In J&B Hopkins Ltd v HMRC [2017] UKFTT 0410 (TC), the First-tier Tribunal (FTT) upheld a VAT assessment, even though the taxpayer had not charged VAT and was unable to recover it as the recipient of the supply had gone into liquidation.

Background

J&B Hopkins Ltd (J&B) entered into a construction contract with Rok Ltd (Rok), under which it agreed to construct a new place of worship for a charity. The charity had issued a zero-rating certificate to Rok who duly zero-rated its supplies of construction services. J&B was provided with a copy of the certificate and on this basis proceeded to not charge VAT on its invoices.

HMRC formed the view that, as sub-contractor, J&B was not entitled to zero-rate its supplies. Note (12) of Schedule 8, Group 5 of the Value Added Tax Act 1994 (VATA) provides that only a supply by a main contractor may be zero rated. Accordingly, HMRC raised assessments on the basis that the supplies were standard rated and that payments received from Rok were deemed to be inclusive of VAT.

After paying J&B's invoices, Rok went into administration and then into liquidation. As a consequence, J&B was unable to collect the unpaid VAT from Rok.

J&B accepted that it was not entitled to zero rate its supplies to Rok. It was also accepted that it was unlikely that Rok in turn was able to recover any input VAT from HMRC. Nevertheless, it appealed the assessments on the basis that HMRC would be unjustly enriched by the windfall (because Rok had not recovered the input VAT on the amounts it had paid to J&B). J&B relied on the European principles of effectiveness and fiscal neutrality. It argued that Reemtsma (Case C-35/05) applied to grant it a claim against HMRC which would effectively cancel out the assessment.

FTT's decision

The appeal was dismissed.

The FTT held that the effect of section 19(2), VATA, was that the amounts paid by the customer included output VAT. It was immaterial that the parties were unaware of that fact at the time. As such, Rok had only paid a proportion of the price due and, therefore, in reality, J&B was an unsecured creditor for the outstanding amount. It followed that as Rok had paid the amount of VAT to J&B, although it had not exercised it, Rok had a right to recover that sum from HMRC.

There was no doubt in the FTT's mind that Reemtsma created directly effective rights justiciable in the UK. The FTT accepted that the principle could apply in cases of underpaid VAT (such as the instant case), as well as overpaid VAT. However, the FTT concluded that the principle established in Reemtsma could not apply in the present case as J&B had actually been paid for the supply on which it had been assessed to tax. 

In the FTT's view, Reemtsma required the windfall for HMRC to be at the supplier's expense, whereas in this case, it was the customer's expense. J&B was seeking relief from tax because of a windfall that HMRC might have had at the expense of Rok (or its creditors), as the price under the contract had been inclusive of VAT. 

The FTT held that the principles of effectiveness and fiscal neutrality did not assist J&B. Reemtsma confirmed that where a customer's restitutionary rights against its supplier for overpaid VAT are ineffective due to insolvency, the obligation on the tax authority to repay the VAT is transferred from the supplier to the customer. In this case, the supplier's rights were effective as the payment received from Rok included VAT.

Finally, the FTT dealt with a point J&B raised concerning whether the assessment had been made to HMRC's best judgment (section 73(1), VATA). The FTT held that it had no jurisdiction in relation to the decision of HMRC to make the assessment. That is an exercise of discretion which can only be challenged by way of judicial review. Even if it had jurisdiction, the FTT commented that it would not have found in favour of J&B because there would not be a windfall on HMRC if J&B had correctly issued Rok VAT notices as it should have done. Moreover, the FTT considered it would not be a proper exercise of HMRC's discretion to forgo enforcement of the law to protect taxpayers against their customers' insolvency.

Comment

J&B's difficulty in this case was that it had accepted a VAT inclusive price under the misunderstanding that no VAT was payable. It serves as an important reminder that subcontractors must take care to determine the correct VAT liability of the works they undertake and not rely on assurances given by the main-contractor.

This case is also a helpful reminder that it is essential to choose the correct forum for any public law challenge to HMRC. When considering a judicial review challenge, expert legal advice should be sought at the earliest possible opportunity.

A copy of the decision is available to view here.