Baines & Ernst Ltd v HM Revenue & Customs

Under the Value Added Tax Act 1994, section 80(3), a taxpayer’s right to repayment of VAT paid when not due is subject to an exception which HMRC must prove. The evidence must establish both the extent to which the tax burden was passed on and the resulting unjust enrichment. Passing on is a question of fact. No presumption follows from describing a price as plus VAT or inclusive of VAT. The tribunal must compare the actual position with the hypothetical position if VAT had not been chargeable, including irrecoverable input tax and relevant market evidence. A finding that the hypothetical price would have been lower is insufficient without evidence identifying that price and the amount passed on.

Baines & Ernst supplied debt management services and, after a tribunal ruling that indistinguishable services were VAT-exempt, sought repayment of output VAT accounted for in 2000–2002. The VAT and Duties Tribunal upheld HMRC’s unjust-enrichment defence under section 80(3). Warren J allowed the appeal in part in [2005] EWHC 2300 (Ch), ordering repayment for 2002 but remitting the claims for 2000 and 2001. HMRC appealed, and Baines & Ernst cross-appealed against the remittal. The central issues were how passing on and the hypothetical financial comparison had to be proved, and whether the evidential defects justified remittal.

Disposition

Lord Justice Lloyd delivered the leading judgment. Lord Justices Gage and May agreed. HMRC’s appeal was dismissed, and Baines & Ernst’s cross-appeal was allowed. The claims for 2000 and 2001 were not remitted to the Tribunal.

1. Statutory framework. Section 80 of the Value Added Tax Act 1994 gives a taxpayer a primary right to repayment of VAT paid when not due, subject to the unjust-enrichment defence. HMRC bears the burden of proving that the tax burden was passed on wholly or partly and that repayment would unjustly enrich the taxpayer. A complete defence requires proof of the whole burden; if only part was passed on, only that part can be withheld.
2. Evidence and hypothetical comparison. Passing on and its extent are questions of fact. The Tribunal must use all relevant and probative evidence, without presumptions about the effect of describing a price as plus VAT or inclusive of VAT. The necessary comparison is between the taxpayer’s actual financial position and the position it would have occupied if the supplies had not been treated as taxable. That enquiry includes the price that would have been charged, irrecoverable input tax, overheads, market conditions and possible effects on sales. An economic analysis is not required in every case, but pricing issues will commonly require admissible economic or commercial evidence.
3. Application. The Tribunal wrongly treated the contractual price formula and related circumstances as establishing pass-on. It also assumed that the competitor would have charged 15% in the hypothetical situation, without evidence of what the competitor would have charged or what Baines & Ernst would then have charged. The finding that the hypothetical charge would have been below 17.625% did not identify the relevant charge or quantify any part of the burden passed on. The phrase 15% plus input tax was not an adequate answer.
4. Final order. The evidential failure was fundamental. HMRC could not establish the defence in full or in part and was not entitled to another opportunity to adduce additional evidence. The Court did not decide whether the hypothetical comparison must be confined to the three-year claim period, although it regarded that approach as having considerable force in an established business.

• Court of Appeal (Civil Division): In [2006] EWCA Civ 1040, HMRC’s appeal was dismissed and Baines & Ernst’s cross-appeal against remittal was allowed.
• High Court of Justice, Chancery Division: In [2005] EWHC 2300 (Ch), Warren J allowed the appeal in relation to 2002 and remitted the claims for 2000 and 2001.
• VAT and Duties Tribunal: The Tribunal held that HMRC had established the unjust-enrichment defence and that no repayment was due.