This week’s Blog is a case of HMRC pec-king at a small charity and ending up with a bloody nose.
Reason for the Tax Tribunal
The small privately funded charity ‘Will Woodlands’ was involved in forestry and acquired parcels of land to establish woodlands. Its charitable aims are stated being “conserving, restoring and establishing plants and all forms of wildlife in the United Kingdom and securing and enhancing public enjoyment of the natural environment in the United Kingdom.”
The Tribunal held that the charity’s primary objective is to establish and protect woodlands, which became a significant point in the arguments before the tribunal, as the charity’s primary income source was not income directly generated by forestry activities.
The charity was registered for VAT in 1994, and in due course, it agreed to separate business from non-business activities which were exempt and to use an approved special method to correctly apportion the VAT on expenses, known as the partial-exemption calculation (PEC).
This seemed sensible, since the stated activity was that of a “taxable forestry business” and the charity’s Annual Accounts showed substantial investment and grant income, outweighing the forestry income significantly, which in fairness is to be expected during the early years of forestry activities.
In 2013, following a routine check, HMRC decided to challenge the calculation method used by the charity. The HMRC officer wrote: “I am concerned that the method agreed does not produce a fair and reasonable apportionment of VAT on taxable goods and services supplied.” Although he accepted that a significant proportion of the trees grown would ultimately be harvested which would generate taxable supplies, this would not be for some years.
More seriously, he expressed the opinion that the forestry business was not a primary objective of the charity, but merely a consequence arising from its charitable activities. Its main purpose, he said, was “charitable environmental work”, and noted that the main income was investment (43.2%) and grants (46.3%). He concluded that the land area basis for the PEC method was inappropriate, and invited the charity to propose a revised method.
Correspondence followed between the parties, leading to VAT assessments covering 19 months for a total of £75,000 in disallowed input tax. HMRC’s calculation was based on income, which is always their default position. The charity disagreed, which is why the case ended up at the Tribunal.
HMRC arguments at the Tribunal
At the Tribunal the officer, in response to a question from the chairman, stated that he thought the apportionment did not give a fair result “because it allowed them too much input tax credit.”
Of course he did. The officer further commented that the land was not used entirely for taxable purposes, as there were pathways, water, grasses and other plants, which would not be harvested. He also said that the trees were not used entirely for business purposes; they were also to be used for charitable, heritage and environmental purposes.
In my opinion the VAT officer’s arguments are, quite frankly, fatuous and ridiculous. Why would a forest not also contain other plants? Why would trees not be environmentally friendly?
In reaching its conclusion, the tribunal indicated that there were two questions to be determined:
- Whether the partial-exemption calculation method operated by the charity was fair and reasonable
- A more detailed question as to how the attribution of certain costs had been calculated
The Tribunal stated that the partial exemption method was not at issue, although HMRC had queried this. The chairman pointed out that the assessment raised did not actually mention partial exemption.
The chairman also commented that, although the burden of proof normally lies with the taxpayer, in this case, HMRC had to demonstrate that its own method was preferable to the method previously agreed with them by the charity. It noted that the previously agreed PEC method had been operated for many years.
Evidence was given that income from the woodland would be generated for up to 150 years, but the levels of income, from thinning, and then from felling and the sale of timber was not readily predictable. During the early years little taxable business income was generated, as you would expect, but HMRC don’t seem to have taken this into account. The Tribunal held that HMRC’s income-based method was unreasonable.
In agreeing with the charity’s land area calculation, the Tribunal held that there was “no dual use” of the land and that land-related costs were attributable solely to taxable business supplies. Thus, the charity’s PEC method was both fair and reasonable.
The Tribunal threw out the £75,000 VAT assessment and awarded Will Woodlands full costs.
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