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In this post, Neal Chandru, an associate in the Tax team at CMS, previews the decision awaited from the Supreme Court in DCM (Optical Holdings) Ltd v Commissioners for Her Majesty’s Revenue and Customs (Scotland) [2020] CSIH 60. The appeal was heard by the Supreme Court on 8 February 2022.

Background

DCM is an optician that sells spectacles and provides refractive eye surgery services.  Under the value added tax regime, it makes both taxable supplies of goods and exempt supplies of medical services.  The dual nature of its supplies creates difficulties in calculating the amount of VAT chargeable on its supplies and input tax recoverable on its acquisitions. In fact, from at least 2000, DCM had been in dispute with HMRC over a different input tax and output tax related issue.

In 2003, DCM

  • entered into a settlement agreement with HMRC under which it agreed that 64% of its supplies were exempt supplies and 36% were taxable supplies under a full cost apportionment methodology; and
  • notified HMRC that it had been using the standard method to apportion residual input tax between taxable and exempt supplies in proportion to the value of those supplies.

In the relevant periods, DCM acted contrary to the settlement agreement and the notification. In particular, it treated 70 % of its supplies as exempt and 30% of its supplies as taxable, and it did not use the standard method to apportion residual input tax but instead adopted a different method under which a greater percentage residual input tax was recovered.

Issues on Appeal

The first issue on appeal before the Supreme Court is whether tax assessments made by HMRC in 2005 through which HMRC sought to recover additional output tax on the basis of a 64/36 split between exempt supplies and taxable supplies (as opposed to the 70/30 split adopted by DCM) were made out of time and therefore time barred. The second issue is whether HMRC have an implied power to refuse to accept a sum claimed by a taxpayer by way of input tax.

With respect to the first issue, DCM argues that the 2005 assessments were issued out of time under s 73(6) of the Value Added Tax Act 1994 (‘VATA’). The section relevantly provides that the assessments issued in October 2005 shall not be made later than

‘one year after evidence of facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge’.

As HMRC knew from 29 January 2004 that DCM had not been using a full cost apportionment methodology to calculate the split between exempt and taxable supplies, DCM argued that 29 January 2005 was the last date on which the assessments could be raised. As they were raised on 20 October 2005, they were out of time.

With respect to the second issue, DCM argues that HMRC does not have an implied power to refuse to accept a sum claimed by a taxpayer by way of input tax. If DCM is right about this, then HMRC would have had no basis on which to refuse DCM’s input tax claim, given the time limits for making assessments, or issuing directions to a taxpayer to amend their return under regulation 35 of The Value Added Tax Regulations 1995, had expired.

Procedural History

The two issues on appeal had been decided adversely to DCM in the First-tier Tribunal (‘FTT’). The FTT decided that the 2005 assessments had been made in time and that HMRC had an implied power to refuse to accept a sum claimed by a taxpayer by way of input tax as it had a duty to investigate repayment claims.

In deciding that the 2005 assessment had been made in time, the FTT noted that it was only in August 2005, that is, not earlier than one year before the date the 2005 assessments had been made, that HMRC:

  • had been provided information relating to the percentage split used by DCM to calculate taxable outputs for the relevant periods; and
  • discovered that DCM had not been using the standard method to apportion residual input tax but had instead been using a different method under which a greater percentage of residual input tax was recovered.

As this information enabled HMRC to calculate the figures underpinning the 2005 assessment, the 2005 assessment had been made in time.  In coming to this conclusion, the FTT treated VAT assessments as “unitary” assessments.  This means that if HMRC discovers facts relating to a taxpayer’s overstated input tax, it can within one year not only make an assessment to counteract the overstated input tax but can also make an assessment to counteract any understated output tax for the same VAT accounting period.  The alternative approach would involve treating the elements of a VAT assessment as distinct.  The time limits for making VAT assessments under s 73(6) VATA would then have to be applied separately to the different components of the assessment.  On this alternative approach, HMRC’s discovery of facts relating to overstated input tax would not enable it to make an assessment relating to understated output tax. HMRC would be precluded from making an assessment relating to understated output tax because facts relating to understated output tax (as opposed to overstated input tax) would not have been discovered within the previous year.

On appeal, the Upper Tribunal agreed with the FTT that HMRC had an implied power to refuse to accept a sum claimed by a taxpayer by way of input tax, but it overturned the FTT’s decision that the 2005 assessments had been made in time. Those assessments were instead out of time to the extent they assessed DCM as having understated output tax. According to the Upper Tribunal, the only new information that had come into HMRC’s possession not earlier than one year before the date the 2005 assessments had been made related to overstated input tax.  In particular, it related to DCM’s failure to use the standard method to apportion residual input tax.  The information relating to understated output tax had, however, been known to HRMC since 29 January 2004.  In reaching the conclusion that the 2005 assessments were out of time to the extent they assessed DCM as having understated output tax, the Upper Tribunal in contrast to the FTT found that VAT assessments are not “unitary”.  The consequence of this is that HMRC’s discovery of facts relating to overstated input tax does not enable it to make an assessment relating to understated output tax and vice versa.

The Inner House of the Court of Session reinstated the relevant conclusions of the FTT.  It agreed with the FTT and the Upper Tribunal that HMRC had an implied power to refuse to accept a sum claimed by a taxpayer by way of input tax.  It agreed with the FTT, and thus disagreed with the Upper Tribunal, that the 2005 assessments had been made in time.  In coming to this conclusion, the Inner House stated that the Upper Tribunal had not been entitled to overturn the FTT’s finding of fact that the new information that had come into HMRC’s possession in August 2005 related to both overstated input tax and understated output tax, rather than just to overstated input tax.  As this new information had come into HMRC’s possession not earlier than one year before the date the 2005 assessments had been made, the 2005 assessments were in time.  The Inner House did not comment on whether the Upper Tribunal was right to conclude that VAT assessments are not unitary assessments as it was not necessary to do so to determine the appeal, and thus the Upper Tribunal’s conclusion in this respect remains good law.

Comment

DCM is a case of great significance.  The two issues to be decided by the Supreme Court are of central importance to the operation and administration of the value added tax regime.  Moreover, the Supreme Court will have the opportunity to determine an issue on which the FTT and Upper Tribunal reached opposite conclusions and on which the Inner House did not opine: that is, whether VAT assessments are unitary assessments.