Editorial

Welcome to the latest edition of The VAT Bulletin!

Sometimes in life, we see wheels being reinvented. An unfortunate example has come around again with respect to the pre-registration input tax on the back of the new legislation for VAT on private schools. There is a broader article on schools in this bulletin as that subject clearly merits a section on its own.

However, input tax, and in particular VAT on pre-registration expenses, has resurfaced with HMRC again apparently inventing their own additions to what is a fairly simple piece of legislation. They tried this around eight years ago, stating that VAT on assets such as vans could only be claimed on the value of that asset taking into account depreciation at the registration date. I felt so strongly about the issue that I took HMRC to a tribunal. They pulled out before the hearing date, and the client was allowed full recovery of the disputed input tax and received all costs in connection with the tribunal case. The law hasn’t changed but once again they are attempting to introduce rules that will limit any claims. Hopefully, they will be as unsuccessful as the last time!

In this edition, we share more information on the above topics as well as a short and sweet VAT question that may surprise you.

VAT on private school fees

Labour is delivering on one manifesto pledge. VAT will be due on private school fees for terms starting after 31 December 2024.

The first consideration needs to be the correct date for VAT registration, assuming the schools are not already registered. While VAT is not applied on fees until after 31 December 2024, it is likely that invoices will be issued before that date. Where payments for those invoices will be received before 1 January 2025, VAT registration will be determined under what is called the ‘forward look’. For example, a school which is not VAT registered issues invoices on 1 December and knows that payments exceeding £90,000 will be received by 31 December. Under the forward look they must register from 1 December.

Whilst not certain, it is likely that HMRC will apply a light touch with regard to penalties where schools register late, particularly when they declare VAT on all fees for terms starting after 31 December 2024.

There are a number of quirks that may apply to what is a fundamental change in the treatment of the VAT liability of private schools’ income. Some of these at first glance appear counterintuitive. For example, supplies ‘closely connected to the supply of education’ will remain exempt, even though that education will of course become taxable. In addition, there are some supplies, such as school trips made outside of the UK, that could fall outside of the exemption if not deemed education (such as ski trips) but may result in a better VAT outcome. The reason for this is that they may fall under the Tour Operators Margin Scheme with VAT being declared on the profit margin at the zero rate of VAT.

We will publish an updated article in due course when the position on some of the intricacies become a little clearer.

Pre-registration input tax

We are closely monitoring HMRC’s views on pre-registration input tax, and the rules regarding use of goods prior to registration. This could result in schools potentially recovering less VAT than they might expect. However, we are of the view that HMRC’s approach could be incorrect although we need to see what actually happens in practice.

The legislation in respect of pre-registration input tax is within the VAT Regulations SI 1995/2518 reg 111. This states that a taxable person can recover VAT on goods on hand on registration if they have used them for the purpose of business. For example, if a person bought a van for private use then started a business a few years later and registered for VAT, there would be no entitlement to input tax. The key point here is that the law only allows restriction of input tax on goods purchased prior to registration where that purchase was not for business purposes, they do not mention taxable or exempt supplies.

HMRC’s new approach is to see goods on hand as having an economic life of five years, and so for example if a business made exempt supplies four years before registering and bought an asset when they started trading, then only one fifth of the VAT originally incurred would be reclaimable. This, they argue, fits in with partial exemption and the Capital Goods Scheme for computers, boats etc. On the face of it, this sounds sensible. However, HMRC are not above the law, and regulation 111 does not mention apportionment either directly or indirectly and makes no mention of previous exempt supplies, only whether the taxable person was in business. Of course, it also ignores the fact that if a person bought an asset four years and a day before registering, with an economic life left of a year there would be no entitlement. Regulation 111 was only ever meant to be a blunt instrument.

It seems too much of a coincidence that this change in interpretation of pre-registration input tax coincides with thousands of schools registering for VAT. We await the new guidance but are firmly of the opinion that any change in policy is not within the scope of the law as it stands.

Deliberate penalties

The amount collected by HMRC in respect of deliberate penalties has increased by 38% in the year 2023/24. Penalties are based on behaviours when a taxpayer makes a mistake. At one end of the scale, a mistake can be made despite taking reasonable care which will not attract a penalty. The next level is ‘careless’ behaviour. This can attract a penalty of up to 30%, but importantly a penalty can be suspended if controls are implemented to ensure that mistakes won’t happen again. After careless is ‘deliberate and not concealed’ where a taxpayer has under declared or over claimed VAT knowing it is incorrect but hasn’t taken steps to hide it. Penalties can be up to 70% of the tax avoided and no suspension is allowed. Finally, there is ‘deliberate and concealed’ which is again deliberately under declaring VAT, but actually hiding the behaviour from HMRC. The penalty can be 100% of the tax avoided and again no suspension is allowed.

HMRC officers appear to be deciding that more behaviour is deliberate rather than careless. However, the onus is on HMRC to demonstrate that the behaviour is deliberate – they have to show that on the balance of probabilities a person knowingly took action to reduce their liability to VAT. Anyone who does receive a deliberate penalty should take advice because in our experience they can very often be successfully appealed.

Marshmallows – size does matter

The VAT rules often throw up some strange anomalies. Some goods or services depend almost entirely on certain facts to determine the VAT liability. The famous Jaffa Cakes tribunal deciding that Jaffa Cakes going hard when left outside a container meaning that they were cakes rather than biscuits and therefore zero-rated, is a great example. Marshmallows are probably even more interesting as it really is all about the size!

It has long been established that very small marshmallows are zero-rated as they are used in cooking and are sold in the cooking aisle of a supermarket. Medium size marshmallows are treated as standard rated; they are designed to be eaten with fingers and are placed in the sweet aisle and compete with other confectionery. There has been a recent tribunal case concerning the VAT liability of giant marshmallows. One could be forgiven for thinking that these were sweets for people with big appetites! However, both the first-tier tribunal and upper tribunal found that as giant marshmallows were sold specifically for roasting, they were zero-rated food items like their much smaller counterparts. HMRC are seeking permission to appeal to the Court of Appeal but in the meantime, if you want to check the VAT liability of marshmallows, get your ruler out!

The Gerald Edelman VAT team

We hope that you found this edition insightful. If you have any questions about any of the topics covered, please reach out to our specialist VAT team via vat@geraldedelman.com.