DCM challenged HMRC’s VAT output tax assessment as time-barred and disputed HMRC’s power to reduce self-assessed VAT credit claims. The Supreme Court upheld both HMRC’s assessment as timely and confirmed HMRC’s implied statutory power to verify and refuse unjustified VAT credit claims pending investigation.
Background
DCM (Optical Holdings) Ltd (‘DCM’) operated an optical business under the name Optical Express, making both taxable supplies (frames, lenses, accessories) and exempt supplies (dispensing services, eye tests, laser surgery). As a partially exempt trader, DCM’s VAT liability required apportionment of consideration between taxable and exempt supplies under section 19(4) of the Value Added Tax Act 1994 (‘VATA’). A 2003 settlement between HMRC and DCM established a 36:64 split between taxable and exempt supplies for earlier periods and required voluntary disclosure of any under-declared output tax for subsequent periods. DCM never made those voluntary disclosures and was found by the First-tier Tribunal to have misrepresented its apportionment methodology to HMRC through its advisers PwC.
On 31 August and 1 September 2005, HMRC officers visited DCM’s premises and for the first time gained access to DCM’s VAT account. This revealed that DCM had not adopted an acceptable Separately Disclosed Charges methodology and had applied differing percentages across quarters. HMRC issued a best judgment assessment on 20 October 2005 covering periods from October 2002 to April 2005. Separately, between 2008 and 2013, HMRC made decisions reducing the VAT credits DCM had claimed in periodic returns, having placed a repayment inhibit on DCM’s ledger from September 2005.
The Issue(s)
Time Bar Challenge
Whether HMRC’s assessment of 20 October 2005 was invalidated by the statutory time limit in section 73(6)(b) of VATA, which requires an assessment to be made within one year after evidence of facts sufficient in the opinion of HMRC to justify the assessment comes to their knowledge. DCM argued HMRC had sufficient knowledge by January 2004 to issue an assessment.
Vires Challenge
Whether HMRC had the legal power to refuse to accept a taxable person’s self-assessed claim for payment of a VAT credit while verifying the claim, and subsequently to pay a lower amount than that claimed.
The Court’s Reasoning
Time Bar
Lord Hodge, delivering the unanimous judgment, endorsed the principles established by Dyson J in Pegasus Birds Ltd v Customs & Excise Commissioners [1999] STC 95, which were upheld by the Court of Appeal. The critical point was that section 73(6)(b) addresses the assessment HMRC actually made, not a hypothetical assessment they might have made. Lord Hodge stated:
It is clear from these dicta, which in my view are a correct statement of the law, that section 73(6)(b) addresses the assessment which HMRC has in fact made and not a hypothetical assessment which they might have made but did not.
The focus is on the subjective opinion of the relevant HMRC official regarding the sufficiency of evidence for the particular assessment issued. Lord Hodge observed:
Absent a perverse view, akin to Wednesbury unreasonableness, on the part of the official as to the adequacy of the evidence before him or her in relation to the assessment which is later made, it is HMRC’s knowledge of the evidence relevant to the particular assessment which starts the clock running under section 73(6)(b).
The First-tier Tribunal had made a critical finding of fact:
We are wholly unable to see any material fact which was known to HMRC prior to 31 August 2005 which would have justified making the assessment earlier.
The tribunal also found:
It [ie FCA] was not [in place] and we do not accept that HMRC could have known what DCM were doing without seeing their records.
Lord Hodge noted that the figures for DCM’s mixed supplies uncovered at the 2005 visit differed from the figures disclosed in DCM’s VAT returns by £11,378,146. The assessment was therefore not out of time as the last pieces of evidence came to HMRC’s knowledge at the 2005 visit.
Vires Challenge
Lord Hodge addressed DCM’s argument that section 25(3) of VATA mandated HMRC to pay the VAT credit as claimed by the trader, and that HMRC’s only recourses were the five specific statutory mechanisms identified by DCM’s counsel. The Court rejected this for six reasons.
First, it was undisputed that HMRC had both a power and duty to conduct reasonable and proportionate investigation into the validity of repayment claims and were entitled to take reasonable time before authorising repayment.
Second, the real issue was whether HMRC could give effect to the result of verification by refusing to pay in full or in part.
Third, Lord Hodge held that the obligation in section 25(3) was implicitly conditional:
it is implicit in section 25(3) of VATA … that the obligation on HMRC to pay a VAT credit arises only once it is established that the VAT credit is due. There must be a VAT credit due before HMRC are under the statutory obligation to pay. The obligation on HMRC to pay does not depend solely on the say-so of the trader.
Fourth, the implied power arose from paragraph 1 of Schedule 11 to VATA, which makes HMRC responsible for the collection and management of VAT. The Court noted that powers have been implied into the statutory VAT scheme by the courts to make it work.
Fifth, the principle of fiscal neutrality supported HMRC’s position. Lord Hodge addressed DCM’s argument about differential treatment of payment and repayment traders, noting important differences between them. He cited Tradecorp:
a claim which has been admitted or upheld (and only such a claim) gives rise to a right of deduction and, if the deduction exceeds the amount of tax due, a prima facie right to immediate payment.
Lord Hodge found that fiscal neutrality could be achieved through interest payments and other statutory remedies, and that the differences in treatment did not amount to unjustified discrimination.
Sixth, the implied power was not inconsistent with VATA’s express provisions. The power to assess under section 73(1) was available only where VAT was due from the trader, making those time limits irrelevant to verification of VAT credit claims. The specific powers DCM relied upon were not a comprehensive list of HMRC’s powers.
The Court confirmed that taxable persons were not left without remedy, as HMRC remained amenable to judicial review if verification was not expeditious or proportionate, and traders could appeal adverse decisions to the First-tier Tribunal under section 83(1)(b) or (c) of VATA.
Practical Significance
This decision is of considerable importance to the administration of VAT. It confirms that HMRC possess an implied statutory power to withhold payment of self-assessed VAT credit claims pending verification and to pay less than the amount claimed where investigation justifies doing so. This power is not confined to the specific statutory mechanisms enumerated in VATA but arises by necessary implication from HMRC’s responsibility for the collection and management of VAT. The decision reinforces that the obligation to pay a VAT credit under section 25(3) is conditional upon the credit being genuinely due, not merely upon the trader’s assertion.
On the time bar issue, the judgment confirms the established Pegasus Birds principles: the one-year time limit in section 73(6)(b) runs from when HMRC obtained the last piece of evidence sufficient to justify the specific assessment actually made, assessed by reference to the subjective opinion of the relevant HMRC officer, and not from when a different hypothetical assessment could have been issued. This provides important protection for HMRC against traders who obstruct or delay access to their records.
The decision also highlights the safeguards available to traders: HMRC must conduct verification expeditiously and proportionately, are subject to judicial review, and may be liable to pay interest and repayment supplements where verification is protracted.
Verdict: The Supreme Court unanimously dismissed DCM’s appeal on both grounds. The time bar challenge failed because the evidence sufficient to justify the assessment of 20 October 2005 only came to HMRC’s knowledge at the visit on 31 August 2005, within the statutory time limit. The vires challenge failed because HMRC have an implied statutory power, arising from section 25(3), Schedule 11 paragraph 1, and the broader statutory scheme of VATA, to refuse to accept a VAT credit claim in whole or in part following verification, and are not confined to the specific mechanisms identified by DCM.
Source: DCM (Optical Holdings) Ltd v Revenue and Customs (Scotland) [2022] UKSC 26
