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HMRC internal manual

Business Income Manual

Specific receipts: refunds of sums paid as VAT: refund of output tax

This is direct tax guidance; for indirect tax guidance, refer to VAT Guidance.

S19(2) Value Added Tax Act 1994

The treatment of refunds of sums wrongly treated as output tax is relatively straightforward.

The trader received a sum from their customer for the goods and/or services supplied. Part of that was paid to HMRC in the mistaken belief that it was due as VAT. As a consequence the profits for that period were accordingly reduced as explained below.

Suppose that the trader sells an item for £120. They receive that amount from the customer. At the time of the initial receipt the trader considers that £20 is due in respect of VAT and pays that amount over to HMRC. In their profit and loss account they include an amount of £100 as the gross trading receipt.

When the mistake is discovered, the trader claims and obtains a refund of the money wrongly paid as VAT, in this case say the full amount of the VAT £20.

The trader however received £120 from the customer. If none of that is VAT, then the gross trading receipt in the profit & loss account should have been £120, not £100.

Under the VAT rules the value of a supply of goods or services is taken to be equal to the amount which, with the VAT chargeable, is equal to the consideration. So the refund is not a windfall; unless it is passed back to the original customer (see BIM40186), it forms part of the value received by the trader for the original supply of goods or services.

Although legally it has always been the trader’s money, the sum refunded is included in computing the profits of the period in which it is recognised for accounting purposes in accordance with GAAP. If the trader pays some of the money on to their original customer then the trader will get a deduction for that payment see BIM40186. The original customer is taxable on the sum paid on to them, if they were able to deduct the original expenditure in computing their trade profits. The refund is an adjustment to an allowable trading expense, see BIM40166.

This can be called a ‘scope of the trade argument’. It has been put to HMRC that in cases where:

  • the disputed refund does not ‘belong’ to the entity disclosing it in their accounts, or
  • where there is the possibility of having to repay or pay to someone else at a future date,

the refund is not taxable. HMRC do not accept either proposition.

Support for HMRC’s position can be found in the judgment of Arnold J in the recent case of Pertemps Recruitment Partnership Ltd v HMRC FTC/65/2010 (see BIM40240). In Pertemps the taxpayers attempted to argue that overpayments made by their customers by mistake were not trade receipts, relying on the case of Morley v Messrs Tattersall [1938] 22TC51, but Arnold J decided that the payments in question were taxable as trade receipts and could be distinguished from the payments held by Tattersall:

‘Tattersall were auctioneers. Accordingly, they never had title to the horses they sold as agent for their clients. Thus they received the purchase money in a fiduciary capacity and held it on trust for the clients. Beneficially, therefore, the money did indeed belong to the clients. As Ungoed-Thomas J said in Elson v Prices, “the balances were not the property of the traders but of their clients”. Accordingly, they could not be trading receipts of Tattersall. By contrast, as I have said, in the present case the mistaken payments are the property of Pertemps, albeit that the customers have a claim for restitution.’

Example A

A Ltd is not a member of a group for either Corporation Tax or VAT purposes. It is a mass retailer and has been carrying on the same trade since 1980. A Ltd makes a claim for a refund of sums which it has paid as VAT because it has wrongly treated one of its food lines as subject to VAT.

A Ltd makes a valid claim for part of this amount and receives a refund of £75,000, which the directors recognise in the accounts for the year ended 31 December 2012.

The £75,000 is a taxable receipt and is included in calculating the trading profits for the year ended 31 December 2012 as this is the accounting period where it is recognised as income under GAAP.

You may see this scenario described as ‘plain vanilla’.

Example B

B Ltd traded as a retailer between 1980 and 2010. But now B Ltd carries on a property business, the letting of its former retail outlets. B Ltd makes a claim for a refund of sums which it paid as VAT when trading, because it had wrongly treated one of its food lines as subject to VAT.

B Ltd makes a valid claim for part of this amount and receives a refund of £75,000, which the directors recognise in the accounts for the year ended 31 December 2012.

The £75,000 is a taxable receipt. Because the trade has ceased, it is taxable as a post cessation receipt (see BIM90000 onwards).

For analogous situations involving VAT groups see BIM40171 onwards.