HMRC have an implied power to refuse VAT credits

In DCM (Optical Holdings) Ltd v HMRC [2022] UKSC 26, the Supreme Court (SC) ruled on whether a VAT best judgement assessment was made in time and confirmed that HMRC’s obligation to pay a VAT credit arises only when it is established that the VAT credit is due.

• DCM (Optical Holdings) Ltd (DCM) traded as Optical Express, dispensing spectacles and providing laser eye surgery.
• For VAT purposes, DCM was the representative member of a VAT group and Partially exempt.
  • The supply of frames and lenses (a Supply of goods) is taxable.
  • Dispensing Services are VAT exempt.  
• In 2005, HMRC raised a Best judgement assessment in respect of under-declared output VAT in 2002 and 2003.
  • This under-declaration resulted from an issue in calculating the split between taxable and exempt supplies.
• In respect of VAT returns between 2005 and 2008, HMRC also reduced the input VAT credit due to DCM.
• Following appeals to the First Tier Tribunal, Upper Tribunal, and Inner House of the Court of Session, DCM Appealed to the Supreme Court (SC).
• DCM argued that:
  • The best judgement assessment was made out of time as HMRC knew that something was wrong with its output VAT apportionment method by January 2004.
  • HMRC did not have the power to make reductions to the input VAT claimed as section 25(3) of VATA 1994 mandated HMRC to pay the amounts claimed.

Under section 73(6) VATA 1994, a VAT assessment must be made by HMRC by the later of:

1. Two years after the end of the accounting period.
2. One year after evidence of facts comes to HMRC’s knowledge which is, in HMRC’s opinion, sufficient to justify making the assessment.

In respect of the best judgement assessment, the SC found that:

• ‘Knowledge’ meant actual, rather than constructive, knowledge.
  • Constructive knowledge is knowledge that HMRC did not, in fact, have, but which they could have had if they had taken the necessary steps to acquire it. 
• HMRC obtained the last pieces of evidence relevant to making the assessment (DCM’s VAT account) on 31 August 2005 and 1 September 2005.
  • Before those dates, HMRC did not have evidence of facts sufficient to justify the assessment.
• The assessment raised in October 2005 was made within 12 months and was, therefore, made in time.

On HMRC's reduction of input VAT claims, the SC found that:

• It is implicit in s.25(3) that HMRC’s obligation to pay a VAT credit only arises once it is established by verification that the VAT credit is due.
  • The obligation to pay does not depend solely on the say-so of the taxable person.
• This implied power is also implicit in HMRC’s duty to be responsible for the collection and management of VAT and is not inconsistent with any statutory provisions. The power aligns with ensuring that a taxable person pays the right amount of VAT or receives the right amount of VAT credit.
• The principle of fiscal neutrality was not breached and there was no unjustified discrimination between payment traders and repayment traders.

DCM’s appeal was dismissed.

Useful guides on this topic

Assessments: Best judgement
What is a 'best judgement' assessment for VAT? When can HMRC raise one? What are your rights of appeal? How do you displace a best judgement assessment?

R & C Brief 14 (2020): Opticians and sellers of hearing aids
Revenue & Customs Brief 14 (2020) changes to the methods used by opticians and sellers of hearing aids to account for VAT on their supplies.

Partial exemption & input VAT
How do you calculate the amount of input tax you can recover under the VAT partial exemption rules? What are the de minimis rules?

Goods or services for VAT?
What are goods and what are services for VAT? The answer may have an impact on the time of supply, the place of supply and in some cases the rate of the supply. The answer is not always as straightforward as it may seem.

Groups (VAT)
What are the conditions for forming a VAT group? What rules apply once a VAT group is in place?

External link

DCM (Optical Holdings) Ltd v HMRC [2022] UKSC 26