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HMRC internal manual

VAT Refunds Manual

What to do with claims resulting in unjust enrichment: loss or damage

Overview

If VAT is imposed on a supply with a consideration of £100, the cost to the customer (consumer) will be £120. However the true economic position, as far as the supplier is concerned, may well depend upon the principles of supply and demand.

If VAT has been wrongly imposed, the consequential increase in price may have an effect upon the supply and demand for those goods or services. It is a general assumption in business and economics that an increase in price will affect the number of sales. Simply put, as price increases, demand falls.

It is this fall in demand and consequential loss of sales (and loss of profits) that will often be said to give rise to any economic loss or damage. However the relationship between a price increase and supply and demand is not necessarily linear or straightforward. Thus, the extent to which a business may suffer economic loss or damage, if at all, will depend very much upon the particular economic market in which those supplies are made.

Generally, in an economic market where there is a very high demand from customers (consumers), a business making supplies in that market will be able to pass on any additional costs. On the other hand, where demand is lower, additional costs are less easily passed on.

Unforeseen or unplanned costs arising as a consequence of a mistaken assumption about VAT, such as previously recoverable input tax becoming irrecoverable, might also give rise to an argument for economic loss or damage.

This basic analysis illustrates that errors in the imposition of VAT will have different effects in different business sectors and their associated economic market. At the two ends of the scale you may find that in one market sector it is possible to pass on the burden of the VAT in full while in another the trader is forced to absorb the entire burden himself. To establish the precise effects in any particular case will require some economic analysis.

Extent of loss or damage

The loss or damage that we are required to take into consideration when dealing with the refusal of claims is not limited only to damage cause to the business or line of business on which the VAT was wrongly accounted for.

The claimant is entitled to include in his quantified amount any damage caused to any part of his business by having made the mistaken assumption that led him to account for output tax when there was no requirement to do so.

In its decision in Gil Insurance Ltd (VAT Tribunal Decision IPT00009), the VAT & Duties Tribunal held that:

  • Loss or damage is not restricted to loss of sales and profits.
  • We are required to take into account the loss or damage caused to any business carried on by the claimant.
  • We are required to accept as part of the consideration any future loss or damage that the claimant can show will arise as a result of having made the mistaken assumption.
  • We are required to take into consideration loss or damage caused also to the claimant’s non-taxable business activities.
  • The fact that loss or damage arose as the result of the actions of the claimant does not exclude such loss from consideration. That is especially true where the further losses arose as a result of the claimant’s attempts to mitigate the losses.
  • Where the claim is made by the representative member of a VAT group, the loss or damage to be taken into account is the loss or damage caused to the any of the business activities of any member of that VAT group.

Newly blocked input tax

Where a claimant accepts that payment of his claim would unjustly enrich him and undertakes to reimburse his customers under section 80A of the VAT Act or where we have been able to show that he would be unjustly enriched and he agrees to reimburse, amounts newly ‘blocked’ as wrongly deducted input tax are normally treated as falling within the ‘loss or damage’ provisions.

Where a person treats as taxable, supplies that later turn out to have been exempt of VAT, he will have accounted for output tax for which he is not liable and deducted input tax to which he is not entitled.

Any claim under section 80 is only ever paid net and when we are calculating the amount that we are liable to pay, we are required by section 80(2A) to deduct from the amount claimed, the wrongly deducted input tax.

Where the claimant has, for whatever reason, undertaken to reimburse his customer(s) (see the guidance on the reimbursement arrangements), he will only be required to reimburse the amount by which he is said to be unjustly enriched.

Thus, for example, if the claim is for £100 and we have been able to establish that he passed 50% of the wrongly charged VAT on to his customers, we would require the claimant to reimburse £50 of his claim to his customers.

Taking that one step further. The claim is for £100 over-declared output tax, there is £25 wrongly deducted input tax and we have established that 50% of the VAT charge was passed on. All things being equal, we would credit the claimant with £100, pay him £75 and require him to reimburse £50.

The point of this guidance however, in relation to loss or damage, is this. We have a claim to recover £100 over-declared output tax. The claimant deducted £25 as input tax that he ought not to have done. We have established that he passed the burden of the full £100 on to his customers.

We credit him with £100 but we only pay him £75. In doing that we retrospectively increase the cost to him of making the supplies in question. The original cost to him of making the supply was £125 because the £25 VAT on that supply was deductible. By blocking what was thought to be the deductible input tax on that supply, we have increased the cost of making the supplies in question from £125 to £150.

As a result, we will normally treat that £25 as ‘loss or damage’ and the result of that is that we will only require him to reimburse the £75 and not the £100.