In depth

Is there "a" test to characterise a supply for VAT purposes?

The characterisation of a supply is perhaps one of the most popular issues in the VAT world. Despite a large body of case law, there is still room for "fresh" interpretations. In Gray & Farrar International LLP v HMRC [2023] EWCA Civ 121 (G&F), the Court of Appeal recognised the "principle of EU law that the predominant test is the primary test to be applied in characterising a supply for VAT purposes" from the perspective of the typical consumer (at para 47). According to the Court of Appeal, the predominant test was laid down by the CJEU in Mesto Zamberk v Financní reditelstvi v Hradci Kralove (Case C-18/12) (Mesto) in which "the CJEU gave authoritative guidance on the test for deciding how a single complex supply must be categorised for VAT purposes […] the language used by the CJEU in setting out this test is mandatory" (at para 47). 

Whether readers agree with this view from the Court of Appeal to elevate Mesto to such height is open for debate (noting that the decision in G&F is final). In any case, G&F has the merit of upholding a hierarchy of tests to be applied in characterising a single supply for VAT purposes under UK law. Even though the difference between each test (set out below) may appear shadowy at times, in particular regarding test 1 and 2, it provides useful guidance: 

1. The "Mesto predominance test" should be the primary test according to the Court of Appeal. It involves weighing up the individual elements of a supply to determine what the typical consumer would regard as qualitatively the most important one.

2. The second test is the "Card Protection Plan principal / ancillary test". It is only capable of being applied in cases where it is possible to identify a principal element to which all the other elements are minor or ancillary.

3. The third test is the "overarching" test. It involves undertaking a more holistic, qualitative assessment of the supply (the description of the supply will generally be self-evident).

That said, in the author's view, it seems unclear how the primary test (i.e., predominant test) set out in G&F aligns with recent CJEU judgments on this issue in Frenetikexito (Case C-581/19) and Deco Proteste (Case C-505/22) in which no application of such a "predominant test" has been made. 

Is VAT deductible in the context of a share deal?

Perhaps surprisingly, the VAT regime of holding companies continues to generate excitement. Readers are familiar with the now "old" BLP Group (Case C-4/94) (BLP) judgment from the CJEU. The CJEU held that a holding company that provides management services to its subsidiaries makes an exempt supply when it sells shares in those subsidiaries, and is, therefore, unable to recover the VAT it incurs that relates to the sale of the shares. At the time, this decision did not seem unreasonable since it applied general principles that VAT attributable to exempt supplies is not recoverable.  

However, years have gone by, and subsequent judgments from the CJEU looked beyond the "chain-breaking effect" of a share transaction so as to focus on the link between the relevant costs and the taxpayer's wider economic activities. In Kretztechnik (Case C-465/03), it was held that VAT incurred on costs related to a share issue was deductible as part of the company's overheads since those costs have a direct and immediate link with the whole economic activity of the taxable person (assuming, of course, the company is engaged in the making of taxable supplies). Similarly, in SKF (Case C-29/08), the CJEU granted recovery to the taxpayer provided that the relevant costs were part of the cost components of taxable supplies in the course of the taxpayer's wider business. SKF was fully embraced by the Supreme Court in HMRC v Frank A Smart & Son Ltd [2019] UKSC 39. 

Against this background, the conclusion reached by the Upper Tribunal in HMRC v Hotel la Tour Ltd [2023] UKUT 178 (TCC) (Hotel la Tour) was to be expected even if it did not go as far as overruling BLP when it set out "although not formally overruled, the BLP decision can no longer be regarded as representing a complete statement of the CJEU's jurisprudence in this area" (at para 62). Hotel la Tour sold a subsidiary in order to raise financing for a new project and incurred professional fees in doing so. The Upper Tribunal concluded that the taxpayer was entitled to recover VAT on those fees since the purpose of the transaction was to use the sale proceeds for its taxable activities (consisting of a hotel development). 

This decision is of course welcome. However, taxpayers should be advised to carefully document a transaction, in particular when it comes to setting out the purpose of the deal and the use of the sale proceeds. In C&D Foods (Case C-502/17), the CJEU denied recovery on the basis that the sale proceeds were used to settle debts owed to a third party bank, which "cannot be deemed to be either a transaction for which the direct and exclusive reason is the taxable economic activity of C&D Foods, or a transaction constituting the direct, permanent and necessary extension of the taxable economic activity" (at para 39). Although it is debatable whether settling a company's debt is or isn't part of the economic activity as a whole, C&D Foods and Hotel la Tour outline the criticality of documenting the purpose of any deal. We note that HMRC was granted an appeal in Hotel la Tour due to be heard in April 2024. Watch this space. 

Is the outsourcing of payments still capable of being exempt from VAT?

The judgment in Target Group Ltd v HMRC [2023] UKSC 35 (Target) was probably the most exciting case of the year for those working in the financial sector. After all, who does not want to know what a payment is at the time when, coincidentally, VAT celebrates its 50th birthday? With all due respect, hold your breath as the definition or parameters provided by the Supreme Court may not be as helpful as some had hoped for.

For a payment to be exempt from VAT, the "services must in themselves have the effect of transferring funds and changing the legal and financial situation. It is not enough to give instructions do to so thereby triggering a transfer or payment. It is not enough to perform a service which is essential to be carrying out of the transfer or payment, nor one which automatically and inevitably leads to transfer or payment. It is necessary to be involved in the carrying out or execution of the transfer or payment – its 'materialisation'. This requires functional participation and performance. Causation is insufficient, however inevitable the consequences" (at para 56).

Even though one may not necessarily fully understand what "functional participation and performance" means, the conclusion of the Supreme Court certainly narrows the scope of the payment VAT exemption in an outsourcing context since the exemption only applies where a payment or transfer is made. Any step prior to the making of a payment or transfer seems out of reach, making FDR [2000] STC 672 belong to a bygone past. 

On the flip side, though, the Supreme Court upheld that the outsourcing of payments can still be exempt since "the exemption can apply to payments effected by multiple financial institutions, as borne out, for example, by the range of changes in the legal and financial situation of different parties which is referred to a para 53 of SDC" (at para 62). Whether this statement is, in practice, only applicable to the world of interbank clearance will have to be seen. No doubt Target may not be the end of the road when it comes to interpretating the scope of the payment exemption.

Retained EU Law (Revocation and Reform) Act 2023: are we or are we not going to rely on EU law principles?

Running up to June, the future of UK VAT law looked pretty grim (albeit readers may have different opinions on this matter). The government was keen on getting rid of all retained EU law by 31 December 2023 saying that there was "no place for EU law concepts in our statute book." This radical approach would have meant a dramatic risk of legal VAT uncertainty as existing principles of EU law (such as fiscal neutrality and abuse of law) would have simply vanished. In addition, the judgments from the CJEU would have become as relevant as any other jurisdiction around the world, no matter whether they were issued pre- or post-IP completion date (31 December 2020). Given how embedded CJEU cases and EU law principles are in the UK VAT apparatus, such move would have brought too much uncertainty for UK taxpayers.

On 20 October, the government published draft legislation which aimed at clarifying how VAT (and excise) legislation is to be interpreted in light of REULA 2023. In a Twist in the Tale, the draft legislation – which was first published on 20 October for technical consultation, and which was "formally" published in the draft Finance Bill on 29 November following the Chancellor's Autumn Statement (the draft is currently due for second reading in the House of Commons) – essentially states that the supremacy and general principles of EU law will continue to apply as far as VAT and excise are concerned. One key difference between the REULA 2023 and the current regime (i.e. under the European Union (Withdrawal) Act 2018) is that UK courts will not be able to quash or disapply UK law on the basis of an incompatibility with EU law (currently, the supremacy of EU law obliges UK courts to abide by EU law in all circumstances). 

In other news

This year saw two financial services-related consultations take place, whose "results" should be made available in the course of 2024: 

1. The consultation on the VAT treatment of fund management services which closed on 3 February 2023. The consultation was not intended to result in any radical reform; it aimed at giving legislative clarity to the fund types to which the fund management exemption applies, rather than tackling the challenges arising from the concept of fund "management". It is expected that HM Treasury/HMRC will publish a summary of responses to this consultation in the coming months.

2. The consultation on a proposed reform of the Terminal Market Order, which provides for the zero rating of certain commodity transactions on named commodity exchanges. The consultation closed on 12 September 2023. The intention of the government is to modernise, simplify and update the legislation while preserving the existing benefits to market participants. As the UK is outside the EU, such reform – if it takes place – is likely to prove important for the City of London to keep its competitive edge.

It is fair to say that 2023 has been a "grand cru" in terms of VAT developments. Some predicted that Brexit would unleash some new grounds, but it appears to be the opposite. EU law is currently being applied by UK courts as if Brexit did not happen – see G&F, Hotel la Tour and Target – and such approach is unlikely to be brought to a halt in 2024 in light of the "bespoke" approach for VAT and excise law in light of changes made by REULA 2023. Not a bad gift for the 50th year anniversary of VAT if you ask me. 

*This article was first published in the Tax Journal on 15 December 2023.