VAT case-law review of the year

Next year marks 50 years of VAT in the UK. So, all of the big questions have been answered, right? Well… no! Instead, we approach the anniversary with some fundamental questions around the tax still up in the air. Every question answered seems to give rise to three more.

On concepts as fundamental as: when has a supply occurred? (Ventgrove); when can you ignore the legal party to a transaction? (Ashton); and what characterises a fixed establishment? (HSBC) we are still treading on unstable ground. Little surprise that the NYT word of the year was “uncertainty”.

It is against this backdrop that we present our (subjective) top ten cases in our VAT case-law review of the year.

10. HMRC v NHS Lothian Health Board [2022] UKSC 28

We start with this Supreme Court decision focused on the evidence required in order for a taxpayer to make a successful reclaim for input VAT.

In this case, the taxpayer was a Scottish Health Board, who had made reclaims for input VAT incurred in relation to its non-NHS business in the period 1974 – 1997. In the absence of any records for the periods in question, the taxpayer had sought to use data from 2006/2007, which was the first year for which appropriate records were kept. HMRC’s conclusion, which had been upheld by the First-tier and Upper Tribunals, was that there was insufficient evidence for the Health Board to reclaim its input VAT. These decisions were overturned by the Inner House of the Court of Session, however, on the basis of the EU principles of effectiveness and proportionality.

On appeal, the Supreme Court ultimately upheld the decisions of the Tribunals, confirming that the burden of proof for input VAT reclaims rests with the taxpayer, who is required to show that the input VAT they are seeking to reclaim is indeed recoverable, including quantification of the relevant amounts.

This case does demonstrate the importance to taxpayers of maintaining accurate records and appropriate evidence to be able to properly substantiate any reclaims that they may wish to make in the future. A similar situation is unlikely to arise today given the four year cap making this case mostly historic interest and hence preventing it from moving further up the list.

9. GE Aircraft Engine Services Ltd v HMRC (Case C 607/20)

Similarly, this CJEU decision is prevented from rising up the list due to its limited future impact.

The case concerned the provision of fairly routine incentives by an employer to its employees. The question was whether it is obliged to account for output VAT?

Earlier decisions of the CJEU dealing with meals and travel suggested that, in general, such facilities attracted output VAT as the situation fell within the scope of Article 26(1)(d) which deems “the supply of services carried out free of charge by a taxable person for his private use or for that of his staff or, more generally, for purposes other than those of his business” to be a supply of services for a consideration.

The decision of the CJEU in GE Aircraft Engine Services Ltd v HMRC, however, suggests that we (and HMRC) may have been reading this provision incorrectly. GE provided retail vouchers to employers under an incentive scheme. Did the free reward attract VAT? The vouchers were for the private use of staff and so, “yes” said HMRC. It didn’t matter that there was a business purpose, as the first part of Article 26(1)(d) had been satisfied.

“No”, the CJEU answered (ignoring the advice of its own Advocate General). Determining whether Article 26(1)(d) applied on the facts depended on assessment of all the circumstances and, in particular, the nature and objectives of that incentive programme.

In this case, the rewards were designed by GE with the aim of improving the performance of its employees and, therefore, of contributing to the better profitability of the business. The setting up of that programme was dictated by business considerations and the pursuit of additional profits, the advantage for employees being merely incidental to the needs of the business.

However, as the voucher rules have changed since this date, the specifics of the case have limited prospective application. Albeit companies may wish to review their rewards and employee benefit programs.

8. O. Fundusz lnwestycyjny Zamknięty reprezentowany przez O (Case C-250/21)

On the theme of the CJEU disregarding the AG’s Opinion we are left with this case concerning the correct VAT treatment of a sub-participation agreement, which threatened to send reverberations through the industry but ended up a damp squib.

The VAT finance exemptions set out in the 2006 VAT Directive (and in Schedule 9 Group 5 of VATA 1994) largely date back almost 50 years. The transactions that they apply to have, in some cases, changed out of all recognition to those envisaged at the time they were drafted. Capital markets transactions, in particular, have grown significantly in complexity during that period – and the existing rules, designed for a much simpler financial world, are (to put it mildly) creaking…

The EU Commission is currently carrying out a consultation on changes to the insurance and finance exemptions and this holds out some hope for modernisation of the rules at the EU level. But in the meantime, those rules have become difficult to apply to modern financial arrangements such as the loan sub-participation arrangements in this Polish case.

Here, an investment fund paid an originating lender an amount and in return the lender agreed to pay to the fund the proceeds obtained by it under the original loans. This removed the cash flow and the risk from the originator’s balance sheet, but the originator remained legal owner.

The fund contended that its supply was an exempt grant of credit and the CJEU has agreed. The Court considered that the supply consisted, essentially, in a payment of capital in return for remuneration and this was correctly analysed as a grant of credit. The fact that the sub-participant had no legal remedy against the originator in the event of default by the debtors and the fact that the debt securities remained legally owned by the originator did not affect the essential nature of the transaction, which consisted in financing the initial loans.

Whilst all’s well that ends well, the implications of the AG’s Opinion that the services were taxable were significant and left many researching the nuances of Polish sub-participation law. The difficulty in applying near 50-year-old exemptions to a modern financial world is demonstrated well in this case.

7. Sofology Ltd v HMRC [2022] UKFTT 00153

Demonstrating that the more things change, the more they stay the same, it was surprising to see the arguments raised in the 2009 DFS FTT decision on print advertising being rehashed through the prism of web advertising.

The FTT’s judgment in Sofology, concerned the extent to which input VAT incurred on advertising costs was directly attributable to taxable supplies of sofas made by the retailer. HMRC had sought to argue that the input VAT that Sofology was seeking to reclaim was directly and immediately linked with both the taxable supplies of sofas and the exempt supplies of insurance intermediary services made by the retailer in connection with the Sofashield insurance product it made available to customers.

In accepting Sofology’s argument that the input VAT incurred on the Google ‘pay-per-click’ advertisements it had purchased was directly attributable only to the taxable supplies of sofas, the FTT took into account factors including the images used in the adverts themselves, the fact that the link from the advert took the user to a webpage of sofas, and the fact that insurance could not be purchased independently of a sofa. It was stressed in the judgment that, despite there being clear economic and commercial links between the advertisements purchased and the supplies of insurance intermediary services made, those links, no matter how substantial, were insufficient to make an indirect link a direct one, such that a portion of the advertising input VAT incurred could not be recovered.

Although a highly fact specific case, the discussions as to the nature of direct and indirect links is of more general application. The more detailed discussion around the types of advertising on Google and the potential impact of key words on the partial exemption position could mean the indirect tax team needs to spend more time with the advertising team.

6. UAB ‘HA.EN (Case C-227/21) and Climate Corporation Emissions Trading GmbH (Case C 641/21)

Number 6 on our list is actually two cases concerning attempts by Member States to expand the ambit of the 2006 decision in Kittel.

Kittel was an immensely important case for tax authorities across the EU seeking to crackdown on missing trader (MTIC) fraud which was (and still is) costing taxpayers across the EU billions. In the decision, the ECJ established the principle that Member States can deny VAT rights to taxpayers (such as the right to recover input VAT) if that taxpayer knew, or should have known, that, they were participating in VAT evasion carried out by another trader acting in the same chain of transactions.

Given its importance, it is perhaps not that surprising that Member States have sought to extend the scope of the principle. It is equally important, however, given the potentially draconian consequences of its application, that in two recent cases the CJEU has repelled those attempts, drawing a line both in the circumstances that can engage the principle and the nature of the action that Member States can take to counter-act such situations.

In UAB ‘HA.EN, the CJEU rejected the attempt by the Lithuanian tax authorities to apply the Kittel principle to the situation where a purchaser acquired property from a seller it knew was in financial difficulties and did not account for the VAT to the tax authorities. And in Climate Corporation Emissions Trading GmbH the CJEU held that the Austrian tax authority could not use the principle to change the place of supply of a transfer of greenhouse gas emission allowances from an Austrian supplier to a German recipient in circumstances where the supplier knew or should have known that it was participating in VAT evasion in the chain of transactions.

The Kittel principle could not be used to determine (or override) the place of supply, which was a fundamental factor in determining the fiscal competence of Member States in relation to cross-border transactions.

5. Ventgrove Ltd v Kuehne + Nagel Ltd [2022] CSIH 40 and RCB 10/22

As we pass the halfway point we turn to a somewhat unusual but significant tax decision which did not directly involve HMRC, but was brought between two taxpayers: a landlord and a tenant.

The question to be determined by the Inner House of the Court of Session was whether VAT was due on a break fee paid by the tenant to the landlord when exercising its option under a break clause.

The judgment confirms the position set out earlier this year in HMRC’s Revenue & Customs Brief 2 (2022), and accorded with the earlier CJEU decisions of Vodafone Portugal (C-43/19) and MEO (Case C-295/17) in concluding that VAT is due on break fees on the basis that such fees are additional consideration for the underlying supply of goods or services (in this case of the lease). As well as solidifying the VAT treatment of break fees, the decision also raised some interesting questions about legitimate expectation and reliance on HMRC guidance and/or HMRC statements in other litigation – concluding that for the landlord to have relied on legitimate expectation in this case, it would need to show that the claim for VAT would be so unfair as to amount to an abuse of power.

In particular this case discussed at length the various interpretations of HMRC’s business briefs on termination fees and the confusion caused by HMRC issuing a brief and then subsequently withdrawing that brief as they reconsidered the policy implications.

We expect to see increased litigation between parties as to the appropriate VAT treatment of supplies. This is becoming an increasingly contentious area between parties depending on the recipient of the benefit of any exemption and suppliers becoming increasingly risk-averse.

4. Fenix International v HMRC (Case C-695/20)

At number 4 (just missing out on the podium) we have an AG’s opinion with potentially wide-reaching consequences for digital platforms.

The use of online platforms to deliver content is a growing sector of the economy. Article 9a of the VAT Implementing Regulations 282/2011 seeks to clarify the operation of Article 28 of the Principal Vat Directive in relation to electronically services provided via platforms and networks. It deems online platforms to be treated as acting as undisclosed agents when facilitating supplies of electronically supplied services, so that VAT is accountable on the full amounts received rather than merely on the commission charged by the platform.

In this case, the taxpayer is seeking to argue that Article 9a is not compliant with EU law and should not be applied to treat it as the supplier of the underlying services made via its platform. The AG has rejected that contention and opined that Article 9a is compliant with EU law. The final decision of the CJEU in this case will be extremely important, bearing as it does on an ever-growing aspect of e-commerce and a provision that is at the heart of some of the Commission’s proposals to extend the VAT accounting rules to supplies of short-term lets and passenger transport in its VAT in the Digital Age proposals.

We eagerly await the final decision of the CJEU in this matter. Possibly it will make the podium in our 2023 review?

3. Ashtons Legal v HMRC [2022] UKFTT 422

On the face of it, this case seems to be a straight-forward re-run of the exact same scenario that occurred in Lester Aldridge (VAT Tribunal decision 18864).

This case concerned a firm of solicitors that took a lease in the name of a nominee company for reasons related to the fact that the Law of Property Act 1925 allows a maximum of four partners to be named on a lease. This change was made late in the negotiations for the taking of the lease, the landlord insisted on guarantees from all the partners and it was known by all that it would actually be the partnership in occupation. Nevertheless, HMRC rejected the partnership’s claim to recover input VAT on the rental payments on the basis that it was input VAT of the nominee company.

The tribunal held in that case that the input VAT could be recovered by the partnership and the FTT here agreed with that approach. The economic and commercial reality was that the company was a mere cipher and the firm was at the centre of the lease.

The case raises the difficult issue of the extent to which VAT – a tax based on objective factors – can take into account beneficial ownership elements and ignore legal ownership. The fact that HMRC were willing to re-run a case from eighteen years ago indicates how reluctant they are to accept that (in the absence of a statutory provision) it is possible to ignore the legal owner, even where all parties were aware of the position.

Where there is any distance between the contractual position and the economic reality, there is a risk that the position will be challenged by HMRC (in either direction). With increasingly complex business arrangements and complicated intra-group contracts being overlaid with transfer pricing policies and finance cost allocations, we expect to see more HMRC activity in this area.

2. HSBC Electronic Data Processing (Guangdong) Ltd (and Others) v HMRC [2022] UKUT 00041 (TCC)

Just missing out on the top spot, this case tackles the knotty problem of the domestic implementation of the EU VAT grouping provisions, the definition of a fixed establishment for UK VAT grouping purposes, and the relevance of EU case-law on the characteristics of a fixed establishment for supply of services purposes.

The Upper Tribunal (UT) released its decision on the preliminary issues raised by these appeals. In particular, the UT held that each member of a VAT group must be ‘established’ or have a ‘fixed establishment’ in the UK, and that case law on the place of supply rules informs the meaning of those terms without being determinative (see e.g. this year’s CJEU case of Berlin Chemie A (Case C-333/20)).

The UT also held that HMRC’s powers to terminate VAT group membership for ‘protection of the revenue’ is not limited to artificial Halifax ‘abuse’ cases and that such powers can apply to a broader concept of avoidance arising from Direct Cosmetics (Case C-138 and C-139/86). The effect of the decision on the availability of VAT group membership will depend on the specific facts of individual cases, as the decision is largely confined to key points of principle.

We expect to see further movement in this area as HMRC’s policy initiative continues to affect historic VAT grouping arrangements and current applications for VAT grouping.

1. Intelligent Money Ltd v HMRC [2022] UKFTT 148

Finally, our top spot is taken by a case concerning the application of the insurance VAT exemption for a life insurance fund. Intelligent Money has seen HMRC override their guidance as to the definition of insurance and argue that the provision of life insurance, despite being an insurance product from a regulatory and Prudential perspective.

This case required the First-tier Tribunal to manage competing CJEU and domestic case law. It was ultimately concluded that, although the provision of the SIPP amounted domestically to a form of insurance, this was insufficient for the VAT exemption for insurance to apply to the administration fees, as, following the CJEU decision in United Biscuits (Case C-235/19), that exemption was narrower, and not all products meeting the domestic definition of ‘insurance’ were within scope. In particular, the lack of risk borne by the ‘insurer’ providing the SIPP (a key characteristic of a SIPP is that the ‘insured’ bears the investment risk) was fatal to the exemption applying, as United Biscuits concluded that an essential ingredient of an insurance transaction is the adoption by the insurer of risk in return for payment.

Whilst this conclusion was perhaps unsurprising following the CJEU decision in United Biscuits, the case also raised some interesting questions around the possibility of a judicial review claim against HMRC in the Administrative Court on the basis it had not applied the wider definition of insurance referred to in its published manuals in this case.

More widely it demonstrates that even where a service seems to fall within the simple wording of the domestic legislation, in practice it may actually sit outside this exemption.

Summary

We hope that you have enjoyed our review of our top ten VAT cases of the year. Whilst 2022 has been an interesting year for VAT cases, there are still several large cases sitting on the horizon. As we rapidly approach the landmark of 50 years of UK VAT in April, it is nice to be reminded that there is still an awful lot of territory out there to discover.

As a reminder, we offer bespoke VAT updates roughly every 4 months covering case-law, HMRC business briefs, legislative developments and anything else from a technical or practical perspective we think would be relevant. If you would be interested in having us present to your team in the new year please let us know.