The question then is how should the single complex supply be characterised for VAT purposes?

In Levob, where a customer was purchasing basic software on a CD-ROM (i.e., goods) that had been customised (i.e., services), it was held that the customisation element of the single complex supply was the element that "predominates" in the eyes of the consumer and as such should drive the correct VAT treatment.

In this article, we consider more recent case law and whether there are alternative tests to the "predominant element" test and whether there should be any hierarchy for these tests based on jurisprudence to date.

A recent UK case ruled, based on particular pre-Brexit CJEU case law, that the "predominant element" test should take precedence over a more holistic overarching approach, though this appears to diverge from more recent post-Brexit CJEU case law in this area.

UK

Gray & Farrar case

In the UK, the Court of Appeal recently held in the case of HMRC v. Gray & Farrar International [2023] EWCA 121 ("Gray & Farrar") that, when seeking to characterise a single complex supply for VAT purposes, the primary test to apply is one based on the predominant element of the supply.

Gray & Farrar operated a bespoke matchmaking service and agreed to provide its clients with a certain number of curated "introductions" to potential matches over a 12-month period. As part of this process, Gray & Farrar would interview clients, carry out research to find a match and verify/vet potential matches.

The question was whether Gray & Farrar's services should be characterised as a supply of expert matchmaking such that they were the "services of consultants… and other similar services, as well as data processing and the provision of information" within Article 59 of the Principal VAT Directive (and transposed into UK law in Value Added Tax Act 1994 Schedule 4A paragraph 16), or that they were outside the scope of VAT when provided to clients based outside the UK and EU. Alternatively, the question was whether they were a supply of purely introductions to prospective long-term partners, not within Article 59, such that Gray & Farrar's supplies to customers based outside of the UK and EU were within the scope of UK VAT.

The predominant element test

The UK Court of Appeal in Gray & Farrar looked at the CJEU's decision in Mesto Zamberk Financini (Case C-18/12) ("Mesto") and held that the decision in Mesto established a mandatory principle of EU law that the predominant element test is the primary test to apply in characterising a supply for VAT purposes.

As such, the UK Court of Appeal decided that where it is possible to do so, the predominant element must be determined.

In Gray & Farrar, the UK Court of Appeal decided that the introductions were the predominant element of the matchmaker's services and that its single complex supply was within the scope of UK VAT where provided to customers outside the UK and EU.

Should the predominant element test be the primary test and what are the alternatives?

Where there is a "single, indivisible economic supply, which would be artificial to split" per Levob, based on subsequent case law, there are two possible tests for ascertaining the correct VAT treatment:

• The "predominant element" test, which breaks down a single complex supply into its constituent parts, then considers which individual element "predominates"
• The "overarching" test, which involves undertaking a more holistic, qualitative assessment of the supply, from the viewpoint of the typical consumer to evaluate what the recipient considers the supply to be in its entirety.

It is debatable, and subject to much interpretation, whether the UK Court of Appeal correctly applied Mesto in Gray & Farrar by asserting a hierarchy of the predominant element test over the overarching test. The Mesto decision references that "an overall assessment" should be undertaken to conclude which is "qualitative and not merely quantitative". It could be contended that this appears slightly incongruent with the UK Court of Appeal's interpretation of Mesto.

Indeed, an application of the overarching test may have resulted in a different conclusion in Gray & Farrar. It is arguable that, in the eyes of the typical consumer, the Gray & Farrar service, when viewed as a whole, is a supply of matchmaking expertise rather than purely introductions, which would have led to a different VAT treatment.

A post-Brexit ECJ judgment, Frenetikexito – Unipessoal Lda (Case C-581/19), which was ostensibly not considered by the UK Court of Appeal, promoted the use of the overarching test. The Court agreed with the Advocate General's opinion that:

[It is] slightly misleading when the Court sometimes states that the material factor in the assessment of a single supply is whether the elements of the supply of goods or of the supply of services 'predominate.' This wording suggests that the individual elements must be broken down and then weighed.

Instead, the Advocate General again agreed with the Court and appears to promote the overarching test by stating that:

From the perspective of the typical consumer, where there is a single complex supply, the individual elements lose their independence and become secondary to a new sui generis supply. The object to be examined is then only that single supply as a whole. Any weighting of the individual elements of the supply is rightly irrelevant.

Why this matters is that frequently within a single complex supply, there will be different elements with different VAT treatments. Therefore, knowing which of these tests to apply to arrive at the correct characterisation for VAT purposes can affect whether any tax is payable where, for example, exemptions apply.

Presently, within the UK, the judgment in Gray & Farrar suggests that taxpayers should prioritise the predominant element test over the overarching test when considering a single complex supply for VAT purposes. This creates some uncertainty, primarily due to the fact that this appears to be a divergence from the position within the EU based on post-Brexit CJEU case law (notably Frenetikexito).

The Netherlands

In the Netherlands, the approach taken by the local courts has diverged somewhat from the CJEU approach in Frenetikexito. In that case, the supply is viewed from an objective standpoint to determine the economic importance of the different elements. In the Netherlands, courts have taken a more subjective approach, assessing the elements based on their importance to the customer.

Many Dutch cases have revolved around supplies of parking at (theme) parks, as the rate for providing access to a theme park is subject to the reduced rate, whereas the parking is subject to the standard rate. The suppliers here argued that parking is an ancillary supply to the theme park supply and therefore should be taxed at the reduced rate. However, the Dutch Supreme Court confirmed in 2021 that these are in fact two separate supplies. The Dutch Supreme Court argued that (i) not all customers decide to drive to the theme park and (ii) once they have decided to travel by car, parking becomes an important element of the experience to them (meaning that parking becomes an importance of its own).

This approach of looking at every element individually and then judging how much importance consumers put on the service is a more subjective approach to the CJEU's objective test. Breaking down a supply into its different elements is an approach that is more closely aligned to the predominant test that the UK Court of Appeal took in Gray & Farrar.

However, in a recent case from May 2023, the Dutch Court of Appeal seemed to take a more objective approach. The case revolved around whether two elements were separate or composite supplies. The first element was the supply of telecommunication services and the second element was the possibility to donate mobile data (MBs).

The Dutch Court of Appeal held, based on the average percental usage, that these two elements constituted a composite supply, with the telecommunications service being the main service and the data donations ancillary. This seems to be an approach that is more in line with case law from the CJEU. It will be interesting to see whether the Dutch Supreme Court will eventually confirm such an approach and align Dutch case law on this topic with case law from the CJEU.

Italy

In Italy, the topic of so-called "complex transactions" has always been debated, both at Tax Courts level and at Italian Revenue Agency level.

The Tax Authorities have analysed several cases of "complex transactions". However, they did not outline precise guidelines different than those identified by the CJEU to determine whether given transactions should qualify as autonomous, complex or multiple.

In recent years, they appear more aligned with the CJEU's approach in Frenetikexito. In this regard, it is worth mentioning Legal Advice No. 4 issued 2 February 2022, where the Italian Tax Authorities clarified the VAT treatment applicable to a complex transaction related to the maintenance of helicopters.

The Tax Authorities recall CJEU jurisprudence, affirming that it is necessary to consider all the circumstances under which the transaction takes place. No specific rule exists to determine whether a transaction can be considered complex rather than autonomous. According to the CJEU, this classification results in a case-by-case assessment, which should also include the parties' declared intention to levy VAT on the transaction, when proven by objective evidence.

As a consequence, the Tax Authorities clarified that, in consideration of all the contractual elements, the factual circumstances, and the concrete and objective ways in which maintenance work is commonly performed, the transaction was to be considered a single supply of generic services.

However, in the recent Resolution No. 27/2023, the Tax Authorities, by acknowledging the principles laid down by the CJEU in Levob and other CJEU cases, state that if a single transaction is deemed to exist, it is necessary to identify among the different supplies of goods or services which one should be considered the main or predominant transaction or the principal or absorbing one compared to the other supplies of services or goods that should be considered aimed at enabling a better fruition of the principle transaction.

In its turn, the domestic case law on the subject matter also does not provide detailed guidelines on the tests that should be performed to establish whether a complex transaction is deemed to exist.

Next steps

If you would like to know more about any of the cases referenced above or would like to discuss how this may affect your business, your local Baker McKenzie contact would be happy to help. Please reach out to them to discuss.