Today’s Blog concerns a business in Scotland that sells caravans, but who were faced with the problem that caravans and their removable contents are liable to different rates of VAT. The vendor, Abbeyford Caravans Ltd, decided to change their VAT apportionment method, but encountered a hitch when HMRC agreed that whilst Abbeyford’s new method was more accurate, it was not correct for all of their sales.
Background
After considerable research, Abbeyford decided to change its methodology for valuing the caravan and its removable contents, which were submitted to HMRC for a ruling. HMRC having studied the research, fully accepted that the new method of apportioning VAT would result in much more accurate results.
Abbeyford was understandably very surprised when HMRC nevertheless refused to accept that the new method was historically correct. Consequently, Abbeyford appealed to the first-tier tax tribunal (FTT) to decide the twin questions of whether their new valuation method was the correct one, and if so, was there any logical reason why it could not be used retrospectively.
20% or 0%, that is the question
As any reader of this Blog who has ever owned a caravan may be aware, caravans can be subject to either a 5% reduced rate or zero rate of VAT. They are also usually sold with other goods or ‘extras’ that can be removed from the caravan. These extras are invariably subject to the 20% standard rate of VAT.
Most buyers, however, tend to pay a single price for both the caravan and its removable goods. Therefore, one problem for Abbeyford as the seller, was to apportion the price between the reduced-rated caravan and the standard-rated goods. They had originally used a methodology known as the “cost ratio method”, which was the method historically approved by HMRC.
An example: If a caravan seller buys a zero-rated caravan for £20,000 and the manufacturer states that £4,000 of the price is attributable to the removable goods, then the proportion of the price attributable to the removable goods is 20%. So, if the selling firm sells that caravan for say £30,000, the same proportion of the sale is attributable to the removable goods, namely £6,000 giving rise to VAT on the sale of £1,200.
Flawed methodology
Abbeyford considered that this methodology was flawed, as it assumed that the removable goods increased in value proportionately to the caravan. It also became clear that the manufacturer’s method of apportionment was in itself incorrect, because it was attributing the costs to contents that were not removable and therefore should not have been standard rated in the first place.
Abbeyford then decided to carry out an extensive valuation exercise of their stock and found that the proportionate value of removable contents varied between 5% and 9% of the value of their caravans. This was significantly lower than the range of 16% to 27% implied by the cost ratio method.
Having done extensive research on all the caravans they sold, Abbeyford submitted an error-correction notice to HMRC for overpaid output VAT of approximately £150,000. HMRC accepted that Abbeyford’s new valuation method was accurate and should be used on all future sales, but they then inexplicably decided not to apply that method retrospectively. Abbeyford appealed against that decision to the FTT, in an attempt to get their £150k back.
During the appeal, HMRC accepted that the new method was better and provided a more accurate figure than the cost ratio method. However, for their appeal to succeed, Abbeyford had to demonstrate that, in light of the new method, the results of the cost ratio method were not only incorrect for VAT purposes but also that the difference between the methods was substantial.
Abbeyford’s primary argument was that if it was agreed that one method was more accurate than the other, it must follow that the more accurate figure is the correct one. Further, the cost ratio method must be wrong because it resulted in customers actually paying a price for the removable goods that was in excess of their market value.
They further argued that the new method ensured that their customers were paying the respective market value of the caravans and the removable goods. Finally, given the new method resulted in a 64% reduction in output tax, the difference could not be argued as anything other than “substantial”.
HMRC disagreed. It argued that they could only consider a retrospective apportionment in exceptional circumstances. If the cost ratio method was wrong, Abbeyford should have submitted alternative methods sooner. It was HMRC’s view that Abbeyford chose to operate the cost ratio method and that such a method had produced a fair and reasonable result, even if it was less accurate.
Fundamentally flawed reasoning
The FTT decided that once HMRC accepted that the new method was correct going forwards, it followed that the new method must also be the correct method retrospectively. In accordance with the decision of the supreme court in the Advocate General vs K E Entertainments Ltd [2020] UKSC 28, there could only be one “correct” method of calculating output VAT.
The judge then dismissed HMRC’s arguments as being fundamentally flawed and went on to say that It was not possible for both methods to be correct and that it was abundantly clear to all parties, that the new method produced more accurate results. The reduction in output VAT from £296,906.85 to £150,458.45 was by any measure substantial, and therefore Abbeyford’s appeal was allowed.
Accountant’s view
In my opinion, once HMRC had agreed that the new VAT calculation method was far more accurate it was churlish of them to refuse to allow the method to be used retrospectively. It was also a waste of taxpayers’ money to take the case to court in the first place.
