VAT, tripartite arrangements and contractual labels

The FTT has held that arrangements for training pilots put in place between trainee pilots, the taxpayer and airlines involving the payment of a "security bond" by the trainees resulted in a taxable supply of training to those trainees by the taxpayer: Airline Placement Ltd v Revenue and Customs Commissioners [2025] UKFTT 894. The correct interpretation of the contractual arrangements between the three parties based on the commercial and economic reality was that the trainees paid for their training through payment of the "security deposit". Alternatively, even if that conclusion was incorrect, the FTT considered that the arrangements were designed to achieve a VAT saving in a way that was abusive.

The decision emphasises that the labels applied to payments by the parties will not necessarily define their VAT treatment, especially in the context of VAT planning arrangements, where the economic reality points in a different direction.

Background

Airline Placement Ltd (APL) put in place a Sponsored Training Programme (STP) which was originally conceived as an alternative to the traditional method of airlines, such as British Airways (BA), paying upfront for the training of their future pilots and deducting part of that cost from their salaries in the first five years of their employment. Under the STP a Sponsor Airline would, instead of paying for the training of its cadets, would pay a placement fee (equal to the cost of training) plus VAT on employing a fully trained cadet whose training had been sponsored (ie paid for) by APL. On paying the placement fee, the Sponsor Airline would receive a transfer of the "security bond" (also equal to the cost of training) from APL that had been deposited with the APL by the cadet (pursuant to the sponsorship agreement between the cadet and APL). The initial salary paid by the Sponsoring Airline to pilots trained under the STP was at a reduced level but the trained pilots also received repayments of the security bond over that same period from the airline. This enabled the Sponsor Airlines to defer the (expensive) training costs of their pilots. APL worked with EasyJet, BA and Virgin during the period under dispute. In the event that the trainees were not placed with a Sponsor Airline, the bond would be forfeited.

The contractual arrangements underpinning the STP were:

• a "Placement Contract" between APL and a Sponsor Airline under which APL agreed to provide trained cadets to the airline in consideration for the payment of a placement fee
• a "Conditional Employment Contract" between the cadet and a Sponsor Airline under which the Sponsor Airline offered the cadet employment conditional on the cadet successfully completing their training.
• a "Services Contract" between APL and a flight training organisation (FTO) under which APL agreed to pay for the provision of training the cadet.
• a "Sponsorship Agreement" between APL and the cadet under which APL agreed to procure the provision of training from the training provider and the cadet agreed to deposit a security bond equal to the net cost of the training.
• a "Loan Agreement" as between the cadet and the Sponsor Airline.

APL did not account for any VAT in relation to the payment of the "security bond" by trainee pilots on the basis that this was not consideration for any supply. HMRC, however, considered that under the STP arrangements the payment of the "security bond" by the trainee pilot to APL amounted to consideration for the supply of training and was subject to VAT. This was either on the basis that the "security bond" was, in commercial and economic reality, consideration for the supply of training or alternatively based on the arrangements being abusive.

FTT decision

The FTT has concluded that under the STP arrangements, the trainees paid for the training provided by APL through consideration consisting of the payment of the "security bond".

The FTT noted that, in the case of tripartite arrangements, it was clear from the Court of Appeal decision in Secret Hotels2 that (i) the right starting point is to characterise the nature of the relationship between [the parties], in the light of the contractual documentation, (ii) one must next consider whether that characterisation can be said to represent the economic reality of the relationship in the light of any relevant facts. In taking such an approach it is necessary where the question at issue involves more than one contractual arrangement between different parties, to consider the "whole" of the relationship between the various parties when assessing the issue of who supplies what services to whom for VAT purposes. In doing so, the labels which the parties have used to describe their relationship "cannot be conclusive and may often be of little weight" and that, although contractual terms constitute a factor to be taken into account they sometimes do not wholly reflect the economic and commercial reality of the transactions.

In this case, APL argued that the "security bond" was just that, a bond which was ultimately returned to the trainee (albeit that the "bond" was transferred to the Sponsoring Airlines). It did not amount to consideration for the supply of training. The training was paid for by APL and APL was remunerated through the payment of the placement fee by Sponsoring Airlines. Under the programme, was simply facilitating the training via a sponsorship arrangement.

The FTT rejected this analysis. In particular, the FTT rejected the argument that the trainee did not ultimately pay the cost of the training. This was because the bond was transferred by APL to the Sponsor Airline which then pays the cadet a reduced salary to reflect in whole, or in large part, the sum of the placement fee. As such, and as a matter of economic and commercial reality, it was the trainee pilot that bore the costs of training.

It therefore followed from this analysis that the bond does not function as a security bond at all and the description of it as such is merely a label which cannot be conclusive.

As a result, the FTT held that the payment of the "security bond" did amount to consideration for a supply of training and was subject to VAT.

In case it was wrong on HMRC's first argument, the FTT went on to consider the Halifax/abuse argument. In this regard, the FTT concluded that there was a tax advantage in this case and that this comprised two cumulative components. The first that the Sponsor Airlines were able to deduct the input tax on the placement fee even though they were immediately recompensed in the same sum by the proceeds of the bond being transferred to it in return for the placement fee. The second component was that the trainee who bears the economic consequences of training does not pay VAT on those sums.

APL argued that treating the bond as consideration for training (either under the economic reality approach or the Halifax approach) would lead to double taxation as, in addition to the VAT on the supply of training to the trainee there would also be VAT on the supply of that same training under the placement fee and that credit should therefore be given. This was not only a principle of basic fiscal fairness but a prerequisite for fiscal neutrality of the VAT system.

While accepting that general principle, the FTT did not consider it necessarily followed that there would be double taxation in this case. The better analysis is that there were two taxable supplies made by APL. The first of training to the cadets and the second of newly qualified pilots to Sponsor Airlines. APL argued that it made no sense for the Sponsor Airlines pay such an "enormous price" and that the placement fee only makes sense if it is a payment for training, otherwise it would be "an absolutely exorbitant fee for a cadet that has already paid for their own training." However, the FTT considered that, even if that were the case, the outcome does not have to be economically realistic when the transaction is redefined for Halifax purposes. Accordingly, the FTT did not consider any redefinition to give credit for the VAT on placement fees to be necessary.

As a result, the FTT concluded that the payment of the security bond by the trainee to APL was consideration for the taxable supply of training to the trainees and therefore liable to VAT.

However, since the FTT accepted that there was a section 85 VATA 1994 agreement between the parties regarding the place of supply of training provided outside the UK, 27.4% of the amounts paid to APL by the trainees should be treated as training which took place outside the UK and therefore outside the scope of VAT. Although HMRC has sought to withdraw from that agreement by later letter, the FTT considered that this was an attempt "to shut the stable door after the horse had bolted". By that point, the parties had already entered into an agreement from which HMRC could not resile given that it must be treated, under s 85 VATA 1994, as if "a tribunal had determined the appeal in accordance with the terms of the agreement".

Comment

It is clear that the labels applied to payments by parties will not necessarily define their VAT treatment, especially where the economic reality points in a different direction. The FTT in this case were clear that the payment of a "bond" in this case was, in economic reality and when looked at across all the totality of the arrangements, clearly a payment for the training received. Ultimately, this was achieved through a reduction in the salary received by those trainee pilots over their first five years of work for the Sponsor Airline, but it nevertheless made it clear that they bore the cost of the training. Moreover, the fact that this analysis resulted in two VATable payments (one by the trainee and one as a placement fee by the airline) did not detract from that analysis.

However, it does appear that, when compared with the original, simpler arrangements involving the sponsoring airline paying for the training upfront and later recouping it through a reduced salary scale, the main VAT advantage was simply deferral of the VAT payable. In general, deferral of a payment of VAT has been held not to be contrary to the purpose of the VAT Directives making this aspect of the decision perhaps somewhat surprising.