This month’s Chartered Accountants Tax Case digest looks at a First Tier Tribunal (“FTT”) case that examined if a business, on leaving a bespoke VAT retail scheme, was required to make an adjustment for closing stock in respect of zero-rated items when it moved from one bespoke scheme to another, despite the agreement for the bespoke scheme not requiring such an adjustment. The case in question involved a significant potential amount of underpaid VAT, almost £2.2 million.

It is not yet clear if HMRC plans to appeal the decision of the FTT which held not only that no adjustment was required but also that the assessment raised by HMRC was excessive.

Background

In cases where a VAT registered business has an annual turnover of £100 million or more, the business is required to agree a bespoke VAT retail scheme with HMRC which is confirmed in writing by both parties and clearly sets out the precise terms and conditions of its operation.

Poundland Ltd, the appellant, operated a bespoke VAT retail scheme, (herein referred to as “the old scheme”) from December 2002 – March 2017.

The terms of the old scheme provided that Poundland’s liability to output VAT for each accounting period was calculated by reference to the expected selling price (“ESP”) of zero-rated stock delivered to its stores during that period which, together with the zero-rated element of any multi-rated items, was deducted from Poundland’s daily gross takings in order to arrive at the value of Poundland’s standard-rated sales on which it was liable to VAT. The old scheme did not require any annual adjustments for stock movements or any adjustment for closing stock on ceasing to use the scheme.

From the end of March 2017, the company changed to a new retail scheme based on an electronic point of sale (“EPOS”) system.

HMRC issued an assessment in respect of the company’s failure to include a closing stock adjustment for zero-rated items in its March 2017 VAT return, the final return under the old scheme. The assessment was originally in the amount of £2,349,471 which was later reduced to £2,150,777.

The company requested an internal review which later confirmed the assessment in May 2019. Poundland then formally appealed against the assessment to the FTT.

HMRC argued that the old scheme was fundamentally flawed because it did not make provision for any closing stock adjustment when Poundland ceased to use the scheme. Fundamentally flawed was a term used in Clause 6.4 of the old scheme in the context of reviewing it which both parties acknowledged referred to circumstances where the old scheme did not produce a fair and reasonable valuation of taxable supplies and therefore of the output tax to be accounted for.

Although HMRC accepted that the terms of the old scheme did not expressly require a closing stock adjustment, they argued that unless a closing adjustment was carried out, Poundland would effectively be claiming zero rating twice on the same goods as follows:-

1. At the point at which zero-rated goods moved from the warehouse into its retail stores, thereby reducing the value of standard-rated sales made; and
2. If those goods were not supplied within the last VAT period under the old scheme, the same goods were supplied and accounted for as zero-rated supplies under the new scheme through the EPOS system.

Counsel for HMRC submitted that a bespoke scheme is not intended to be a complete code of accounting for identifying the value of standard-rated retail supplies and should not be expected to make provision for every possible future contingency. Bespoke schemes will inevitably be silent on some issues.

The fact that a bespoke scheme was silent as to some potential future issue, such as the consequence of changing from one scheme to another could not prevent HMRC from either requiring a closing stock adjustment or assessing VAT based on a closing adjustment.

Poundland Ltd disagreed and argued that there was no fundamental flaw in the old scheme arguing as follows:-

• Poundland was not “claiming” zero rating twice on the same goods as zero rating was applied only once, at the time of supply;
• The significance of the ESP of zero-rated stock delivered to Poundland’s retail stores under the old scheme was that it was a proxy for the value of zero-rated goods supplied in the period;
• Under the new scheme, supplies of zero-rated goods which were in stock at the end of March 2017 would be supplied for VAT purposes in later periods and would properly be treated as zero-rated supplies at the time of supply in later periods;
• There was no question of supplies of zero-rated stock reducing the value of standard-rated supplies;
• Making a closing stock adjustment in the final period without any opening stock adjustment in the opening period would distort the value attributed to standard-rated sales over the lifetime of the old scheme;
• The requirement for stock adjustments was not simply overlooked – the parties clearly agreed to a bespoke scheme which did not include any requirement for an annual stock adjustment or a closing stock adjustment; and
• It could not be assumed that a bespoke scheme was flawed simply because an alternative approach might produce a different result – the old scheme expressly recognised this at Clause 6.4.

Decision

The FTT was satisfied that the need for annual adjustments was not overlooked by the parties. Both parties must also be taken to have accepted that there was no need for any annual adjustments to reflect changing stock levels. It was therefore not possible to read in any requirement the need for a closing stock adjustment. To do so would be to re-write the old scheme, rather than to construe it according to its terms.

The real question was whether the old scheme failed to give a fair and reasonable valuation of standard-rated supplies. In other words, was it fundamentally flawed?

The fundamental flaw identified by HMRC was that without a closing stock adjustment Poundland would effectively be claiming zero rating twice on the same goods. However the FTT held that there was not two “claims” or double counting of zero- rated stock. Under the old scheme, the value of zero-rated goods delivered to stores whether or not they were sold at the end of March 2017 was simply used to estimate the value of standard-rated supplies. The goods were not supplied at that time and there was no “claim” to zero rating. They were supplied in subsequent accounting periods when sold to customers and properly treated as zero-rated supplies at that time.

The FTT also agreed that an adjustment for closing stock without any corresponding adjustment for opening stock would not make the old scheme any fairer and more reasonable than without any adjustment at all.

HMRC also argued that the quantum of the assessment itself indicated that the old scheme did not give a fair and reasonable valuation of standard- rated supplies. However, the old scheme was in operation for just over 14 years. Ignoring the question of opening stock, the assessment could be viewed as the cumulative effect of failing to have annual adjustments in calculating Poundland’s output tax over that period. There the quantum of the assessment could not be viewed in isolation as indicating that the old scheme did not give a fair and reasonable valuation.

The absence of a closing stock adjustment was not a matter of mere oversight but was consistent with the old scheme being treated as a rough and ready method of calculating output tax with an element of “swings and roundabouts”. In circumstances where there had been no opening stock adjustment and where there was no requirement for annual adjustments, it is not surprising that there was no requirement for a closing stock adjustment. The old scheme was not therefore fundamentally flawed and the appeal was allowed.

The full judgment in this case is available from:- https://www.bailii.org/uk/cases/UKFTT/TC/2021/TC08138.pdf.