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VAT Voice by Andrew Needham

Andrew Needham, Director of VAT Solutions (UK) Ltd, considers the development of this important VAT principle.The defence of ‘unjust enrichment’ has only been available to HMRC since 1 January 1990, when the relevant legislation (s. 80 VATA 1994) was amended following the decision in Fine Art Developments plc (1989) 4 BVC 26, when restrictions on the liability of the then HM Customs & Excise to repay VAT overpaid by mistake were permitted.

This stance was later reinforced by the ECJ in Societe Comateb & others v Directeur General des Douanes et droits indirects (1997) STC 1006 (TVC 21.360,) when they accepted that money need not be refunded if the claimant would be unjustly enriched.

HM Revenue & Customs are not liable to repay a claim made under VATA 1994 s.80, if the repayment would unjustly enrich the claimant (VATA 1994, s. 80(3)). To be unjustly enriched by a repayment, the taxpayer has to be put in a better economic position than if he had not mistakenly accounted for VAT, i.e. he would receive a “windfall” profit. If the sums are repaid to the customer, then the unjust enrichment provision does not apply. HMRC’s published guidance states that unjust enrichment:

“usually arises where you are unable or unwilling to pass on to your customers a refund of a sum of money that, for practical purposes, they paid to you as VAT which wasn't due.”

Burden of Proof

The burden of proof rests on HMC to show that a claimant has been unjustly enriched. The defence is for HMRC to invoke, and therefore for HMRC to prove. It is not for the claimant to prove that he would not be unjustly enriched if they were to pay a claim; it is for them to prove that he would (although in practice it seems as if the taxpayer has to prove that he is not unjustly enriched). HMRC can only successfully invoke the defence of unjust enrichment if they can show that someone other than the claimant effectively bore the burden of VAT. It cannot be assumed that any VAT charged has been passed on to customers because the claimant may have absorbed the VAT by accepting a reduced margin.

A good guide is if the price did not go up when VAT started to be accounted for or that the price did not fall when VAT ceased to be accounted for. This is often the case when businesses deal directly with the public and there is a competitive market with a “market rate”. A recent example of this has followed the Empowerment Enterprises Ltd Tribunal case which centred around the VAT exemption for private tuition provided in subjects “normally taught” in schools and Universities. Normally taught covers most subjects now including languages, sports, motor bike lessons, dancing etc. As a result a number of dance schools etc have applied for deregistration and a reclaim of overpaid VAT. It is common that in these cases, the price did not increase when they registered for VAT, so the VAT was absorbed from the profit. In such cases, it will be difficult for HMRC to prove unjust enrichment.

HMRC approach

As a general rule, HMRC take the following factors into account:

• substitute products;

• addictiveness;

• necessity;

• market position;

• price and margin usually aimed for and achieved;

• how long the error occurred;

• any decline in profits; and

• whether customers are generally VAT registered.

In an attempt to extend their ability to refuse claims based on the unjust enrichment defence, HM Revenue & Customs made changes to the legislation in March 1997 following difficulties in invoking the defence of unjust enrichment in a number of cases. The changes were as follows:

• where the amount of VAT has been borne by someone other than the claimant (i.e. the customer), the amount of the claim is restricted to an amount which compensates the claimant for loss or damage which he has or may incur as a result of mistaken application of the legislation (VATA 1994, s. 80(3A)–(3C), as inserted by FA 1997, s. 46(1)); and

• there are regulations concerning reimbursing customers who have borne the original VAT charge (Value Added Tax Regulations 1995 (SI 1995/2518), reg. 43B and 43C). HM Revenue & Customs can assess amounts due under these arrangements (VATA 1994, s. 80A and 80B, as inserted by FA 1997, s. 46(2)). There is a right of appeal against such an assessment (VATA 1994, s. 83(ta), as inserted by FA 1997, s. 46(3)). Broadly, a reimbursement scheme is only acceptable to Customs if the taxpayer undertakes:

(a) to reimburse to customers by cash or cheque the full amount of the VAT and of any interest, without deduction of any handling charge, within 90 days of receiving repayment (Value Added Tax Regulations 1995, reg. 43C);

(b) to keep a record of the amounts repaid (Value Added Tax Regulations 1995, reg. 43E); and

(c) to pay back to HM Revenue & Customs within 14 days any amounts not repaid to customers within the 90-day period (Value Added Tax Regulations 1995, reg. 43D).

These provisions only apply where the claimant would be unjustly enriched by a repayment which was not passed on to customers. The prohibition against making any handling charge appears indefensible. A claimant, who makes a reasonable charge that does no more than cover the cost of administering repayments to customers, is not enriched, so cannot be unjustly enriched.

The unjust enrichment provisions were further extended in May 2005. Prior to these changes, the unjust enrichment defence applied only to claims where persons had overpaid VAT. The changes extended the unjust enrichment defence for all claims, so it no longer matters whether a claimant is in a net payment or repayment position on individual VAT returns.

Also, unjust enrichment is no longer limited to any amount overpaid. It will be considered in respect of the gross amount of the overcharged output tax.
This second change is most likely to apply where a supply, which should be exempt, has been erroneously treated as subject to VAT. This is best illustrated using an example of a scenario where an exempt supply is mistakenly treated as taxable. In the example, output tax is £100 and input tax £25. The net payment to HMRC on the VAT return is £75. The actual cost to the taxpayer in collecting the tax is nil.

The 'true’ scenario of the supply correctly being treated as exempt would be:

• output tax nil;

• input tax nil (£25 paid to supplier but irrecoverable as relating to exempt supply);

• paid to HM Revenue & Customs on VAT return nil;

• actual cost to taxpayer - £25 (i.e. the irrecoverable VAT).

Under the existing rules, provided HMRC were satisfied that the £100 had been repaid to the customer, they would refund £100 to the taxpayer.

Under the new rules, in respect of claims made on or after 26 May 2005, provided HMRC are satisfied that the £100 has been repaid to the customer, they will not invoke the unjust enrichment defence, but they will only refund £75 to the taxpayer.

Presumably, HMRC’s stance is that an interpretation of unjust enrichment whereby the taxpayer must, in avoiding the unjust enrichment defence in unwinding the above from the 'actual' to the 'true' position, repay £100 to its customers in order to obtain a refund of £75 from HMRC (thereby leaving the taxpayer with an actual cost of £25), is the right one.

As before, claims for input tax and for refunds of, for example, duplicated payments of VAT, are not subject to the defence of unjust enrichment.

’Capping’

The ‘three-year cap’ still applies to all claims for a credit of tax, but the three years will start from:

• the end of the prescribed accounting period covered by the return, if the error was on a return;

• the end of the prescribed accounting period in which the voluntary disclosure was made, if the over accounted for output tax was on a voluntary disclosure;

• the end of the prescribed accounting period in which the assessment was made, if the output tax error was in an assessment; and

• the date of the overpayment where the error arises from a duplicate payment.

The latest development regarding unjust enrichment is the continuing saga of the Marks & Spencer case. The House of Lords has now referred the matter to the ECJ, so it will be quite some time yet before we have clarity in this area.

November 2005

Andrew Needham

Andrew Needham
Director, VAT Solutions (UK) Ltd
Email: andrewneedham@vatsolutions-uk.com

VAT Solutions (UK) Ltd
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VAT Solutions (UK) Limited is an established independent firm of Chartered Tax Advisers, formed by Andrew Needham and Steve Allen. The company has a cross-section of clients from multi-national companies through to medium-sized and numerous smaller regional firms of accountants and solicitors. They produce a regular publication 'VAT Voice', which can be downloaded directly from the Internet via their website: