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VAT briefing for August 2014

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In Banco Mais, the CJEU suggested that VAT on overhead expenditure incurred by a financial leasing business should only be attributed to its exempt supplies of credit. In Lok’nStore Group, the UT upheld the use of a floor-based partial exemption special method by a business selling self-storage services and insurance cover to its customers. HMRC has published Revenue & Customs Brief 27/14 to explain a number of changes in its policy relating to TOGCs. The FTT has released two decisions of interest relating to VAT recovery by holding companies: Norseman Gold and African Consolidated Resources.

Banco Mais: VAT recovery on financial leasing contracts

The CJEU has given judgment in Fazenda Pública v Banco Mais SA (C-183/13). Banco Mais carried out, alongside its normal banking activities, financial leasing activities in the automotive sector. In calculating its partial exemption fraction, Banco Mais employed the turnover-based method in article 19(1) of the Sixth Directive, including all of the rental payments made under the leasing arrangements in the numerator and denominator of the fraction.

The Portuguese tax authority argued that this distorted the calculation, leading to an over-recovery of input VAT; it required Banco Mais to include in its partial exemption calculation only the interest element of the finance lease charges, omitting the amounts that represented the cost of the vehicles from both the numerator and denominator.

The CJEU held that member states may only utilise their authority under article 17(5)(c) of the Sixth Directive to compel a taxable person to make the deduction of residual input VAT on the basis of the use of the relevant costs if this leads to a more precise determination of the deductible proportion of input VAT than the standard turnover-based method.

The CJEU commented that, in a finance leasing business, the use of overheads such as buildings and electricity was primarily a consequence of the financing and management of the contracts entered into by the lessor and its customers, not a consquence of the provision of the vehicles. However, it was for the national court to decide whether this was the case in relation to Banco Mais’ activities. Assuming this was so, the method proposed by the tax authorities would lead to a more accurate determination of the deductible proportion than Banco Mais’ turnover-based method.

Why it matters

This is a disappointing result for companies making supplies under finance leasing and hire purchase contracts. It does not really explain how the ‘use’ of overhead expenditure is to be determined for input VAT deduction purposes, and the case would probably have benefited from an advocate general’s opinion. Banco Mais is likely to be very influential on the outcome of the UK case of Volkswagen Financial Services [2012] UKUT 394 (TCC), where the appeal to the Court of Appeal was stayed pending the judgment in Banco Mais.

Lok’nStore Group: partial exemption special method

In HMRC v Lok’nStore Group PLC (LnS) [2014] UKUT 0288 (TCC), the Upper Tribunal (UT) considered the methodology to be applied in apportioning residual input VAT incurred by partially exempt traders. 90% of LnS’s business was the taxable supply of self-storage services, but it also offered exempt insurance cover to customers. Such exempt supplies accounted for between 4% and 7% of LnS’s turnover, and made a significant contribution to its gross and net profit. LnS argued that rather than applying the standard method (which uses a turnover-based calculation), it should be entitled to apply a partial exemption special method (PESM) which used floor space as a proxy for the use of VAT-bearing costs, together with a turnover element for the reception areas which were used for both taxable and exempt supplies. This would entitle it to recover around 99.98% of the residual input VAT. The First-tier Tribunal (FTT) had found in favour of LnS, relying on the direct and immediate link test in deciding how the residual input VAT should be apportioned.

The UT held that the FTT had made an error of law by relying on the direct and immediate link test at the second (apportionment) stage, as this test is only relevant at the initial stage of attributing input tax to exclusively exempt or taxable supplies, or (in the case of overheads) to the business as a whole. The UT went on to say, however, that this does not mean that the two stages always have to be treated as being ‘rigidly distinct’ from each other. Depending on the facts, the same considerations may apply when examining the economic use made of the overheads at the second (apportionment) stage (for example, if such considerations show that it would be fairer to apportion a larger proportion of the overheads to taxable or exempt supplies than the standard method would allow, as was the case in Volkswagen Financial Services). The outcome was, therefore, that the UT refused to overturn the decision of the FTT, stating that there was no obvious flaw in the PESM.

Why it matters

The UT decision contains some useful clarification in relation to the application of PESMs through its demonstration of the potential overlaps between the analyses at the first (attribution) stage and the second (apportionment) stage.

Brief 27/14: changes relating to TOGCs

HMRC has published Revenue & Customs Brief 27/14 to explain a number of changes in its policy relating to the transfer of a business as a going concern (TOGC). HMRC now accepts that there is, in principle, no obstacle to the surrender of a lease being a TOGC, subject to the normal TOGC conditions being met. This will apply, for instance, where a tenant that is subletting premises subsequently surrenders its interest in the property, together with the benefit of the subtenants.

The brief also announces that HMRC has revised its position in relation to TOGCs of new developments of dwellings and relevant residential and relevant charitable property, allowing for the inheritance of ‘person constructing’ status by a person acquiring a completed residential or charitable development as part of a TOGC. This will allow for the grant of a first major interest in such a development, or part of it, to be zero rated, subject to certain conditions, including that the person acquiring the building as a TOGC would suffer an unfair VAT disadvantage if the grant were exempt, and would not obtain an unfair VAT advantage if it were zero rated.

Why it matters

The revisions to HMRC’s policy should present welcome news to those dealing in real estate, as it opens the door to refund claims in respect of VAT paid in certain circumstances. It will also allow for SDLT payments to be reconsidered, where an amount of SDLT was paid in respect of incorrectly charged VAT.

Norseman Gold and African Consolidated Resources: VAT recovery by holding companies

The FTT has released two decisions of interest relating to VAT recovery by holding companies: Norseman Gold [2014] UKFTT 573 (TC) and African Consolidated Resources [2014] UKFTT 580 (TC).

In Norseman, the holding company provided management services to its foreign subsidiaries, but did not charge for them. In the words of the FTT, it had ‘a rather vague intention to levy an unspecified charge, at some undefined time in the future’. The FTT held that while a taxable supply can exist even where a supplier does not issue VAT invoices or receive payment, there does need to be a pre-agreed enforceable payment obligation (so that there is reciprocity of obligation between the parties). On the facts, this requirement was not met, because there was no agreement as to the amount or timing of the consideration before the supplies of management services were made. The holding company therefore had no basis on which to deduct VAT.

In African Consolidated, the holding company (ACR) provided debt funding to its foreign subsidiaries and management services to one of them (Canape Investments). The intra-group loans were informal, with no fixed repayment date, and no interest had ever been paid. The FTT held that this intra-group lending was not an economic activity. as it was not carried out on a business or commercial basis. The loans were quasi-equity and lending that is similar to equity funding is not an economic activity (see Polysar (C-60/90)).

The fees for the management services to Canape were agreed retrospectively, were conditional on Canape making a profit, and were left outstanding as inter-company debt. The FTT held that that there was no economic link between the services provided and the consideration charged for them (as required by Tolsma (C-16/93)), because they were based on the recipient’s ability to pay rather than the value of the services provided. Accordingly, ACR did not make any taxable supplies and therefore had no basis on which to deduct VAT.

Why it matters

There has been a lot of attention on VAT recovery by holding companies recently following the case of BAA (see ‘The VAT briefing for March’) on the Court of Appeal judgment). It seems that companies are still falling into the traps exposed in BAA and are not doing all that is possible to maximise their VAT recovery. These cases make it clear that in order to give a basis for VAT deduction, holding companies should, when making supplies of management services to their subsidiaries, ensure that they agree and document an enforceable payment obligation before the relevant supplies are made, which is not conditional on the subsidiary’s ability to pay.

What to look out for

A number of interesting judgments of the CJEU are due out in September:

  • On 3 September, GMAC UK (C-589/12) on whether a taxpayer is entitled to invoke the direct effect of a provision of the Directive in relation to one transaction and a provision of national law in relation to a connected transaction where this gives rise to a VAT advantage.
  • On 11 September, K Oy (C-219/13) on the treatment of e-books.
  • On 17 September, Skandia America (C-7/13) on the treatment of supplies by a company’s main establishment in a third country to its branch in a member state where the branch belongs to a VAT group.