NHS Lothian claimed over £900,000 in historic unrecovered VAT input tax from 1974-1997 on laboratory services. The Supreme Court held the First-tier Tribunal was entitled to reject the claim due to insufficient evidence substantiating the amount, reversing the Inner House’s decision that had remitted the case.
Background
NHS Lothian Health Board submitted a late claim to HMRC in March 2009 seeking to recover VAT input tax incurred between 1 April 1974 and 30 April 1997 (‘the claim period’). The claim related to laboratories within NHS Lothian’s remit which primarily provided clinical services for NHS hospitals but also provided some services to outside bodies for fees. HMRC accepted that services to outside customers constituted business activity for VAT purposes, meaning NHS Lothian could have claimed a proportion of input VAT reflecting the ratio of business to non-business activity. The claim was made possible by section 121 of the Finance Act 2008, which opened a window for taxpayers to claim unrecovered input VAT for historic periods provided claims were lodged by 31 March 2009.
The claim was initially valued at over £7 million but was reduced to approximately £900,000 by the time of the First-tier Tribunal (‘FTT’) hearing. HMRC rejected the claim in full in December 2010, citing amongst other reasons that the method used to apportion expenditure between business and non-business use had not been adequately explained. NHS Lothian’s methodology involved taking a 14.70% taxable percentage derived from the 2006/07 consolidated accounts and extrapolating it back across the entire claim period of approximately 25 years.
The Issue(s)
The central question was whether the Inner House of the Court of Session was correct to overturn the FTT and Upper Tribunal decisions and remit the case for rehearing. Four grounds of appeal were advanced by HMRC:
1. Standard of proof and the nature of the right to deduct
Whether the Inner House erred by drawing a distinction between establishing the right to deduct some input tax and quantifying that tax.
2. The EU principle of effectiveness
Whether the Inner House wrongly applied the EU principle of effectiveness in a manner that required the FTT to adopt a more flexible approach to evidence.
3. State fault
Whether the Inner House was wrong to hold that fault on the part of the state required the FTT to lean towards allowing the claim.
4. Error of law in the FTT’s decision
Whether the Inner House was entitled to interfere with the tribunals’ conclusions in the absence of an identifiable error of law.
The Court’s Reasoning
Mischaracterisation of the FTT’s findings
Lady Rose, delivering the unanimous judgment, identified a critical error in the Inner House’s reasoning. The Inner House had misread the FTT’s finding that the claim was ‘essentially the same’ — a finding that related only to whether the revised claim was time-barred as a new claim — as a finding that the balance between business and non-business activity had remained essentially the same throughout the claim period. Lady Rose stated:
The FTT certainly did not find that the balance of business to non-business activities was ‘essentially the same’ over the period. The phrase ‘essentially the same’ used at the end of para 189 … related to the issue whether the claim being made before the FTT was so different in value and methodology from the claim submitted before the 31 March 2009 deadline as to be in effect a new claim and hence time-barred.
This misunderstanding led the Inner House to conclude incorrectly that the FTT must have applied too high an evidential threshold.
Ground 1: The nature of the right to deduct
Lady Rose held that the Inner House was wrong to treat the establishment of a right to deduct some input tax as separate from quantification. Relying on the CJEU’s ruling in Vădan v Agenția Națională de Administrare Fiscală (Case C-664/16), she held:
The taxpayer must present either the specified documents showing the amount of input tax incurred or devise a credible alternative method by which that amount can be estimated by HMRC with reasonable certainty that the amount now being claimed was at least close to the amount that had in fact been incurred.
The Inner House’s approach would have meant that once a taxpayer could show it bought some goods and services for some business activity, HMRC would have to accept whatever amount was put forward unless they could disprove it. This was held to be inconsistent with the Principal VAT Directive and with Vădan.
Ground 2: The EU principle of effectiveness
Lady Rose rejected the Inner House’s expansive interpretation of the principle of effectiveness. She held it was wrong to describe the principle as requiring a ‘proportionality exercise’ or to hold that quantification of historic input tax claims should be possible ‘in all but exceptional circumstances’. She approved Lord Tyre’s reasoning in the earlier NHS Lothian capital expenditure claim:
In all cases the standard of proof remains the balance of probabilities: that applies equally to historic claims for unrecovered input tax. There is no rule of law or procedure restricting the exercise of the right of recovery in such cases; proof by means of estimates, assumptions and extrapolations was open to it as it is in all cases. The problem for the appellant was that the tribunal was not satisfied that the material placed before it was of sufficient value to enable any reliable conclusions to be drawn, whether by way of estimation, assumption, extrapolation or otherwise.
Lady Rose emphasised that both HMRC and the FTT had in fact adopted a very flexible attitude towards the methods by which NHS Lothian could substantiate its claim. Neither insisted on contemporaneous VAT invoices. HMRC accepted in principle that a proxy percentage could be used and extrapolated. The difficulty was that NHS Lothian could not establish that the 14.70% ratio from 2006/07 was representative of the claim period, given the ten-year gap and a preceding 25-year taxable period.
The Court also distinguished W v Sanofi Pasteur MSD SNC (Case C-621/15), holding it did not require rules of evidence to be set aside in these circumstances. Lady Rose observed:
There was no unusual rule of evidence applied in the present case that had been introduced especially for these kinds of claims and which might be regarded as an impermissible hurdle. There was no evidence that NHS Lothian sought to rely on that was rejected as inadmissible or ignored by the FTT.
Ground 3: State fault
Three categories of alleged state fault were considered and all rejected. First, there had been no failure by the UK to implement the EU right to reclaim input tax; the UK had in fact been generous in allowing indefinite recovery until 1997. Second, the Government’s earlier policy that different branches of government should not trouble each other with VAT claims was not a factor that should influence the evidential assessment. Third, the suggestion that HMRC had destroyed relevant records was not borne out by the facts — HMRC’s document destruction related mainly to post-1994 manual records digitised before destruction, and NHS Lothian and its predecessors had themselves destroyed their own documents by 2006.
The obligation to keep proper accounting records is an obligation placed firmly on the taxpayer by article 242 PVD and regulation 31 of the VAT Regulations. It is not part of HMRC’s role to keep any copies of those records they may hold in case a taxpayer belatedly decides to recover input tax.
Ground 4: No error of law
Lady Rose concluded there was no error of law in the FTT’s reasoning and the Upper Tribunal was right to uphold that decision.
Practical Significance
This decision is of substantial practical importance given the approximately £38 million in similar claims pending before the FTT across the UK from other NHS bodies. The Supreme Court has firmly established that a taxpayer claiming historic unrecovered input tax bears the burden of proving the amount to which it is entitled, not merely that some entitlement must exist. The EU principle of effectiveness does not require domestic tribunals to relax ordinary evidential standards, adopt a broad-axe approach to quantification, or treat alleged state fault as a reason to lower the evidential threshold. The judgment clarifies that section 121 of the Finance Act 2008 re-opened the window for making claims but did not address the practical difficulties of substantiating old claims, and responsibility for such difficulties rests with those who failed to make claims when they first arose.
Verdict: The Supreme Court unanimously allowed HMRC’s appeal, holding that the Inner House of the Court of Session had erred in overturning the decisions of the First-tier Tribunal and Upper Tribunal. The FTT’s decision to dismiss NHS Lothian’s claim for historic unrecovered input VAT was restored.
Source: Revenue and Customs v NHS Lothian Health Board (Scotland) [2022] UKSC 28
