These changes, should they be implemented, are likely to increase VAT costs for organisations that have non-UK establishments in VAT groups, but with the trade-off of reduced compliance burden. For financial services business, amongst those most likely to be impacted, these changes would represent one of the biggest changes to VAT rules in many years.
This article was first published in the 23rd October 2020 issue of Tax Journal.
HM Treasury (HMT) has launched a call for evidence into the UK’s VAT grouping rules. The call for evidence covers a broad range of topics – from limiting UK VAT grouping to UK establishments only, to the eligibility criteria and the optionality of the regime.
This article considers why this has been raised now, what HMT is gathering evidence on, and what future changes might be. As an HMT initiative, the output seems more likely to be changes to legislation, as opposed to a refresh of existing guidance and practice.
This is particularly important for partially exempt businesses (especially financial services and real estate groups), where VAT grouping (especially of overseas branches) is often a key factor for the overall UK VAT profile.
UK and CJEU case law has recently explored the difficulty of reconciling the interaction between different VAT group regimes (Skandia (Case C-7/13)) and eligibility conditions (e.g. Larentia & Minerva (Case C-08/14), Marenave Schiffart (Case C-09/14) and Ballie Gifford & Co v HMRC  UKFTT 410 (TC)).
Recent macroeconomic events, such as Brexit and Covid-19, give HMT further motivation to look at VAT grouping rules now. The EU exit gives HMT the freedom to change rules without external consultation, and Covid-19 adds revenue raising pressure.
The call for evidence poses 28 questions and is split into three areas:
1) Establishment provisions
The call for evidence asks about the implications of the UK shifting to an ‘establishment only’ format of VAT grouping.
This would limit the territorial scope of UK VAT grouping to only the UK establishments of businesses, i.e. only the domestic activities of UK based businesses and UK establishments of non-UK businesses would be able to be VAT grouped.
Were such a change to happen, it would have most impact on global businesses that utilise a branch-based structure to conduct business – often for regulatory capital reasons (although EU exit may well lead to this being less relevant for many in any event).
Non-UK establishments would then be excluded from the VAT group, bringing more supplies to and by UK groups back into the scope of VAT.
The call for evidence asks about the advantages and disadvantages of the two approaches, but the questions reference some interesting points that may hint at HMT’s current thinking, namely:
· whether the administrative burden of VAT grouping, particularly following Skandia, and HMRC’s implementation of it, could be reduced; and
· whether there could be a change to how businesses allocate jobs.
2) Compulsory VAT grouping
Compulsory VAT grouping would, simply, remove the elective nature of UK VAT grouping, which currently allows taxpayers to form or disband a VAT group as they wish, without the obligation to include every eligible member. Some jurisdictions have implemented compulsory VAT grouping – although generally in a way that requires taxpayers to act proactively to meet the conditions.
The questions, and accompanying narrative, suggest HMT is considering whether:
· The optional nature of UK VAT grouping exposes the system to manipulation by businesses seeking to reduce irrecoverable VAT (especially when coupled with the current establishment rules); and
· Different sectors have different needs when it comes to VAT grouping and compulsory treatment, particularly due to interactions with regulatory or specific commercial reasons.
The focus on sector specific needs is interesting, as this can be a difficult area. Concerns about the impact of joint and several liability – a rule requiring UK VAT group members to share VAT debts in the event of a failure by another member to pay – lead to scenarios where VAT grouping might not be appropriate. For example, in lender covenants, a lender may demand that a borrower is not a VAT group member, in case the joint and several liability means a borrower is unable to repay a loan due to another party’s VAT debts. Similarly, real estate groups engaged in both taxable and exempt developments often seek to keep entities separately registered to simplify their VAT position.
Although joint and several liability is not a point of consideration in the call for evidence, this may need further attention depending on how a compulsory VAT grouping regime is implemented.
3) Eligibility criterial for partnership
This section relates to the proposed inclusion of Limited Partnerships (“LPs”) and Scottish Limited Partnerships (“SLPs”) in VAT groups, likely as a result of longstanding ambiguity around their VAT status. This was highlighted in the 2019 First Tier Tribunal decision in Ballie Gifford & Co.VAT grouping legislation was updated with effect from 1 November 2019 (Schedule 18, Finance Act 2019 and SI 1348/2019) to confirm that individuals and partnerships could form/join VAT groups in certain circumstances. This has brought into focus the types of bodies that are not explicitly eligible (in law) to join UK VAT groups – LPs and SLPs in particular. HMRC currently allow LPs to join VAT groups (see HMRC’s VAT Groups Manual VGROUPS03230) although the call for evidence describes this approach by HMRC as “concessionary”. There is a clear need for clarity on this issue in order for VAT grouping to be a reliable approach for groups who use partnerships for non-tax reasons, to understand the VAT implications.
The call for evidence states that “[it] will be used to gather information and views on the current UK provisions, and views on the provisions that have been adopted by other countries. The views collected through the call for evidence will inform future policy direction”.
While future policy directions will never be spelled out in a call for evidence, perhaps some inferences can be made based on the questions asked.
1) Revenue raising and limitations of existing anti-avoidance provisions
HMRC’s stated attitude is that the principal aim of VAT grouping is administrative simplicity, although clearly VAT grouping can also result in a reduced amount of VAT being paid to HMRC for groups that do not have full VAT recovery.
This tension has long been acknowledged in the UK’s VAT grouping provisions by way of ‘protection of the revenue’ powers at s.43C VATA94, that give HMRC the absolute right to refuse VAT grouping should the revenue loss to HMRC go beyond the “normal consequences” of VAT grouping. In such circumstances, HMRC would, in theory, compare the revenue loss to the taxpayer’s administrative savings. This would allow them to consider whether to use their powers (see VGROUPS05000) but the extent to which this limits HMRC’s right to apply these powers remains an open matter.
It is difficult to estimate how much VAT is “lost” as a consequence of VAT grouping. The gross VAT receipts are likely to be significant, but the actual net tax lost on irrecoverable VAT will be much less. The National Audit Office review into the quantum of tax reliefs (The management of tax expenditures, February 2020) did not include a reference to VAT grouping and how much tax might otherwise be paid (VAT grouping was not included in a list of tax reliefs published by HMRC in October 2019 and May 2020). Regardless, there is likely to be a significant amount of net tax loss to HMRC due to VAT grouping.
Current UK VAT grouping rules already have anti-avoidance provisions designed to limit the extent to which VAT grouping can be utilised to reduce VAT due to HMRC. Apart from protection of the revenue, s43(2A) VATA 1994 also imposes VAT as a targeted anti-avoidance measure on certain supplies that would otherwise be disregarded within a VAT group. The application of this anti-avoidance is a consistent area of dispute between taxpayers and HMRC, and highly complex to implement and audit.
Therefore, if revenue raising is the goal, then it is easy to see why UK establishment-only VAT grouping would be considered. s43(2A) would no longer be required; the type of avoidance it aimed to combat would no longer exist. The effect of VAT grouping would be reduced, thereby limiting the need for HMRC to explore its protection of the revenue powers.
The total VAT collected would ultimately be higher, but the UK’s system would actually be less of an outlier than it is now (only Ireland and Netherlands are notable nearby examples of whole legal entity VAT grouping). Indeed, could the UK leverage more straightforward and less administrative costly VAT grouping rules to be at a competitive advantage?
2) Effect on UK jobs
The call for evidence hints at the possibility that a change to UK establishment-only VAT grouping might benefit UK jobs. Currently, charges for internally generated costs (e.g. salaries) between UK VAT group members – whether or not established in the UK – are disregarded.
UK establishment-only VAT grouping would result in VAT being due on those costs generated outside the UK. For UK VAT groups with less than full VAT recovery, this would become an additional cost. It is possible that some businesses could return jobs to the UK that had previously been offshored. In the past few decades, many global firms have established shared service centres in countries such as Poland, Hungary, and the Philippines.
However, this assumes that these jobs are solely UK-centric, which in the types of organisations to be impacted (e.g. large financial services group), is unlikely to be the case. Staff will be serving multiple jurisdictions and focussing on particular geographies.
Therefore, the effect on jobs could be limited, but it may give an advantage to purely domestic organisations with more flexibility to use UK-based resource.
Whatever the outcome, there would still be a bias against outsourcing (whether to third parties, or to a group’s own service centres). The UK Government could consider alternative ideas such as targeted VAT exemptions or valuation provisions (e.g. to disregard salaries from the taxable base of outsourced services) for UK established outsourcers if the primary aim is to boost the UK jobs market. Such ideas could be of real value in sectors such as FinTech, where VAT rules conflict with a market-driven move to an ecosystem with many smaller players coming together in complex supply chains. As ever, however, the introduction of more complexity risks a new wave of litigation and additional distortion across the VAT system as whole.
3) Simplification of VAT grouping provisions
Simplifying the UK VAT grouping rules could be beneficial, reducing uncertainty for organisations as well as compliance and advisory spend. UK establishment-only VAT grouping would remove the need for much of the complex anti-avoidance provisions and calculations currently required, as well as monitoring different implementations of Skandia, where HMRC currently require taxpayers to monitor VAT grouping rules in other EU Member States.
It is not necessarily the case that compulsory VAT grouping would be a simplification, however. Some regimes with compulsory VAT grouping result in challenges for taxpayers to determine if a VAT group actually exists or not, especially if the taxpayer gets its position incorrect.
Taxpayers and industry groups are requested to provide their input by 20 November. Given the current workload for HMT post COVID-19, a new VAT grouping regime may not be a priority, but we would expect to hear more about future plans during 2021.
If HMT does opt to legislate, then this could be a major change to the UK VAT system. While simplicity and clarity are valuable, this may also be the first set of VAT changes not covered by the precedents of EU retained law, and so mark the first important step to a UK approach distinct from the long-established principles of CJEU case law.