The hunt for the VATman

Big business is trading blows with Customs. By Roger Trapp

The VATman must be well used to being a bete noire for people in small business. But increasingly he is looming large in the sights of big business.

Customs & Excise is understandably keen to play down the significance of a recent series of reversals that have reportedly put pre-election tax cuts in jeopardy. But the number of cases either decided or in the pipeline reinforces the view that there is an open season on those responsible for collecting value-added tax. Alan Bucket, a VAT partner at accountants Binder Hamlyn and national chairman of the VAT Practitioners Group, recently urged business not to take rulings from Customs "lying down".

Dario Garcia, head of the VAT litigation group at the accountants Ernst & Young, says the reasons for the clash are partly historical. In general, clients try to stay away from litigation, but in VAT - in contrast to direct tax - litigation forms a central part of business. And this is because the rules can be seen to encourage it.

While Inland Revenue cases go to legally untrained commissioners, those involving VAT go to tribunals, where those sitting are lawyers. In addition, the successful VAT litigant receives costs - something that happens in direct tax cases only if the Revenue has been considered to be trivial or vexatious (ie. never). Moreover, the costs are awarded in principle from the point when the notice of appeal is made. Not only does this encourage appeals, but it also hardens attitudes since it is more difficult to produce a compromise once the process has been set in motion.

Finally, VAT tribunal cases have always been reported, with the result that the issues are well known and the process is much more transparent.

Although recent months have seen a spate of cases, the antagonism between the two sides originated in 1989, when Customs was once more losing significant amounts of revenue. To redress the balance, the Government introduced what Mr Garcia, himself a former solicitor with Customs, calls "a draconian penalty regime". Under this system, penalties were imposed as a matter of course and it was up to individuals or organisations to appeal against them. Such was the feeling of unfairness that many organisations appealed - and often succeeded. The result was to bring the law into disrepute, says Mr Garcia.

The problems could presumably have been dealt with at an early stage through negotiation. But many VAT experts believe that the background of Customs officials - who are not professionally trained like their colleagues in the Revenue and have often spent time in ports seeking out drug smugglers immediately before being transferred - does not equip them for making deals.

"Customs are much more like tax police," says Mr Garcia. "When people say: 'I've got them knocking on my door, is that bad news?' I say, the bad news is when they kick the door down. Knocking is a result."

Now that successive rises in the VAT rate have increased the tax's share of the revenue cake, the stakes are higher for both sides. As the furore earlier this year over the pounds 6bn shortfall in last year's VAT revenues shows, there is a widespread feeling that Customs is under great pressure to raise as much money as it can. At the same time, the rise in the VAT rate, combined with increasing competition, has squeezed companies' margins - with the result that they are more inclined to contest rulings.

Given companies' recent success rate that inclination can only have increased. The only problem is that the involvement of EU law has made matters more complicated - though even here the litigant is protected, because European law cannot make him or her any worse off than under English law. On the other hand, Customs can be brought to book under EU law.

The issue came to a head earlier this year, when Customs lost a landmark case that could create a pounds 5bn bonanza for retailers that had been offering interest-free credit deals. With that case tied up in an appeal, one could have expected a bit of quiet. Not a bit of it. Only last week, accountants Grant Thornton noted that Customs had cracked down on one VAT loophole - where companies supply heating free of VAT where it would otherwise be subject to the 8 per cent rate.

Geoff Edwards, a VAT expert at accountants Grant Thornton, suggests that the anti-avoidance legislation placed before Parliament last month had been rushed through because of serious concerns about the loophole's effect on the nation's finances. But he dismissed the idea that tax avoidance was responsible for the VAT shortfall.

"The problem of VAT leakage is more fundamental than businesses 'avoiding' the tax," he says, detecting a trend towards non-compliance caused by a lack of frontiers in the EU.