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HMRC internal manual

VAT Refunds Manual

What must be set-off in a claim

When a claimant makes a claim, they must make any necessary set-offs so that the amount they claim is appropriate to the full circumstances of the claim. The headings below explain what must be set-off in various situations.

Inherent set-off – Regulation 29 of the VAT Regulations 1995 and section 80(2A) of the VAT Act 1994

Regulation 29

When a person makes a claim for input tax, he makes a claim to deduct an amount of input tax from the output tax for which he is liable in the accounting period in question. It is inherent in that claim that account is taken of any output tax under-declared in that period and any input tax over-claimed.

Section 80(2A)

Where a person makes a claim, for example under section 80(1), he makes a claim for the amount wrongly brought into account as output tax in a given accounting period in respect of specified supplies of goods or services.

That is subject to the set-off provided for by subsection (2A) of section 80. That set-off brings into account any input tax wrongly deducted in the accounting periods in respect of which the claim is made and any output tax under-declared in the same accounting periods.

Set-off – Section 81(3) of the VAT Act 1994

Section 81(3) provides that where HMRC owes an amount to a person (a claimant) (81(3)(a)) and that claimant owes an amount to HMRC (81(3)(b)), the two will be set against each other and, to the extent of the set-off, the respective obligations will be discharged.

An amount falls within the scope of section 81(3)(a) if HMRC has accepted that a claim is a valid claim, that the amount of the claim is correct and that the claim is, in fact, payable to the claimant.

An amount falls within the scope of section 81(3)(b) if an assessment for that amount, whether VAT, interest, penalty or surcharge, has been made and notified.

Differences in the prescribed accounting periods covered by the claim and those for which the assessments are made are irrelevant for the purposes of the set-off but they may make a difference for the calculation of statutory interest.

Set-off – Section 81(3A) of the VAT Act 1994

Section 81(3) has an implied time limit in it as a result of the fact that it is limited to liabilities that we are in time to assess under, for example section 73 of the VAT Act 1994.

Section 81(3A) has the effect of disapplying that time limit by requiring us to set against any amounts for which we are liable under a claim, any ‘liabilities’ that we are out-of-time to assess. Amounts that we would have assessed had we been in time to do so.

However, it only disapplies the time limit in relation to ‘liabilities’ that arose out of the mistake which gave rise to the claim.

For example, if a person has treated as taxable at the standard rate supplies that ought to have been exempt and makes a claim under section 80 of the VAT Act to recover the wrongly declared output tax, section 81(3A) will apply to amounts deducted as input tax as being attributable to the supplies that were wrongly treated as taxable.

However, section 81(3A) does not operate in relation to the accounting periods for which the claim was made but to prescribed accounting periods outside the scope of the claim.

Set-off – Section 81(3A) of the VAT Act 1994 – General example

A person makes a claim on 17 March 2017 for output tax over-declared on the sale of whatsummyjigs between 1 January 2013 and 31 December 2016 on the grounds that such supplies are exempt from VAT.

Under section 80(2A), the VAT incurred and deducted as input tax on the purchase of whatsummyjigs in the prescribed accounting periods covered by the claim is set against the output tax over-declared in those periods.

Section 81(3A) enables HMRC to bring into account input tax wrongly deducted in prescribed accounting periods ending on or before 31 December 2012 – that is to say prescribed accounting periods that are out-of-time under section 80(4) of the VAT Act and out-of-time to assess.

As a matter of policy, this set-off is only to be applied where a claim can be said to be considered ‘abusive’ – see VRM11000 of this guidance.

Set-off – Section 81(3A) of the VAT Act 1994 – When to use 81(3A)

The extension to the section 81(3) set-off provided for by section 81(3A) should only be used where there are unassessed and unassessable liabilities (for example, wrongly deducted input tax) which mean that payment of the claim, as presented, would give the claimant a windfall.

For example, in 2011 Jack paid £50,000,000 for the complete refurbishment of his factory and the purchase of brand new plant and machinery. In January 2017, he discovers that he has been wrongly treating his supplies as taxable at the standard rate (that they should have been exempt) and in March 2017, he makes a claim to recover the output tax wrongly declared on his supplies between 1 January 2013 and 31 December 2016.

He claims £10,000,000 over-declared output tax which is reduced to £7,000,000 when the input tax wrongly deducted between 2013 and 2016 is taken into account.

However, he deducted £8,300,000 as input tax on the refurbishment and the new plant and machinery which, had his supplies been treated as exempt, he would not have been entitled to deduct. As a result, if we were to pay his claim we would be paying him an amount which, in real terms, would constitute a windfall gain.

Section 81(3A) allows us to set the £8,300,000 wrongly deducted as input tax in 2011 against the claim for the amount claimed in relation to 2013 to 2016 to zero the claim.

Another example might be where Jack makes his claim for all four periods in 2013, only two of the periods in 2014, only one period in 2015 and three of the periods in 2016 and the reason that he ignores the six periods that he does is either because they are repayment returns or because the input tax deduction in those periods was significant. In other words, his claim cherry-picks those accounting periods in which there are significant over-declarations and insignificant amounts of wrongly deducted input tax.

Section 81(3A) allows us to take into account all of the accounting periods between 1 January 2013 and 31 December 2016 to achieve a result that is consistent with the VAT Act and EU law.

Set-off – Section 81(3A) of the VAT Act 1994 – Global calculation of set-off

If we are going to apply section 81(3A) we must do so in an equitable manner.

Let’s take the example from above in which 2011 Jack paid £50,000,000 for the complete refurbishment of his factory and the purchase of brand new plant and machinery. In January 2017, he discovers that he has been wrongly treating his supplies as taxable at the standard rate and in March 2017, he makes a claim to recover the output tax wrongly declared on his supplies between 1 January 2013 and 31 December 2016.

He claims £10,000,000 over-declared output tax which is reduced to £7,000,000 when the input tax wrongly deducted between 2013 and 2016 is taken into account.

However, he deducted £8,300,000 as input tax on the refurbishment and the new plant and machinery which, had his supplies been treated as exempt, he would not have been entitled to deduct.

However, we have only looked in this example at 2011 and 2013 to 2016. We must take 2012 into account as well.

In 2012, Jack over-declared £2,500,000 as output tax and wrongly deducted £750,000 as input tax – an over-declaration of £1,750,000.

We have to deduct that £1,750,000 from the £8,300,000 that was wrongly deducted in 2011.

The result is that the amount to be set off as a result of the application of section 81(3A) is now £6,550,000 and Jack gets a payment of £450,000.

If there were an over-declaration in 2012 of £10,000,000, it would clearly wipe out the section 81(3A) set-off. It does not increase the amount to which Jack is entitled under his claim. It simply reduces the amount of the set-off.

Set-off – Section 81(3A) of the VAT Act 1994 – Maximum effect of set-off

Because 81(3A) brings into account prescribed accounting periods for which we are out-of-time to assess, the application of the set-off cannot be used to create a liability.

If we have received a claim for £5,000,000 and have an out-of-time liability that we want to set off of £5,000,001, the most we can do is ‘zero’ the claim. We cannot demand the £1.

Set-off – VAT groups

Where a claim is made by a company that used to be a member of a VAT group, that company will continue to be liable, by way of set-off, for any outstanding debts of the VAT group incurred while the company was treated as a member of that VAT Group, such as write-offs, unpaid assessments, etc. Contact Debt Management & Banking and see the relevant guidance in the DMB Manual at DMBM530180.

That applies whether the group still exists or has been disbanded in the meantime.

It is important to remember that the joint and several liability provided for in section 43(1) continues to apply after the dissolution of the group.

Set-off – Section 130 of the Finance Act 2008

Under Section 130 of the Finance Act 2008, we are entitled to set-off against any amount due to a trader under a claim, any amount due to the department by way of any debt under any other of the tax regimes for which this department is responsible.

However, whilst the set-off provided for in Section 81 of the VAT Act 1994 is mandatory, it is a matter for the Commissioners’ discretion whether we apply the set-off under Section 130. Policy on this aspect of set-off is administered by Debt Management & Banking (DMB).

You should always check that no further liabilities (established debts in relation to any of HMRC’s taxes) have arisen since the claim was made. You will find further details on the policy on set-off between taxes and the mechanics of accounting for it at DMBM700000.

Set-off – Section 133 of the Finance Act 2008

Section 133 of the Finance Act 2008 applies where a person who has overstated his VAT liability (the original creditor) assigns the right to make the consequent claim to another person (the current creditor).

It provides that, in dealing with a claim from a current creditor, HMRC are entitled to set off the following against the amount due under the claim in the following order

  • any amounts that would have been required to have been set off against a claim by the original creditor under sections 81(3) and (3A) of the VAT Act 1994;
  • any amounts that would have been set off against a claim by the original creditor under section 130 of the Finance Act 2008;
  • any amounts that are required to have been set off against the claim by the current creditor under sections 81(3) and (3A) of the VAT Act 1994; and
  • any amounts that HMRC are entitled to set off against the claim by the current creditor under section 130 of the Finance Act 2008.

For the purposes of section 133, the outstanding liabilities at issue are those liabilities that are outstanding on the date on which HMRC authorise payment of the claim to the current creditor.

For the purposes of sections 81(3) and (3A) of the VAT Act, the following are treated as outstanding VAT liabilities:

  • any unpaid assessment for any accounting periods;
  • any unpaid returns for any accounting periods;
  • any over-claim of input tax in the accounting periods covered by the claim;
  • any under-declaration of output tax in the accounting periods covered by the claim; and
  • any amount (whether relating to input tax or output tax) that could have been assessed as VAT, interest, surcharge or penalty (even if it’s now out-of-time) for whatever accounting period provided that any assessment would have been founded on the same mistake that led to the claim.

As a matter of policy, the section 81(3A) set-off is only applied where a claim is considered to be ‘abusive’, see VRM11000.

This ensures that the current creditor cannot be paid any more on the claim than would have been paid to the original creditor had he made the claim himself at the same time and received payment on the same date.

This section applies whether the right to claim is assigned, transferred or sold on its own or whether it constitutes part of a business that is transferred as a going concern from one person (the transferor or original creditor) to another (the transferee or current creditor).

However, the FST has given an assurance in Parliament that the provisions of section 133 will not be used simply as an easy way of enforcing the original creditor’s outstanding debts. On 1 July 2008 in the debate on the introduction of section 133, she said:

‘It is not my intention that HMRC should rely solely on the new clause to recover the original creditor’s liabilities. When the right to claim a repayment from HMRC is transferred, the set-off mechanisms in the new clause will not be applied to a payment to the current creditor until HMRC has taken all reasonable steps to recover any outstanding liabilities from the original creditor.’ (Hansard, 1 July 2008, column 806)

All reasonable attempts must be made to recover outstanding debts-on-file from the original creditor before they are set off against any payment due to the current creditor. This applies to outstanding debts in relation to all taxes.

Those liabilities that are out-of-time for assessment and would normally be set off under section 81(3A) of the VAT Act 1994 should be set off against the amount due to the current creditor under the claim in any event.