You have to feel sorry for Captain Smith. He is a commercial pilot. He underwent an expensive training course before embarking on his career. He may have been a little uncertain at the time of the course whether it was going to be a pastime or a business, but it evolved clearly into a business. He later started flying and registered for VAT accordingly. There is no real dispute that the training course was directly linked to his pilot business, so he ought to have reclaimed the VAT the school charged him.

But he had overlooked one of the rules. In registering for VAT you always should look at the costs you have already incurred and whether they will be 'in time' to be claimed. Services which pre-date the effective date of registration by more than six months are out of time. However, HMRC will often agree to back date the effective date (but only where they are asked at the time of applying for registration, note). Once that door is shut, then it is shut, however unfair it may seem.

Captain Smith was not amused when told by HMRC that he could not claim the VAT, not because the course had been undertaken at a time when its function was a little uncertain, but simply because it failed the time limits. He consulted an accountant who told him that the training course was 'capital', rather than 'revenue'. This encouraged him to equate the course with 'goods' (in VAT terms). The time limit for 'goods' is four years. He thought he should have four years' retrospection. On that, he was wrong as a matter of law. 'Capital' and 'goods' are not the same.

He had not claimed the VAT in his first return but resolved to claim it in his second return. He obtained very clear 'advice' from HMRC that this would be an error. He ascertained however that he could not appeal against this advice. He thought the only way he could establish an appeal would be to claim the VAT and see whether HMRC would assess it, following which he could appeal the assessment. This sounds sensible, and fair, but there is a significant problem. On no analysis was the cost proper to the second VAT return. Furthermore, he was clearly wrong, and had been advised by HMRC not to claim. What he did was in straight defiance of that position.

He warned HMRC that he intended to claim. He then submitted the return, but did not tell them afterwards that he had claimed. HMRC reviewed the return and found the claim. They assessed the tax, and a penalty of 38%.

Now, many readers will wonder about that penalty, because penalties for careless errors are a maximum of 30%, and errors which are not careless have no penalty. The problem was that HMRC classified the error as deliberate, which has a headline penalty rate of 70%, which in this case was mitigated.

The tribunal that heard the case upheld the tax and penalty assessments. The claim was out of time. The action in claiming it was not careless, but deliberate. The fact that he had discussed it copiously with HMRC did not change the deliberate nature of the action, and it was an error. It is possible to conduct an argument about natural justice, and that whilst the claim was deliberate, the making of an error was not (since Captain Smith believed it to be correct). But the tribunal took a literal view of the relevant provisions, and to be fair, it was probably right to.

So, for the want of asking HMRC to backdate the registration (which they would almost certainly have agreed to do) Captain Smith lost the VAT claim, a further 38%, several nights' sleep, and something also of his honour.

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