same mistake which gave rise to the claim.
Only HMRC and not the taxpayer can invoke s.81(3A). It can never increase the value of a claim, nor can it reduce the value of a claim beyond zero so that a claimant would in fact owe an amount to HMRC.
As a matter of policy HMRC will only use this provision where otherwise a person would benefit from an unjustified tax advantage. Put simply, it prevents a person correcting a mistake from being in a better position than if that mistake had never occurred.
What is the ‘same mistake’?
In Birmingham Hippodrome [2013] UKUT 57, a theatre claimed overpaid Output Tax on ticket sales which should have been exempt. HMRC used section 81(3A) to reduce the quantum of the claim by setting off incorrectly claimed Input Tax outside the claim period and which HMRC was out of time to assess.
The theatre argued section 81(3A) could not be used as there were two distinct mistakes. Firstly, the UK government had failed to implement the cultural exemption until 1996. Secondly, HMRC had mis-interpreted or mis-applied domestic legislation from 1996 onwards. It argued its claim arose from the first mistake but the incorrectly claimed Input Tax credits derived from the second mistake.
The Upper Tribunal rejected this argument saying:
If one had asked the Theatre why it was declaring output VAT or reclaiming input VAT, it would have said “because our ticket sales are standard rated”. That is a fair description of the mistake made even though further enquiry might reveal different reasons for different aspects of it.
Artificial attempts to separate the consequences of a mistake should be rejected.
Examples of using Section 81(3A)
Example One
A company sells goods at the standard VAT rate and finds out later these goods should be exempt. It makes a claim in March 2017 for the period 1 January 2013 to 31 December 2016.
| Year | Output Tax | Input Tax | Amount paid to HMRC |
|---|---|---|---|
| 2016 | £3 million | £1 million | £2 milion |
| 2015 | £3 million | £1 million | £2 milion |
| 2014 | £3 million | £1 million | £2 milion |
| 2013 | £3 million | £1 million | £2 milion |
| 2012 | £3 million | £1 million | £2 milion |
| 2011 | £3 million | £10 million | £7 milion |
The claim correctly applies setoff for incorrectly claimed Input Tax in 2013-2016 and totals £8m. In 2011 the company bought machinery to produce the exempt goods and incorrectly claimed £10m Input Tax on the purchase. HMRC is now out of time to assess this amount.
In this scenario the company gets the benefit of the exempt rate while still retaining substantial amounts of Input Tax and would be in a better position than if no mistake had been made.
HMRC applies section 81(3A) to reduce the claims value by the net amount paid by HMRC in 2011. We must also take account of the amounts overpaid in 2012 and apply setoff equitably to undo all the consequences of the mistake. The claim will be reduced by £5m in total, and HMRC will pay £3m to the company.
Example Two
A company finds it incorrectly supplied services at the standard instead of exempt rate from 1st October 2017 to 31st March 2019. It makes a claim in June 2019 for VAT periods 03/19, 12/18, 06/18 and 12/17 totalling £300,000 and leaves out 09/18 and 03/18 where there was more Input Tax than Output Tax.
| Period | Output tax | Input tax | Amount paid to HMRC |
|---|---|---|---|
| 03/2019 | £85,000 | £10,000 | £75,000 |
| 12/2018 | £85,000 | £10,000 | £75,000 |
| 09/2018 | £85,000 | £165,000 | £80,000 |
| 06/2018 | £85,000 | £10,000 | £75,000 |
| 03/2018 | £85,000 | £165,000 | £80,000 |
| 12/2017 | £85,000 | £10,000 | £75,000 |
HMRC will use section 81(3A) to include the 03/18 and 09/18 periods and the claim will be reduced from £ 300,000 to £140,000.
Set-off – VAT groups
When a company leaves a VAT group, it is still jointly and severally liable under section 43(1) VAT Act 1994 for any outstanding debts of the group incurred while the company was a member. Any VAT claim by the ex-member will be subject to set-off against these group debts. (Note only the representative member can make a claim for VAT periods when that company was part of the Group.)
That applies whether the group still exists or has been disbanded in the meantime. See relevant guidance in the Debt Management and Banking Manual at DMBM530180.
Setoff of other Taxes and Duties
Section 130 of the Finance Act 2008
We have a discretion under this section to set-off debts due from any other tax regimes HMRC is responsible for. This is subject to the insolvency rules in section 131 Finance Act 2008. You should always check that no further liabilities have arisen since the claim was made.
Policy in this area is administered by Debt Management & Banking (DMB) – see DMBM700000.
Section 133 of the Finance Act 2008
This provision applies where a person “A” transfers their right to claim to another person “B”. The claim will be subject to set-off of any outstanding liabilities to HMRC from both “A” and “B”.
In section 133, person ‘A’ is called the ‘original creditor’ and person ‘B’ the ‘current creditor’. Person ‘A’ can also be called the ‘transferor’ or ‘assignor’ while person ‘B’ can be known as the ‘transferee’ or ‘assignee’.
Setoff does not make the current creditor liable for the original creditor’s debts but it ensures the current creditor cannot receive a sum greater than the amount the original creditor would have received. The set-off of the original creditor’s liabilities will discharge the obligations of the original creditor to HMRC.
Setoff of the original creditor’s liabilities is done first, followed by setoff of the current creditor’s liabilities.
Section 133(7) also allows HMRC to reduce any amount paid to the current creditor by any defence to a claim by the original creditor. This includes the unjust enrichment defence.
HMRC will make reasonable efforts to recover outstanding debts from the original creditor before applying setoff to the current creditors claim.