HMRC U-turns on contract termination fees

HMRC’s sudden change in VAT policy in Brief 12/2020 had retrospective effects and contradicted existing HMRC guidance. The policy has now been reversed.

 

HMRC announced a major chance of policy for the VAT treatment of termination fees and compensation payments on 2 September 2020, in Brief 12/2020, but it has now reversed that change and confirmed that the policy will be introduced “from a future date.”

First policy change

The key outcome of this policy change was that most termination fees and cancellation payments were deemed by HMRC to be VATable if they related to standard rated contracts, such as the fees paid by mobile phone users to cancel their contracts early. Those charges were previously accepted by everyone in the tax world as being outside the scope of VAT (no supply of goods or services), including in the guidance published in HMRC’s internal VAT manuals.

Unfair to be retrospective

HMRC stated that the policy change was to be retrospective. It expected businesses to go back four years and account for output tax on past fees. However, the latest announcement on 24 January 2021 has completely reversed the September version of Brief 12/2020, confirming that the new rules will be introduced in the future, ie no retrospective adjustments are needed.

In the introduction to the updated Brief 12/2020 HMRC says: “Revised guidance and a new HMRC Brief to explain what businesses need to do, will be issued shortly.”

Two choices

It would be an onerous task to go back five months to refund overcharged VAT to all customers – there might be a lot of them. This is not necessary, and the Brief 12/2020 confirms that a business can carry on treating cancellation fees as VATable.

But the business can also refund past VAT charged to customers if its previous policy (before 2 September 2020) was to treat such cancellation payments as outside the scope of VAT.

The choice here is straightforward: if your customers can claim input tax, there is no benefit in adjusting the VAT that has been charged. However, if the customers are private individuals, exempt or partly exempt businesses, or non-business organisations, a VAT credit will be welcome.

Unfair behaviour

It is noted that HMRC did not seem concerned that the retrospective change of policy contradicted the guidance given in its own internal manuals. When the Brief 12/2020 was issued, the department hastily withdrew the previous guidance and replaced it with the new interpretation.

Accountants and advisers frequently use these manuals to check HMRC’s interpretation of the legislation on key issues. The manuals include more detail and analysis than the VAT public notices, often supported by important case law.

Brexit – Place of supply of services

This article examines the rules for determining the place of supply of services for VAT purposes, highlighting where they have changed following the exit of the UK from the EU, and considers what the potential implications of those changes might be.

 

Although the VAT place of supply rules for services did not fundamentally change as a result of Brexit, the relevant legislation was extensively amended and the potential consequences for some businesses supplying services to the EU have changed.

Rules previously ensuring no VAT applied to services supplied outside the EU have been extended so that there will now be no VAT on supplies outside the UK. But although this may be, for many businesses, a welcome simplification it could also lead to additional VAT registration liabilities in different EU member states.

 

Basic Rule

VATA 1994, s. 7A states that a place of supply of services is to be treated as made:

(a)in the country in which the recipient belongs, if supplied to a relevant business person;

(b)otherwise, in the country in which the supplier belongs,

subject to Schedule 4A which contains the general and other exceptions to this rule based primarily on the nature of the service being supplied.

Determining the place of supply of services

In order to establish the place of supply for VAT purposes, therefore, three key pieces of information are required:

  • whether or not the recipient of the service (the customer) is a ‘relevant business person’;
  • where the recipient is located;
  • the precise nature of the service that is being provided.

The correct treatment, for VAT purposes, can only be identified when all three are fully understood.

‘Relevant business person’

The definition of a ‘relevant business person’ has changed substantially following the exit of the UK from the EU.

From 1 January 2021, a person is a ‘relevant business person’ in relation to a supply of services if:

(a) the person carries on a business; and

(b) the services are not received by the person wholly for private purposes,

whether or not the services are received in the course of business.

It therefore includes charities, local authorities or other government departments who may have both business and non-business activities.

There are no prescribed evidential requirements. Where appropriate, a valid VAT registration number does still appear to be the preferred option by HMRC, notwithstanding the removal of any reference to VAT registration in this new definition, but normal commercial evidence should also suffice.

In relation to whether the supplies are received for private purposes, HMRC have stated (in their new Notice 741A) that unless you have information to suggest the service is wholly for private use, you can presume your customer is in business if they provide you with their VAT number.

A supply to a relevant business person is often referred to as a B2B supply, whereas supplies that are not to a relevant business person (supplies to consumers) are known as B2C supplies.

Customer location

A relevant business person belongs in a particular country if they have a business establishment, or some other fixed establishment, in that country.

The term ‘fixed establishment’ is not defined in law but is, generally, taken to mean a place from where the activities of the organisation are carried out, with the necessary human and technical resources to make or receive the supply in question.

If a relevant business person has more than one business or fixed establishment they are treated, for these purposes, as belonging at the business or other fixed establishment most directly associated with the supply in question.

This is often, but not necessarily, the head office or place where the contracts are signed. If this produces an irrational result, however, other factors such as whether, as a result of signing the contract, another establishment directly benefits, may also be relevant.

A body corporate or other legal person, who is not a relevant business person, is treated as belonging in the country where it is established.

A person who is none of the above is treated as belonging in the country that is their usual place of residence or where they have a permanent address.

Nature of the supply

Under the basic rule, B2B supplies are treated as made where the recipient belongs, while B2C supplies are treated as made where the supplier belongs, unless they fall within one of the many exceptions set out in VATA 1994, Sch. 4A.

Businesses must, first, consider whether their services fall within any of the exceptions before, effectively, defaulting to the basic rule.

Detailed guidance is available on each of the exceptions but, essentially, the exceptions fall into the following broad categories

  1. Services treated as supplied where physically located or performed.

This can include services related to land, transport services, catering, some valuation services and services relating to cultural, educational or entertainment events.

  1. Services treated as supplied where they are used and enjoyed

These provisions have been extended, from 1 January 2021, to include all supplies outside of the UK rather than just those outside of the EU. Broadcasting, telecommunication and electronically supplied services fall into this category which can also include the hire of goods or means of transport and repairs to tangible property under a contract of insurance.

  1. B2C services treated as supplied where received

The B2C supply of intangible professional services set out in Sch. 4A, para. 16(2) was previously treated as supplied where received when they were supplied to a recipient outside the EU. From 1 January 2021 this has been extended so that no VAT will have to be charged on services made to recipients outside the UK.

Implications for businesses receiving supplies in the UK from overseas suppliers

Businesses receiving services deemed to be made in the UK from an overseas supplier not registered, or required to be registered, for UK VAT must still account for the VAT due on the supply under the reverse charge procedure. This has not changed as a result of leaving the EU.

Implications for businesses making B2C supplies in the EU

UK suppliers of B2C digital services, to customers in the EU, had previously been entitled to account for VAT under the MOSS scheme. From 1 January 2021 they have had to register for VAT in an EU member state and transfer to the non-union MOSS scheme or register for VAT in each EU member state in which a liability arose.

From 1 July 2021 the non-union MOSS scheme is to be extended to include all B2C supplies of services to customers in the EU. The non-union One Stop Shop (OSS) will allow UK suppliers to register electronically for VAT in one EU member state and declare, in a single OSS return, all eligible sales of services to customers in any of the member states.

Prior to 1 July, therefore, there is a risk that UK suppliers will be required to register for VAT in multiple member states, some also requiring the appointment of a fiscal representative, if they supply B2C services in the EU that fall outside the MOSS scheme. Unfortunately, the relevant rules are not uniformly applied across the EU and therefore suppliers will have to consider their own situation in relation to the particular member state in which they make such services.

Implications for businesses making B2B supplies to the EU

The situation is a little clearer for suppliers of B2B services. The reverse charge applies across the EU but, as noted previously, the place of supply rules may differ between member states, particularly in relation to the use and enjoyment provisions, leading to a mismatch of treatment that could ultimately result in a tax leak, or even double taxation in certain instances.

Conclusion

The place of supply rules for cross border services has not changed significantly as a result of leaving the EU. UK businesses may even benefit from bringing the treatment for supplies to customers in the EU in line with supplies to the rest of the world. For some businesses, however, the lack of certainty around interactions with the EU represents a considerable risk, at least in the short term, before the introduction of OSS from 1 July 2021.

 

Way forward

4 Eyes Ltd is the UK Member of a leading EU VAT network. Our partners throughout the member states will be pleased to assist your business with its VAT compliance obligations. Please call us if this is relevant to you.

No VAT relief on construction services to CASC

In Eynsham Cricket Club v R & C Commrs [2021] BVC 3, the EWCA (Civ) dismissed an appeal by the taxpayer and agreed with the previous decision of the UT that the Club could not be a charity or, therefore, obtain the benefit of zero rating on the supply of relevant construction services.

Summary

The Court of Appeal (EWCA) upheld the decision of the UT in Eynsham Cricket Club v R & C Commrs [2019] BVC 518 that a cricket club which was registered as a Community Amateur Sports Club (CASC) was not a charity for VAT purposes and could not qualify for zero rating on the construction of a new cricket pavilion.

The Club was a local village, amateur cricket, club run by volunteers and registered with HMRC as a CASC (community amateur sports club). The Club’s pavilion was destroyed by fire. Following an extensive fund-raising effort a new pavilion was constructed. The contractor initially zero rated their supplies of construction services but, following discussions, HMRC decided the Club was not entitled to benefit from zero rating of the construction services.

The Club appealed that decision. Whether the Club was entitled to have the construction services supplied on a zero-rated basis depended on whether it was a ‘charity’ for the purposes of VATA 1994, sch. 8. In particular, whether it was ‘established for charitable purposes only’ under FA 2010, sch. 6. The FTT had found that it was possible for the Club to be both a CASC and a charity but, because it had a subsidiary purpose of providing social facilities to the residents of Eynsham, the Club was not established for charitable purposes alone and not entitled to zero rating.

The UT upheld the conclusion that the Club was not a charity but on the different basis that the deeming provision in section 6 of the Charities Act (CA 2011, s. 6) applied in this case and the Club, as a CASC, could not be a charity within the meaning of FA 2010, sch. 6.

Section 6 states that a registered sports club (CASC) established for charitable purposes was to be treated as not being so established, and accordingly could not be a charity.

Both the FTT and UT rejected the Club’s submissions that the principles of equal treatment and fiscal neutrality applied.

There were two issues to be determined by the EWCA:

  1. whether CA 2011, s.6 prevented a CASC from being treated as established for charitable purposes and therefore from being a charity entitled to the zero rating of construction services and;
  2. whether the denial of zero rating was a breach of the EU principles of equal treatment and/or fiscal neutrality.

Examining the historical development of the definition of a charity for VAT purposes, it was noted this had been a matter of general law until 1 April 2008 when the Charities Act 2006 came into force and provided a statutory definition that would have applied for VAT purposes.

The concept of a CASC was introduced by the Finance Act 2002 creating a statutory entity to give CASCs some, but not all, of the tax benefits available to charities. Before 1 April 2009 when Charities Act 2006, s.5(4) and (5) came into force, it would have been possible for a club such as ECC to be treated as a charity for VAT purposes, even although it might also be registered as a CASC. From this date that was no longer the case.

CA2006, s.5(4) absolved CASCs from the additional, potentially burdensome, administrative requirements of registering as a charity for charity law purposes. A CASC that was charitable could therefore cease to be registered as a CASC, register as a charity, be subject to the administrative requirements and get the full tax benefits of being a charity. Or it could decide to remain a CASC and obtain the more limited benefits available. But a CASC established for charitable purposes was to be treated as not being established for charitable purposes and could not be a charity.

CA 2011 came into force on 14 March 2012. Section 6 contained substantially identical provisions to CA 2006, s.5(4) and 5(5)

FA 2010, sch. 6 provided a separate definition of ‘charity’ for tax law purposes, including VAT, in relation to supplies of goods or services made on or after 1 April 2012. The Club contended, having failed to cross refer the new legislation to section 6 of CA 2011, Parliament had not continued the prohibition on CASCs being charities and section 6 was thereafter confined to operating as a deeming provision within CA 2011.

HMRC argued that section 6 is clear and unambiguous and was a deeming provision for all purposes, and fully applicable to the definition of a charity in FA 2010, sch. 6, para 1(1)(a).

The EWCA confirmed the task of the court was to ascertain and give effect to the true meaning of what Parliament had said, having regard to the purpose of a particular provision, and to best give effect to that purpose, without producing an absurd result. In this case, two Acts had to be interpreted together in a coherent way.

FA 2010, sch. 6 dealt with charities (in Part 1) and CASCs (in Part 3) separately, which reflected the fact these were separate and distinct entities eligible for different tax reliefs. It introduced a new definition of ‘charity’ for tax purposes and para. 1(1) provided that for a body to qualify as a charity for tax purposes it must be:

(a)established for charitable purposes only;

(b)meet the jurisdiction condition;

(c)meet the registration condition; and

(d)meet the management condition.

It permitted a charity established under the laws of other EU member states to be treated as a charity and qualify for UK tax reliefs. It also introduced a new management condition. It did not, otherwise, depart significantly from the previous definition in CA 2011. In fact, the first condition had the meaning given in CA 2011, s 2.

CA 2011, s.6 was a deeming provision but there was nothing in the words of this section to limit the scope of its effect. The language is general and there is no ambiguity. It stood on its own as a provision for all purposes unless disapplied. Nothing in FA 2010, Sch. 6 limited or disapplied its effect. A CASC was, for all purposes, to be treated as not being established for charitable purpose and therefore could not satisfy the charitable purpose condition in FA 2010, sch. 6, para. 1.

The EWCA concluded the statutory definition of a charity that applied for VAT purposes meant that it was possible, from 6 April 2002, for a local amateur sports club to be both a CASC and a registered charity until 1 April 2009 when CA 2006, s. 5(4) came into force (now CA 2011, s. 6). From then on, a club registered as a CASC was treated as not being established for a charitable purpose and so could no longer be a charity for any purpose of the law of England and Wales, including for VAT. A sharp divide was introduced between the two and existing CASCs had to decide whether to register as charities or remain as CASCs. There was nothing in the clear and unambiguous language of FA 2010, sch. 6 (or in the Explanatory Notes and Memorandum) to indicate that Parliament intended, on its introduction, a fundamental change in this earlier approach adopted to CASCs. The absence of any reference to such a policy change suggests there was no policy change and therefore a CASC was for all purposes to be treated as not established for charitable purposes and could not be a charity or obtain the benefit of zero rating of the relevant construction services. It also followed from the fact a CASC cannot be a charity that it is not subject to the control of the HIgh Court in the exercise of its jurisdiction in relation to charities. A CASC therefore cannot satisfy the jurisdiction condition.

On the question of the principles of equal treatment and/or fiscal neutrality, the Club argued the only thing stopping them from being a charity, and obtaining the same treatment as a charity, was a deeming provision. This constituted a breach of those principles on the basis that this classification can have no significance for EU VAT law and yet it results in otherwise identical supplies being subject to different rates of VAT.

This was rejected by the EWCA. Instead, it concluded the FA 2010 and CA 2011, taken together, reflected a domestic social policy choice to treat a CASC and a charity as separate and different entities, governed by different regulatory regimes. The legislation permitted VAT relief to charities who have chosen to submit to the regulatory regime governing charities with the greater burden that imposes. A club that registered as a CASC to obtain different tax reliefs and lesser regulatory burdens cannot qualify as a charity. The two regimes are different and the difference in treatment is objectively justified.

Appeal dismissed