A recent case has highlighted the need for VAT registered businesses to be operating on sound and commercial terms for input VAT to be reclaimable. In particular, this case focused on an agricultural activity which was being operated through a company, separately to the owners’ other activities.
Babylon Farm Ltd (the taxpayer) had incurred costs in building a new barn to replace other agricultural buildings that had been recently sold. The new building was to be used for the storage of equipment used for haymaking by the taxpayer.
Whilst in earlier years the taxpayer had carried out a range of farming activities and had been VAT registered since 1991, in the period of question the only income related to the sale of hay and totalled £440 per annum. All hay sales were in fact made to Jeremy McLaughlin, one of the directors, for use in his livery business.
HMRC denied the claim by Babylon Farm Ltd for all input VAT claimed in the period from May 2014 to February 2018, totalling £19,760.50. The majority of this claim related to the construction of the barn.
Should Babylon Farms Ltd have been deregistered first?
Firstly, the taxpayer’s defence was that HMRC had erred in not deregistering the business for VAT. If HMRC did not believe the company was carrying on a business, it should have deregistered the taxpayer first before denying credit for input tax. By HMRC not doing so, Babylon Farms Ltd remained a taxable person and could claim the input VAT.
The UT ruled that it was not necessary for HMRC to deregister the business first as paragraph 13 (2) of Schedule 1 VATA 1984 states that: 'where the Commissioners are satisfied that a registered person has ceased to be registrable, they may cancel his registration with effect from the day on which he so ceased or from such later date as may be agreed between them and him' (my emphasis).
The use of the word 'may' conferred no obligation to deregister the business; and also ruled that even if the taxpayer had the status of a taxable person, there still is no business for which there is deductible input tax. Therefore the UT rejected this defence.
Was Babylon Farms Ltd carrying on a business?
The defence argued that the First Tier Tribunal had erred in law in ruling that the taxpayer was not carrying on a business.
In its discussion, the UT referred to the guidance provided by the Court of Appeal in Wakefield College v HMRC  on whether a person is carrying out an economic activity.
It was accepted that the taxpayer did make a supply of goods for consideration. However, on the question of whether the supplies were made for the purposes of obtaining income on a continuing basis, the UT found fault and dismissed the taxpayer’s appeal.
The reasons that the UT gave for this decision were namely:
- The business was not being conducted in a regular manner and on sound and recognised principles. The land the hay was grown on belonged to Mr and Mrs McLaughlin personally and the UT questioned the legal and commercial basis for the taxpayer’s ability to carry out the activity on that land. Did the hay even belong to the company? There was nothing clear to support this.
- There was no direct link between the activity and the income. The income was not determined by the value of the supplies nor the associated business costs. It was all on Mr McLaughlin’s judgement as to whom bore what costs and there was no “symmetry” between the operating costs and income.
- No invoices for payment were raised, nor were payments made until HMRC were involved.
- It would not be able to be argued that Babylon was operating in the open market nor even operated on general market terms.
What this case demonstrates is that there needs to be a clear business undertaken on commercial terms for HMRC to be satisfied that the related input VAT is claimable. It is interesting to note that this is a case where there was once a clear farming trade, yet in time operations have significantly reduced to an extent whereby it has been ruled that there clearly is no longer a business. If there is a trend for farming businesses to scale down operations in favour of rental or subsidy income such as from ELMS, then advisors need to clearly look at whether these clients will still qualify as a business.*The views expressed are the author's and not ICAEW's.