The entitlement to reclaim VAT on expenditure as input tax depends on the use or intended use of the relevant goods or services at the time of supply.
Therefore, if a business intends to use positive rated purchases in making exempt supplies, no VAT is recoverable. However, it is clearly unfair on taxpayers who make a correct decision, but their intended use subsequently changes, unless there is some appropriate provision.
Thankfully, legislation allows for this through Regulation 109 of the VAT Regulations 1995, otherwise known as the ‘payback’ rules. With prior approval from HMRC, input tax may be reclaimed to the extent the costs will now be used to make taxable supplies.
Exactly how this works has not always been clear, but HMRC have recently published clarification on their policy following the High Court Decision in Community Housing Association (CHA).
In essence, CHA was a housing association, which built new houses for rent (exempt from VAT) but then decided to insert a subsidiary between itself and its suppliers, raise invoices from CHA to the subsidiary for work to date (a taxable supply) and make a ‘payback’ claim on the grounds of change of intent. HMRC refused the claim, CHA appealed to the Tribunal and lost. CHA then appealed to the High Court and won.
HMRC’s argument had been that there was no supply between CHA and the subsidiary and even if there were, the relevant costs were not cost components of the supply (a prerequisite for entitlement to input tax deduction), but the High Court found that ‘useful and material rights’ were transferred.
Following the defeat, HMRC have stressed that for there to be a supply, the recipient must receive some benefit and give some consideration. They say the costs components of a supply will flow from the nature of that supply, but the mere raising of invoices and passing of funds between companies does not automatically create a supply.
Clearly, businesses should take extra care to ensure payback claims reflect a genuine change of intent, especially as HMRC have expressed reservations about relevant supplies between close associates.
