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HMRC internal manual

VAT Refunds

HM Revenue & Customs
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Set-off and net-off: For VAT

Section 81 VAT Act 1994 (‘Interest given by way of credit and set-off of credits’) requires us to set off against amounts that we owe to taxpayers, amounts owed by them to us by way of VAT, penalty, interest or surcharge.

Thus if Adana Ltd has a claim against the Commissioners for £1,000,000 but, at the same time, it owes HMRC £250,000 in VAT assessments, £350,000 in penalties, £100,000 in default interest and £50,000 in default surcharge, the Commissioners will only pay the company £250,000 - the difference between what HMRC owe to the company and what the company owes to HMRC.

However, a trader cannot set off an amount owed to him by HMRC until he has received written confirmation from HMRC that the refund claimed is due to him. Section 81(3)(a) provides that a claimant can only set off what is due to him from HMRC. No amount claimed by a person can be said to be due to him until we have confirmed that it is. Where a trader does make a set-off without receiving agreement from HMRC, debt recovery action should be taken.

Equally, no amount can be said to be due from the trader until the debt has been established, for example, by making and issuing an assessment. Once an assessment has been made and notified, sections 73(9) and 76(9) of the VAT Act 1994 deem that amount to be VAT due subject, of course, to the outcome of any appeal.

Section 81(3A) requires that we set off against amounts for which we are liable to a claimant any amounts which, although not assessed, would have been assessed had the mistake that led to the claim not been made.

For example, Adana Ltd makes a claim on the 30th of June 2007 for output tax overdeclared on the sale of widgets. The claim covers all accounting periods between 1 April 2004 and 30 June 2007.

Section 81(3) requires that we set off against the amount due under the claim all outstanding debts on file.

However, section 81(3A) brings into the equation, for example, input tax that was attributable to the supplies in respect of which output tax is being claimed where it was deducted as a result of the same mistake that led to the overdeclaration of output tax. What’s more, the set-off is not limited only to that input tax that was incurred in the accounting periods for which the claim was made.

As a matter of policy, where a claim is not considered to be ‘abusive’, the section 81(3A) set-off should only be applied to liabilities in the accounting periods which are covered by the claim.

It is our view that this provision must also be applied where a trader had been treating as exempt a supply that later turns out to be taxable. A trader who attempts to recover previously blocked input tax would have to set off against the input tax that he ought to have been able to deduct the output tax that he ought to have accounted for on his supplies. In effect, in the vast majority of cases, this would leave him with no claim at all as the output tax liability will almost always exceed the input tax entitlement. Such claims might fall within the definition of ‘abusive’ claims - see the sections in this guidance on abusive claims.