Loyalty points VAT victory is good news for other businesses, expert says

Ian Hyde a VAT expert at Pinsent Masons, the law firm behind Out-Law.com, said that although the Nectar loyalty scheme differed from many others, the UK Supreme Court's decision in favour of scheme operator Loyalty Management UK (LMUK), now known as Aimia, was "good news" for a range of businesses.

"This victory for the taxpayer is good news for businesses involved not only in loyalty type arrangements but many situations where they pay for the supply of goods or services but are not the obvious purchaser," he said. "It shows that the Redrow  principle is still alive".

Nectar points are collected when customers shop at partner companies, most notably supermarket chain Sainsbury's. Once collected, points can be redeemed for a range of goods and services, either in whole or in part. As operator of the scheme, LMUK paid the companies offering rewards a 'service charge' at an agreed value per point redeemed. Those companies charged VAT on this service charge, which LMUK sought to deduct as input tax.

HM Revenue & Customs (HMRC) argued that LMUK could not recover the input tax because the retailers had supplied goods and services to customers who redeemed their Nectar points and not to LMUK. The payments made by LMUK were third party consideration for those supplies. LMUK argued that, following the principle in the Redrow case, there were two supplies made by the retailers. There was a supply of the goods or services to the customer redeeming the points but also a supply of redemption services to LMUK.

In the Redrow case, the housebuilders, Redrow, promoted the sale of new houses by arranging for estate agents to value and market the customers' existing homes. This was done on the basis that the cost would be borne by Redrow, provided the customer bought a Redrow house. The House of Lords decided that there was a supply of services by the estate agents to the customers, and simultaneously a supply of services by the estate agents to Redrow. Since the supply from the estate agents was received by Redrow for the purposes of its business, it was entitled to deduct the VAT input tax.

The House of Lords (the predecessor of the Supreme Court) referred the LMUK case to the Court of Justice of the European Union (CJEU) for a preliminary ruling.

The CJEU said that the payments made by LMUK in respect of the service charge amounted to a "third party consideration" for a supply of goods or services to customers. Generally, this would mean that LMUK would not be able to recover VAT unless it could show that it was receiving a clear and separate service from the reward suppliers; however, the CJEU did not consider this supply and said that this would be a matter for the national courts to decide.

The Supreme Court had to apply the CJEU decision to the facts. By a majority of three to two, the Supreme Court found that the CJEU made its determination based on an "incomplete evaluation" of the facts of the case. The CJEU had not been able to fully consider the relationships between LMUK, the 'sponsor' companies that issued Nectar points, the customers and the 'redeemer' companies that supplied the rewards, it said. However, the CJEU was right to suggest that the "economic reality" must be considered when deciding whether, and where, VAT should be charged where a transaction happens as part of a "bundle".

"Since no monetary consideration is paid by the collector in so far as the goods and services are exchanged for points, but a payment is subsequently made by LMUK which is based on the value of the points as agreed with the redeemer, it would be possible, if these aspects of the present case, were considered in isolation, to conclude that that payment should be regarded as third party consideration for that supply, and taxed accordingly," said Lord Reed in his leading judgment.

"As I have explained, however, there is another dimension to the case ... [LMUK's] business model is to sell the right to receive goods and services, pay redeemers to provide the goods and services, and derive a profit from the difference between its income from the sponsors and its expenditure on the redeemers," he said.

Lord Reed went on to say that the only "economically realistic explanation" for both the 'redeemer' companies accepting points with "no inherent value" in exchange for goods or services, and for the service charge paid by LMUK to the 'redeemer' companies, was "the value to LMUK itself of the redeemers' acceptance of [the] points". He pointed out that if LMUK was not entitled to recover the VAT it paid on the service charge, HMRC would be receiving VAT on both the amount received by LMUK for supplying the right to receive those goods and services and also the amount that LMUK must pay to satisfy that right.

The judge acknowledged that the facts of the case were "complex and unusual", differing as they did from the sort of loyalty schemes operated by retailers as part of their own business.

The company and HMRC have been asked to provide "further submissions" to the Court to help it decide the "precise form of the order to be made", according to the judgment.

Editor's note 18/03/2013: This replaces and corrects an earlier version of this story.