VAT recovery and non-taxable investment activities
In HMRC v The Chancellor, Masters and Scholars of the University of Cambridge (Case C-316/18), the CJEU has held that the University of Cambridge is not entitled to attribute input VAT on fund management fees incurred on its non-taxable investment activities to its wider economic activities. It was clear that the costs incurred were not cost components of the wider economic activity of the university but were solely attributable to its non-taxable investment activity.
Cambridge University is a partially exempt business which carries on a mixture of exempt educational activities and taxable commercial research, publication sales and hiring out facilities. The university has a range of investments in equities, bonds etc which produce over £40m a year which is used to fund its business activities. The university incurred input VAT on the services of investment fund managers to manage these investments. The dispute with HMRC concerned whether it could recover part of this input VAT on the basis that it was residual.
The university contended that the input VAT incurred on investment management fees had a direct and immediate link with the whole of its business activities, since the monies raised from its investment activity were used to fund the wider business. In contrast, HMRC contended that the input VAT was directly attributable to the non-taxable investment activities. Since those activities were outside the scope of VAT, no input VAT could be recovered, and it was irrelevant that the ultimate purpose of those activities was to raise capital for use in the university’s business.
Both the FTT and the UT found in favour of Cambridge University, but the Court of Appeal referred the matter to the CJEU.
Firstly, the CJEU confirmed that the investment activities of the University did not amount to an economic activity. Raising and collecting donations and endowments was not a taxable activity and, accordingly, any ‘input VAT paid in respect of any costs incurred in connection with the collection of donations and endowments is not deductible, regardless of the reason why those donations and endowments were received’. The same principle applied to costs associated with the investment of those donations and endowments.
But what of the court’s case law suggesting that there can nevertheless be an ‘objective link’ to a taxpayer’s wider business activities? On this point, the court stressed that this is dependent on a ‘cost component’ approach. Looking beyond the immediate non-economic activity depends on those costs being ‘incorporated into the price of particular output transactions or into the price of goods and services provided by the taxable person in the context of that economic activity’. However, in the present case, it was clear that the costs were incurred in order to generate resources that were used to finance all of the university’s output transactions, thus allowing the price of its goods and services to be reduced. As such, the investment management costs could not be considered components of the university’s prices.
Why it matters
The court has stressed the importance of the ‘cost component’ approach to any argument that seeks to link costs incurred on a non-taxable activity to a business’s wider economic activities. However, in the university’s case, the cost component analysis failed. Even if the purpose of the non-taxable investment activity was to ultimately subsidise its wider economic activity, it could not (on the facts) be a cost component of those activities. This was because the monies raised by such activities were used to reduce the cost of the university’s output transactions.
Seen in this light, the decision may well be limited to its own fact pattern where the non-economic activity is generating funds to reduce the cost of the wider outputs. Other taxpayers, who can show that the costs of raising additional finance through investment activities were incorporated in their output transactions, may, therefore, have more success with a similar argument.
VAT and ‘free’ item promotions
In Marks and Spencer v HMRC [2019] UKUT 182, the UT has upheld the decision of the FTT that the provision of a ‘free’ bottle of wine as part of a £10 promotion was subject to VAT. The bottle of wine was not ‘free’ either as a matter of the true construction of the offer nor as a question of economic reality. Instead, it was necessary to attribute part of the consideration of £10 to the wine.
Before 2015, M&S ran a ‘dine in for £10’ promotion under which three food items plus a bottle of wine could be acquired for £10. From 2015, this changed to a ‘dine in for £10’ promotion under which a customer who bought three food items for £10 could receive a bottle of wine for free. M&S argued that, under the new promotion, it was no longer required to apportion part of the £10 consideration to the wine.
M&S contended that it was a fundamental part of the VAT system that the terms of a bargain made at arm’s length were to be respected. Here, the promotion in the stores clearly spelled out that the wine was free and that the £10 consideration was entirely paid for the food items.
Both the FTT and the UT have rejected this argument. The payment of £10 in this case clearly constituted consideration for the food and wine together. There was a direct link between the provision of the wine and the payment of £10.
M&S had relied heavily on the CJEU decision in Kuwait Petrol (Case C-48/97) [1999] STC 488, in which both petrol and vouchers were provided in return for payment. The vouchers were later exchangeable for ‘free’ gifts. On the question whether part of the price paid was attributable to the vouchers (and indirectly the reward goods), the CJEU suggested that the vouchers were provided free of charge since: the redemption goods were described as gifts; and the retail price was the same whether or not a customer accepted the vouchers. However, the UT distinguished Kuwait Petrol on the basis that it effectively involved two separate transactions ‘which destroyed the reciprocity of performance between the parties (ie between the payment for the fuel and supply of the reward goods)’. In contrast, under the M&S promotion, wine could only be taken simultaneously with the food. There was clear reciprocity between the payment of £10 and receipt of the wine.
The UT also agreed with the FTT’s conclusion that the economic and commercial reality was that M&S was offering a package of items – dine in for two for £10 with free wine – but the wine was not being supplied as a gift or for nil consideration. Applying ‘commercial common sense’, the term ‘free’ was clearly being used in a marketing or promotional sense only.
This analysis was not affected by the fact that a customer would have had to pay £10 for the three food items, even if they did not take the wine. The proportion of customers opting to take the wine was not of any legal significance. A customer had a choice as to whether to obtain three food items or four items (including wine) for £10. The payment of £10 was consideration for the actual items obtained in either case.
Why it matters
Whilst generally true that the VAT system will respect the terms of a bargain made at arm’s length, that bargain must be properly analysed. The decision is a reminder that the label applied by the parties to the provision of goods or services under a contract will not be determinative of the true supply for VAT purposes.
VAT on financial and insurance services review
Those with long memories will recall the EU Commission’s 2006 public consultation on the VAT treatment of financial and insurance services. That consultation led to a wide-ranging and long-running review led by the Commission with input from member states with a view to modernising the VAT finance and insurance exemptions to take account of developments in the market such as outsourcing and the increased use of technology-based solutions. Ultimately, that project faltered because of disagreements amongst member states (and also due to a change of focus following the 2008 financial crisis), and it was finally (and quietly) laid to rest in 2016.
Recent work by the EU Commission’s Group on the Future of VAT has once again focused on the problems of applying the current VAT rules to new forms of financial and insurance transactions, usually carried out electronically. As a result, a decision has been taken to conduct a broader review to reassess the current exemptions, with a special emphasis on their cross-border dimension. In the first place, the Commission will carry out a study to evaluate the functioning of the current VAT rules on financial and insurance services with a view to developing possible options for the review of the provisions of the VAT Directive, including ways in which financial and insurance transactions could be taxed. Based on recent press reports, it is understood that the Commission has now accepted external tenders to carry out this study.
Why it matters
The original review of the finance and insurance exemptions proved politically sensitive. There were a number of areas on which member states found it very difficult to reach agreement, including in relation to the VAT exemption for the management of SIFs (and its potential harmonisation) and also the application of the exemptions to outsourced services. It is highly unlikely that the study and subsequent review will lead to any fundamental changes any time soon, but it will be very important for potentially affected businesses to involve themselves in the process to ensure that their voices are heard. It may be that rather than the (overly) ambitious approach to reform advocated in 2006, the Commission could be persuaded to move forward with particular aspects of the review, particularly where there are pressing business and commercial issues that require greater clarity.
VAT adjustment rules following change to consideration
The VAT (Amendment) Regulations, SI 2019/1048, have been enacted, amending the rules which determine when VAT adjustments may be made following a change to the consideration for a supply. The changes will have effect for increases or decreases of consideration which take effect on or after 1 September 2019. HMRC has published Revenue & Customs Brief 6/2019 on the revised rules.
The regulations provide that a VAT adjustment may only be made provided that an actual increase or decrease in the consideration for a supply occurs and in the case of a decrease in consideration, the supplier must make an actual repayment of money (or equivalent set-off) to the customer. In addition, the supplier must now provide a debit note or a credit note containing prescribed information.
The changes are intended to prevent manipulation of the existing rules, such as occurred (unsuccessfully) in the recent UT decision in Inventive Tax Strategies Ltd (in liquidation) and others v HMRC [2019] UKUT 221. In that case, the UT held that there had been no reduction in price for the purposes of article 90 of the Principal VAT Directive in circumstances where there had been no actual repayment, merely a contractual obligation to repay. The case involved firms which had sold tax planning schemes on the basis that there would be a repayment of the consideration they received for their advice if the schemes proved unsuccessful. The SDLT schemes involved were unsuccessful and the firms incurred a significant liability to repay fees to their clients. The firms were put into liquidation or administration. They issued credit notes to their customers as evidence of each customer’s entitlement to a refund of the fee charged for the SDLT avoidance scheme services, however, no amount was actually paid to those customers at the time the credit notes were issued and there was no real prospect of any significant payments being made to those customers. In those circumstances, the UT held that it was not possible to say that the ‘price has been reduced’ in any commercially or economically real sense.
Why it matters
The revised rules provide a much tighter procedure for suppliers to comply with in order to ensure than any adjustment to the consideration can be reflected in VAT accounting and, in the case of reductions in the consideration, require an actual repayment or equivalent.
It is arguable that this goes beyond the decision in the Inventive Tax Strategies case. In that case, HMRC argued that there can only be a price reduction for the purposes of article 90 if and when there is an actual repayment of the price. The UT declined to determine whether such a broad proposition was correct, but it did comment that it may be possible that ‘it will be sufficiently clear that there will be an actual repayment (or some genuine commercial equivalent) to justify the conclusion that there is a real reduction of the price prior to that repayment actually being made, so as to justify (and require) adjustments under article 90’.
VAT grouping and partnerships
In Baillie Gifford v HMRC [2019] UKFTT 410, the FTT has adopted a conforming interpretation of the UK VAT grouping rules to allow grouping of a controlling partnership. The decision indicates that a controlling partnership or individual should be entitled to join a VAT group with any bodies that it controls.
In 2015, the decision of the CJEU in Larentia + Minerva (Case C-108/14) indicated that member states may not restrict VAT grouping only to entities having legal personality, unless it is justified by the prevention of abusive practices, tax evasion or avoidance. UK legislation in VATA 1994 s 43 limits VAT grouping to ‘bodies corporate’ and, accordingly, HMRC consulted on an extension of the VAT grouping rules. This led to limited changes included in FA 2019 (effective from a date to be appointed) to allow individuals and partnerships to join a VAT group, provided that the non-corporate entity controls all of the members of the VAT group.
Baillie Gifford (BG) applied to form a VAT group with itself as the representative member under s 43. HMRC refused the application on the basis that BG was a Scottish partnership and, therefore, not a ‘body corporate’ as required by s 43. BG appealed.
The FTT held that a conforming interpretation of s 43 in line with the CJEU decision in Larentia + Minerva was possible. The requirements of EU law could be read into the UK legislation in a way that ‘goes with the grain’ of the UK VAT grouping provisions. However, the FTT suggested that a conforming interpretation had its limits. Whilst the VAT grouping rules could be construed to include within a VAT group a partnership controlling bodies corporate, by extending an existing deeming provision in s 43A(3) to apply to s 43 also, that deeming provision applies only to a controlling body and not to bodies that are controlled. Accordingly, the FTT considered that it would not be possible to extend a conforming interpretation to permit a partnership to be included in a VAT group where it was controlled by another entity (though this aspect of the decision is obiter).
Why it matters
The decision may prove to be of largely historical significance given that FA 2019 contains provisions extending VAT grouping to individuals and partnerships that control the other bodies in a VAT group. However, until those provisions are brought into force, the decision is important in confirming the extension of the UK VAT grouping rules.
Possible simplification of the partial exemption and CGS regimes
As promised at the Spring Statement 2019, HMRC has published a call for evidence exploring ways to improve the operation of the partial exemption (PE) and the capital goods scheme (CGS) regimes (see bit.ly/2Mp8wIR). These two regimes can involve a significant amount of ongoing administration for businesses, with complex calculations often being required for some businesses to determine the amount of input tax that they are entitled to recover.
The call for evidence focuses on potential simplifications to the regimes. In particular, the call for evidence is split into three sections:
Why it matters
In its 2017 report, the Office of Tax Simplification highlighted that the processes involved for operating the PE and the CGS regimes are not as efficient as they could be. This call for evidence gives taxpayers the opportunity to feed into HMRC’s review and affect the final outcome of any reform to these administratively burdensome aspects of the VAT system.
Responses to the call for evidence should be made by 26 September 2019.
What to look out for
VAT recovery and non-taxable investment activities
In HMRC v The Chancellor, Masters and Scholars of the University of Cambridge (Case C-316/18), the CJEU has held that the University of Cambridge is not entitled to attribute input VAT on fund management fees incurred on its non-taxable investment activities to its wider economic activities. It was clear that the costs incurred were not cost components of the wider economic activity of the university but were solely attributable to its non-taxable investment activity.
Cambridge University is a partially exempt business which carries on a mixture of exempt educational activities and taxable commercial research, publication sales and hiring out facilities. The university has a range of investments in equities, bonds etc which produce over £40m a year which is used to fund its business activities. The university incurred input VAT on the services of investment fund managers to manage these investments. The dispute with HMRC concerned whether it could recover part of this input VAT on the basis that it was residual.
The university contended that the input VAT incurred on investment management fees had a direct and immediate link with the whole of its business activities, since the monies raised from its investment activity were used to fund the wider business. In contrast, HMRC contended that the input VAT was directly attributable to the non-taxable investment activities. Since those activities were outside the scope of VAT, no input VAT could be recovered, and it was irrelevant that the ultimate purpose of those activities was to raise capital for use in the university’s business.
Both the FTT and the UT found in favour of Cambridge University, but the Court of Appeal referred the matter to the CJEU.
Firstly, the CJEU confirmed that the investment activities of the University did not amount to an economic activity. Raising and collecting donations and endowments was not a taxable activity and, accordingly, any ‘input VAT paid in respect of any costs incurred in connection with the collection of donations and endowments is not deductible, regardless of the reason why those donations and endowments were received’. The same principle applied to costs associated with the investment of those donations and endowments.
But what of the court’s case law suggesting that there can nevertheless be an ‘objective link’ to a taxpayer’s wider business activities? On this point, the court stressed that this is dependent on a ‘cost component’ approach. Looking beyond the immediate non-economic activity depends on those costs being ‘incorporated into the price of particular output transactions or into the price of goods and services provided by the taxable person in the context of that economic activity’. However, in the present case, it was clear that the costs were incurred in order to generate resources that were used to finance all of the university’s output transactions, thus allowing the price of its goods and services to be reduced. As such, the investment management costs could not be considered components of the university’s prices.
Why it matters
The court has stressed the importance of the ‘cost component’ approach to any argument that seeks to link costs incurred on a non-taxable activity to a business’s wider economic activities. However, in the university’s case, the cost component analysis failed. Even if the purpose of the non-taxable investment activity was to ultimately subsidise its wider economic activity, it could not (on the facts) be a cost component of those activities. This was because the monies raised by such activities were used to reduce the cost of the university’s output transactions.
Seen in this light, the decision may well be limited to its own fact pattern where the non-economic activity is generating funds to reduce the cost of the wider outputs. Other taxpayers, who can show that the costs of raising additional finance through investment activities were incorporated in their output transactions, may, therefore, have more success with a similar argument.
VAT and ‘free’ item promotions
In Marks and Spencer v HMRC [2019] UKUT 182, the UT has upheld the decision of the FTT that the provision of a ‘free’ bottle of wine as part of a £10 promotion was subject to VAT. The bottle of wine was not ‘free’ either as a matter of the true construction of the offer nor as a question of economic reality. Instead, it was necessary to attribute part of the consideration of £10 to the wine.
Before 2015, M&S ran a ‘dine in for £10’ promotion under which three food items plus a bottle of wine could be acquired for £10. From 2015, this changed to a ‘dine in for £10’ promotion under which a customer who bought three food items for £10 could receive a bottle of wine for free. M&S argued that, under the new promotion, it was no longer required to apportion part of the £10 consideration to the wine.
M&S contended that it was a fundamental part of the VAT system that the terms of a bargain made at arm’s length were to be respected. Here, the promotion in the stores clearly spelled out that the wine was free and that the £10 consideration was entirely paid for the food items.
Both the FTT and the UT have rejected this argument. The payment of £10 in this case clearly constituted consideration for the food and wine together. There was a direct link between the provision of the wine and the payment of £10.
M&S had relied heavily on the CJEU decision in Kuwait Petrol (Case C-48/97) [1999] STC 488, in which both petrol and vouchers were provided in return for payment. The vouchers were later exchangeable for ‘free’ gifts. On the question whether part of the price paid was attributable to the vouchers (and indirectly the reward goods), the CJEU suggested that the vouchers were provided free of charge since: the redemption goods were described as gifts; and the retail price was the same whether or not a customer accepted the vouchers. However, the UT distinguished Kuwait Petrol on the basis that it effectively involved two separate transactions ‘which destroyed the reciprocity of performance between the parties (ie between the payment for the fuel and supply of the reward goods)’. In contrast, under the M&S promotion, wine could only be taken simultaneously with the food. There was clear reciprocity between the payment of £10 and receipt of the wine.
The UT also agreed with the FTT’s conclusion that the economic and commercial reality was that M&S was offering a package of items – dine in for two for £10 with free wine – but the wine was not being supplied as a gift or for nil consideration. Applying ‘commercial common sense’, the term ‘free’ was clearly being used in a marketing or promotional sense only.
This analysis was not affected by the fact that a customer would have had to pay £10 for the three food items, even if they did not take the wine. The proportion of customers opting to take the wine was not of any legal significance. A customer had a choice as to whether to obtain three food items or four items (including wine) for £10. The payment of £10 was consideration for the actual items obtained in either case.
Why it matters
Whilst generally true that the VAT system will respect the terms of a bargain made at arm’s length, that bargain must be properly analysed. The decision is a reminder that the label applied by the parties to the provision of goods or services under a contract will not be determinative of the true supply for VAT purposes.
VAT on financial and insurance services review
Those with long memories will recall the EU Commission’s 2006 public consultation on the VAT treatment of financial and insurance services. That consultation led to a wide-ranging and long-running review led by the Commission with input from member states with a view to modernising the VAT finance and insurance exemptions to take account of developments in the market such as outsourcing and the increased use of technology-based solutions. Ultimately, that project faltered because of disagreements amongst member states (and also due to a change of focus following the 2008 financial crisis), and it was finally (and quietly) laid to rest in 2016.
Recent work by the EU Commission’s Group on the Future of VAT has once again focused on the problems of applying the current VAT rules to new forms of financial and insurance transactions, usually carried out electronically. As a result, a decision has been taken to conduct a broader review to reassess the current exemptions, with a special emphasis on their cross-border dimension. In the first place, the Commission will carry out a study to evaluate the functioning of the current VAT rules on financial and insurance services with a view to developing possible options for the review of the provisions of the VAT Directive, including ways in which financial and insurance transactions could be taxed. Based on recent press reports, it is understood that the Commission has now accepted external tenders to carry out this study.
Why it matters
The original review of the finance and insurance exemptions proved politically sensitive. There were a number of areas on which member states found it very difficult to reach agreement, including in relation to the VAT exemption for the management of SIFs (and its potential harmonisation) and also the application of the exemptions to outsourced services. It is highly unlikely that the study and subsequent review will lead to any fundamental changes any time soon, but it will be very important for potentially affected businesses to involve themselves in the process to ensure that their voices are heard. It may be that rather than the (overly) ambitious approach to reform advocated in 2006, the Commission could be persuaded to move forward with particular aspects of the review, particularly where there are pressing business and commercial issues that require greater clarity.
VAT adjustment rules following change to consideration
The VAT (Amendment) Regulations, SI 2019/1048, have been enacted, amending the rules which determine when VAT adjustments may be made following a change to the consideration for a supply. The changes will have effect for increases or decreases of consideration which take effect on or after 1 September 2019. HMRC has published Revenue & Customs Brief 6/2019 on the revised rules.
The regulations provide that a VAT adjustment may only be made provided that an actual increase or decrease in the consideration for a supply occurs and in the case of a decrease in consideration, the supplier must make an actual repayment of money (or equivalent set-off) to the customer. In addition, the supplier must now provide a debit note or a credit note containing prescribed information.
The changes are intended to prevent manipulation of the existing rules, such as occurred (unsuccessfully) in the recent UT decision in Inventive Tax Strategies Ltd (in liquidation) and others v HMRC [2019] UKUT 221. In that case, the UT held that there had been no reduction in price for the purposes of article 90 of the Principal VAT Directive in circumstances where there had been no actual repayment, merely a contractual obligation to repay. The case involved firms which had sold tax planning schemes on the basis that there would be a repayment of the consideration they received for their advice if the schemes proved unsuccessful. The SDLT schemes involved were unsuccessful and the firms incurred a significant liability to repay fees to their clients. The firms were put into liquidation or administration. They issued credit notes to their customers as evidence of each customer’s entitlement to a refund of the fee charged for the SDLT avoidance scheme services, however, no amount was actually paid to those customers at the time the credit notes were issued and there was no real prospect of any significant payments being made to those customers. In those circumstances, the UT held that it was not possible to say that the ‘price has been reduced’ in any commercially or economically real sense.
Why it matters
The revised rules provide a much tighter procedure for suppliers to comply with in order to ensure than any adjustment to the consideration can be reflected in VAT accounting and, in the case of reductions in the consideration, require an actual repayment or equivalent.
It is arguable that this goes beyond the decision in the Inventive Tax Strategies case. In that case, HMRC argued that there can only be a price reduction for the purposes of article 90 if and when there is an actual repayment of the price. The UT declined to determine whether such a broad proposition was correct, but it did comment that it may be possible that ‘it will be sufficiently clear that there will be an actual repayment (or some genuine commercial equivalent) to justify the conclusion that there is a real reduction of the price prior to that repayment actually being made, so as to justify (and require) adjustments under article 90’.
VAT grouping and partnerships
In Baillie Gifford v HMRC [2019] UKFTT 410, the FTT has adopted a conforming interpretation of the UK VAT grouping rules to allow grouping of a controlling partnership. The decision indicates that a controlling partnership or individual should be entitled to join a VAT group with any bodies that it controls.
In 2015, the decision of the CJEU in Larentia + Minerva (Case C-108/14) indicated that member states may not restrict VAT grouping only to entities having legal personality, unless it is justified by the prevention of abusive practices, tax evasion or avoidance. UK legislation in VATA 1994 s 43 limits VAT grouping to ‘bodies corporate’ and, accordingly, HMRC consulted on an extension of the VAT grouping rules. This led to limited changes included in FA 2019 (effective from a date to be appointed) to allow individuals and partnerships to join a VAT group, provided that the non-corporate entity controls all of the members of the VAT group.
Baillie Gifford (BG) applied to form a VAT group with itself as the representative member under s 43. HMRC refused the application on the basis that BG was a Scottish partnership and, therefore, not a ‘body corporate’ as required by s 43. BG appealed.
The FTT held that a conforming interpretation of s 43 in line with the CJEU decision in Larentia + Minerva was possible. The requirements of EU law could be read into the UK legislation in a way that ‘goes with the grain’ of the UK VAT grouping provisions. However, the FTT suggested that a conforming interpretation had its limits. Whilst the VAT grouping rules could be construed to include within a VAT group a partnership controlling bodies corporate, by extending an existing deeming provision in s 43A(3) to apply to s 43 also, that deeming provision applies only to a controlling body and not to bodies that are controlled. Accordingly, the FTT considered that it would not be possible to extend a conforming interpretation to permit a partnership to be included in a VAT group where it was controlled by another entity (though this aspect of the decision is obiter).
Why it matters
The decision may prove to be of largely historical significance given that FA 2019 contains provisions extending VAT grouping to individuals and partnerships that control the other bodies in a VAT group. However, until those provisions are brought into force, the decision is important in confirming the extension of the UK VAT grouping rules.
Possible simplification of the partial exemption and CGS regimes
As promised at the Spring Statement 2019, HMRC has published a call for evidence exploring ways to improve the operation of the partial exemption (PE) and the capital goods scheme (CGS) regimes (see bit.ly/2Mp8wIR). These two regimes can involve a significant amount of ongoing administration for businesses, with complex calculations often being required for some businesses to determine the amount of input tax that they are entitled to recover.
The call for evidence focuses on potential simplifications to the regimes. In particular, the call for evidence is split into three sections:
Why it matters
In its 2017 report, the Office of Tax Simplification highlighted that the processes involved for operating the PE and the CGS regimes are not as efficient as they could be. This call for evidence gives taxpayers the opportunity to feed into HMRC’s review and affect the final outcome of any reform to these administratively burdensome aspects of the VAT system.
Responses to the call for evidence should be made by 26 September 2019.
What to look out for
