VAT: When can HMRC impose market value?

Andrew Needham looks at when HMRC can impose an open market value on a transaction for VAT purposes.

Many businesses offer discounts on goods or services that they provide to the customer. It is common for supermarkets to offer price reductions and ‘buy-one-get-one-free’ type deals which reduce the price paid and, therefore, the amount of VAT payable to HMRC.

Businesses will also provide goods free to customers and suppliers as well as transferring assets between associated businesses for nil consideration. 

On occasion, some businesses will transfer assets at a reduced value in order to avoid VAT. For example, a fully taxable business buys some computer equipment for £10,000 plus £2,000 VAT. It reclaims the VAT and sells the equipment on to an associated business, an insurance brokers that only has exempt income and is therefore not VAT registered, for £2,000 plus £400. Between the two businesses, they have saved £1,600 in otherwise irrecoverable VAT. 

HMRC never likes to see the amount of VAT they receive reduced by this type of active tax avoidance; but what, if anything, can they do about it?

In some limited circumstances, HMRC has the power to impose open market value on a transaction.

The legislation is contained in VATA 1994, Sch 6, para 1, and stops businesses reducing their irrecoverable input tax by (for instance) forming a management services company, which incurs all costs and then recharging them to the exempt or partially exempt associated business at a lower price.

 

HMRC can act retrospectively, and go back up to four years by directing the substitution of open market value for the price charged, but only if a supply is:

In Oughtred & Harrison Ltd [1988] VTD 3174, the tribunal confirmed the direction in a case where charges for use of a computer by an insurance broker had been at below cost.

This means that where a transaction is between unconnected parties or where the recipient of the supply can recover all its VAT, HMRC has no powers to impose an open market value on a transaction.

Where assets are transferred at a nil value, HMRC can direct a business to account for output VAT equal to the input tax originally claimed when the goods were purchased – this is under the ‘business gifts’ rules where the goods cost more than £50 and input tax was recovered.

If a business transfers an asset to an associated business, it can escape this charge by making a nominal charge for the item providing the open market valuation rules do not apply. In these circumstances, HMRC has no power to interfere with the value agreed between the parties. For example, if a company wants to transfer an opted commercial property from an associated business to another and the transferor originally claimed back £50,000 in VAT on its purchase, they would have to account for £50,000 in output tax on the transfer. However, if they charge £1 for the property, HMRC cannot impose a value on the transfer and 0.20p output tax is due! 

HMRC can only impose open market value on below value transactions if the two parties are connected and one of them cannot recover all of their VAT. You can escape VAT on a nil value transaction by making a nominal charge.