Can a VAT refund be denied as "unjust"?

VAT refunds

It may seem that if a business has paid too much VAT to HMRC it’s entirely fair for them to demand the excess back as a refund. However, where the overpayment results from overcharging customers VAT, the refund could leave the business pocketing the money at their expense. HMRC calls this “unjust enrichment” and it can refuse to refund it.

Unjustly enriched

Unjust enrichment can occur in different situations, some less obvious than others. It can occur whenever the business reclaims VAT that it collected from customers and paid on to HMRC. It’s most common with retail and entertainment businesses as it’s very difficult or impossible to trace all the customers overcharged.  If the business can use its records to identify the customers affected and have their details, it should pass any VAT refund on to them to avoid HMRC arguing that they’ve been unjustly enriched.

Challenging unjust enrichment

Not every situation where a business has overcharged VAT and reclaimed it without passing on the refund is unjust enrichment.

To prove unjustly enrichment HMRC must show that it’s the customers who have borne the “economic burden” of the excess VAT.

Example. Bill runs a domestic window cleaning business. The competition in the area is tough. He takes on two staff and increases sales to the point he must register for VAT. This reduces profitability because Bill can’t increase the price he charges without losing business. Three years later he realises that he has been working out the VAT element incorrectly. On a charge of, say, £25 he’s accounted for VAT of £5 (£20 x 20%) when actually the VAT element should have been £4.16 (£25 x 20/120).

It’s Bill and not the customers that met the economic burden of the extra VAT because he imputed it within the £25 (or whatever the rate was for cleaning the windows). The customers’ fees weren’t affected by the amount of VAT, Bill simply accounted for more out of this amount than he needed to. It’s Bill that’s out of pocket and therefore HMRC can’t refuse his claim for a refund on the grounds of unjust enrichment.

Not unjust

There’s one more argument a business can use to fight a claim of unjust enrichment by HMRC. For example, if it had to put up prices to cover the VAT but overcharged it, it might have lost customers as a result. If the business can show that sales reduced because of the overcharge, then it has suffered the economic burden and any VAT refund is simply compensating for this.

If challenged by HMRC the business must have viable evidence that the economic burden of overcharging VAT was met by it. However, the onus is then entirely on HMRC to disprove that evidence. It can challenge but can’t refuse a claim for a refund without demonstrating that on the balance of probability the business would be unjustly enriched if it made the refund