This month’s VAT Update primarily covers recent rulings in legal cases. This includes a judgement from the Court of Justice of the European Union (CJEU) on a case involving VAT recovery on investment management charges. The outcome of this case has significant implications for the not-for-profit sector, but could extend beyond that. HM Revenue & Customs’ (HMRC’s) comment on the case is awaited.
VAT recovery on investment management charges
The CJEU concluded in The Chancellor, Masters and Scholars of the University of Cambridge CJEU C-316/18 that VAT incurred on investment management fees by a university was not recoverable as the fees were incurred in relation to a non-economic activity it was undertaking. The university, a registered charity, received donations and endowments from third parties, which it invested. The activity of investing donations and endowments is not an economic activity within the scope of the EU VAT Directive, and costs relating to such non-economic activities are not deductible as input tax, the CJEU concluded.
It is understood that some charities and other not-for-profit organisations treat VAT incurred on investment management costs as a general overhead for VAT purposes.
Despite HMRC having previously lost its case in the UK courts, the CJEU judgement is consistent with HMRC’s position. Whilst HMRC has yet to pass comment on the CJEU judgement, it is anticipated that VAT recovery on investment management fees will be restricted. HMRC is now likely to review the position on other significant cases, such as that in the judgement in the High Court case of Church of England Children’s Society, which has shaped policy since 2005 in relation to the raising of unrestricted income such as donations and legacies.
There are potentially wider implications for clients operating in different sectors and corporates may also be affected. In any situation where a taxable person is not able to demonstrate that a supply received is not a cost component of one of more of its taxable business activities, it may face a restriction in the amount of input tax it is able to deduct. The Supreme Court decision from 29 July 2019 in the case of HMRC v Frank A Smart & Sons Ltd  UKSC 39 provides further commentary on the availability of recovery and when costs are components of future taxable supplies. We will provide a further update on this case in our August issue.
Comment: Charities relying on the Children’s Society judgement from 2005 to support their VAT recovery position should consider these recent decisions. As HMRC has not yet commented on the decisions, it is too early to give definitive advice on the past and future VAT recovery position. However, charities that have been recovering VAT on investment management services should consider ceasing to reclaim the VAT until HMRC’s position has been clarified. Once HMRC’s position has been understood we will be able to comment further.
We are currently considering the Frank Smart decision and the wider implication for VAT recovery. The Supreme Court appears to indicate that businesses should be prepared to support the use of costs over a longer period, with HMRC being able to review historic recovery of VAT on costs of funding a business to ensure that the “downstream” activities are taxable. How this will be handled in practice is not yet clear and a further update will be issued in due course.
The Chancellor, Masters and Scholars of the University of Cambridge CJEU C-316/18
HMRC v Frank A Smart & Son Ltd  UKSC 39
At some point in the future it will be possible to add an individual or a partnership to a VAT group with UK body corporates, provided the individual or partnership concerned controls a UK body corporate or multiple body corporates and is established or has a fixed establishment in the UK. This follows new rules included in the Finance Act 2019. However, these changes are only effective from a date to be set in regulation. That date is yet to be set.
However, a recent FTT case involving a Scottish partnership has demonstrated that it is possible to achieve this, in certain circumstances, by relying on EU law principles. It should be noted that Scottish partnership law is different to English law.
This case involved a Scottish investment management partnership which applied to HMRC in 2013 to form a VAT group with three of its ‘subsidiaries’. Supplies between VAT group members are ignored for VAT purposes and therefore there was a significant benefit to the partnership in being able to form a VAT group. However, HMRC rejected the application on the basis the partnership was not considered a ‘body corporate’ as far as the VAT grouping provisions allowed. HMRC’s decision was upheld following a request for a review. The partnership appealed the decision, which was heard by the FTT in 2018.
Since the time HMRC rejected the VAT grouping application, a prominent case at the CJEU found that there was no good reason for excluding partnerships from VAT groups (Laurentia & Minerva, CJEU case C-108/14).
In the FTT decision issued earlier this month, it was judged that a Scottish partnership was able to join a VAT group despite it not being a body corporate for the purposes of UK VAT legislation. The FTT considered that conforming legislation can be applied to the VAT Act 1994 following the CJEU decision in the case of Laurentia & Minerva. Although courts have hitherto been relatively unwilling to apply this principle (they consider their position is to interpret legislation rather than rewrite it) the FTT in this case agreed that it was possible to make minor amendments to the VAT Act 1994 to reflect the intention of the Principal VAT Directive.
Comment: As this was an FTT judgement, the decision will have limited effect, especially given the changes introduced by the Finance Act 2019 which will, in due course, allow individuals and partnerships to form VAT groups. However, this case will be of particular interest to those outstanding VAT grouping applications, not just Scottish partnerships, where applicants are in a similar position.
Baillie Gifford & Co TC/2014/05260
VAT adjustments and finance leases
In a recent Bulgarian case, a company had granted a lease over land that included an option for the lessee to acquire the property. Under EU and Bulgarian VAT law this means the supply of the property was a supply of goods and VAT was due on the entire lease rentals at the start of the agreement, despite the lease rentals falling due over a number of years.
However, the agreement had a clause that meant that in case of default, the agreement was terminated, and any unpaid lease rentals over the full 11-year term were payable as compensation. The tenant defaulted early into the 11-year agreement and triggered the relevant clause that meant an amount equivalent to the remaining lease rentals became due. The lessor tried to claim a refund of the VAT originally accounted for from the Bulgarian authorities. The tenant, not surprisingly, never paid the amount due.
The Bulgarian authorities refused permission to adjust the VAT originally accounted for. The case was litigated and then referred to the CJEU.
The CJEU decided that the compensation due was further consideration for the lease supply and therefore could not be reclassified as outside the scope of compensation. However, the CJEU did decide that the Bulgarian authorities must allow the lessor VAT relief if the VAT debt was determined to be irrecoverable from the lessee.
Comment: In the UK we have bad debt relief, which should have allowed an equivalent UK lessor in this case VAT relief. The key point from this judgement for the UK is that describing a payment as compensation is not sufficient to make it outside the scope of VAT. If the economic reality is that a payment is further consideration for the original supply, it will be so treated irrespective of how it is described in the contract. The decision is not without its practical difficulties. In the UK there are a number of circumstances where contractual agreements contain clauses that describe penalties and termination payments as compensatory and there is an expectation they are treated as outside the scope of UK VAT. The judgment is likely to trigger some further debate on what true outside the scope compensation is when derived from a breach of a vatable contract for goods and services.
UniCredit Leasing CJEU Case C-242/18
Update of the new reverse charge for renewable energy certificates
As reported in the June Update, a new domestic reverse charge has been introduced in an attempt to tackle VAT fraud in the renewable energy certificates sector. Initial evidence suggested electricity suppliers had concluded that the reverse charge would not just apply to those businesses who actively trade in these certificates but also generators of electricity who supply both electricity and renewable energy certificates to the supplier at the same time. HMRC has since clarified that such generators will not be affected by the new reverse charge although they are now consulting with stakeholders to decide whether this should change.
An EU business that is not currently required to be VAT registered in the UK, because of an available EU simplification or easement, can now register in advance of the UK leaving the EU without a deal on 31 October 2019. The advance notification facility allows a voluntary registration that would have an effective date of 1 November 2019.
When completing the online application, businesses should choose trade class/SIC code 99000 European Community and also describe accurately what the business does and enter a number in the estimated turnover section. This will enable HMRC to identify these applications which are being submitted in case there is a ‘no-deal’ Brexit.
Comment: The reverse charge continues to be introduced in sectors where there is a high degree of VAT fraud occurring. This, along with the reverse charge on construction services which comes in later this year, is the latest example of how the reverse charge is seen as the best mechanism available to tackle wide-spread VAT fraud in a particular sector. Operators within the renewable energy certificate market should now be implementing the new rules.
For advice regarding any of the issues raised here, please speak to your usual Saffery Champness partner.