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HMRC internal manual

VAT Refunds

Unjust enrichment: Economic loss or damage: Newly blocked input tax

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.

When calculating the amount that we are liable to pay under section 80(2A) of the VAT Act 1994, we are required by section 81(3A) to deduct the wrongly deducted input tax from the amount claimed.

However, generally speaking, we accept that such ‘newly’ blocked input tax constitutes an unforeseen cost to the claimant and as such can be said to be an amount that would appropriately compensate him for loss or damage caused to his business by having proceeded on the basis of the mistaken assumption that led him to account for output tax for which he was not liable.

What happens in this scenario is this. Aleksej Ltd claims output tax £1,000,000 accounted for on exempt supplies. On verification, we set against that (under section 81(3A)) £250,000 which he deducted in input tax on the assumption that the supplies he was making were taxable and that the input tax was therefore taxable. However, we accept that the application of the mistaken assumption has caused loss or damage to his business in that amount and that, as a result, payment of £250,000 would appropriately compensate him for that loss or damage. That £250,000 would be excluded from any amount that Aleksej Ltd would have to reimburse under section 80A of the VAT Act 1994 and regulations 43A to 43G of the VAT Regulations 1995.