Monthly Archives: March 2019

VAT: Partial exemption, the N Brown case

By Marcus Ward 18 March 2019

Latest from the courts.

Partial exemption has always been, and probably always will be, the most complex and oft debated area of the tax.

Attribution

In the First Tier Tribunal (FTT) case of N Brown Group plc the issue was how to attribute input tax incurred on marketing. This included:

online
catalogues and leaflets
parcel packs
inserts in magazines and newspapers
direct mailings
advertisements in publications
TV advertisements
telemarketing
brand development
PR
celebrity endorsements
market research
photo shoots

Background

N Brown, as you may know, sells clothing and household goods online to the public. It has only a few retail stores so does not have the facility that a “bricks and mortar” retailer would have of displaying goods in its stores. It therefore has to incur significant marketing costs to bring its products to the attention of its customers and present them in an attractive way that encourages sales. The activities of the appellant include the sale of these goods, which is standard-rated for VAT purposes, and the provision of finance, which is exempt for VAT purposes. The finance element is the provision of credit which produces significant income from the interest on monthly balances which consumers do not pay off.

Issue

The issue was whether the input tax incurred on the marketing was attributable to the sale of goods which were advertised or, as HMRC contended; to both its taxable and exempt income (so that it was residual). If HMRC were correct an element of the input tax would fall to be irrecoverable via the appellants’ partial exemption calculation. HMRC’s position was that the input tax which N Brown incurred in respect of the marketing is residual because, although they did not seek to deny the existence of a “direct and immediate link” between the relevant goods and services and taxable supplies that the appellant made, they consider that there is also a direct and immediate link to the exempt credit provided.

Unsurprisingly, N Brown’s position was that the vast majority of goods and services received in connection with the marketing had a “direct and immediate link” only with taxable supplies that it made and so the relevant input tax was not residual and is therefore recoverable in full.

A subtle distinction, however, as £42 million of VAT was at stake, quite a vital one!

Technical

A general guide to partial exemption is available here

Broadly, a partially exempt business is required to attribute input tax incurred to three categories:

Taxable activities (here, the sale of goods) fully recoverable
Exempt activities (here the provision of credit) not recoverable
Non-attributable (residual) – input tax attributable to both taxable and exempt activities, or neither. This input tax must be apportioned either by the “standard method” or special method agreed with HMRC.

Decision

The judge found that there was a two-way relationship between the sale of the goods and the provision of credit terms. As a consequence, the input tax fell into the category of non-attributable (residual) even if the relevant advertisements made no mention of credit at all. It was also found that the standard method (used by HMRC) did not produce a reasonable outcome so the assessment issued by HMRC would need adjustment in the taxpayer’s favour. This required a different method to be devised and that certain elements of exempt income could be ignored in the calculation. I suspect that negotiations on an agreeable method might take some time…

Commentary

This case demonstrates that care is always required when costs are attributed to a business’ activities. This is especially important when the costs are significant. There tends to be a lot of “debate” with HMRC on such matters and slight nuances can affect attribution and thus the outcome of the calculation. It is an area which always requires specialised advice.

VAT: Input tax recovery on director’s costs

By Marcus Ward 18 March 2019

Latest from the courts: Directors expenditure – what may be recovered as input tax?

The Praesto Consulting UK Limited Court of Appeal (CoA) case.

This is a subject that pops up every now and again: Is a purchase for the director’s business purposes (input tax usually recoverable by the company) or for a director personally (so non-business and not recoverable)?

Background

Mr Ranson was an ex-employee of a claimant in civil proceedings; Customer Systems plc (“CSP”). Mr Ranson resigned to set up a company of which he was sole director, “Praesto”, which then carried on a consultancy business competing with CSP. CSP issued proceedings against Mr Ranson (and three other employees) over the nature of the departure from the company, but not against Praesto itself. The acting solicitor firm issued eight invoices (containing the VAT in question) to Mr Ranson personally, and not his company. The invoices were paid by Praesto

Issue

Praesto paid the legal fees relating to the defence of the civil proceedings brought by CSP against its sole director. Is the company entitled to credit for VAT input tax charged in relation to those fees? That is, was it proper business expenditure by the company, or was the defence of the case a personal cost of the director as a (distinct) individual?

HMRC laid great stress on the fact that the invoices were addressed to Mr Ranson personally, that they related to services provided in relation to the claim brought by CSP against him and that Praesto was never joined as a party to the proceedings.

Decision

The CoA ruled that Praesto could recover VAT on the fees. The action against Mr Ranson was the first phase of litigation which would ultimately seek damages from Praesto (and therefore Praesto had a direct interest in CSP’s claim being dismissed). This was an indication that there was a direct and immediate link between the legal services provided and the business. In reality, Praesto was throughout the proceedings, the main target of the litigation: It was Praesto which had made the profits which CSP sought to claim.

The fact that the invoices were addressed to Mt Ranson provided no legal bar to the company recovering the associated input tax. The judge observed that there was a joint retainer whereby the solicitor firm was being instructed by, and acting on behalf of, both Mr Ranson and Praesto. Under such a retainer both Mr Ranson and Praesto would be entitled to the solicitor’s’ services and both would be jointly and severally liable for the fees. That is a legal relationship involving reciprocal performance. As both parties were jointly and severally liable for the fees, there would be no particular significance in addressing invoices to only one of the parties so liable.

This seems an entirely sensible decision.

Commentary

This has echoes of the P&O case: P&O Ferries (Dover) Ltd v Commissioners of Customs & Excise [1992] VATTR 221 referred to in this case, where criminal proceedings were brought against various P&O employees and the company itself arising out of the Herald of Free Enterprise Zeebrugge disaster – the company paid for the legal representation of all the individual defendants and claimed input tax on the costs of so doing. It was held that the conviction of even one of the individual employees would have caused severe damage to the public perception of the company’s business. To mitigate the real risk of being driven out of business the board took the view that the company had to take every step available to it to guard against the successful prosecution of each of the individual employees. The legal services in question were, therefore, used for the purpose of the company’s business.

Another area where VAT on costs invoiced to a (future) director personally are recoverable is in pre-incorporation cases where (obviously) the company does not exist so cannot, at that time, recover the VAT. HMRC permit recovery in such cases if the recipient of the invoice does indeed become a director of the company and the supply is used by that company for business purposes

Please contact us if you have any queries.

VAT: Property – The Option To Tax

By Marcus Ward 13 March 2019

Opting To Tax commercial property

Opting to tax provides a unique situation in the VAT world. It is the only example of where a supplier can choose to add VAT to a supply….. or not.

What is an option to tax?

The sale or letting of a property is, in most cases, exempt (VAT free) by default. However, it is possible to apply the option to tax (OTT) to commercial property. This has the result of turning an exempt supply into a taxable supply at the standard rate. It should be noted that an OTT made in respect of a residential property is disregarded and consequently, the supply of residential properties is always exempt.

Why opt?

Why would a supplier then deliberately choose to add VAT on a supply?

The only purpose of OTT is to enable the optor to recover or avoid input tax incurred in relation to the relevant land or property. The OTT is a decision solely for the property owner or landlord and the purchaser or tenant is not able to affect the OTT unless specific clauses are included in the lease or purchase contracts. Care should be taken to ensure that existing contracts permit the OTT to be taken. Despite a lot of misleading commentary and confusion, it is worth bearing in mind that the recovery or avoidance of input tax is the sole reason to OTT.

Once made the OTT is usually irrevocable for a 20-year period (although there are circumstances where it may be revisited within six months of it being taken – see below). There are specific rules for circumstances where the optor has previously made exempt supplies of the relevant land or property. In these cases, HMRC’s permission must usually be obtained before the option can be made.

What to consider

The important questions to be asked before a property transaction are:

Was VAT incurred on the purchase price?
Is the purchase with the benefit of an existing lease (will the tenant remain?) if so, it may be possible to treat the transaction as a VAT free TOGC (see below)
Is the property subject to the Capital Goods Scheme (CGS here)?
Is it intended to spend significant amounts on the property, eg; refurbishment?
What other costs will be incurred in respect of the property?
If renting the property out – will the lease granted be full tenant repairing?
Will the tenant or purchaser be in a position to recover any or all VAT charged on the rent/sale?

These are the basic questions to be addressed; further factors may need to be considered depending on the facts of a transaction.

Input tax recovery

Input tax relating to an exempt supply is usually irrecoverable. In fact, a business only making exempt supplies is unable to register for VAT. A guide to partial exemption here. So input tax incurred on, say; purchase, refurbishment, legal costs etc would be lost if a property was sold or rented on an exempt basis. In order to recover this tax, it must relate to a taxable supply. If an OTT is taken, the sale or rent of the property will be standard rated which represents a taxable supply. VAT on supply = input tax claim.

Two-part process

The OTT is a two-part process.

The first part is a decision of the business to take the OTT and it is prudent to minute this in Board meeting minutes or similar. Once the decision to OTT is taken VAT may be added to a sale price or rent and a valid tax invoice must be raised.
The second part is to formally notify HMRC. If the OTT is straightforward the form on which this is done is a VAT1614A. Here. In some cases, it is necessary to obtain HMRC’s permission in which case separate forms are required. HMRC guidance here – para 5.

There can be problems in cases where the OTT is taken, but not formally notified.

Timing

It is vital to ensure that an OTT is made at the correct time. Even one day late may affect the VAT treatment. Generally speaking, the OTT must be made before any use of the property, eg; sale or rent. Care should also be taken with deposits which can trigger a tax point before completion.

Disadvantages

As mentioned above (and bears repeating) the benefit of taking the OTT is the ability to recover input tax which would otherwise fall to be irrecoverable. However, there are a number of potential disadvantages.

opting a commercial property may reduce its marketability. It is likely that entities which are unable to recover VAT would be less inclined to purchase or lease an opted property. These entities may be; partly exempt business, those not VAT registered, or charities/NFP organisations.
the payment of VAT by the purchaser may necessitate obtaining additional funding. This may create problems, especially if a VAT charge was not anticipated. Even though, via opting, the VAT charge is usually recoverable, it still has to be paid for up-front.
an OTT will increase the amount of SDLT payable when a property is sold. This is always an absolute cost.

Transfer of a Going Concern (TOGC)

I always say that advice should be taken in all property transactions and always in cases of a TOGC or a possible TOGC. This is doubly important where an opted building is being sold, because TOGC treatment only applies to a sale of property when specific tests are met. A TOGC is VAT free but any input tax incurred is recoverable, so this is usually a benefit for all parties.

Revoking an Option To Tax

The cooling off period – If an OTT has been made and the opter changes his/her mind within six months it can be revoked. This is as long as no tax has become chargeable on a supply of the land, that no TOGC has occurred, and the OTT has actually been notified to HMRC. There are additional considerations in certain cases, so these always need to be checked.
No interest has been held for more than six years – An OTT is revoked where the opter has not held an interest in the opted building for a continuous period of six years. The revocation is automatic, and no notification is required.
20 years – It is possible to revoke an OTT which was made more than 20 years ago. Certain conditions must be met, and advice should be taken on how such a revocation affects future input tax recovery.

Summary

Property transactions are high value and often complex. The cost of getting VAT wrong or overlooking it can be very swingeing indeed. I have also seen deals being aborted over VAT issues. of course, if you get it wrong there are penalties to pay too. For these reasons, please seek VAT advice at an early stage of negotiations.

More on our land and property services here

VAT MOSS and No-Deal Brexit

By Marcus Ward 11 March 2019

In the event of an increasingly likely no deal Brexit, changes have been put in place to the existing MOSS (Mini One Stop Shop) arrangements. Details of MOSS here.

These intended changes will affect UK businesses which provide electronically supplied services such as cross-border telecommunication, television and radio broadcasting, or digital services to non-business (eg; individuals) recipients in the EU.

Such services include:

website hosting
supply of software
access to databases
downloading apps or music
online gaming
distance teaching

The existing threshold of £8818 pa introduced by Schedule 4A, para 15(1) of the VAT Act 1994 will be removed via SI2019/404.

This means that if there is a no deal Brexit UK businesses supplying such services will either be required to:

MOSS Non-Union Scheme

A business may use the Non-Union scheme when it supplies cross-border electronically supplied services to consumers in all EU countries (including the EU country selected as the Member State of identification).

The EU countries where a business supplies services to are known as Member States of consumption.

Selecting a member state of identification

A business must designate a Member State of identification. This can be any EU country a business chooses. A business may change the member state of identification at a later date if it wants. Again, this can be any EU country a business chooses.

Registration

A business registers online via the Member State of identification’s portal.

VAT rules

A business will be allocated a VAT number by the EU country chosen to be the Member State of identification and charge VAT at the rate of the EU countries where its customers reside. The same invoicing rules as your Member State of identification must be used (although an invoice is not required in most countries when supplying services under the MOSS scheme).

VAT returns

A business must submit detailed online quarterly VAT returns within 20 days of the end of each return period. The information is then securely transferred from your Member State of identification to the relevant Member State of consumption.

VAT rates

VAT rates can be checked for the supply of telecommunications, broadcasting and electronically supplied services using the Tax Information Communication database.

For further information and to register for MOSS please see here.

VAT: Input tax claims – alternative evidence

By Marcus Ward 7 March 2019

What can be used to make a claim?

It is well known that in order to claim input tax on expenditure a business is required to have a valid tax invoice to support it. But what if there is no VAT invoice? Can HMRC accept any other evidence to support a claim? Well, the answer is yes… sometimes.

HMRC has discretion provided by EC law. The right to deduct is given by Article 167 of the Principal VAT Directive (via VAT Regulations 1995/2518 Reg 29(2) in the UK). Specifically, the wording most relevant here is “…such other documentary evidence of the charge to VAT as the Commissioners may direct.” Broadly, a business must hold the correct evidence before being able to exercise the right to deduct.

Where claims to deduct VAT are not supported by a valid VAT invoice HMRC staff are required to consider whether there is satisfactory alternative evidence of the taxable supply available to support deduction. HMRC staff should not simply refuse a claim without giving reasonable consideration to such evidence. HMRC has a duty to ensure that taxpayers pay no more tax than is properly due. However, this obligation is balanced against a duty to protect the public revenue.

Full details of tax invoices here.

What HMRC consider

HMRC staff are required to work through the following checklist:

Does the business have alternative documentary evidence other than an invoice (for example a supplier statement)?
Does the business have evidence of receipt of a taxable supply on which VAT has been charged?
Does the business have evidence of payment?
Does the business have evidence of how the goods/services have been consumed or evidence regarding their onward supply?
How did the business know the supplier existed?
How was the business relationship with the supplier established? For example: How was contact made?
Does the business know where the supplier operates from (have staff visited?)
How did the business contact them?
How does the business know the supplier can supply the goods or services?
If goods, how does the business know they are not stolen?
How does the business return faulty supplies?

Outcome

If the responses to the above tests are credible, HMRC staff should exercise their discretion to allow the taxpayer to deduct the input tax. Overall, HMRC are required to be satisfied that sufficient evidence is held by the business which demonstrates that VAT has been paid on a taxable supply of goods or services received by that business and which were used by that business for its taxable activities

Challenge HMRC’s decision

A business may only challenge HMRC’s decision not to allow a claim (did not exercise its discretion) if it acted in an unfair or unreasonable way. In these cases, the onus is on the taxpayer to demonstrate that HMRC have been unreasonable in not using the available discretion. This is quite often a difficult thing to do.

Case law

Not surprisingly, there is significant case law on this subject. The most relevant and recent being the Upper Tribunal (UT) cases of James Boyce and Scandico Ltd.

Tips

If possible, always obtain a proper tax invoice from a supplier, and don’t lose it! The level of evidence required when no invoice is held usually depends on the value of the claim. There would be a difference between persuading an inspector that £20 input tax on stationery is recoverable and the claiming of £200,000 VAT on a property purchase is permissible. As always in VAT, if you get it wrong and claim VAT without the appropriate evidence there is likely to be a penalty to pay.

If you, or your clients are in dispute with HMRC on input tax claims, please contact us.

VAT: More on the Mercedes Benz Financial Services case – PCP

By Marcus Ward 1 March 2019

Further to my article on the Mercedes Benz Financial Services (MBFS) case on Personal Contract Purchase (PCP), HMRC has published a Briefing Note – Changes to the VAT treatment of PCPs

HMRC has fully implemented the findings in the MBFS CJEU case. In summary, HMRC state that:

“The correct treatment of PCP and similar contracts depends on the level at which the final optional payment is set:

if, at the start of the contract, it is set at or above the anticipated market value of the goods at the time the option is to be exercised, the VAT treatment of the contract will follow the MBFS It is a supply of leasing services from the outset and VAT must be accounted for on the full value of each instalment, there is no advance, or credit, so there is no finance
if, at the start of the contract, it is set below the anticipated market value, such that a rational customer would buy the asset when they exercise the option, it is a supply of goods, with a separate supply of finance. VAT is due on the supply of goods in full at the outset of the contract, the finance is exempt from VAT”

This treatment must be used by 1 June 2019. Past declarations which have been in error must be adjusted per PN 700/45. Businesses affected by the changes may also need to consider adjustments to input tax claimed, or forgone in respect of partial exemption. A guide to partial exemption here.