Hippodrome v HMRC reinforced the difficulty of convincing HMRC to approve PESMs to calculate residual input VAT recovery.
While the decision by the Court of Appeal (CA) in Hippodrome Company Limited v HMRC [2025] UKFTT 806 (CA) isn’t trailblazing, it does reinforce the increasing difficulty of convincing HMRC to approve (i) partial exemption special methods (PESMs) or (ii) the use of the standard method override mechanism where the method applied is anything other than the standard (turnover values-based) method.
The reasons for this may be many, but likely centre on HMRC’s growing reluctance to make significant decisions. Another symptom of this includes the non-statutory clearance, sadly long endangered and now on the brink of extinction. HMRC’s reluctance to exercise discretion, added to the fact that the standard method applies by default, makes it seem like the trend is unlikely to reverse any time soon.
About the case
Hippodrome had argued for a floorspace-based method instead of the standard method to calculate its residual input VAT recovery. Hippodrome owned a building from which it operated:
- A casino/gaming business (VAT-exempt)
- restaurants, bars and a theatre (taxable)
The more profitable (and revenuable) side of the business was the VAT-exempt side – leading to a low residual input VAT recovery rate. The taxable side of the business used more floorspace as a proportion of the whole (property) than it generated income as a proportion of the whole (revenue). It’s easy to see why Hippodrome preferred the floorspace approach.
The CA reiterated the fact that the legal default for partial exemption is the standard method. To displace the standard method, the proposed method must provide a “more precise” result.
To say this is difficult to do in practice is an understatement. The CA stated that the standard method will lead “to a fair and reasonable recovery … as a matter of law” because it is the default. The onus is on the taxpayer to prove that the alternative method is more fair and reasonable.
Applying PESMs
The hurdles to applying a non-standard method in practice can be neatly summarised as follows:
- The standard method is fair and reasonable by default
- HMRC don’t like to take decisions that may come back to haunt them
- If the dispute goes before a tribunal or court, the burden of proof will fall on the taxpayer to show that the proposed method is more fair and reasonable
So is the PESM going the same way as the dodo and the non-statutory clearance?
Not quite. HMRC are more than happy to approve PESMs which provide (in their view) a more precise result. To HMRC this means more resolution.
Instead of a single taxable/total supplies calculation for a large business, HMRC encourage sectorised methods which allocate input VAT to specific pots. Residual recovery will then be determined by each sector’s own formula (which will often be turnover-values-based). What HMRC are not so keen on, is approving exotic formulas conjured up by crafty tax advisers to increase their clients’ residual input VAT recovery.
Would you like to know more?
For more information about VAT exemption rules and PESMs, and specialist guidance on VAT compliance for your business, get in touch with Luigi Lungarella or send us an enquiry.
