HMRC investigations bring in a record £3.9bn of extra VAT from SMEs

Publications thats covered this story include The Telegraph, 8 December and The Independent, 8 December.
  • 10% jump in small business VAT investigation yield in just a year
  • Worry that SMEs are treated as ‘second-class citizens’ in VAT disputes

HMRC took a record £3.9 billion in extra VAT from compliance investigations into small businesses in the last year*, up 10% on the £3.6 billion brought in the previous year, according to our research.

The amount of extra VAT taken from investigations into SMEs by HMRC’s local offices has almost doubled in three years, rising from £2.2billion in the 2010/11 tax year (see graph).

We explain that HMRC has become increasingly aggressive in challenging the VAT arrangements of small businesses as it aims to increase its tax receipts.

We add that organisations as diverse as Financial Advisers, property development companies and sports clubs have all been targeted by HMRC, either to challenge long-accepted VAT arrangements, or to impose what some businesses see as unrealistic burdens on them to claim back VAT.

Many SMEs cannot afford a potentially drawn-out challenge to HMRC’s demands for extra VAT but, even so, the tax authority has had mixed results when forced to argue its case in court.

In July this year, HMRC failed in its attempt to reduce the amount of VAT that can be reclaimed by self-storage businesses, after one such company, Lok’n Store, successfully argued in court that it should be able to reclaim 99.98% of the VAT it pays – the percentage of its floor space that is used for storage.

However, HMRC in October announced its intention to ignore this ruling not only when VAT is reclaimed by other self-storage businesses, but also in VAT cases in general, a move that has been criticised by the tax profession.

Last year, HMRC argued that online sales of glasses by retailer Glasses Direct were not accompanied by ‘medical dispensing services’, unlike sales in a bricks-and-mortar shop, making Glasses Direct liable to pay VAT on the full value of the spectacles without any exemptions. The first-tier tax tribunal disagreed, in a ruling that may have significant cost-saving implications not only for online healthcare businesses, but all online businesses if HMRC attempt to tax them differently than their high street counterparts.

Simon Newark, Partner, says: “HMRC has taken an increasingly hard line over the last year in its attempts to increase tax receipts, so more and more small businesses in particular are finding themselves facing investigation over VAT arrangements that have long been accepted by the tax authority.”

“Unfortunately, the law is heavily weighted in HMRC’s favour. Once they make a decision it is irrelevant if the decision is right, wrong or even unlawful. Unless the taxpayer challenges it, the decision will be enforced by the full might of the State with bailiffs if necessary.”

“Some argue that HMRC wants to have its cake and eat it when it comes to VAT decisions. When HMRC wins a non-binding Tax Tribunal case on VAT, it may choose to treat it as a precedent and a reason to change official policy, but when it loses a binding case in a higher court, it is sometimes ignored.”

“The belief voiced by many businesses facing these challenges is that HMRC has gone through all the obvious, high-value tax avoidance targets and often met with resistance or the likelihood of expensive court cases being drawn out for years. They are worried that HMRC is hoping to achieve some easy results by targeting smaller businesses using novel arguments against VAT treatments that have been accepted for years.”

“The cost of challenging demands for extra VAT through the courts can be prohibitive for a lot of small businesses, and many will simply decide it’s simpler and more cost-effective to just write a cheque to HMRC, even if they believe the demands are incorrect.”

Concerns that SMEs treated as ‘second-class citizens’ in VAT disputes

There are concerns among SMEs that they are treated as ‘second-class citizens’ in VAT disputes, in comparison with large businesses.

We explain that the tax affairs of the 2,000 largest businesses in the UK are handled by HMRC’s specialist Customer Relationship Managers, whose role includes resolving differences over VAT treatments. SME tax affairs are handled by HMRC staff in local offices nationwide.

Says Simon: “HMRC’s Customer Relationship Managers are highly-trained, experienced tax professionals that deal in depth with a relatively small number of large, complex businesses. They have a day-to-day relationship with the businesses they work with, which helps them avoid any nasty surprises in their tax bills.”

“Small businesses, on the other hand, run the gauntlet of HMRC’s local offices and the much-maligned National Advice Service helpline and Written Enquiries office. The level of service and accuracy of decisions they receive from HMRC can vary quite widely, and there is concern that many of them struggle to get a fair and cost-effective outcome from investigations because of that.”

Record high in extra VAT from SME compliance investigations

VAT release

*Year end 31 March  2014