The issue was tested in 2019 in the case of HMRC v Frank Smart & Son Ltd, where a business incurred input tax in acquiring farm subsidy entitlements which would result in additional income falling outside the scope of VAT. That case was decided in favour of the taxpayer.

In April 2021 a similar point came before the First Tier Tribunal, in Colin Newell v CIR. Mr Newell ran a business which used biomass boilers to dry a range of wood and animal bedding products and also to dry materials for third parties. Almost half the business turnover came from Renewable Heat Initiative subsidies and HMRC contended that input tax recovery should be restricted. The taxpayer successfully argued that the expenditure was incurred in carrying out a taxable business and the receipt of subsidy should not inflate those costs by denying input VAT relief. The defence is analogous to a farm where expenditure is necessarily incurred on hedging or fencing required in the business, but which also becomes eligible for a CSS grant.

The points established by this case are important. A victory for HMRC here might have led to increased attention to both existing subsides and also future grants under the new Environmental Land Management Schemes. With the phasing out of the Basic Payment Scheme in the near future, such alternative income streams will be important for survival and it would be vital that the necessary expenditure is not inflated by irrecoverable amounts of VAT. It would be perverse for the government to give money to secure environmental benefits with one hand, and then to take it back with another.