HMRC’s recent guidance on Skandia requires UK taxpayers to account for VAT on charges to the UK from some member states, but not all. In order to implement this, taxpayers will now need additional information on how VAT grouping works overseas, and on the nature of these previously disregarded recharges. Getting ready for an implementation date of 1 January 2016 means starting work now to evaluate the extra costs which may arise and how to manage these
On 10 February, HMRC released its updated guidance (Revenue & Customs Brief 2/2015) on how it will implement the Skandia judgment in the UK (Skandia America Corp. (USA), filial Sverige v Skatteverket (C-7/13)). This case made front page headlines in the Financial Times, given its potential multi-million pound impact on the financial services industry (FSI), which quickly elevated it to being the focus of board-level attention for many in the FSI sector.
The release of HMRC’s guidance is the next step in the story for UK taxpayers, but implementing it correctly will require significant work and changes to current processes before 1 January 2016, including wholesale reviews of cross-border charges.
The CJEU’s judgment in Skandia (released 17 September 2014) set out that:
The court’s conclusion in Skandia was that the VAT group was obliged to account for reverse charge VAT on costs recharged to it from the US head office, on the basis that the Swedish branch was no longer the same taxable person as its US head office.
Significantly, the questions referred to the CJEU were in respect of third party costs recharged to the Swedish establishment, not internally generated costs of the US establishment. The judgment did not draw a distinction between the two, leaving it to local courts and tax authorities to interpret what the CJEU meant by this.
Furthermore, the CJEU did not comment on the various ways that article 11 of the Principal VAT Directive (Dir. 2006/112) has been implemented by different member states. Broadly speaking, there are two different approaches that have been taken by member states which have chosen to introduce local VAT grouping provisions:
‘Swedish style’ VAT grouping
Most member states which have introduced VAT grouping provisions have a system where only the local establishments of the members of the group are regarded as part of the local VAT group.
‘UK style’ VAT grouping
Under this regime, VAT grouping extends to the entire legal entities in the group, i.e. the local VAT group includes the overseas establishments of all the entities which are members of the group.
Additionally, some member states have implemented forms of VAT grouping which only enable reporting and administrative simplification. Such systems require members of the group to have separate VAT registration numbers and impose VAT on charges between members.
HMRC’s guidance confirms that the UK position remains that a UK VAT group includes the entire legal entity, and not just UK establishments.
However, VAT is now due on supplies (which do not fall under an exemption) when two conditions are met:
Therefore, HMRC has developed a position where the UK treatment of charges from an overseas VAT group will depend upon what sort of overseas VAT group is making the charge.
If an overseas VAT group is ‘UK style’ (i.e. in a country which regards the whole legal entity as being a member of the VAT group, rather than just the local establishment), then there is no change to the current treatment. Where an overseas VAT group is ‘Swedish style’ (i.e. only the local establishment is a member of the VAT group), then the treatment will change.
HMRC has said that it will update its guidance later this year to include a list of member states where it considers that the local VAT grouping rules are ‘UK style’. A preliminary analysis of the situation suggests that this could be a short list, including the UK, the Netherlands and possibly a few others.
The guidance also notes that this will have an impact on charges out of the UK to overseas VAT groups. Where a charge is made to an establishment in a ‘Swedish style’ VAT group in another member state, then the UK establishment will now be making a supply of services. These supplies will need to be taken into account when determining the VAT recovery position in the UK.
Finally, the guidance will be compulsory for all UK taxpayers from 1 January 2016, but it is available for immediate implementation.
This guidance will not be the final word on the interaction of VAT grouping and cross-border charges. Particular areas of discussion are likely to be:
The next meeting of the EU VAT Committee is in March, and HMRC’s guidance is likely to be discussed, following which there may be further statements from other member states and possibly at the EU level.
There are broadly three potential outcomes for partly exempt UK taxpayers such as banks and insurers:
No change
Taxpayers which have included UK establishments of non-EU shared service centres or operating companies in UK VAT groups are likely to be unaffected by the changes outlined above. This is subject to these UK establishments continuing to meet the requirements for being VAT grouped.
Losers
The main losers under the new arrangements will be UK establishments of EU financial services companies ,which are also established in a member state that has ‘Swedish style’ VAT grouping. Such companies will now face additional UK reverse charge VAT on costs which are charged to the UK for a number of functions, even where those costs were internally generated.
Winners
Taxpayers which are partly exempt in the UK and make charges out to establishments in member states with ‘Swedish style’ VAT grouping will now be entitled to greater input tax recovery in the UK. However, this could of course be at the expense of increased irrecoverable VAT in those other establishments.
Irrespective of the position, there are issues common to all affected taxpayers that will need to be addressed:
Information gathering
Previously there has been no (or little) need for tax teams to scrutinise or understand charges made between different establishments of the same legal entity. This is no longer the case, and it will take time and effort to gather such information and build up a complete picture (see below).
VAT recovery methods
In the UK, taxpayers will need to ensure that their partial exemption method captures both the additional input VAT accounted for under the reverse charge, as well as the value of the new supplies recognised between the UK and some other establishments.
Awareness
Many UK taxpayers will think that the complexities of Skandia only affect them if they have a UK VAT group. However, the guidance makes it clear that the UK treatment is dependent upon the position in other member states, and a large number of taxpayers will need to become familiar with the rules in these countries, which may not be aligned with those in the UK.
Some taxpayers are already finding it difficult to determine appropriate partial exemption special methods (PESMs) especially where branches are involved, after the Crédit Lyonnais (C-388/11) case, where we continue to await HMRC guidance. It is therefore important to be aware that this is likely to add to the complexity of the process due to previously disregarded supplies being recognised.
Next steps
The release of the guidance now allows affected taxpayers to quantify what the impact is likely to be for them. They should start this now, as this will then inform the business as a whole as to whether major changes will be required from 1 January 2016.
An essential element of refining the initial analysis is to develop a proper and detailed understanding of what services are included within charges between different establishments of the same legal entity. Only when this has been done can taxpayers move to a full plan of how to calculate and manage the amount of VAT which may be due.
Information gathering
This process will normally cover the following areas:
In summary, the guidance provides some progress on a difficult and high-profile issue. However, there are some key points to take away from this latest development. Firstly, there is still a long way to go before there will be full certainty in the UK – and even further for most other member states. Secondly, taxpayers should nevertheless act now so that they are ready for 1 January 2016: businesses need to get behind the detail of their cross-border charges, and manage the VAT on these appropriately.
