Suppliers, particularly building contractors, are often faced with the question of whether to charge VAT at the standard rate, at the reduced rate or at the zero-rate.
Getting it right can be so complex that the lowest risk approach is often seen as being to charge VAT at the standard rate if the customer can recover all their input tax. A recent case will make taxpayers think again.
The case in question involved two companies, a supplier (building contractor) and their customer. The two parties were opposed in the case of Deluxe Property Holdings Limited v SCL Construction Limited  EWHC 3354 (TCC), which was heard on 8 December 2020. The supplier, SCL Construction Limited, had charged VAT at the standard rate to Deluxe Property Holdings Limited, but it was later found that this was incorrect and the supply was zero-rated as the construction of this particular building (student accommodation) was mostly zero-rated. The amount overcharged by the supplier was by that stage almost half a million pounds.
Where VAT has been overcharged by a supplier and paid to HMRC, a claim can be made to HMRC for those funds to be reimbursed to the supplier. These applications are lengthy processes: HMRC generally wish to satisfy themselves that the repayment is appropriate, usually requiring a promise from the supplier that any refunded VAT will be passed on to the supplier’s customer. In the case in question, the judge ruled that the refunded VAT was only held on trust by the supplier for the benefit of their customer. This created a difficulty for the supplier as they had already used the funds in the furtherance of their own business, potentially in breach of trust law.
There is also a wider point to note from this decision. The circumstances show how difficult matters can become if a supplier charges VAT at the standard rate when the applicable rate of VAT is not clear, as is often the case with construction work. The VAT charged by the supplier to the customer will be recovered by the customer in their VAT returns. HMRC will review the customer’s VAT returns before making repayments to them, particularly when there is a significant claim, and if HMRC is not satisfied that the VAT was charged correctly to the customer, HMRC will refuse to refund to the customer the VAT claimed. The customer’s recourse is then to the supplier, who in turn enters a lengthy claim with HMRC for incorrectly charged VAT before being able to refund their customer. Paying VAT at the standard rate can turn a customer’s profitable project into a loss-making one if their claim is refused and the process of recovering overpaid VAT can significantly impact cash flow.
For both supplier and customer, seeking expert advice to ensure the appropriate rate of VAT is charged at the start of a project is a worthwhile exercise in helping to mitigate these risks in the long run.