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2010 review: VAT

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2010 has been another year of change in VAT, with much more promised for 2011. Everyone involved in cross-border supplies has been affected by the VAT Package and all kinds of businesses have begun online filing of VAT returns. The end of Lennartz is bad news for not-for-profit entities and ECJ decisions in AstraZeneca, LMUK and Baxi Group are expected to have a negative effect on employee and customer incentive schemes. However, the financial services sector celebrated victory in the Insurancewide/Trader Media case in which price-comparison websites were found to be eligible for VAT exemption as insurance intermediaries.

VAT is a fast moving tax and 2010 has been another action-packed year. Significant legislative changes, together with numerous developments in case law, have kept businesses and their VAT advisers extremely busy. Set out below are my ‘Top 5’ developments this year. They aren’t necessarily my favourites, but most organisations will have been affected by at least one of these issues during the last 12 months.

1. The VAT Package

1 January 2010 not only brought another VAT rate change (a subject which has been extensively covered in previous issues of the Tax Journal), but also the first phase of what is known as the ‘VAT Package’, which changed the VAT treatment of cross border services throughout the European Union. The following changes came in at the start of the year:

  • New rules for the place of supply of services mean that most business-to-business (B2B) supplies of services are now taxed in the country where the customer is situated, rather than where the supplier is located. This changed the place of taxation of many activities, including management services, freight transport, work on goods etc.
  • The procedure for reclaiming VAT incurred by EU businesses in other Member States was replaced by a new, fully electronic procedure – intended to create a simpler, more accessible system and a quicker refund to claimants.
  • The time of supply for reverse charge services was harmonised throughout the EU.
  • New reporting obligations were introduced for EC Sales Lists (ESL); in particular the obligation to include intra-EU B2B services.

Why it matters: These new procedures were intended to improve the functioning of the EU internal market and simplify VAT on B2B transactions. In particular, they were designed to reduce the need to register for VAT in your customer’s country, and to make it easier to reclaim VAT incurred in other member states. However, additional VAT costs now arise in many sectors, especially VAT-exempt organisations who must now account for VAT as a reverse charge on activities outsourced to overseas service providers. Many organisations have also experienced difficulties in complying with the requirement to submit a quarterly ESL; in particular the need to find out each customer’s local VAT number. HMRC’s light-touch approach to enforcing these changes is expected to come to an end at the start of 2011, so penalties could arise for incorrect VAT accounting or failure to submit an ESL

It’s not just businesses that have experienced difficulties with these changes. In September 2010, HMRC announced that all EU Member States had agreed to extend the deadline for submission of EU VAT Refund claims for 2009, from 30 September 2010 to 31 March 2011, to allow all EU Member States to fully implement the new computerised refund system.

2. Auf wiedersehen Lennartz

January 2010 continued to be a tough month, particularly for the not-for-profit sector, as HMRC issued Revenue & Customs Brief 02/10, setting out its revised policy on Lennartz accounting following the ECJ judgment in the case of Vereniging Noordelijke Land-en Tuinbouw Organisatie v Staatssecretaris van Financien [2009] STC 935. The ECJ made a distinction between ‘non business’ use made of an asset by an organisation and the private use of an asset by an individual, holding that Lennartz could only be used in the latter instance. As a result, HMRC announced that, from 22 January 2010, Lennartz accounting will only be available for partnerships and sole proprietors.

Why it matters: Lennartz accounting has historically helped finance many capital projects, by acting like an interest-free loan from HMRC. Those in the not-for-profit sector must now apportion the VAT on capital expenditure between business and non-business activities, much like their other expenditure. The non-business VAT will be an immediate VAT cost, which will add to the up-front costs of the project. HMRC will honour existing Lennartz arrangements, but these should be reviewed to ensure their benefit is not negated by the imminent rise in the VAT rate to 20%.

3. Compulsory online filing of VAT returns

April Fool’s Day 2010 was the first day of VAT return periods where the return must be submitted online and paid by electronic means. Whilst many taxpayers have filed and paid electronically for some years, most businesses, particularly smaller ones, had continued to submit a paper return and pay by cheque. Even though the requirement to file online was limited to traders with a turnover exceeding £100,000, it was estimated that around 940,000 businesses would be affected by this change.

In addition, HMRC also announced that those still entitled to pay by cheque would need to submit and pay their VAT return much earlier; a default would arise unless the cheque had cleared HMRC’s bank by the due date for the return. This seems rather sneaky, considering businesses that file and pay electronically automatically receive a seven-day extension to the normal due date.

Why it matters: This is just one of many steps being taken by HMRC to require businesses to file their tax returns online, whether PAYE, corporation tax or VAT, and pay any liabilities by electronic means. HMRC plans to extend compulsory online filing to all businesses in 2012, bringing the remaining 500,000 businesses (ie those with annual turnover below £100,000) into the online club.

4. Insurance intermediaries

On 22 April 2010 the insurance industry will have celebrated, or at least breathed a sigh of relief, when the Court of Appeal handed down its judgment in the joined cases of Services Ltd and Trader Media Group Ltd [2010] STC 1572. The judgment stated that, in order to qualify for VAT exemption for insurance intermediary services, it was not necessary for there to be intermediation of the insurance contracts. The introductory services provided by IW and TMG were exempt because they were doing much more than providing a mere ‘click through’ facility to a broker or insurer – they actively identified and provided those looking for insurance with access to insurers who provided a range of competitive insurance products.

Even better news came on 3 August 2010, when Revenue & Customs Brief 31/10 confirmed that HMRC would not appeal the Court of Appeal’s judgment and set out four conditions that online intermediaries must meet in order to qualify for the exemption.

Why it matters: Clearly, this is good news for the sector, as it confirms that many services provided by comparator websites and similar intermediaries are exempt from VAT. It also enables businesses to submit claims for repayment of any VAT previously overpaid and provides some general guidance on the application of the exemption to finance intermediary services.

5. Incentive schemes

In contrast, 2010 was a bumpy year for those involved in staff or customer loyalty schemes. First, on 29 July 2010, the ECJ handed down its judgment in the case of Astra Zeneca UK Ltd [2010] STC 2298. AZ’s remuneration package allowed its employees to opt for retail vouchers which could be redeemed in certain shops, with a discounted cost for the vouchers deducted from the employees’ remuneration. AZ sought to reclaim the VAT paid on the purchase of the vouchers, but contended that no VAT should be accounted for on their distribution to staff. Unfortunately, the ECJ ruled that the provision of the vouchers to staff constituted a supply of services for consideration and was thus subject to VAT.

Secondly on 7 October 2010, the ECJ handed down its judgment in the joined cases of Loyalty Management UK Limited and Baxi Group Limited [2010] STC 2651. These cases addressed whether VAT could be deducted by operators of the Nectar loyalty scheme (LMUK) and the Bonus Direct loyalty scheme (Baxi). In both cases, the ECJ concluded that neither LMUK nor Baxi were entitled to deduct in full the VAT charged by the businesses that provided the redemption goods to the scheme participants; this was because the ECJ regarded the payments made to those businesses by LMUK and Baxi as third party consideration for the supply of the reward goods to the final customer.

Why it matters: Many businesses run some form of loyalty or promotion scheme, either for their staff or for customers. The Astra Zeneca judgment has the potential to apply VAT to many employee benefit schemes, and its full implications will be thrashed out in the UK courts next year. It is hoped that non-VATable benefits, such as buying extra holiday or childcare vouchers will not be affected, but employers should review their remuneration packages to ensure they are not building up a VAT cost. Similarly, customer-focused incentive schemes could also be problematic, particularly following the ECJ’s endorsement of the UK’s business gifts rules in EMI Group Limited [2010] STC 2609.

What’s ahead in 2011?

With such a busy 2010, will 2011 give us some respite? Not a chance. 1 January 2011 brings the next wave of VAT Package changes, bringing the place of supply of cultural, artistic, sporting, scientific, educational and entertainment services into the new B2B basic rule and, as widely reported, the standard rate of VAT rises to 20% on 4 January 2011.

There is also plenty of ongoing litigation, including the recovery of VAT on corporate finance transactions, compound interest claims and whether default surcharges can be removed because they are disproportionate; the list is almost endless.

What is certain is that there will be some winners and some losers, but definitely some surprises. Happy New Year!

Richard Wild, Director, PKF