I have previously commented on the Yeshivas Lubavitch Manchester tribunal case in the context of whether a proposed use of a building is a ‘relevant charitable purpose’. However, the case also concerned whether the works in question created an ‘annexe’ as distinct from an ‘extension’ to an existing structure. For the zero rate to apply to the works, this condition also needed to be met. The First tier Tribunal decided that it had been, contrary to HMRC’s views. The case therefore provides interesting insight into HMRC’s attitude to various aspects of such cases. To read more: click here
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VAT Chatter Newsletter
By Graham Elliott
I have been spurred on to write my latest edition of VAT Chatter by a comment received recently from a client to the effect that my advice had been written in ‘rather delightful prose’. I am glad that the otherwise dispiriting subject of VAT can be imbued with the higher virtues of great literature, so here is my own Christmas offering of ‘Tales from the Wastes of VATland’.
Changes to the Flat Rate Scheme for small businesses
In what I thought was an almost Stalinist deployment of truth-bending language, the Chancellor’s announcement of changes to the flat rate scheme was supplemented on 23 November with some spitting rhetoric of HMRC in its publication which referred to ‘Tackling Aggressive Abuse’ of the flat rate scheme. What was this ‘aggressive abuse’ that they had valiantly decided to tackle? None other than people applying the existing rules.
The reality is that HMRC (or probably someone else) had spotted that certain people get a financial benefit from the flat rate scheme, as well as a reduction in administration. We had known that all along. If HMRC did not know that, they have lost track of basic arithmetic. In setting, say, the rate for lawyers at 14.5% of the gross turnover, they are assuming an effective rate of VAT of approximately 17%, which is 3% lower than the standard rate. Put another way, for every £1000 that lawyer charges, he bills an extra £200 of VAT but pays only £174 to HMRC, which is 87% of the VAT he has collected. Whilst that is an advantage, he is not able to reclaim input tax under the scheme. If his input tax amounts to 13% of his output tax, he breaks even under the scheme. That means the scheme works in his favour if his taxable costs are less than £130 for every £1000 he bills.
Our hypothetical lawyer is, by definition, a small operation of one or two people, so he may have limited office costs (he may even work from home). His computer and computer support will not be a great burden. His subscriptions for CPD programmes will be reasonably high, as will his payments for access to technical resources such as PLC. He will pay a lot in PI insurance, though that will be exempt from VAT. Yes, it is certainly possible that he will do well out of being in the flat rate scheme, although the extent to which that is true will vary from case to case. But he is told that his percentage must be 14.5%, and who is he to argue with that? It is inherent in the scheme that it applies a percentage to the category of trade closest to that of the supplier. There is no other choice, except not to use the scheme. And whereas he has the right not to use it, he also has a clear entitlement to use it if he is within the conditions, and those conditions do not include the need for him to consider whether it is financially advantageous.
Furthermore, HMRC’s Notice lists three benefits of being in the scheme:
• Simplified record keeping
• Fixed rate percentages that are lower than the standard rate
• Helps manage cash flow
Let’s ignore the fact that that last ‘benefit’ is specious, and concentrate on the second. This is effectively a statement that says that a benefit of the scheme is a lower rate than the standard rate. That can only be a ‘benefit’ if the lost input tax is lower than the effective reduction in the applicable rate on sales. So, it actually promotes financial advantage as a benefit.
But having done this, and having set the percentage in line with what HMRC wanted to do, and which it prescribes as being compulsory under the scheme, we are now being told that those who benefit financially from it are ‘aggressive abusers’.
A person with a cynical turn of mind would say that this is a farrago intended to obscure, to the Chancellor, the fact that HMRC had deliberately calibrated the scheme in that way, and were themselves to blame for any advantage it offered. And, considering that the burden of VAT on small traders who compete with micro-traders who are below the registration threshold is comparatively heavy in real terms, it may have been the case that HMRC originally wanted the percentages to be mildly ‘encouraging’ to those trading in this space. We now find that the ‘salt of the earth’ have become the ‘scum of the earth’, and HMRC have emerged as their own self-proclaimed knight in shining armour to protect the public coffers from the brigands.
So, that is the history – what about the future?
In order to remove the advantage, users are now to consider whether they are a ‘limited cost trader’, in which case a flat rate of 16.5% is to apply, which eliminates any margin for recoverable input tax. How are they to determine whether they are a limited cost trader? By reference to the proportion of their turnover which pays for goods. For some reason, best known to HMRC, they have not set a simple test based on whether one’s VATable costs are a certain proportion of turnover, but have chosen goods as being the relevant test. They give no explanation as to why they have chosen goods. And, by the way, some goods are specifically excluded.
Where does this leave our lawyer? He pays for technical materials which he consumes in electronic format (services), pays rent which includes any utilities under, say, a five year lease (services), and attends training courses (services). He buys in occasional help from other specialist advisers (services) and meets certain costs of transactions he performs for clients (services). He may pay commissions for referrals of clients to him or for the use of IP of one kind or another (services). He has insurance and Law Society subscriptions to pay (but these are exempt, admittedly). He may have to pay quite a bit for cabs to go to meetings (services). If all the above were goods he might qualify to remain on 14.5%, but the proposals effectively exclude him merely because what he buys are not generally classified as goods.
So, I put a question to HMRC: What is your agenda? A justification for this kind of discrimination is not obvious to me.
Pre-registration input tax
I seem to recall the issue of pre-registration input tax rearing its head about 18 months ago, though it may have been before then. It arose from someone noticing that HMRC’s internal manuals (which they helpfully publish for all to see) had changed the rules relating to VAT incurred on costs falling prior to the effective date of registration. But it was also noted that HMRC’s policy in that respect had not been changed when one read their outward-facing materials (the Notices) which are regarded as the primary guidance on which the public should rely. In short, the two contradicted each other following the change to the manuals. But inspectors use the manuals, so they started to apply the change, which was to the disadvantage of businesses.
The change relates to goods purchased prior to registration but still on hand at the date of registration. Where this is stock, it is clear that the goods are on hand and have not been used. Where it is a capital asset, the goods will be on hand, but will have been used. The change was to the effect that the VAT on the latter ought to be apportioned to reflect use prior to the business starting to charge VAT. This restriction was not mentioned in the outward facing literature, and has not been applied in all the years up until around 18 months ago.
HMRC were asked to consider this discrepancy, the result of which is R&C Brief 16(2016). This basically tells us that the former policy is the correct one. The policy stated in the revised manuals is therefore not correct. There is no apportionment of the VAT on assets on hand at the effective date of registration after all, and the four year time limit applies as before.
There should be much rejoicing over the repenting sinner in this case, but I am surely not the only one to feel a lack of Christmas charity towards HMRC’s chosen ‘narrative’, which recites that the policy had never changed, and merely that there had been inconsistencies of application by businesses and inspectors. Well, that inconsistency arises from a change in their manuals. If the manuals change, that means that policy has changed. Or are they trying to say that the manuals do not reflect HMRC policy? I think their own inspectors would be pretty concerned if that were the case.
Cathedral Good Cheer
Turning to a happier subject, with suitable seasonal overtones, I can report a sensible and helpful outcome in litigation between Durham Cathedral and HMRC. That said, the fact that HMRC ever took this case is a puzzle to me. The sums were insignificant, but the wider implications may prove unhappy for them.
But there is nothing wrong in HMRC taking a case which proves a point, where it is against them, so I am grateful to them for doing that.
The issue was VAT recovery on the Cathedral’s expense in maintaining an ancient bridge on the edge of the Cathedral site (a little away from the ‘close’, but nonetheless part of an area for which the Cathedral is generally responsible). This bridge is used by tourists, dog walkers, water-colourists, and visitors to the Cathedral. If you do choose to visit the Cathedral, via this bridge, there are some taxable goods and services you can consume. Or you can attend a service. The bridge has little other use than the above.
HMRC said that the bridge’s connection with those taxable services was too distant (or, that is what I think they meant). But the Cathedral had made the claim following the decision by the CJEU in the case of Sveda. If you want to read about Sveda, please see an edition of Charity Tax Brass Tacks, here.
But, to follow our Durham story, the issue was whether the fact that the bridge is used (amongst other things) as a route to the Cathedral’s taxable offerings was enough to allow VAT recovery of part of the costs.
HMRC’s arguments included the notion that the bridge was very old (more than 200 years) so could not be connected with the supplies. Another was that it was too far away (despite being closer than would commonly arise in regard to walls and gates for a stately home which charges for admission). It also appeared to be important to HMRC that it was a very steep hill up from the bridge to the Cathedral (which is an occupational hazard in Durham). I struggle to see the relevance of any of this. So did the tribunal. The Cathedral won its appeal, and pocketed its £6,000 of input tax.
For more on what I think this means for charities please visit here.
Input Tax on management buyout
Staying with input tax, I was interested in a recent case, Heating Plumbing Supplies Limited, where HMRC unsuccessfully tried to restrict VAT recovery on costs incurred by a management buy-out vehicle on the basis that the vehicle only had an investment intention when incurring the costs, not an intention which related to making the underlying business supplies.
In the topsy turvy world of VAT it is possible to incur costs which can only really have a business use, and to run a wholly taxable business, but find that the costs somehow escape qualification for recovery because they are not ‘directly and immediately linked’ to the taxable supplies, nor are an ‘overhead’ of the business. That happened in the case of BAA a few years ago, regarding costs of an aggressive takeover bid. And HMRC won an unrelated case, with overtones of similarity, in the recent Supreme Court decision in Airtours concerning the costs of a re-financing scheme.
So, their new Everest (or perhaps Ben Nevis) was to try the same argument on a management buyout vehicle. But all the ingredients for their success were missing. There was no issue with the engagement letter for the services (which had scuppered Airtours). The management company had a clear intention to supply management services to the business vehicle (and this was hardly strange, because the managers were now directors of the said company – because it was a ‘management buyout….’). And the two companies were in a VAT group prior to the conclusion of the services (unlike BAA).
So HMRC had gone a step too far in this case. To be fair, the advisers to this tax payer had got several things right which had not been entirely right in other earlier cases. We are all learning all the time. HMRC wanted the same result despite the arrangements being watertight. I suppose they are entitled to push their luck, and we are entitled to being pleased when they fail.
Our Friends on the Continent
It’s good to hear from the European Commission about their proposals to improve the VAT system. The wheels of the EU grind very slow, but quite often improvements do emerge. Their latest missive (dated 1 December 2016) is (inter alia) about plans for MOSS and for reading material.
The good news starts with their proposal for a threshold of €10,000 before MOSS applies to electronically delivered services, allowing micro-businesses to apply home VAT to all electronic supplies without the need to do the MOSS procedure. It’s not set at our UK registration threshold of £83k (indeed, it is about one tenth of that) so will still cause such operations to argue that they are not in business at all if they exceed the €10k figure, but it is better than nothing. Given that the UK were pushing hardest for this easement, it is nice to see that it has been adopted by the Commission despite the Brexit vote. They have also reduced some related compliance burdens at turnovers of less than €100,000.
They announce the plan to extend MOSS accounting to B2C goods across EU borders and claims this will reduce related administration costs by a staggering 95%. I find this hard to believe and am not convinced by their explanation of the change. But, in any case, it will not be relevant to us after we have left the EU, save for any intra-EU goods movements British companies may carry out.
The Commission also proposes that E-literature should have the same VAT rate as hard copy. This is a real and important breakthrough, allowing the UK to apply the zero rate to comparable E-literature and giving the much-needed level playing field. However, member states will be able to choose not to align the treatment.
These changes need European Parliament approval, and acceptance by the EU Council, but one cannot see any reason why they will not receive these and be introduced in due course.
Payment Handling Services
The summer saw a significant blow dealt to the payment handling industry in the form of decisions by the CJEU that two UK businesses, Bookit and NEC could not exempt services in handling payments for event tickets booked on the internet or by phone. Both companies had claimed that the predominant element in their services was handling payments via credit card, and this was an exempt provision of financial services. But the CJEU decided that its actions did not qualify for exemption because all it did was transfer data which allowed the banks to make the money transfers. This is ‘useful’ in the sense that it does set a tight boundary around the exemption for ‘transfers of money’, but ‘unhelpful’ in just how tight that now is seen to be. It seems unlikely that any intermediation service for payment transfers can hope to qualify. Only the banks, it seems, can handle the end to end process in such a manner as to qualify for exemption.
Well, now, at least, we know.
Meanwhile, the Upper Tribunal has noted that the CJEU has applied a conflicting treatment to services of collecting payment for a dental scheme, and has referred the matter to the CJEU to resolve its own internal conflict. This was the first referral of a question to the CJEU after the Brexit vote. However, the terms in which it was couched was, shall we say, scornful of the CJEU’s performance in past decisions. As I mentioned in my Brexit Breakfast, one advantage of leaving the EU ought to be avoiding the need to reconcile the various opaque decisions of the CJEU.
I always think that the government is overly fond of the ‘too difficult tray’ as a means of managing the handling of challenging issues. A case in point is the proposed changes to VAT recovery on final salary pension schemes following the CJEU decision in PPG. The details of that case are almost ancient history, so I will not remind you of them. But they have presented significant legal challenges in their implementation.
Accordingly, HMRC decided in 2015 to delay implementation until sometime in 2016. But last summer HMRC announced that no changes would be made until 2017, with a backstop date of 31 December 2017. No guidance has been given on how they might resolve the legal issues identified. If it is so easy to delay any changes for over a year, why would they not extend to 2018, or 2019 (when we may even leave the EU, thus removing the legal need to comply with the CJEU decision)? Indeed, I cannot help feeling that the true intention is best summarised as ‘… sometime; never’.
2016 has been the first full year of trading for City & Cambridge Consultancy, and I am pleased to report that it has all gone very well. That is one reason I have not had time enough to publish this newsletter at all regularly. But my readers will be aware that I also write for Accountancy Magazine, Tax Journal, and many others, so there is only limited time to do these extra activities alongside the ever-present client work. I hope nonetheless that you enjoy reading my musings.
If anyone would like me to muse about their own issues, and challenges with HMRC, please feel free to contact me. To paraphrase the Chancellor of the Exchequer: we are open for business, and a beacon for free trade….