HMRC: incoming UK VAT 'accounting' changes were needed following Skandia judgment, says expert

The UK tax authority said that no changes to 'grouping' provisions allowing closely-linked companies to be treated as a single entity for VAT purposes were required following a ruling by the EU's highest court the Court of Justice of the European Union (CJEU) last year. However the ruling, in favour of the Swedish tax authorities against US-headquartered insurance business Skandia, would affect UK VAT accounting and may result in VAT becoming due in some circumstances, HMRC said.

The changes would have cost implications for banks and insurers operating in the UK and in Sweden, or other EU member states operating similar grouping rules, said financial services VAT expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com. These businesses cannot recover VAT paid in the same way as businesses in other sectors, as much of their business is VAT exempt, he said.

"The impact of the changes, as put forward in the brief, does not appear to be as damaging as businesses at first feared, following last year's CJEU judgment," he said.

"However, the policy to be implemented by HMRC from the beginning of 2016 will require businesses to undertake specific due diligence concerning the VAT rules around grouping in those member states in which they have branches. In particular there could be problems for those UK businesses with VAT groups in Germany, the rules for which operate on both a compulsory and 'German establishment only' basis," he said.

Last year the CJEU ruled that services supplied by the US headquarters of an insurance business to a Swedish branch which was VAT grouped with other local companies were subject to VAT. The court said that because the branch of the US company was the member of a VAT group, it could no longer be treated as being the same legal entity as its US head office for VAT purposes. The creation of the VAT group established a new entity, for VAT purposes, which was an amalgam of all its members, it said.

UK rules require companies to have an establishment in the UK before they can join a UK VAT group. However, unlike in Sweden, the whole company becomes part of the UK VAT group, not just the particular branch or head office located in the UK. This means that the situation as in the Skandia case, where services were provided by an overseas unit of the same company to a Swedish unit, would not normally be treated as taxable supplies for VAT purposes at all in the UK as they are transactions within the same taxable person.

"The Skandia judgment did not consider the UK's different rules, which allow the whole body corporate into the UK group, and so did not rule this to be contrary to the VAT Directive," HMRC said in its briefing note.

"The current grouping rules relating to UK VAT-grouped companies with overseas establishments will therefore be maintained. If an overseas company with a fixed establishment in the UK joins a VAT group, the whole legal entity (the company and its branches) becomes part of that taxable person," it said.

However, the judgment would affect the tax treatment of overseas establishments of UK businesses based in EU member states that operate similar 'establishment only' grouping provisions, HMRC said. In these cases, if the overseas part of the business was part of a VAT grouping in that member state, it would no longer be part of the same entity as the UK business. Supplies between the UK business and its overseas counterpart would therefore have to be treated as supplies made to or by another taxable person, with VAT accounted for in the usual way, HMRC said.

HMRC said that it would confirm the member states that operated similar VAT grouping rules as Sweden "as soon as possible". It would then update its guidance to make it clear on which intra-entity transactions VAT would have to be accounted for, it said.

The new UK rules are to be implemented with effect from 1st January 2016. In addition to the basic legal entity principle, HMRC also confirmed that the impact of the changes would apply to any s43(2A) calculations being performed by the business.

"It is probable that the combination of the prospective date of implementation along with the narrowed scope of the changes will lead many businesses to conclude that the news could have been a lot worse," Mellor-Clark said. "However, it remains the case that a number of businesses may well see profound impact from even this more limited iteration of the VAT group principle."

One must assume that HMRC took legal advice prior to announcing the implementation and so should be reasonably confident of its position. That being said, there will be a sense of watch this space as we await any reaction from the Commission, which has, in the past, disagreed with the UK's establishment position," he said.