VAT Best Judgment Assessments: Standard of Proof & Appeal

When HMRC believes a trader has failed to account for the correct amount of VAT, it may issue an assessment “to the best of its judgment” under section 73 VATA 1994. Such assessments are routinely inflated, are frequently challenged on both methodological and evidential grounds and require advisers to understand a distinct analytical framework at the First-tier Tax Tribunal. This guide examines the statutory power, the case law defining the standard of best judgment, the dual burden of proof that applies on appeal and the practical strategies for mounting an effective challenge.

The s73 VATA 1994 Power

Section 73(1) of the Value Added Tax Act 1994 provides the cornerstone power for HMRC to assess a trader for VAT that HMRC believes to be due but which has not been declared. It applies where a person:

• has failed to make returns for any period;
• has made returns which appear to be incomplete or incorrect; or
• has failed to keep documents or records required under the VAT legislation.

In any of these circumstances, HMRC may assess the amount of VAT due to the best of its judgment and notify the trader of that assessment. The section gives HMRC a broad discretion, but that discretion is not unlimited: the requirement that the assessment be made “to the best of judgment” imports an objective standard of reasonableness that the courts have developed through a line of authorities stretching back to Van Boeckel v Customs and Excise Commissioners [1981] STC 290.

When s73 Is Most Commonly Deployed

Best judgment assessments arise in a range of situations. The most common fact patterns in the current enforcement environment are:

• Cash-based businesses where HMRC considers that cash receipts have been suppressed, restaurants, takeaways, hair salons, market traders;
• Sectors with known suppression risk where HMRC uses sector benchmarks (gross profit ratios, mark-ups) to reconstruct turnover;
• Businesses that have failed to register for VAT and HMRC reconstructs the VAT liability they should have accounted for;
• Post-insolvency assessments where records are incomplete or have been destroyed;
• Supply chain investigations where output tax on supplies is disputed alongside an input tax denial argument.

The Van Boeckel Standard of Best Judgment

The foundational authority on what “best judgment” requires of HMRC is Van Boeckel v Customs and Excise Commissioners [1981] STC 290, in which Woolf J (as he then was) in the Queen’s Bench Division set out the parameters of the obligation.

The Core Holding

Woolf J held that “best judgment” does not require the Commissioners to make their assessment with the same degree of care as a chartered accountant preparing a set of accounts. The standard is that of a responsible assessing officer who takes into account all material available and uses that material fairly and honestly to arrive at a reasonable estimate of the liability. The test is whether the assessment represents a genuine attempt to quantify the unpaid VAT, not whether it is the closest possible approximation to the truth.

The judge identified the following as hallmarks of a valid best judgment assessment:

1. HMRC must genuinely consider all relevant information that is reasonably available to it;
2. HMRC must not take into account irrelevant considerations;
3. HMRC must not act in a way that is dishonest or wholly unreasonable so as to suggest that its assessment was not a genuine exercise of judgment;
4. The assessment must be based on reasonable grounds, not on speculation or arbitrary guesswork.

What Van Boeckel Does Not Require

The decision is equally important for what it does not require. Woolf J was explicit that the absence of records does not relieve HMRC of the obligation to exercise genuine judgment, but equally that HMRC is entitled to make reasonable assumptions in the absence of evidence. Critically, he recognised that where records are absent or unreliable, HMRC is permitted to use indirect methods of reconstruction, provided those methods bear a rational connection to the taxpayer’s actual business. The court will not interfere with an assessment simply because it could have been made differently or because the trader disputes the figures.

Pegasus Birds Ltd v HMRC [2004]: The Court of Appeal Refines the Test

The Court of Appeal decision in Pegasus Birds Ltd v HMRC [2004] EWCA Civ 1016; [2004] STC 1509 is the leading modern authority on the standard of best judgment and is central to any FTT challenge.

The Facts

Pegasus Birds was a business involved in the supply of exotic birds. HMRC raised a best judgment assessment following its belief that the business had not accounted for all VAT due on its supplies. The FTT found in favour of the taxpayer, concluding that the assessment was not made to the best of HMRC’s judgment because the officer had not sufficiently considered the available evidence. HMRC appealed.

The Court of Appeal’s Analysis

The Court of Appeal, delivering judgment through Carnwath LJ (as he then was), confirmed and refined Van Boeckel. The key propositions from Pegasus Birds that remain authoritative are:

1. The VAT tribunal (now FTT) should normally set aside an assessment that is not made to best judgment only if satisfied that the assessing officer acted in a way no reasonable officer could have acted or based the assessment on no material at all or on wholly inadequate material. This is a high threshold for the taxpayer to overcome on the best judgment ground alone.
2. However, the FTT is not limited to asking whether best judgment was exercised. Even if best judgment was exercised, the FTT has jurisdiction to examine whether the quantum of the assessment is correct. These are two distinct questions.
3. An assessment that survives the best judgment challenge may still be reduced on the merits. The FTT can substitute its own figure for the assessed amount if it is satisfied, on the evidence, that the assessment is excessive. The burden of proof on this second question initially lies with HMRC to establish the assessment is correct, but the taxpayer must adduce evidence to displace it.

The Significance of the Two-Stage Analysis

The Pegasus Birds two-stage framework is essential to advising clients. Many practitioners focus only on whether HMRC exercised best judgment and, finding that threshold hard to surmount, accept inflated assessments. The correct approach is to move immediately to stage two: what does the evidence show the actual VAT liability to be? Even where HMRC’s process was defensible, the FTT has full jurisdiction to arrive at a different figure based on credible evidence of the business’s true trading pattern.

The Dual Burden of Proof at the FTT

The allocation of the burden of proof in a VAT best judgment appeal is nuanced and must be understood before framing the grounds of appeal.

Stage One: The Best Judgment Challenge

On the question of whether HMRC exercised best judgment in the Van Boeckel/Pegasus Birds sense, the burden lies with the taxpayer. The appellant must demonstrate that HMRC’s process was so flawed as to fail the test. This is a high bar: showing that HMRC could have done the calculation differently or reached a different figure, is not sufficient. The taxpayer must demonstrate that no reasonable HMRC officer, acting properly, could have arrived at the assessment in the way HMRC did.

Stage Two: The Quantum Challenge

On the question of quantum, what is the correct VAT liability? , the starting position is that the assessment is deemed correct under s83 VATA (the notification and assessment provisions create a presumption of validity). However, the FTT approaches the evidence independently and will determine the correct figure on the totality of the evidence before it. In practice, the taxpayer must adduce positive evidence of the actual level of supply and output tax if it wishes to displace the assessed figure. A bare assertion that the figure is wrong is not sufficient.

Practical Implications for Grounds of Appeal

The grounds of appeal should therefore be drafted to address both stages separately:

• Ground 1 (Process): Set out the specific respects in which HMRC’s methodology was unreasonable, failed to take into account available evidence or produced a result that no reasonable officer could have reached;
• Ground 2 (Quantum): Set out the taxpayer’s positive case as to the correct VAT liability, supported by the best available evidence of actual turnover, mark-up ratios, waste and other material factors;
• Ground 3 (Limitation, if applicable): Challenge the validity of the assessment on temporal grounds if there is any question about whether it was notified within the applicable time limits under s73(6) VATA.

HMRC’s Common Assessment Methodologies

Understanding the methodology HMRC has used is the first step in building a challenge. HMRC uses a range of indirect reconstruction techniques, each of which has specific vulnerabilities.

1. Gross Profit Ratio / Mark-Up Methodology

HMRC compares the trader’s declared gross profit ratio against sector benchmarks derived from industry data, comparable businesses or HMRC’s own risk profiling. Where the trader’s declared margin is significantly below the benchmark, HMRC assumes that additional turnover is being suppressed. The methodology has weaknesses:

• Sector benchmarks are averages; individual businesses may legitimately operate on lower margins due to location, customer mix, supplier arrangements or competitive factors;
• HMRC often fails to adjust benchmarks for businesses that operate on a deliberate low-price, high-volume model;
• Wastage, staff meals, free samples and promotional discounts are frequently under-counted or ignored.

2. Purchases-Based Reconstruction

HMRC works backwards from verified purchase records (using third-party supplier data obtained via Schedule 36 information notices) and applies a standard mark-up to reconstruct turnover. The methodology fails where:

• Purchase records are themselves incomplete or include non-trading purchases;
• The mark-up applied does not reflect the business’s actual mix of products, a takeaway that sells more low-margin beverages than HMRC assumed will have a lower realised mark-up than the standard applied;
• HMRC applies a single mark-up across a multi-rate or partly-exempt business without apportioning correctly between standard-rated, zero-rated and exempt supplies.

3. Z-Reading Analysis

For businesses with electronic point-of-sale systems, HMRC may obtain Z-readings (daily till summaries) and compare them against declared VAT returns. The methodology can be challenged where:

• Z-readings include refunds or voids that inflate the gross figure;
• The till system does not differentiate between VAT-rated and zero-rated sales;
• Staff training transactions or test sales have not been excluded.

4. Third-Party Data and Bank Analysis

HMRC increasingly uses bank statement analysis (obtained via Schedule 36) and third-party payment processor data (card machine transaction records, online marketplace data) to reconstruct turnover. The analysis must be scrutinised for double-counting, timing differences and non-trading receipts (loans, capital introductions, intra-account transfers).

Challenging the Methodology

Effective challenges to best judgment assessments are built on positive evidence, not mere criticism of HMRC’s approach. The following steps are central to building a robust case.

Commission an Independent Expert Reconstruction

In any significant best judgment assessment case, the adviser should commission an independent accountant or sector expert to prepare an alternative reconstruction of the business’s VAT liability. The expert’s report should:

• Identify the specific errors or unreasonable assumptions in HMRC’s methodology;
• Provide a positive alternative figure based on the best available evidence;
• Address HMRC’s sector benchmarks and explain any legitimate reasons why the client’s business diverged from them;
• Quantify the impact of each error in HMRC’s approach, so the FTT can understand the financial consequence of accepting each individual ground of challenge.

Gather All Available Evidence of Actual Trading

Even where records are incomplete, the following sources may permit a positive reconstruction:

• Bank statements for the full assessment period;
• Supplier invoices and purchase records, even if incomplete;
• Card payment summaries from the merchant services provider;
• Third-party records: accountant’s working papers, payroll records, lease agreements;
• Historical VAT return data and records from periods not in dispute, as evidence of the business’s normal trading pattern.

Challenge HMRC’s Sector Benchmarks

Where HMRC relies on sector benchmarks, those benchmarks should be scrutinised. Obtain HMRC’s source data where possible (via Freedom of Information Act requests). Industry trade association data, published ONS statistics and comparable business evidence can all be deployed to demonstrate that the sector benchmark is inappropriate for the specific business type, location or market position of the client.

Time Limits and Notification

Section 73(6) VATA 1994 imposes time limits within which HMRC must notify assessments. An assessment that is not notified within the applicable period is invalid and cannot be enforced.

The Standard Two-Year Period

An assessment under s73 must not be made more than two years after the end of the VAT period to which it relates (s73(6)(a) VATA), unless a later discovery exception applies. The period runs from the end of the VAT quarter, not from the due date for submission of the return.

The Three-Year Extended Period

Where HMRC has evidence from its central records (returns made to HMRC by the trader or information obtained from third parties) which discloses facts making it reasonable to believe there has been an under-declaration, an assessment may be made within three years of the end of the period, provided it is made within one year of the evidence coming to HMRC’s attention (s73(6)(b) VATA).

The Twenty-Year Fraudulent Evasion Period

Where the insufficiency is attributable to a deliberate act or fraudulent evasion of VAT, HMRC has twenty years from the end of the period in question. However, HMRC must formally allege fraud or evasion to invoke this extended window and the burden of establishing it rests on HMRC. This is a contested finding at the FTT and cannot be presumed from the mere fact of under-declaration.

Notification Requirement

The assessment must be formally notified to the trader. Notification requires actual communication, not merely the creation of an internal HMRC record. Late notification or notification to the wrong address, can vitiate an otherwise valid assessment. Advisers should check the notification date carefully against the applicable time limit, particularly in post-insolvency or change-of-address situations.

Interaction with the Penalty Regime

A best judgment VAT assessment will typically be accompanied by a penalty under Schedule 24 Finance Act 2007 (inaccuracies in documents) or under the VAT default surcharge regime (Sch 1 Finance Act 2022, which replaced the old surcharge from January 2023 for VAT-registered businesses).

The New VAT Penalty Regime (from January 2023)

From 1 January 2023, new penalties apply to VAT-registered businesses:

• Late submission penalties: A points-based system. Each missed return earns one point. At threshold (4 points for quarterly filers, 5 for monthly, 2 for annual), a flat £200 penalty is applied and a £200 penalty for each subsequent late submission until the points are reset;
• Late payment penalties: A two-stage interest and penalty regime. No penalty if full payment made within 15 days of due date. A first penalty of 2% of the outstanding VAT arises at day 15; a second penalty accrues from day 31 at 4% per annum on the outstanding balance.

These penalties apply to returns due from 1 January 2023. The old default surcharge continues to apply to returns due before that date.

Schedule 24 Inaccuracy Penalties

Where HMRC raises a best judgment assessment on the basis that the taxpayer’s VAT returns were inaccurate (whether carelessly or deliberately), a Schedule 24 FA 2007 penalty may follow. The key points for practitioners are:

• Penalty is a percentage of the Potential Lost Revenue (PLR) , the VAT underpaid. PLR is assessed by reference to the assessment itself, which is why challenging the quantum of the assessment reduces the penalty base;
• The behaviour category (careless, deliberate or deliberate and concealed) determines the penalty range. Each category has a minimum and maximum, with reductions available for prompted or unprompted disclosure and the quality of cooperation;
• Penalties are separate decisions from the assessment and can be appealed independently. An assessment that is upheld on appeal does not automatically mean the associated penalty is correct, the behaviour finding may still be challengeable.

Practitioner Checklist: VAT Best Judgment Assessment Challenge

1. Obtain and review the full assessment workings. Request HMRC’s supporting schedule and officer’s notes. You cannot challenge a methodology you have not seen. If HMRC has not provided workings, request them formally and indicate that grounds of appeal will be reserved pending receipt.
2. Check the time limits. Identify the VAT period(s) covered, the date of the assessment and the date of notification. Confirm whether the standard two-year, three-year extended or twenty-year fraud window was applied. Challenge the limitation point if there is any vulnerability.
3. Identify the methodology. Is HMRC using gross profit ratio, purchases reconstruction, bank analysis or a hybrid? Document the specific assumptions made and identify each one that is potentially incorrect or unjustified.
4. Gather all available positive evidence of actual turnover. Bank statements, card machine records, supplier invoices, payroll records, lease and utility bills as proxies for business activity. The more positive evidence of actual trading, the stronger the quantum challenge.
5. Commission expert evidence where the assessment is substantial. For assessments over approximately £50,000, an independent forensic accountant or sector expert report should be considered. The report should address both HMRC’s methodology and the positive reconstruction of the correct liability.
6. Challenge sector benchmarks specifically. Request HMRC’s source data for any benchmark figures via FoIA if not already disclosed. Obtain published industry data and ONS figures for the relevant sector and period. Show why the benchmark is inapt for this specific business.
7. Draft grounds of appeal addressing both stages. Ground 1: best judgment process failure (if the process was genuinely flawed). Ground 2: quantum, the correct liability with supporting evidence. Ground 3: limitation, if applicable.
8. Assess the penalty separately. Once the assessment quantum is challenged, review the Schedule 24 or surcharge penalty independently. Challenge the behaviour finding, the PLR calculation and any failure to apply appropriate reductions for disclosure quality or cooperation.
9. Consider a without-prejudice settlement offer. Where the evidence supports a substantial reduction from the assessed figure, a reasoned without-prejudice letter to HMRC setting out the positive reconstruction can resolve the matter before FTT listing. HMRC will often negotiate on quantum where the taxpayer has credible evidence.
10. File the appeal promptly. The appeal must be made to HMRC within 30 days of the assessment (or penalty notice) and if not resolved, lodged with the FTT within 30 days of HMRC’s review decision. Missing these deadlines requires a late appeal application, which the FTT has a discretion to refuse.

Frequently Asked Questions