The European Commission launches infraction proceedings over the UK’s VAT treatment of commodity derivatives, write Jeremy Cape & Frankie Beetham (Squire Patton Boggs).
The European Commission notified the UK on 8 March 2018 of infraction proceedings against it in respect of the UK’s VAT treatment of certain commodity derivatives transactions, alleging that the UK has not applied EU law and respected single market rules.
Currently, derivatives transactions on spots, futures and options on commodities contracts traded on certain exchanges are zero rated for VAT purposes in the UK. This includes commodities such as coffee, oil, wool and rubber, to the extent that the relevant derivatives are traded on specific named terminal markets, including the Intercontinental Exchange, London Metal Exchange, London Coffee Terminal Market, and London Grain Futures Market. Usually it is only necessary for one of the parties to the transaction to be a member of the relevant terminal market to attract the zero-rating, although slightly different rules apply depending on the type of transaction.
Where zero rating doesn’t apply, the VAT treatment will generally follow the liability of the underlying commodity, although this is slightly different with options: the right to buy a commodity is a supply of services and is standard rated; exercise of the option is a supply of the commodity itself and will follow the liability of the commodity.
The UK rules on zero rating of these transactions are contained in the Terminal Markets Order 1973 and have been permitted by derogation by the EU since 1977 under article 394 of the VAT Directive as a permitted special measure and a type of ‘standstill’ derogation. Article 394 allows member states to simplify rules for collecting VAT, provided there is only negligible effect on VAT revenue overall.
As such, the UK is not permitted to extend the original scope of the derogation. The Commission is alleging that the UK has done just that, not because the UK has changed the wording of the derogation (it hasn’t, aside from amendment orders, mostly altering the specified terminal markets), but because the UK has allowed increasingly complex types of instruments, traded on increasingly complex markets, to fall within the derogation, with the consequence that the derogation is now no longer limited to trading in the commodities and as such is not being applied correctly. In the Commission’s view, it seems, the ‘standstill’ agreement from 1977 is no longer fit for purpose.
The Commission argues that the UK’s commodity derivatives transactions zero rating creates ‘major distortions of competition to the detriment of other financial markets within the EU’. There have reportedly been a number of informal complaints from other member states that London’s commodity markets have an unfair advantage. Grouchiness that the home of two of the EU’s largest commodities exchanges is (a) permitted a competitively advantageous VAT zero rating and (b) leaving the EU is perhaps unsurprising.
The Commission’s letter (pursuant to article 258 of the TFEU) is the first stage of infraction proceedings, a process which ultimately allows the Commission to refer the case to CJEU. At this stage, the UK is invited to respond within two months and present its views regarding the breach the Commission has alleged. The UK government’s statement (see bit.ly/2GhmFm5) gives little insight on its position, merely stating that it will respond in ‘due course’.
If the UK’s response is considered ‘insufficient’, the Commission will then issue a ‘reasoned opinion’, before referring to the CJEU.
In infraction proceedings, the UK has a strong track record both in terms of resolving cases without the need for CJEU involvement, and in terms of winning cases that have reached the court. The question as to whether the UK government will agree that the Commission is entitled to continue proceedings after Brexit remains an open one. Infringement proceedings often take over three years to be settled, and the UK is set to leave the EU on 29 March 2019, in little over a year’s time. It remains to be seen whether this will impact on the government’s approach to these proceedings. For now, the UK remains subject to EU law and the Commission remains within its right to commence proceedings.
Discussion about Brexit and VAT has tended to focus on import VAT and the impact on ‘frictionless’ trade on the Irish borders and at English Channel ports. But with last week’s European Council guidelines (see bit.ly/2I8bhK0) on the future relationship between the UK and EU specifically mentioning the prevention of ‘unfair competitive advantage that the UK could enjoy through undercutting of current levels of protection with respect to [inter alia] tax’, the UK will need to negotiate hard to prevent it being fettered in its ability to design its VAT system after Brexit.
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Terminal Markets Order: please terminate
The European Commission launches infraction proceedings over the UK’s VAT treatment of commodity derivatives, write Jeremy Cape & Frankie Beetham (Squire Patton Boggs).
The European Commission notified the UK on 8 March 2018 of infraction proceedings against it in respect of the UK’s VAT treatment of certain commodity derivatives transactions, alleging that the UK has not applied EU law and respected single market rules.
Currently, derivatives transactions on spots, futures and options on commodities contracts traded on certain exchanges are zero rated for VAT purposes in the UK. This includes commodities such as coffee, oil, wool and rubber, to the extent that the relevant derivatives are traded on specific named terminal markets, including the Intercontinental Exchange, London Metal Exchange, London Coffee Terminal Market, and London Grain Futures Market. Usually it is only necessary for one of the parties to the transaction to be a member of the relevant terminal market to attract the zero-rating, although slightly different rules apply depending on the type of transaction.
Where zero rating doesn’t apply, the VAT treatment will generally follow the liability of the underlying commodity, although this is slightly different with options: the right to buy a commodity is a supply of services and is standard rated; exercise of the option is a supply of the commodity itself and will follow the liability of the commodity.
The UK rules on zero rating of these transactions are contained in the Terminal Markets Order 1973 and have been permitted by derogation by the EU since 1977 under article 394 of the VAT Directive as a permitted special measure and a type of ‘standstill’ derogation. Article 394 allows member states to simplify rules for collecting VAT, provided there is only negligible effect on VAT revenue overall.
As such, the UK is not permitted to extend the original scope of the derogation. The Commission is alleging that the UK has done just that, not because the UK has changed the wording of the derogation (it hasn’t, aside from amendment orders, mostly altering the specified terminal markets), but because the UK has allowed increasingly complex types of instruments, traded on increasingly complex markets, to fall within the derogation, with the consequence that the derogation is now no longer limited to trading in the commodities and as such is not being applied correctly. In the Commission’s view, it seems, the ‘standstill’ agreement from 1977 is no longer fit for purpose.
The Commission argues that the UK’s commodity derivatives transactions zero rating creates ‘major distortions of competition to the detriment of other financial markets within the EU’. There have reportedly been a number of informal complaints from other member states that London’s commodity markets have an unfair advantage. Grouchiness that the home of two of the EU’s largest commodities exchanges is (a) permitted a competitively advantageous VAT zero rating and (b) leaving the EU is perhaps unsurprising.
The Commission’s letter (pursuant to article 258 of the TFEU) is the first stage of infraction proceedings, a process which ultimately allows the Commission to refer the case to CJEU. At this stage, the UK is invited to respond within two months and present its views regarding the breach the Commission has alleged. The UK government’s statement (see bit.ly/2GhmFm5) gives little insight on its position, merely stating that it will respond in ‘due course’.
If the UK’s response is considered ‘insufficient’, the Commission will then issue a ‘reasoned opinion’, before referring to the CJEU.
In infraction proceedings, the UK has a strong track record both in terms of resolving cases without the need for CJEU involvement, and in terms of winning cases that have reached the court. The question as to whether the UK government will agree that the Commission is entitled to continue proceedings after Brexit remains an open one. Infringement proceedings often take over three years to be settled, and the UK is set to leave the EU on 29 March 2019, in little over a year’s time. It remains to be seen whether this will impact on the government’s approach to these proceedings. For now, the UK remains subject to EU law and the Commission remains within its right to commence proceedings.
Discussion about Brexit and VAT has tended to focus on import VAT and the impact on ‘frictionless’ trade on the Irish borders and at English Channel ports. But with last week’s European Council guidelines (see bit.ly/2I8bhK0) on the future relationship between the UK and EU specifically mentioning the prevention of ‘unfair competitive advantage that the UK could enjoy through undercutting of current levels of protection with respect to [inter alia] tax’, the UK will need to negotiate hard to prevent it being fettered in its ability to design its VAT system after Brexit.
