Indirect tax forum Case law update

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1 Indirect tax forum Case law update David Anderson and Holly Grantham November 2017

2 Agenda Iberdrola BlackRock SC Paper Consult Littlewoods Avon Look ahead Implementing a new PESM Partial exemption future issues November

3 Iberdrola Inmobiliaria Real Estate Investments (C-132/16) Indirect Tax Forum - Case law update November

4 Iberdrola background The Taxpayer owned land on which a holiday village was to be constructed. The village was to be leased on a taxable basis. In order to connect to an existing but dilapidated municipal wastewater pump station, the pump station had first to be extensively renovated. The Taxpayer and the municipality concluded a contract under which the Taxpayer undertook to carry out repairs at its own expense, engaging a building contractor which charged VAT to the Taxpayer. After the repairs, the buildings in the holiday village were constructed and connected to the pump station. The Taxpayer deducted input VAT in respect of the repair costs but was assessed by the tax authority. The Administrative Court held that, by repairing the pump station, the Taxpayer had supplied the municipality with a service free of charge. However, as this had served the purposes of the Taxpayer's economic activity of leasing the holiday village, the expenditure must be part of the Taxpayer's overhead costs and constitute a cost component of its leasing supplies, both for accounting purposes and for VAT purposes. So the Administrative Court overturned the assessment. Indirect Tax Forum - Case law update November

5 Iberdrola CJEU referral questions "1. Do Article 26(1)(b), Article 168(a), and Article 176 of Directive 2006/112 preclude a provision of national law such as Article 70(1)(2) of the ZDDS, which restricts the right to deduct input VAT in respect of the supply of services relating to construction or improvement of a property owned by a third party, which are used both by the recipient of the supply and by the third party, for the sole reason that the third party enjoys the result of those services free of charge, without taking into account the fact that the services are to be used in the context of the economic activity of the taxable recipient? 2. Do Article 26(1)(b), Article 168(a), and Article 176 of Directive 2006/112 preclude a tax practice consisting of refusing to recognise the right to deduct the input VAT in respect of the supply of services, where the expenditure corresponding to those services is counted among the taxable person s general costs, on the ground that it was incurred in order to construct or improve a property owned by another person, without taking into account the fact that that property is also to be used by the recipient of the supply of building services in the context of its economic activity?" Indirect Tax Forum - Case law update November

6 Iberdrola - CJEU s judgment The CJEU reiterated well established principles - there must be a direct and immediate link between a particular input transaction and a particular output transaction, or the costs may be general business costs which are components of the price of the overall goods or services which the taxpayer supplies. But where costs of a taxable person are used for purposes of transactions that are exempt or outside the scope of VAT, no output tax can be collected and so no input tax can be deducted. When testing for a direct and immediate link, it is necessary to consider all circumstances and take account only of those transactions which are objectively linked to the taxpayer s taxable activity. The existence of such a link must be assessed in light of the objective content of the transaction - Sveda. Without the reconstruction of the pump station it would have been impossible for the Taxpayer to undertake its economic activity. Therefore in this case the circumstances were likely to demonstrate the existence of a direct and immediate link between the repair of the pump station and the Taxpayer s taxable activity. Indirect Tax Forum - Case law update November

7 Iberdrola implications In contrast to Southern Primary Housing Association Ltd [2003] EWCA Civ 1662, there was no 'chain breaking' exempt supply, and the CJEU held that, even if the municipality derived a benefit from the repair services, full recovery would be available to the Taxpayer, provided that the costs it incurred went no further than were necessary for it to be able to complete its own taxable project. This seems to reflect the Redrow principle that the fact that someone else freely obtains a benefit from a service contracted and paid for by a taxpayer does not prevent deduction, provided that the service is a cost component of the taxpayer's own economic activity (in Redrow the Taxpayer needed the estate agents to perform the whole of their services of selling prospective buyers' houses so that Redrow could sell them new houses). A question that may remain is whether the Taxpayer might have been subject to an output VAT charge, having made services in respect of which input VAT had been recovered freely available to the municipality. In the UK, art 3 VAT (Supply of Services) Order 1993 provides: "Subject to articles 6, 6A and 7 below, where a person carrying on a business puts services which have been supplied to him to any private use or uses them, or makes them available to any person for use, for a purpose other than a purpose of the business, he shall be treated for the purposes of the Act as supplying those services in the course or furtherance of the business except for the purposes of determining whether tax on the supply of the services to him is input tax of his under section 24 of the Act." Whether or not art 3 would be regarded as applicable in these circumstances may be the subject of future litigation. Indirect Tax Forum - Case law update November

8 BlackRock Investment Management (UK) Ltd [2017] UKFTT 633 (TC) Indirect Tax Forum - Case law update November

9 BlackRock - background The Appellants make supplies of investment management services to special investment funds ( SIFs ), which are exempt, and supplies of investments management services to entities which are not SIFs, which are standard rated. The Appellants receive supplies from an associated company in the US which they use for the purpose of their supplies of investment management services. The services are the use of an investment management computer platform called Aladdin (the Aladdin services ). The dispute was over whether the Appellants were required to account for the reverse charge on receipt of the Aladdin services. The FTT considered 2 issues emerging from the case: 1. The exemption issue 2. The apportionment issue The exemption issue The Appellants considered that the Aladdin services were exempt from VAT under art 135.1(g) Principal VAT Directive: "1. Member States shall exempt the following transactions:... (g) the management of special investment funds as defined by Member States;..." insofar as those services were used in the management of SIFs (Special Investment Funds). The Appellants also considered that the Aladdin services would fall within Item 9 Grp 5 Sch 9 VAT Act 1994, which exempts the management of a number of specified types of special investment funds including authorised open-ended investment companies and authorised unit trust schemes, or item 10 which exempts the management of closed ended collective investment undertakings, such as investment trust companies. If the services would be exempt under any of these provisions, the reverse charge would not apply. Indirect Tax Forum - Case law update November

10 BlackRock - background contd. The apportionment issue The company supplying the Aladdin services did not make a separate supply in respect of each fund managed by the Appellants, but a single supply to the representative member of the Appellants VAT group. This supply was then used by all of the Appellants to supply both SIFs (exempt) and non-sifs (taxable). The majority of supplies were to non- SIFs. The FTT therefore considered whether, although the Aladdin services formed part of a single supply which was predominantly used for the management of non-sifs (taxable), the single supply and the consideration could be approtiooned and taxed differently - i.e. so the reverse charge would only be due on the element relating to management of non-sifs. Indirect Tax Forum - Case law update November

11 BlackRock - judgment Exemption On the basis of Abbey National plc (C-169/04) and GfBk Gesellschaft (C-275/11), the FTT concluded that the key test would be whether the Aladdin services formed a distinct whole and were specific to, and essential for, the management of SIFs. It was clear on the facts that the Aladdin services satisfied this test.. Aladdin was specifically designed for fund management. To assess if the services formed a distinct whole the FTT adopted the Advocate General s approach in Abbey National by determining if the various services were interrelated (with inner coherence) or if the services were an amalgam of unrelated and disparate services. It was held that the Aladdin services were indeed interrelated and had an inner coherence. They provided a sophisticated analytical and monitoring information service, gave access to extensive data stored on BlackRock s supplier s servers, and covered the full range of the investment management cycle. The Aladdin services therefore satisfied the principles for exemption. Apportionment It was not in dispute that the supplier s supply was a single supply and that the funds managed by the Appellants were predominantly non-sifs. And the FTT considered it inevitable that the single supply must be taxed at a single rate, it not being permissible to apportion the consideration between the use of the Aladdin Services for SIFs and non-sifs. Indirect Tax Forum - Case law update November

12 BlackRock - implications Another example of the law struggling to keep up with the pace of changing technology. See also - Dollar. Investment management definition The judgment indicates that the scope of 'management' is much wider than that which HMRC acknowledges in the published guidance (and the interpretation which HMRC were advocating before the FTT). A wider definition of the term 'management' opens the door to further supplies potentially becoming exempt when outsourced by an investment manager Apportionment In light of the FTT s approach, it may be possible for investment managers, where commercially viable, to adjust the way in which they engage with their suppliers for services which may fall within the definition of management, in order to access VAT exemption to the greatest degree possible (e.g. contracting for separate supplies for different fund types) Indirect Tax Forum - Case law update November

13 SC Paper Consult SRL (C-101/16) 3 Indirect Tax Forum - Case law update November

14 SC Paper Consult background In 2010 the Taypayer s supplier was declared as inactive by the Romanian Tax Authority due to failure to file tax returns. It was then struck from the VAT register. Taxpayers declared inactive must pay the taxes demanded but are not allowed to deduct expenses and VAT on purchases made during the period of inactivity. Persons acquiring goods and services from taxpayers declared inactive are not entitled to deduct VAT on those purchases, except for purchases of goods made in enforcement proceedings and/or purchases of goods and/or services from taxpayers in bankruptcy proceedings. The supplier made supplies to the Taxpayer under a contract concluded in 2011, and the tax authority refused the Taxpayer s claim to deduct the VAT it had paid on those supplies. Indirect Tax Forum - Case law update November

15 SC Paper Consult CJEU referral questions 1. Does EU VAT Directive (2006/112) preclude national rules under which a taxable person is denied the right to deduct VAT on the grounds that the person upstream, which issued the invoice in which the expenditure and VAT are indicated, has been declared inactive by the tax authorities? 2. If the answer to the first question is in the negative, does EU VAT Directive (2006/112) preclude national rules under which it is sufficient to display the list of registered inactive taxpayers at the headquarters of the Agenției Națională de Administrare Fiscală (National Agency for Fiscal Administration) and to publish that list on the website of that agency, in the section Public information Information relating to economic operators, in order that the right to deduct VAT in the circumstances described in the first question may be refused?" Indirect Tax Forum - Case law update November

16 SC Paper Consult judgment The CJEU noted that all that was asked of the Taxpayer was to consult the published list of businesses declared inactive, which was a straightforward check to carry out. However, it was still necessary to determine whether that legislation goes beyond what is necessary to achieve the objective pursued. And the CJEU noted that, at the time in question, even if the taxpayer declared inactive were to correct its VAT position with the tax authority and pay over all the VAT due, the purchaser of the goods or service would not be able to recover the right to deduction of the VAT after the supplier was re-activated. The CJEU held that the fact that it was not possible for the Taxpayer to demonstrate that the transactions with the taxpayer declared inactive meet the conditions for recovery or to demonstrate that the VAT had been paid into the public purse by their supplier, meant that the legislation did go beyond what is necessary to achieve the objective of preventing abuse. Indirect Tax Forum - Case law update November

17 SC Paper Consult implications The CJEU has again emphasised that the right to deduction of input VAT is a fundamental principle that is to be denied only in exceptional circumstances. But that does not relieve the taxpayer of the obligation to carry out reasonable due diligence on those with whom it does business. Formal requirements may be acceptable, provided that the Member State does not impose rules that are disproportionate, e.g. the formal procedures effectively put the onus of fraud prevention on the taxpayer rather than the tax authority, or the right to deduct cannot be restored once it is shown that no fraud or abuse took place. The CJEU also stressed that its judgments reflect how the EU law is to be interpreted and how it always should have been interpreted. Only in very limited circumstances would it contemplate limiting its temporal effect. This is also an interesting case in the manner in which the Court resolved the competing principles of fiscal neutrality in its deduction sense with the principle of precluding reliance on EU law for fraudulent ends. Indirect Tax Forum - Case law update November

18 Littlewoods Limited and Others [2017] UKSC 70 4 Indirect Tax Forum - Case law update November

19 Littlewoods background The taxpayer initiated proceedings before the High Court. In his judgment Vos J determined certain matters but also referred questions to the CJEU. CJEU gave its judgment stating that the availability of compound interest is a matter for Member States, provided that the principles of EU law are respected. Proceedings were resumed at the High Court before Henderson J (due to Vos J s promotion to the Court of Appeal). Henderson J found in favour of the taxpayer. On appeal the Court of Appeal also found in favour of the taxpayer. The Supreme Court, departing from both Henderson J s and the Court of Appeal s judgments, found in favour of HMRC. It heard arguments on the following two issues: i. Whether s 78 VAT Act 1994 was an exclusive and exhaustive statutory code for interest in relation to VAT; and, ii. How to interpret what the CJEU meant by adequate indemnity. Indirect Tax Forum - Case law update November

20 Littlewoods - judgment Issue one The SC held that s78 VATA impliedly excluded the taxpayer's common law claim. The right to interest in s 78 is subject to certain limitations, which would be defeated and rendered effectively pointless if it were possible for the taxpayer to bring a common law claim. Therefore the scheme created by s 78 is inconsistent with the availability of concurrent common law claims to interest. s78 cannot be read literally, but must be construed as referring only to statutory liabilities to pay interest (and not to a common law liability for interest which was not recognised at that time). Issue two The SC held that the CJEU's judgment does not require reimbursement of the losses constituted by the unavailability of money, contrary to the lower courts findings. The CJEU had given Member States a discretion to provide reasonable redress in the form of interest in addition to the principal sum, and the lower courts in this case had read too much into the phrase adequate indemnity in the CJEU's judgment. The SC concluded that the payment of simple interest by HMRC to the Taxpayer in this case was "adequate indemnity" for the purposes of the CJEU's judgment. Indirect Tax Forum - Case law update November

21 Littlewoods implications Clearly this judgment will be disappointing for the many taxpayers with compound interest claims stoodover behind Littlewoods. It appears that this is the end of the road for those claims, at least insofar as they relate to interest on principal amounts reclaimed under the VAT Act. Sempra Metals establishes that there is a right to compound interest at common law (i.e. in the law of unjust enrichment). The Supreme Court has in Littlewoods confirmed that this case remains good law. The effect of this is that Littlewoods may not be a complete answer where the claim for the principal sum relies on common law (the law of unjust enrichment e.g. UB and Zipvit claims) rather than statute (e.g. section 80 or regulation 29). Most compound interest claims made are, however, likely to be based upon a repayment of VAT or other indirect taxes claimed under statute. Indirect Tax Forum - Case law update November

22 Avon Cosmetics Ltd (C- 305/16) 5 Indirect Tax Forum - Case law update November

23 Avon - background The Appellant s business model is to sell its products to its network of resellers who in turn sell the products to their customers. The resellers obtain the goods at a discount from the brochure prices, and that discount represents their profit when they sell the goods, unless they decide to pass on any of the discount and reduce the amount they receive below the brochure price. Very few resellers are registered for VAT. This would normally mean that the Appellant would account for output VAT on the amounts paid to it by the resellers. The resellers would neither be entitled to recover the VAT charged by the Appellant nor obliged to account for output VAT on their income. However the UK obtained a derogation from the normal scheme of VAT accounting for sales conducted in this way. This enables HMRC to issue a Notice of Direction on a business, which means that the business must calculate its VAT liability by reference to open market values of its products, rather than the company s actual discounted income from sales to the resellers. Indirect Tax Forum - Case law update November

24 Avon - background The Appellant sought to challenge the validity of the UK s derogation (implemented in para 2 Sch 6 VAT Act 1994). The Appellant's concern was that resellers incur VAT on costs that would have been recoverable as input VAT if they were VAT registered, and if VAT is to be accounted for on the retail sales value, the neutrality of the VAT system is breached if the VAT incurred on costs at that stage is not deducted in calculating the Appellant s net VAT liability to HMRC. That offends the principle that input VAT must be deductible at each stage in a taxable retail sales chain of supply. The basis for the Appellant s claim was that, if it is required to account for VAT on goods sold to customers by reference to the notional sales consideration receivable by the resellers at the retail stage, it is wrong that the derogation disregards the VAT suffered by the resellers in making the retail sales. The Appellant should be entitled to set off against the output VAT on retail sales the VAT charged to the resellers for demonstration goods. The Appellant considered that the method for calculating its VAT liability without credit for VAT on costs in the chain of supply breaches the parameters within which derogations should be requested and authorised, because it results in the Appellant s net liability to VAT being greater than the amount of potential VAT loss that the derogation was meant to prevent. It also breaches the principle that the total tax charged must not be in excess of the amount that should be suffered by the end consumer, and distorts competition with VAT-registered high street retailers by imposing more VAT on those governed by the derogation (despite the UK s justification for the derogation being that the Appellant s business model gave it an advantage over High Street retailers). Indirect Tax Forum - Case law update November

25 Avon CJEU referral questions "1. Where a direct seller sells goods ("Sales Aids") to unregistered resellers or the unregistered reseller purchases goods and services from third parties ("Third Party Goods and Services") which are in both cases used by the unregistered resellers to assist their economic activity of selling other goods which are also purchased from the direct seller and the subject of administrative arrangements issued pursuant to a derogation most recently authorised by Council Decision of 24 May 1989 (89/534/ EEC ) (the "Derogation"), do the relevant authorisations, implementing legislation and/or administrative arrangements offend any relevant provisions and / or principles of European Union law in so far as they require the direct seller to account for output tax on the unregistered resellers' sale price of the other goods with no reduction for the VAT incurred by the unregistered reseller on such Sales Aids and /or Third Party Goods and Services? 2. Whether the UK was under any obligation to inform the Commission when seeking authorisation from the Council for the Derogation, that unregistered resellers incurred VAT on purchases of Sales Aids and /or Third Party Goods and Services used for the purposes of their economic activities and that, accordingly, an adjustment to reflect that irrecoverable input tax, or overpaid output tax, should be accommodated in the derogation? Indirect Tax Forum - Case law update November

26 Avon AG opinion The AG did not agree with the Taxpayer that the derogation was invalid. The derogation granted did not make provision for notional input VAT, and therefore did not permit HMRC to apply it in a way that takes notional input VAT into account. The derogation was not intended to be applied so as to replicate the precise VAT position that would result if the resellers were all VAT registered. The purpose of the derogation was to prevent tax avoidance by applying the VAT rules in a non-standard way to a specific situation, i.e. the direct selling business model whereby sales to final consumers by non-taxable persons would escape the VAT net. The AG did not consider that the derogation not taking into account notional input tax breached the principles of proportionality or fiscal neutrality, or exceed the limits imposed by art 27. Proportionality: the derogation adjusted the taxable amount where the price paid by the final consumer was less than the market price, and so the output tax imposed was proportionate, i.e. it went no further than needed to prevent avoidance. As regards notional input tax, the AG considered that the derogation might be disproportionate if the amount of disregarded notional VAT was very significant, in which case the remedy would be that the derogation could not be applied to this Taxpayer. The national court would have to decide that, but the AG considered it highly unlikely. Fiscal neutrality: the AG was not convinced that products sold via the two different business models were 'similar' in the sense that fiscal neutrality would be breached if they were taxed differently. But even if they were 'similar', the AG considered that with the derogation, there was detriment to the Taxpayer and without the derogation there was detriment to the Taxpayer's competitors. The AG also did not consider Article 27 to have imposes a requirement on the UK to have raised the issue of irrecoverable input VAT when seeking the derogation. Indirect Tax Forum - Case law update November

27 Avon implications This case raises some fundamental issues of wider import than the specific derogation at issue. The first of those issues is whether or not output tax and input tax are part of a singular whole in determining the amount of VAT to be borne by the final consumer. The second is the extent to which derogations may depart from fundamental principles of the VAT system. This opinion appears to suggest that both HMRC and the Commission are bound by the letter of the derogation, rather than the spirit of what it is seeking to achieve. It remains to be seen whether the CJEU will follow the AG s opinion. Indirect Tax Forum - Case law update November

28 Look ahead 6 Indirect Tax Forum - Case law update November

29 Look ahead United Biscuits Taylor Wimpey Recovery of input tax on supplies for new build homes Upper Tribunal hearing listed for January 2018 Veolia Judicial review of HMRC landfill tax decision Upper Tribunal hearing listed for January 2018 Iveco London Clubs Zipvit Recovery of over-declared output tax in respect of price reductions Court of Appeal hearing held on 8/9 November judgment awaited Gaming duty on nonnegotiable gaming chips and free bet vouchers Court of Appeal hearing listed for 17 January 2018 Recovery of 'embedded' input tax on payments to Royal Mail Court of Appeal hearing listed for 27/28 November 2017 November

30 Any questions? David Anderson T: M: Holly Grantham T: M: This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. In this document, refers to the UK member firm, and may sometimes refer to the network. Each member firm is a separate legal entity. Please see for further details CS-OS