Supreme Court Sets Stricter Standards for Late VAT Input Tax Recovery Claims in Revenue and Customs v NHS Lothian Health Board

Introduction

The case of Revenue and Customs v NHS Lothian Health Board (Scotland) ([2022] UKSC 28) addresses critical issues surrounding the recovery of Value Added Tax (VAT) input tax by public bodies long after the tax was initially paid. NHS Lothian, one of Scotland's National Health Service (NHS) Boards, sought to reclaim over £7 million in VAT input tax incurred between April 1974 and April 1997. The dispute centered on the admissibility and quantification of these historic claims under both UK domestic law and European Union (EU) VAT directives.

This commentary delves into the intricacies of the case, examining the Supreme Court's reasoning, the application of EU principles, and the implications for future VAT recovery claims.

Summary of the Judgment

The United Kingdom Supreme Court delivered a landmark judgment on October 19, 2022, affirming the decisions of the lower tribunals that had previously dismissed NHS Lothian's VAT input tax recovery claims. The Supreme Court held that NHS Lothian failed to adequately demonstrate the amount of VAT it was entitled to recover, primarily due to insufficient documentation and flawed methodologies in apportioning input tax between business and non-business activities.

The Court emphasized that the burden of proof lies with the claimant to substantiate the exact amount of input tax to be reclaimed. The decision underscored the necessity for precise and reliable evidence, especially in cases involving historic claims where records may be scarce or non-existent.

Analysis

Precedents Cited

The judgment extensively engaged with prior case law to elucidate the principles governing VAT input tax recovery. Key cases include:

Fleming (UKHL 2, 2008): Addressed the retrospective application of VAT recovery time limits and underscored the necessity for transitional provisions when altering such limits.
Marks & Spencer plc v Customs and Excise Commissioners (Case C-62/00): Examined the compatibility of retrospective time limits with EU law, particularly the principle of effectiveness.
University of Sussex v Customs and Excise Commissioners (2001): Discussed whether claims for input tax should be subject to time limits and affirmed that Member States can impose reasonable time constraints.
Vădan v Agenția Națională de Administrare Fiscală (Case C-664/16): Emphasized that taxpayers must provide credible evidence to quantify input tax claims.
Sanofi Pasteur MSD SNC (Case C-621/15): Highlighted the balance between procedural autonomy and the principle of effectiveness in the context of evidence admissibility.

Legal Reasoning

The Court's legal reasoning hinged on several core principles:

Burden of Proof: Consistent with the Principal VAT Directive (Council Directive 2006/112/EC) and domestic law, the burden rests on NHS Lothian to prove the amount of input tax it seeks to recover. Mere demonstration of business activity is insufficient without quantifying the corresponding VAT.
Apportionment Methodology: The tribunal found NHS Lothian's method of applying a flat 14.70% apportionment ratio from 2006/07 to the entire claim period unsubstantiated and methodologically flawed, given the decade-long gap and potential variability in business activities.
Evidence Requirements: Reliance on secondary evidence and extrapolations without robust primary data did not meet the standard required to establish the owed VAT with reasonable certainty.
Principle of Effectiveness: While the Supreme Court acknowledged the principle's importance in ensuring EU rights are enforceable, it clarified that national procedural rules do not need to be overridden unless they make the exercise of rights virtually impossible or excessively difficult. In this case, the existing procedures did not infringe upon this principle.

Impact

This judgment has significant implications for:

Historic VAT Claims: Sets a precedent that late claims for VAT input tax recovery must be substantiated with credible and precise evidence, discouraging broad extrapolations without robust supporting data.
Public Bodies and SMEs: Although NHS Lothian is a public body, the principles apply broadly, affecting how both public bodies and small to medium-sized enterprises (SMEs) approach historic VAT recovery.
EU VAT Compliance: Reinforces the alignment of UK VAT recovery processes with EU directives, ensuring that domestic regulations do not undermine the effectiveness of VAT rights.
Tribunal Practices: Tribunals will likely adopt more stringent standards for evidence in VAT recovery cases, emphasizing the necessity for detailed documentation and accurate apportionment methods.

Complex Concepts Simplified

To facilitate a clearer understanding of the judgment's legal intricacies, the following key concepts are simplified:

Value Added Tax (VAT)

VAT is a consumption tax placed on a product whenever value is added at each stage of the supply chain, from production to the point of sale. Businesses can reclaim VAT paid on their purchases (input VAT) against the VAT they collect from their sales (output VAT).

Input Tax vs. Output Tax

Input Tax: VAT paid on purchases of goods and services used in the course of business.
Output Tax: VAT collected from customers on sales of goods and services.

Partial Exemption Calculation

When a business engages in both taxable and exempt activities, it must apportion its input VAT accordingly. Only the portion related to taxable activities is recoverable.

Principle of Effectiveness

An EU legal principle that ensures that rights conferred by EU law are practicable and enforceable within Member States’ judicial systems. It prevents Member States from imposing procedural barriers that would render EU rights ineffective.

Burden of Proof

The responsibility to prove the truth of a claim lies with the party asserting it. In this case, NHS Lothian must prove the amount of VAT it seeks to recover.

Conclusion

The Supreme Court's decision in Revenue and Customs v NHS Lothian Health Board serves as a pivotal clarification on the standards required for the recovery of historic VAT input tax. By affirming the necessity for precise quantification and robust evidence, the Court underscores the importance of meticulous record-keeping and methodological accuracy in tax claims.

This ruling reinforces the taxpayer's burden to substantiate VAT claims and aligns domestic practices with EU directives, ensuring that VAT system integrity is maintained. For public bodies and other entities contemplating historic VAT recoveries, the judgment highlights the critical need for comprehensive documentation and reliable methodologies to support their claims.

Ultimately, the judgment balances the taxpayer's rights against the state's need for administrative efficiency and legal certainty, setting a clear framework for future VAT input tax recovery endeavors.