The Court of Appeal has now ruled in the case of Revenue and Customs Commissioners v Hippodrome Casino Ltd and upholds HMRC’s rejection of the Standard Method Override (SMO) proposed by the taxpayer.
The importance of Standard Method Override (SMO)
The SMO applies when the usual way of calculating input tax does not give a fair result. You must make an adjustment if the amount of VAT you’ve claimed using the standard method is substantially different from what you would claim based on how the purchases are actually used in your business.
The SMO helps prevent VAT avoidance based on the standard method and addresses situations where the standard method breaks down. By applying the SMO correctly, businesses demonstrate compliance with VAT legislation and reduce the risk of penalties or disputes from HMRC.
Summary of the case
Hippodrome Casino Limited (HCL) operated a casino with gaming areas, which were exempt from VAT. The venue included bars, a theatre, restaurant and a smoking terrace, which were taxable.
HCL sought to deduct input tax based upon SMO, based on floorspace, aiming to override the standard method of apportioning residual input tax. The SMO led to a significantly higher recovery of input tax than if the standard method had been used.
HMRC rejected the SMO, disputing that the floorspace used for taxable supplies, such as entertainment, was also being used for VAT exempt supplies of gaming, making the floorspace method flawed. They argued that these areas had dual use, serving both taxable hospitality and exempt gaming purposes.
The First-tier Tribunal (FTT) initially sided with HCL, accepting that the floorspace method more accurately reflected the economic use than the standard method. However, HMRC appealed, and the Upper Tribunal found that the FTT had failed to properly address HMRC’s central argument around dual use.
Ultimately, the Upper Tribunal ruled in favour of HMRC, concluding that the SMO did not provide a more precise reflection of economic use, and that HCL had not provided sufficient evidence to justify overriding the standard method.
The Court of Appeal upheld the Upper Tribunal’s decision, agreeing that the First-tier Tribunal had erred in law by failing to properly consider HMRC’s argument regarding the dual use of hospitality areas. The Court confirmed that for an SMO to succeed, the taxpayer must demonstrate, through clear and robust evidence, that the proposed method provides a more precise and reliable reflection of the economic use of costs than the standard method. It found that the FTT had not adequately addressed either aspect of HMRC’s dual use contention, particularly the economic overlap between areas used for taxable hospitality and exempt gaming. It also affirmed that a comparative evaluation was necessary and concluded that the floorspace-based SMO did not offer a more precise reflection of economic use than the standard turnover-based method.
The outcome
Although the ruling did not result favourably with HCL, it highlights a strategic opportunity for other businesses. The case reinforces the importance of strong evidence when proposing an override.
It also clarifies HMRC’s expectations, giving businesses a clearer framework to tailor their approach and enhance their VAT recovery where the standard method does not accurately reflect the true economic use of costs.
When can SMO be considered?
It can be of particular importance when a business, which makes both taxable and exempt supplies, carries out large capital works and the use of such assets would be heavily weighted towards either taxable or exempt use. In such cases, the standard-method of recovering input tax may break down due to the large disparity between actual use and the general approach to input tax recovery the standard method offers.
If your business is partially exempt and planning on carrying out a large capital project, or incurs significant business expenses that do not relate to the exempt part of your business, you should consider whether SMO could improve your VAT recovery position.
When the default method does not fairly reflect the economic use of costs, businesses can propose an alternative method that better aligns with how such costs are used.
How we can help
The decision made by The Court of Appeal reinforces the need for businesses to be proactive in managing VAT recovery, especially where partial exemption is involved. Businesses are encouraged to evaluate whether their current recovery method truly reflects how costs are used across taxable and exempt activities. By doing so, they can strengthen their VAT position and uncover opportunities to improve recovery.
Our Indirect Tax team can:
- Assess whether an SMO applies to your business.
- Model alternative recovery methods.
- Support with HMRC engagement and documentation.
Please don’t hesitate to get in touch to explore how we can help you optimise your VAT recovery.
