A fundamental principle of VAT groups is that transactions between the members are disregarded.

The Court of Appeal in The Prudential Assurance Company Ltd v. HMRC [2024] EWCA Civ 300 explored the limits of this principle, in the context of an invoice being issued or payment being made at a time when the parties were no longer members of the same VAT group.

The Court of Appeal did not reach its judgment with ease: the case was described as being 'a difficult one' (Nugee LJ), involving 'difficult questions' (Newey LJ), with the Vice-President noting that he '[had] not found the point straightforward' (Underhill LJ). These issues resulted in a split decision, in favour of HMRC.

Although the case concerned difficult legal points, the facts were mercifully simple: investment management services had been provided by Silverfleet Capital Ltd ("Silverfleet"), a member of a VAT group, to Prudential, another member of the same group. The twist came when Silverfleet ceased providing these services and exited the VAT group. Years later, Silverfleet became eligible for a performance fee based on investment returns.

The pivotal legal question: should VAT be levied on the performance fee when Silverfleet was no longer part of the same VAT group as Prudential?

HMRC contended that the time of supply rules provided for a continuous supply of services, and so the supply for VAT purposes must be treated as having taken place after Silverfleet's departure from the VAT group – meaning VAT was chargeable.

Prudential, on the other hand, argued that no VAT was due because the relevant commercial activities occurred during the period of their shared VAT group membership. There could be no supply between members of the same VAT group, and without a 'supply', the time of supply rules were not relevant.
The majority in the Court of Appeal sided with HMRC, emphasising the time of supply rules as being decisive. It was held that transactions undertaken within a VAT group would be chargeable to VAT if the 'chargeable event' (i.e. when VAT becomes chargeable, such as payment or the issue of an invoice) occurred after the parties were no longer members of the same VAT group. This judgment underscores the impact of the time of supply rules on both the timing and nature of the supply.

Decision of the Court of Appeal

Effect of time of supply

The focus of their Lordships' analysis was whether the previous Court of Appeal case of B J Rice & Associates v. C&E Commrs [1996] STC 581 ("BJ Rice")) was binding on them.

In BJ Rice, the supplier performed services while he was not registered for VAT, but received payment several years later (at which point he was registered for VAT). HMRC ruled that, since BJ Rice's original invoice was not a VAT invoice, the services should be treated as supplied on the receipt of payment, The supply was therefore chargeable to VAT as it occurred when the supplier was registered for VAT. The Court of Appeal in BJ Rice held that the existence of a chargeable transaction had to be determined at a time when the services were actually performed. In other words, it held that the time of supply rules determined when, but not whether VAT should be chargeable.

Prudential relied on BJ Rice for the authority that, if a transaction takes place when the supplier is not a taxable person, there ought to be no VAT charged, even if payment is received at a time when the supplier is a taxable person.

In Prudential, the majority's reasoning was that BJ Rice could be distinguished from the present case because Silverfleet was not outside the scope of VAT in the same way as Mr. Rice (Silverfleet was part of a VAT group rather than being under the VAT registration threshold). However, in any event, because of earlier cases, namely Svenska International plc v C&E Commrs [1999] 1 WLR 769 (Svenska) and Royal & Sun Alliance Insurance Group plc v C&E Commrs [2003] UKHL 29 (RSA), BJ Rice could no longer be binding in the circumstances of this case.

HMRC relied on three House of Lords judgments: C&E Commrs v. Thorn Materials Supply Ltd [1998] 1 WLR 1106 (Thorn), Svenska and RSA. The key points from each case are as follows:

From Thorn:

• In Thorn, the taxpayer argued that a 90% prepayment for a supply should not be taxed. The reasoning was that, when the prepayment was made, the parties were members of the same VAT group and so should be disregarded. VAT was accepted to be due on the remaining 10% payment because, by the time the goods were transferred and the 10% paid, the parties were no longer part of the same VAT group.
• However, there was no dispute on the existence of supply. In Thorn, the question was focused on the value of the supply. The House of Lords decided to tax the full 100%. 

From Svenska:

• Svenska incurred VAT while making its own supplies of management services to an affiliate. However, Svenska did not invoice the affiliate or receive payment from the affiliate in respect of the management services until both parties were members of the same VAT group.
• The House of Lords decided that Svenska never made the intended taxable supplies prior to joining the VAT group. The basis for VAT recovery, therefore, had to be by reference to the VAT group's supplies (and the VAT group was partially exempt, resulting in the VAT group having to repay some of the VAT originally recovered by Svenska).
• The time of supply rules played a central role in the House of Lords judgment. Notably, Svenska clarified that where a transaction occurs, there is no chargeable transaction for VAT purposes until the invoice or payment is made. If there is no chargeable transaction prior to entering the VAT group, the input tax recovery must be based on the VAT group's supplies.
• The House of Lords was concerned with a situation where all the ingredients were in place for a taxable supply when the transaction took place, but there was a delay to the chargeable event as no invoice was issued or payment made. However, the BJ Rice scenario was where all the necessary ingredients for a supply were not in place during the initial transaction (such as the supplier not being a taxable person at the time). Instead, Svenska concerned a situation where the ingredients for a supply were in place, but with a delayed payment. 

From RSA:

• In RSA, the taxpayer sought to claim input tax in respect of the VAT charged on renting a leasehold property. The taxpayer intended to sublet the property (and the onward sublet would be exempt from VAT).
• The crucial issue was whether the supply of the leasehold to the taxpayer constituted a single supply or a series of successive supplies. The House of Lords decided in favour of the latter.
• Importantly, the High Court's analysis regarding the time of supply rules was rejected by the House of Lords. The overturned High Court's decision had relied on BJ Rice. But BJ Rice was arguably not undermined: RSA was not concerned with whether the time of supply rules could impose a charge to tax where the person was not a taxable person at the time of the transaction. 

As noted above, none of the authorities raised by HMRC were quite on point: Thorn concerned the valuation of a supply, Svenska concerned input tax recovery when there was no chargeable event prior to joining a VAT group, and RSA concerned the impact of a lease being a series of successive supplies rather than a single supply. However, for the majority, the principles set out in Svenska and RSA meant that the time of supply rules impacted both the timing of supply and the nature of the supply itself – and so BJ Rice was held not to be binding on them.

Effects of a VAT group

In the battle of legal fictions, and following the historic House of Lords case law, the time of supply fiction appears to prevail over the VAT group fiction.

In Prudential, the Court of Appeal considered whether the principles outlined in article 11 of Council Directive 2006/112/EC should prevail. The effect of article 11 is to treat members of the same VAT group as a single taxable person. The argument followed that activities undertaken within a single taxable person are not activities that can be subsequently taxed. The Court of Appeal was asked to apply the Marleasing principle to achieve the result envisaged by article 11.

As a slight digression: the Marleasing principle continues to be highly relevant for interpreting VAT andexcise law. While retained EU law is no longer supreme following the Retained EU Law (Revocation and Reform) Act 2023, the general principles of retained EU law continue to apply for the purpose of interpreting VAT and excise law (FA 2024 s 28(5)). This means VAT law should still be interpreted in accordance with retained EU law, and the Marleasing principle of interpretation still applies in respect to VAT law.

In this case, Marleasing did not persuade the Court of Appeal to apply the VAT group fiction in the way argued by Prudential. However, there will be further cases heard in due course, which may provide future opportunities for the courts to consider the scope of the VAT group fiction. The focus of the upcoming cases concerns the scope of HMRC's power to 'protect the revenue' and the circumstances in which HMRC can reject an application for an entity to join a VAT group, or to terminate an entity's membership of a VAT group where VAT savings go beyond the normal consequences of grouping.

As a result of Prudential, there may be more uncertainty as to the meaning of 'normal consequences' of transactions conducted by members of the same VAT group, with potentially more uncertainty as to how, and in what circumstances, HMRC ought to exercise its powers to 'protect the revenue'.

Conclusion

The case ultimately boiled down to a clash between two distinct VAT 'fictions'. On the one side was the time of supply fiction, which treated the supply as occurring when VAT invoices were issued or payments were made. On one other side stood the VAT group fiction, which would have the court disregard the commercial activities conducted by entities within the same VAT group.

These VAT fictions have real world tax consequences: companies enter and leave VAT groups for many reasons including reorganisations of corporate groups and M&A activity – and it is important for the scope of legal fictions to be clear to taxpayers. The Court of Appeal in Prudential has clarified that VAT will apply to transactions between members of the same VAT group, if payments occur at some time in the future after the parties are no longer part of the same VAT group.

It is crucial for VAT advisers to recognise and allocate the risks that may arise from activities conducted while parties are members of the same VAT group where payments might become due after the parties are no longer part of the same VAT group. 

The author's firm acted for the appellant in this case.

This article was first published in Tax Journal on 12 April 2024.