19568

VAT ASSESSMENT & PARTIAL EXEMPTION: Appellants medical practice partnership claimed input tax in full on partners’ fuel expenses incurred on business/personal use – partnership subject to partial exemption regime – Respondents’ assessment for unpaid VAT included the input tax on fuel expenses in non-attributable supplies for1996 & 1997 partial exemption   annual adjustment – Appellants contending that they should not have claimed input tax on the fuel expenses because they were partners’ expenses not partnership business expenses – Appellants had a choice under VAT legislation to claim input tax on fuel expenses – Appellants knowingly chose to claim input tax – cannot now say it was a mistake – Appellants’ accountants disregarded input tax on fuel supplies in 1998 annual adjustment – retrospectively correcting a perceived mistake – cannot be done under regulation 107 of 1995 Regulations – Appeal dismissed. 
MANCHESTER TRIBUNAL CENTRE

KANNAITAT USERIL RAGHVAN JOY
and
PAPPU BHOGESWARA RAO 	                         Appellants

- and -

HER MAJESTY’S REVENUE and CUSTOMS	Respondents

Tribunal:	Michael Tildesley OBE (Chairman)
Kathleen Ramm FCA

Sitting in public in North Shields on 23 February 2006 

David Patrickson, Head of VAT for Tax Server, Tax Consultancy, for the Appellants

James Puzey, Counsel instructed by the Acting Solicitor for HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2006

DECISION
The Appeal

1.	The Appellants were appealing against an assessment for unpaid VAT in the sum of £9,942 for the periods 09/97, 06/98, 09/98 and 12/98 issued by way of letter dated 7 June 1999. On 10 June 2005 the assessment was reduced to £9,304, which was the disputed sum in this Appeal.
2.	The Appeal was stood over pending the outcome of the House of Lords decision in Benyon et al which accounted for the delay in hearing the Appeal.
Background
3.	 The Appellants were medical practitioners working in partnership from their general practice in Workington. Dr Joy has since retired from the partnership with Dr Rao forming a new partnership with Drs English, Mort and Eddy.
4.	The partnership was registered for VAT because it dispensed medicines which was a zero-rated taxable supply. The partnership also made exempt supplies which meant that the recovery of input tax by the partnership was subject to the partial exemption regime. Thus the partnership could recover the input tax on the taxable supplies but not the input tax on exempt supplies unless it fell within the de minimus rule.  The partnership could also recover some of the input tax relating to non-attributable supplies in the proportion of the value of the taxable supplies against the value of  total supplies rounded up to the nearest whole percentage.
5.	Following a routine VAT inspection on 16 February 1999 and 12 May 1999 the Respondents discovered that the partnership had recovered the input tax in full on the fuel receipts relating to the medical practitioners’ driving expenses. The partnership applied the scale charge for fuel purchased by the practice and used for private purposes in periods 06/96 to 03/98 but not for subsequent periods where the partnership continued to recover the input tax on the fuel receipts. Further, the Appellants’ accountants had removed the input tax on the fuel receipts from the annual adjustment for the partial exemption calculation for the year ending June 1998.
6.	 The Respondents were of the view that the partners’ fuel supplies fell within the category of non-attributable supplies which restricted the amount of claimable input tax to the proportion of taxable supplies against the value of total supplies. The Respondents redid the annual adjustment for the partial exemption periods 1 April 1996 to 30 June 1997 and 1 July 1997 to 30 June 1998. The Respondents were unable to go further back in time because of the time limits on assessments. The outcomes of their recalculations were that
(1)	Annual adjustment 1 April 1996 to 30 June 1997: input tax over claimed by the partnership equalled £6,025.77 which represented the input tax on exempt supplies which could no longer be recovered because the input tax exceeded the de minimus level of 50 per cent of total input tax for the period.
(2)	Annual adjustment 1 July 1997 to 30 June 1998: input tax over claimed by the partnership equalled £2,283.24.
7.	In addition to the two amounts for input tax over claimed, the Respondents disallowed £1,007.88 which represented a further claim for input tax arising from the accountants’ annual partial exemption adjustment for period 1 July 1997 to 30 June 1998. Further the Respondents raised an assessment for the fuel scale charges for periods 06/98, 09/98 and 12/98 amounting in total to £627. The sum of the amounts owed by the Appellants was £9,942 which was later reduced to £9,304 by amending downwards the total for the fuel scale charges and increasing the recoverable proportion of non-attributable input tax to 13 per cent.
The Issue in Dispute
8.	The Appellants contended that the Respondents were wrong to include input tax on the motor fuel bills in the partial exemption calculations because the fuel bills were the expenses of the individual partners not of the partnership. The book-keepers for the partnership through their inexperience with VAT mistakenly incorporated the fuel bills in the partnership business accounts and as a result made incorrect claims for input tax on the fuel. The Appellants’ accountants were not attempting to correct this mistake when they did not include the fuel input tax in the annual partial exemption adjustment for period 1 July 1997 to 30 June 1998. Their adjustment was calculated with reference to the input tax borne by the partnership which did not include the input tax on the expenses incurred by the partners in their individual capacities. 
9.	The Respondents submitted that the VAT legislation allowed the partners to treat the motoring expenses as business expenses of the partnership. In their view, the evidence demonstrated that the partners deliberately chose to treat their motoring expenses as partnership business expenses and could not now avoid the VAT consequences of their decision by saying it was a mistake. The Respondents considered that the Appellants’ accountants were using the annual adjustment to correct the Appellants’ alleged mistake over the fuel input tax which was not allowed by the legislation. The VAT and Duties Tribunal decided in Greenpeace Ltd  (LON/99/32) that a taxpayer could not use the annual adjustment mechanism to correct mistakes retrospectively. The mechanism for correcting errors was found in another part of the Value Added Tax Regulations 1995, regulations 34 and 35.  
10.	The principal issue for us to decide was whether the fuel expenses incurred by the partners were a business expense of the partnership or an expense of the individual partners.
The Evidence
11.	We heard evidence from Dr Rao and Mr Jeffrey Harry Finney for the Appellants. Mr Finney was a Chartered Accountant and a Fellow of the Institute of Chartered Accountants for which he was Chairman of the Healthcare Special Interest Group. Mr Finney specialised in the preparation of accounts for medical partnerships, having 35 years experience in this field of accountancy and during that time responsible for the accounts of approximately 150 medical practices. We regarded Mr Finney as an expert witness.
12.	The Respondents called Mrs Shirley Tweedie, the Officer who carried out the routine inspection and raised the assessment, as their witness.
13.	Both parties presented us with a bundle of documents.
14.	Dr Rao joined Dr Joy’s practice in 1990. Their partnership agreement dated 25 April 1991 did not state that motoring expenses incurred by the partners for the purpose of the practice were to be treated as non-partnership expenses, unlike Dr Rao’s later partnership agreement with Doctors English, Mort and Eddy dated 4 April 2005, which defined non-partnership expenses.
15.	Dr Rao explained that when he joined the practice, the accountants handled the financial affairs for the partnership. As the practice grew the partnership appointed a practice manager who dealt with the day-to-day accounts of the practice and acted as a go-between the practice and the accountants. At the end of each month Dr Rao would give his petrol receipts to the practice manager. The partnership reimbursed Dr Rao for his petrol expenses with a cheque drawn on the partnership account signed by both partners. Dr Rao treated the partnership as a bank from which recovered his expenses. The re-imbursement of expenses was recorded under the drawings of the individual partners in the partnership annual accounts.
16.	Dr Rao pointed out that any private income earned by the partners would be paid into the practice. At the end of the accounting year the accountants would separate out from the partnership accounts the individual partners’ private income and expenses, in order for the partners to complete their own individual income tax returns.
17.	Dr Rao and Dr Joy signed the VAT returns for the practice which were prepared by the accountants. Dr Rao accepted that the partners and the staff employed by the practice were ignorant about VAT. Dr Rao did not know about the fuel scale charge. 
18.	The partnership accounts for the year ending 30 June 1996 (as recorded in the 1997 Accounts) included partners’ expenses under the administration expenses of the partnership. The accounts for the years ending 30 June 1997, 1998 and 1999 omitted partners’ expenses from administration expenses.
19.	The partnership appointed a new firm of accountants in May 1997.
20.	Mr Finney opined that the motoring costs of medical practitioners were rarely regarded as expenses of the practice in which they work. The motoring costs were nearly always the specific expense of the practitioner himself. As such VAT was not usually claimed in respect of fuel purchases nor was there a requirement to account for a fuel scale charge. Mr Finney, however, accepted that he had come across instances where medical practices had claimed VAT on petrol purchases but this had been made in error and had been corrected when the error was identified.
21.	Mr Finney highlighted the problems of completing medical practitioners’ income tax returns under self assessment, in particular the requirement to separate out the individual medical practitioner’s private income and expenses from the partnership. The normal circumstance was that expenses paid by the medical practitioner were treated as personal expenses which would then be accounted for in the medical practitioner’s tax return as a deductible expense provided it was incurred for the purposes of the medical practice. In his experience payment of business expenses by the medical practice was not typical.
22.	Mr Finney noted that about ten years ago medical practices did not have the expertise to deal with its complex tax affairs. They largely left it to firms of accountants, many of which did not have specialist expertise in this area. Mr Finney was one of the prime movers for the establishment of the Healthcare Special Interest Group of the Institute of Chartered Accountants. He considered that specialist accountants should deal with the accountancy affairs of medical practices. 
23.	Mr Finney noted that 1996 Appellants’ accounts appeared to include the partner’s expenses in the partnership administration costs. He was unable to give a firm opinion because he did not have a copy of the 1996 accounts. They were recorded in the 1997 accounts. Mr Finney, however, observed that the Appellants’ previous accountants had prepared the 1996 accounts and they were probably not au fait with the tax complexities for medical practices. The new accountants compiled the 1997 to 1999 partnership accounts and were in the form that Mr Finney would expect for a medical practice.
24.	Mrs Tweedie visited the Appellants’ medical practice twice in 1999. She inspected the practice’s business records which had no separate book for VAT. The records were not kept in one place and she did not see a separate item of expenditure for each partner. The partnership staff informed Mrs Tweedie that they knew what they were doing in relation to the accounts.
25.	Mrs Tweedie identified that the only taxable supply made by the practice was that of medicines which was zero-rated. She found that input tax had been claimed on all the supplies made to the partnership including the fuel expenses incurred by the individual partners.  The fuel expenses had been paid by partnership cheques drawn on the partnership bank account. The practice manager confirmed to Mrs Tweedie that the fuel expenses were treated as partnership business expenses upon which the partnership claimed input tax. The partners had not reimbursed the partnership for the expenses. The partnership declared the fuel scale charge to period 03/98.
26.	Mrs Tweedie discovered that no annual adjustment for partial exemption had been performed for 1996 and 1997. She found an annual adjustment for 1998 which ended in June 1998 rather than March 1998. The 1998 adjustment  excluded the input tax on the fuel expenses from the calculation. Mrs Tweedie found that the partnership’s practice of claiming input tax on fuel expenses had been consistently applied throughout the period under investigation. She, therefore, allocated that input tax to non-attributable input tax for the annual adjustments for 1996 and 1997, and disallowed the under claim of input tax in the 1998 adjustment.
27.	Mrs Tweedie included the input tax on the fuel expenses incurred by the individual partners in the annual adjustments for partial exemption because the partnership had consistently claimed input tax on these purchases throughout the period in question. Further, the practice manager informed her that the fuel purchases had been treated as a business expense of the partnership since the partners incurred the majority of the expenses in visiting patients. The partners did not reimburse the partnership for the expenses.
Findings of Fact
28.	We find the following facts:
(1)	 The partnership was registered for VAT and subject to the partial exemption regime.
(2)	The individual partners’ motoring fuel bills were paid by the partnership from the partnership bank account. The partners did not reimburse the partnership for the expenses.
(3)	The partnership agreement current at the time of the assessment did not prevent the partnership from bearing the costs of the individual partners’ motoring fuel bills.
(4)	Throughout the period of assessment the partnership claimed input tax on the fuel bills incurred by the partners, and applied the scale charge until period 03/98.
(5)	The partners signed the partnership VAT returns which were compiled by their accountants.
(6)	Throughout the period of the assessment the partnership treated the fuel expenses incurred by the individual partners as a business expense of the partnership. The majority of the expenses were incurred for visiting  patients. 
(7)	Mr Finney’s evidence was helpful with providing a background to the tax and accountancy problems facing medical practices. However, the thrust of his evidence concentrated on the income tax implications for medical practitioners and their partnerships rather than the VAT implications. We found his statement about VAT not usually claimed in respect of fuel purchases and where it has been claimed it has been in error as a generalisation of preferred practice. We did not consider it to be probative evidence in support of the Appellants’ contention that they mistakenly recovered input tax on the fuel purchases. 
(8)	Mr Finney noted that the 1996 Appellants’ partnership accounts appeared to include partners’ expenses under partnership administration costs.  Also the payment of expenses by the partnership was not the norm for medical practices. We considered that Mr Finney’s observation of the Appellants’ actual practices supported the conclusion that the Appellants made a conscious decision to treat the fuel expenses as business expenses of the partnership.
(9)	The Appellants produced no compelling evidence to support their assertion that they mistakenly claimed input tax on the fuel purchases incurred by the individual partners. The Appellants did not call the practice manager to corroborate their assertion. The practice manager told Mrs Tweedie that they treated the fuel purchases as a business expense because the majority of it was incurred in visiting patients. Although Dr Rao pleaded ignorance on VAT, their accountants advised the partners throughout the period of assessment. The partnership only stopped declaring the fuel scale charge towards the end of the period of assessment.
The Reasons for Our Decision
29.	The partnership agreement current at the time of the assessment did not specify that fuel expenses incurred by the individual partners were non-partnership expenses. The majority of the fuel expenses were expended in visiting patients of the practice and so could be legitimately regarded as expenses of the business. The published advice for income tax self assessment required medical practitioners to separate out their personal business expenses and personal income from partnership income and expenses. However, that advice did not apply to the VAT treatment of business expenses. 
30.	Under VAT legislation a partnership can be registered in its own right and is entitled to treat fuel expenses incurred in the course of its business as proper expenditure against which a claim for input tax can be made. Where the fuel expenses are incurred for business and private use and the fuel for private use has been provided at no cost or below cost the partnership can claim input tax on the fuel purchases but must also apply the fuel scale charge for the private use element. Alternatively the partnership can take advantage of extra statutory concession 3.1 by electing not to pay the scale charge provided no claim for input tax is made on the fuel purchases.
31.	We are satisfied on the facts found that throughout the period of the assessment the Appellants chose to treat the fuel expenses incurred by the partners as business expenses of the partnership. They were not prevented by the partnership agreement from treating the expenses as partnership expenses. Under VAT legislation the Appellants as a partnership were entitled to claim input tax on the fuel bills and required to declare the scale charge where the fuel was used for mixed business and personal use. This was what the Appellants did throughout the period of assessment except for the scale charge which was not declared for 06/98, 09/98 and 12/98.
32.	The Appellants sought to persuade us that they mistakenly claimed input tax on the fuel bills. However, our facts found demonstrated that this was not the case. In our view the facts found overwhelmingly supported the conclusion that the Appellants knowingly chose to claim input tax on the partners’ fuel bills and at the time were advised by accountants. They were legally entitled to claim input tax on the fuel purchases expended for business purposes. The notion of mistake seemed to arise after the visit from Mrs Tweedie when they realised that claiming input tax on fuel bills was not tax efficient under the partial exemption scheme. In our opinion it was not open to the Appellants to undo their previous decision because they were made aware after the event of the tax consequences of their actions. Effectively what the Appellants were putting forward was that they did not know the full legal consequences of their actions when they made their choice to treat the fuel expenses as business expenses of the partnership for VAT purposes. Their lack of knowledge at the time of making the choice did not invalidate their choice of regarding the fuel expenses as partnership business expenses.
33.	Thus we are satisfied that the Appellants knowingly chose to treat the fuel expenses as business expenses of the partnership and claimed input tax thereon. Further the Appellants were entitled to take this course under VAT legislation and the partnership agreement current at the time. Their mistake was that they treated the input tax on the fuel bills as wholly attributable to taxable supplies. They should have allocated the input tax to the category of non-attributable supplies and carried out quarterly and annual adjustments under the partial exemption rules.
34.	The Appellants’ accountants similarly were not entitled in the 1998 partial exemption adjustment to disregard the Appellants’ claimed input tax on the partners’ fuel expenses in the relevant quarterly periods covered by the 1998 adjustment. The purpose of the annual adjustment regime as set out in regulation 107 of the Value Added Tax Regulations was described in the Greenpeace Tribunal decision at paragraph 16:
“Our principal reason is that regulation 107 is concerned exclusively with annual adjustments of attributions of input tax to taxable supplies. Paragraph 1(a) of the Regulation focuses in terms on the amount of input tax which is attributable to taxable supplies; paragraph 1(b) of the Regulation is directed at over declarations and under declarations of input tax in the earlier prescribed accounting periods. The Regulation has no bearing on the antecedent question of whether the tax incurred by the taxable person is or is not input tax”. 
35.	In the 1998 annual adjustment the accountants were seeking to correct retrospectively a perceived error on the part of the Appellants in claiming input tax on the fuel supplies. They were not allowed to do this under the provisions of regulation 107.  Regulations 34 and 35 provide the mechanism for correcting supposed errors by the taxpayer. Under regulation 107 the accountants were required to perform the adjustment on the figures declared by the Appellants in their quarterly returns which included the input tax claims for the fuel expenses.   
36.	 In view of these findings we hold that Mrs Tweedie was entitled to take account of the input tax claims for fuel expenses in the annual adjustments for 1996 and 1997 and to disallow the input tax under claim in the 1998 adjustment carried out by the Appellants’ accountants. Also the Appellants should have declared the scale charge for 06/98, 09/98 and 12/98 because they were claiming input tax on the fuel purchases which were used for mixed business/personal use. 
37.	We, therefore, hold that the assessment of £9,304 amended on 10 June 2005 was correct. We dismiss the Appeal.
38.	The Respondents have applied for their costs in this Appeal because Mr Finney’s witness statement was not given to them until two days before the hearing and the Appellants’ explanations given at the hearing differed from those given in the correspondence prior to the Appeal. The general rule is that the Respondents will not apply for costs against unsuccessful Appellants except in a limited number of circumstances which include Appellants misusing tribunal procedure. One of the examples given of misuse is where the Appellant has produced at a hearing relevant evidence which ought properly to have been disclosed at an earlier hearing  and which could have saved public finds had it been produced timeously. 
39.	Our starting point is that we should only consider ordering the Respondents’ costs in exceptional circumstances. We have considered the Appellants’ submissions in correspondence prior to the hearing and compared them with the submissions made at the hearing. We do not consider that there is a significant variation between the two sets of submissions. Essentially the Appellants have maintained the same position throughout the Appeal proceedings. Although the Respondents suffered inconvenience by the late submission of Mr Finney’s witness statement, they were not put at a disadvantage during the hearing. We, therefore, find that there are no exceptional circumstances to merit an order for costs. Therefore, we make no such order. 

MICHAEL TILDESLEY
CHAIRMAN
Release Date: 27 April 2006

MAN/99/0720