VAT Partial Exemption APPORTIONMENT METHODS AND CASE LAW IMPLICATIONS SPECIAL METHODS

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1 VAT Partial Exemption APPORTIONMENT METHODS AND CASE LAW IMPLICATIONS SPECIAL METHODS Roger Adams, Tax Risk & Technical Director Aviva 14 th December 2009

2 1. LAW ARTICLE 173 of Directive 2006 / 112 EC provides: Member States may take the following measures: a) authorise the taxable person to determine a proportion for each sector of his business, provided that separate accounts are kept for each sector; b) require the taxable person to determine a proportion for each sector of his business and to keep separate accounts for each sector; c) authorise or require the taxable person to make the deduction on the basis of the use made of all or part of the goods and services; Paragraph 102 S / 2518 provides: 102 (1) Subject to [paragraphs (2) and (9) below and [regulations 103, 103A and 103B], the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 [proportion of taxable supplies]. [(9) With effect from 1 st April 2007 the Commissioners shall not approve the use of a method under this regulation unless the taxable person has made a declaration to the effect that to the best of his knowledge and belief the method fairly and reasonably represents the extent to which goods or services are used by or are to be used by him in making taxable supplies. A taxpayer and HMRC have a large canvas on which to paint and only a broad outline to determine the resulting art work. page 2

3 2. Analysis Note that a method may under EU law apply a deduction on the basis of the deductible proportion, that is deductible supplies over total supplies, OR based on the concept of use. However the over-riding principle in UK law is that the method fairly and reasonably represents use to which a supply is put. page 3

4 Use is therefore an important correcting factor in deducting or not deducting VAT. In BLP v C&E Commissioners 1995 STC 424 at page 437 the Court of Justice held that to be deductible the goods and services in question must have a direct and immediate link with the taxable transactions and that the ultimate aim pursued by the taxable person is irrelevant in this respect. It therefore followed that input tax arising on the sale of a subsidiary s shares was not deductible even though the ultimate purpose was to fund taxable transactions using the proceeds of sale. The over-riding idea in establishing a special method in the UK is therefore to look for a direct and immediate link to a particular supply made by a particular sector of a tax payer s business. That leads to some rational but peculiar results. page 4

5 3. SOME PRACTICE There is for an insurance group no published model special method. Each taxpayer devises its method without knowledge of other taxpayers special methods. HMRC by comparison is informed by the universe of possibility. Given the wide divergence between business groups using special methods (e.g. insurance groups which include other businesses such as fund managers, groups which outsource services etc) a model method would be difficult but not impossible to devise. The fact that business groups do not to any significant degree compare notes on special methods reflects the competition between them. However it does not ensure legal certainty nor facilitate the application of VAT by reference to the objective character of transactions. There are some agreements with Trade Associations (VAT Notice 700/57). These are mainly prescriptive and don t address broad principles. page 5

6 4. SOME CASES There is a body of jurisprudence on the link of costs to a taxable supply; that informs the purpose and operation of Special Methods but not their design. The jurisdiction of the courts in the design of Special Methods is set out in St Helen s School v R & C Commissioners 2007 STC 633. HMRC s decision not to approve a proposed Special Method can be appealed under Section 83 VAT Act 1994 and the court can consider whether the proposed method would secure a fair and reasonable recovery of input tax, not merely the process applied. That jurisdiction requires the court to establish facts regarding the costs used in making a supply, to decide how costs are used, and to apply judgement in deciding what is a fair and reasonable recovery of the VAT used. The Court decided that use meant economic use, not physical use (in that case of a building, page 655). In the particular case the standard method produced a fair and reasonable result the overwhelming use of the asset, a swimming pool, was in education and the taxable use for club and community purposes was secondary. Tiley and Collisons UK Tax Guide says Practical experience suggests that a lengthy period may elapse before there is a meeting of minds regarding the terms of a new method. This situation has long been unsatisfactory (2009/10 edition 66.09). Do we agree? page 6

7 MBNA Europe Bank v R&C Commissioners 2006 STC 2089 This case concerns the application of a special method to a securitisation structure. It considers what are supplies in this context and how inputs received by the securitising bank were used. The bank s dispute with HMRC began in 1995 and reached the High Court in July The issues are difficult, however it does suggest a meeting of minds was not effectively achieved. HMRC are considering using Alternative Dispute Resolution procedures; would those have worked in MBNA? The End page 7