Many VAT-registered businesses take VAT recovery for granted - the logic being that if VAT is due on sales then there is an entitlement to recover all the VAT paid on costs. As one would expect, however, HMRC is quite zealous in ensuring that there are appropriate restrictions on VAT recovery where the costs in question do not have a direct link to a sale which affords the right to VAT recovery.
This approach prompted HMRC to challenge the right of a company owned by Mr Smart, a Scottish farmer, to recover more than £1m of VAT incurred on the purchase of the rights to receive around £7.7m of EU farm subsidies.
Following defeats for HMRC in the lower courts, the Supreme Court has now also ruled in the company’s favour - a decision which could prompt many other UK taxpayers to revisit unrecovered VAT incurred on fundraising activities. We await HMRC’s response to this most recent decision.
Mr Smart’s company carries on a farming business and, as its income is VAT taxable, it ordinarily has the right to recover VAT on costs associated with running the business. This means that if the business pays VAT on purchasing (for example) a tractor that will be used on the farm, then this VAT can be reclaimed in full on that purchase.
So why did HMRC refuse the recovery of over £1m of VAT incurred when the company purchased the right to receive EU farm subsidies, referred to as Single Farm Payments, from other farmers. After purchasing the rights to receive these subsidies, the company was entitled, in accordance with the EU’s Common Agricultural Policy, to receive income in respect of its business of running the farm Mr Smart owned in partnership with his wife. Without this business, the Company would not have the right to receive the subsidies even after purchasing the rights from other farmers.
HMRC claimed that these purchases were akin to a financial investment, in other words the expenditure was incurred in order to generate the receipt of subsidies which represented a form of investment income which is outside the scope of VAT. HMRC contended that as there was no direct and immediate link between the expenditure on which the VAT was incurred and the company’s farming income the VAT could not be reclaimed. The taxpayer successfully argued that there was such a link, as the subsidies would be used to support the company’s current and planned economic activities, which consisted of the making of taxable farming supplies and would not include any VAT exempt transactions.
While the issue may sound relatively straightforward, a raft of case law was referred to during the lengthy litigation process through the courts.
So, should VAT incurred on costs related to the financing of an organisation be attributed to that organisation’s VAT taxable income and recovered, or should recovery be blocked on the grounds that the immediate purpose of the funding cannot be looked through? Perhaps unsurprisingly given the volume of relevant case law, this remains a contentious area that is highly sensitive to the facts. However, this decision does mark an important point of principle from the UK’s most senior court of law.