VRM12200 - What to do with claims resulting in unjust enrichment: passing on

What is Pass On?

In simple terms VAT may be passed on to some degree if the price of a supply is higher than it would have been if no VAT had been chargeable. But in practice it can be very difficult to determine if this occurred or the extent of any pass on.  

Take for example a small business that begins trading and later exceeds the VAT threshold for registration. 

Business A begins by charging £100 a supply, but after registration increases the price to £120 (£100 +£20 VAT).

Business B begins by charging £120 a supply, but after registration keeps the price at £120 and decides to absorb the VAT cost, so also charges £120 (£100 +£20 VAT).

Both sets of invoices will show the same amount, but Business A has passed on the VAT charge while Business B has not. This is one reason why accounting evidence is not enough to determine if pass on occurred and why an economic analysis may be needed.

Comparing pre and post registration prices may not answer the question either. A business might – at the same time as registration – suffer an increase in costs from its supply chain which caused it to increase costs by 20% or thereabouts. It would have appeared to increase its price to account for VAT, but in fact was absorbing the VAT cost itself to remain competitive. Pricing can be affected by many different factors and any increases may be staged over an extended period.         

VAT Registered Customers

If a supply is made to a customer that can recover VAT as input tax, then we can assume the VAT has been passed on. This will also apply when the VAT can be recovered through other provisions such as section 33 or 41 VAT Act 1994.

If some of the input tax is blocked or irrecoverable due to partial exemption recovery rules, this assumption will only apply to the proportion of VAT that is recoverable (but we may be able to prove the remainder has been passed on without this assumption).

Pass-on is determined at the time of the supply. If the claimant believes the VAT on a supply is fully recoverable by his customer, and prices accordingly, then we will assume the VAT has been passed on, even if that input tax was later found out to be irrecoverable.

Customers who can’t recover VAT 

The starting assumption in a free market economy is that a supplier will absorb the VAT cost to stay competitive. To use the unjust enrichment defence HMRC will have to overturn that assumption by showing economic evidence.

Some factors will indicate pass on, and others not but the relative weight of each will vary with individual circumstances. You should make a balanced judgement taking into account all relevant information and bear in mind the burden of proof is on HMRC. Assertions by the taxpayer are not necessarily evidence without documentary proof to back them up.  

Indicators that the VAT has been passed on

  • Addictive or necessary goods
  • Monopolies
  • Uncompetitive Market and/or with few comparable substitute products
  • High Profit Margins
  • Prices change when VAT is introduced

Indicators VAT has not been passed on

  • Competing with zero-rated similar goods or substitutes
  • Most other businesses in market treated VAT correctly
  • Low Profit Margins
  • Competitive Market
  • Newly registered business which have not increased prices
  • No price change when VAT is introduced

These lists are not exhaustive.

Addictive or Necessary Goods – Customers may well continue buying these types of goods regardless of any price rises. Examples are cigarettes or food staples like bread.   

Monopolies – Where there is a lack of practical alternatives (e.g water companies for domestic use). This may also apply to high end luxury goods (for example cars) where the cheaper alternatives are significantly different. It might also apply to new markets where there is a lack of competition for whatever reason.         

High Profit Margins – If VAT had not been passed on, profits would have been squeezed. High means higher than typical or average margins for that sector. Low Profit Margins may be evidence that profits are being squeezed to stay competitive.

Competing with zero-rated goods – In markets where VAT liabilities vary (food for example), a product might have to compete with substitute products that are zero-rated. Claimants are more likely to absorb VAT in this situation.

Newly registered business which have not increased prices – this is normally an indicator that VAT has been absorbed, but there may be other factors involved.

When a business begins to charge VAT it will be unlikely to want to hike prices too much at once. Over time it is more likely that incremental price increases will pass on the burden of that VAT to the customer.   

When conducting an economic analysis you should consider; 

  • Who are the claimant’s competitors and if possible how they set their prices?
  • What is its market?
  • How does it set its wholesale and retail prices and how often does it change them and why?
  • What are its overheads?
  • Who are its suppliers and what volume discounts or interest free credit sales were received?