Misleading advice led to a partnership having to pay back nearly £400,000 in VAT

What happened

The partnership had an 'option to tax' the tenants of an office (the company). But there was a connection between the partnership and the company, which meant that the partnership was not allowed an 'option to tax'. The partnership started building a new office for the company to occupy and recovered VAT on the construction costs on the basis of having an 'option to tax'. That was wrong for two reasons. Firstly, they were not allowed an option to tax. Secondly, even if they were allowed one, their existing 'option to tax' did not cover the new office building.

An HMRC officer visited the partnership to check its returns.

She explained that the partnership would need to apply for another 'option to tax' for the new office building and helped them with this. The partnership continued to recover VAT.

About three years later, another HMRC officer visited the partnership and discovered the connection between the partnership and the companyHMRC issued a VAT assessment in order to collect the VAT that the partnership had recovered.

The partnership complained that the first HMRC officer to visit had misled it and/or given it a legitimate expectation that the VAT was recoverable. HMRC and the Adjudicator's Office (which looks into complaints about HMRC) did not uphold the complaint. The Adjudicator's Office said there was insufficient evidence to say whether or not HMRC had misled the partnership.

What we found

The partnership could have sought a legal determination on the matter of legitimate expectation through the courts. We noted that we cannot make legal determinations. Consequently, we limited our consideration of legitimate expectation to considering whether HMRC had applied its guidance on misleading advice fairly.

On the balance of probabilities, the first HMRC officer mistakenly reassured the partnership that it had an 'option to tax'. The officer should have disallowed the VAT the partnership had already claimed, and was about to claim. Instead, the partnership received a VAT repayment of £385,000. If it had not received that sum, it would have had to have borrowed it from the bank to pay the construction costs. While that would have probably been an option for the partnership at the time, it told us that changing circumstances meant that was no longer so, and it would have serious difficulty paying the VAT.

HMRC's guidance sets a number of conditions and a case must meet all of them before HMRC will be bound by incorrect advice. This case did not meet one of the conditions. This says that HMRC will be bound by incorrect advice it has given if 'the customer would suffer detriment if the correct statutory position were applied (e.g. he would be financially worse off than if the correct advice had been given in the first place)'. This did not apply in this case because if HMRC had given the correct advice in the first place, the partnership would have had to pay the VAT that HMRC was now seeking from it.

The failure to retain the first officer's notebook was another error. This deprived the partnership of documentary evidence for its case. We said that was frustrating for it and made it more difficult for a decision to be reached on the case.

We did not uphold a complaint against the Adjudicator's Office. We took a different view on the evidence available but we did not find that its consideration of the case was flawed or unreasonable.

Putting it right

HMRC apologised for the inconvenience it had caused. It gave up the penalties it had applied to the partnership, and invited the partnership to apply for compensation for professional representative fees. It agreed to consider this compensation claim within three months.

It agreed to take a flexible approach to the collection of the arrears and interest, discussing this with the partnership. It also agreed to use our findings on the failure to retain the visiting officer's notebook and the overall outcome of our investigation as the basis of a 'lessons learnt' and timely reminder campaign to HMRC managers.