Customs targets Ernst & Young NHS over VAT

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Customs & Excise has mounted an investigation into top accountancy practice Ernst & Young over a scheme using shadow companies in Guernsey to reduce value added tax (VAT) payments by National Health trusts.

On Friday, a spokeswoman said: "Customs is aware of the allegations that Ernst & Young has been involved in a scheme for reducing VAT payments, and we will be trying to find out what the scheme entails and to look at what action can be taken."

She warned: "If it is a way of avoiding tax, Customs generally takes that very seriously."

The scheme was set up to exploit a loophole, where health trusts can escape paying VAT on equipment purchases. A trust buys equipment and then leases it to a third party - the Guernsey shadow company. Because there is no VAT in Guernsey, the lease is not liable to VAT.

The company then leases the equipment back to the trust, which also escapes VAT.

Greg Sinfield, VAT partner at City law firm Lovell White Durrant, said the use of VAT reduction schemes for National Health Trusts raised a number of questions. "The real story is whether NHS Trusts, as quasi-public bodies, should be engaged in this sort of activity."

He added that Ernst & Young was using a known loophole, and while it would be unlikely for Customs to retrospectively claim back the VAT, it would probably see legislation introduced to stamp out the practice.

Ernst & Young is known to have used the scheme with a number of trusts. Christie's hospital in Manchester is one. Mike Fry, its chief executive, said the dilemma for health trusts was real. "We're a cancer hospital that doesn't have enough funding, and we are looking at innovative ways to eke out our patient care budget. Is that a bad thing?"

The real issue for those examining the issues will be whether public funds earmarked for equipment purchases should eventually end up in the hands of private sector consultants.

Mr Fry believes Christie's is at least obtaining value for money from its accountants. He said the level of public funding being spent on management consultants to "do your thinking for you" in other areas of the public sector was "obscene".

In the Budget, Chancellor Gordon Brown unveiled a number of measures to combat VAT avoidance. The new rules are designed to protect up to pounds 2bn in revenues that may be at risk from avoidance tactics and are expected to raise pounds 10m in 1997 and pounds 20m in 1998.

A spokesman for Ernst & Young said the firm never discussed clients' affairs.