VATA 1994 Sch 6 permits HMRC to issue a direction that open market value shall be applied on transfer prices between related parties where the recipient of the service is unable to reclaim all of their VAT, and a charge has been made at an insufficient level. There has been very little litigation concerning the application of this rule. For this reason, the recent FTT decision in Temple Finance [2016] UKFTT 41 is helpful.
Two related companies (separately VAT registered) operated closely connected businesses. One company (TR) sold electrical goods. The other (TF) also sold electrical goods on HP terms. TR was fully taxable. TF was partly exempt. 98% of TR’s sales were to TF. TR incurred costs relating to the two businesses, and recharged a proportion to TF. These costs were partly recoverable by TF. HMRC believed that the charge was below open market value (OMV) in order to suppress VAT leakage in TF. It issued a direction under Sch 6. It then litigated on the footing that TR had not complied with the direction. In essence, the question was whether or not the charge TR had made was at OMV.
The answer might be obvious where a supply has a ready comparison in the open market, but that was not the case here. In this case, the tribunal largely sided with the taxpayer.
HMRC appears to have approached the calculation on the basis of how the result would have looked if the supplies had all been made by one company. It said there should be no difference between two separately VAT registered entities in this context and the result when they were one fiscal unit. However, it did not allege any ‘abuse’, so redefining the transactions was not in point. It relied instead on a general premise that the Sch 6 powers should lead to the same result.
The tribunal did not accept this. Schedule 6 simply required the calculation of an OMV for the supplies. Parliament had not passed legislation to replicate a different structure, nor does the VAT Directive support that. The tribunal largely accepted the professional advice provided to the taxpayer. Whilst most of this advice had been requested for different purposes (direct tax), the tribunal accepted that the issue was identical, namely establishing an appropriate OMV. It accepted the consultants’ view that TF operated a ‘concession’ within shops owned by TR. It therefore accepted that market comparisons with such concessions should be made, and did not accept HMRC’s argument that the degree of integration between them mandated a different result or approach.
Where did HMRC go wrong? It seems it lost sight of the logic that the whole point of the provision is to try to treat two related companies as though they were unrelated, for VAT purposes, so that they could not artificially reduce transfer prices. HMRC instead took the quixotic view that the critical consideration was that they were related and that the pricing should in fact reflect this. That is diametrically opposite to the purpose of the provision. It seems strange that HMRC failed to grasp (or even notice) this. Perhaps HMRC thinks that the legislation has limited practical use, so it feels obliged to apply a more effective interpretation based on wishful thinking. As none of the evidence would support the accusation of ‘abuse’, HMRC tried to arrive at the same general result by mangling the purpose of the legislation that was available to it to use.
HMRC rightly invokes the concept of the tax being paid in accordance with the intentions of Parliament, but sometimes loses sight of this principle where the result seems inconvenient. However, it would perhaps be useful if HMRC appealed so that we had binding authority on the point.
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Temple Finance: open market value
VATA 1994 Sch 6 permits HMRC to issue a direction that open market value shall be applied on transfer prices between related parties where the recipient of the service is unable to reclaim all of their VAT, and a charge has been made at an insufficient level. There has been very little litigation concerning the application of this rule. For this reason, the recent FTT decision in Temple Finance [2016] UKFTT 41 is helpful.
Two related companies (separately VAT registered) operated closely connected businesses. One company (TR) sold electrical goods. The other (TF) also sold electrical goods on HP terms. TR was fully taxable. TF was partly exempt. 98% of TR’s sales were to TF. TR incurred costs relating to the two businesses, and recharged a proportion to TF. These costs were partly recoverable by TF. HMRC believed that the charge was below open market value (OMV) in order to suppress VAT leakage in TF. It issued a direction under Sch 6. It then litigated on the footing that TR had not complied with the direction. In essence, the question was whether or not the charge TR had made was at OMV.
The answer might be obvious where a supply has a ready comparison in the open market, but that was not the case here. In this case, the tribunal largely sided with the taxpayer.
HMRC appears to have approached the calculation on the basis of how the result would have looked if the supplies had all been made by one company. It said there should be no difference between two separately VAT registered entities in this context and the result when they were one fiscal unit. However, it did not allege any ‘abuse’, so redefining the transactions was not in point. It relied instead on a general premise that the Sch 6 powers should lead to the same result.
The tribunal did not accept this. Schedule 6 simply required the calculation of an OMV for the supplies. Parliament had not passed legislation to replicate a different structure, nor does the VAT Directive support that. The tribunal largely accepted the professional advice provided to the taxpayer. Whilst most of this advice had been requested for different purposes (direct tax), the tribunal accepted that the issue was identical, namely establishing an appropriate OMV. It accepted the consultants’ view that TF operated a ‘concession’ within shops owned by TR. It therefore accepted that market comparisons with such concessions should be made, and did not accept HMRC’s argument that the degree of integration between them mandated a different result or approach.
Where did HMRC go wrong? It seems it lost sight of the logic that the whole point of the provision is to try to treat two related companies as though they were unrelated, for VAT purposes, so that they could not artificially reduce transfer prices. HMRC instead took the quixotic view that the critical consideration was that they were related and that the pricing should in fact reflect this. That is diametrically opposite to the purpose of the provision. It seems strange that HMRC failed to grasp (or even notice) this. Perhaps HMRC thinks that the legislation has limited practical use, so it feels obliged to apply a more effective interpretation based on wishful thinking. As none of the evidence would support the accusation of ‘abuse’, HMRC tried to arrive at the same general result by mangling the purpose of the legislation that was available to it to use.
HMRC rightly invokes the concept of the tax being paid in accordance with the intentions of Parliament, but sometimes loses sight of this principle where the result seems inconvenient. However, it would perhaps be useful if HMRC appealed so that we had binding authority on the point.
