The Vatman and his missing billions

It has been a tough few weeks for Customs and Excise. Just when one might have expected the organisation to be enjoying the prime-time publicity afforded by the latest series of The Knock, along come eagle- eyed accountants and lawyers to start challenging their policies on that most hated of duties, value-added tax.

Until the High Court last week put a stop to the process, at least temporarily, it was beginning to look like some kind of vicious blood sport. Every time an accountancy firm put up one of its tax experts, the estimate of potential lost VAT revenue went up, until it reached the point where Coopers & Lybrand predicted a "worst-case scenario" could see the Exchequer having to pay back as much as pounds 40bn.

The Customs' long-running difficulties over VAT only really came to light when the Government admitted that last year's VAT take of pounds 43bn was about pounds 6bn less than the Treasury had estimated for the period. Suggestions that the shortfall had at least something to do with over-exuberant tax planning advice from big accountancy firms were still being pooh-poohed by the profession when the Court of Appeal ruled that Customs had taken the wrong approach to charging for VAT on "interest-free" credit deals since the tax was introduced in 1973. Since the case brought by the little- known furnishings company Primback potentially applied to companies such as Dixons, Currys and department stores that use such incentives in the sale of furniture, hi-fis, washing machines and other goods, accountants were swift to calculate a possible cost, including interest, of pounds 5bn - enough to throw the Government's scope for pre-election tax cuts off course. Customs has always insisted that its liabilities will be nowhere near as large as suggested.

However, this estimate was dwarfed by the possible ramifications of the challenge to the Government's "blocking order" preventing British companies reclaiming VAT on their cars in the way that the tax on other goods and services can be reclaimed under the European VAT directive. The cost of defeat for the Customs there was put by some at between pounds 15bn and pounds 25bn.

For now, though, any estimates are academic, because of last week's decision by the High Court. The court said that European directives allowed the Government to block the deduction of VAT on goods and services capable of being used for private purposes - in this case, brought by the drinks group Allied Domecq and others, cars bought by fleets. But VAT experts are confident that there will be an appeal.

Peter Jenkins, partner specialising in VAT at accountants Ernst & Young, expected a challenge on the grounds that the judges did not draw a distinction between goods or services provided for personal use - such as "perk cars" - and those where there was a clear business purpose, such as cars bought by driving schools.

Meanwhile, there are other cases to trouble Customs. Alan Buckett, chairman of the VAT Practitioners Group, for instance, points to the climbdown following the Court of Appeal's ruling in the UBAF Bank case. Customs has now accepted that where the assets of a business are acquired for use in the making of taxable supplies, the VAT incurred on such acquisition costs as accountancy and legal fees can be recovered in full. The lesson, he says, is "Don't take rulings from Customs lying down."