ECJ says VAT should not be due on music industry samples

Since 1987 UK label EMI has been distributing free samples of music to thousands of reviewers, DJs and industry professionals and has been paying VAT on the tapes, CDs and records.

In 2003, though, the company asked Her Majesty's Customs and Revenue (HMRC) to refund it that VAT because, it said, demands for the tax were incompatible with the 1977 EU directive on VAT.

EMI took its case to the VAT and Duties Tribunal, which asked the ECJ to rule on whether UK demands for VAT on free copies of albums was consistent with EU rules on samples and small gifts.

The ECJ said that EMI should be entitled to distribute the albums as samples without incurring VAT.

The EU Directive says that when companies distribute goods they should pay VAT on them. It contains exemptions, though, for samples and for small gifts. EMI argued that these exemptions should apply to its distribution of free music.

The UK implementation of the exemption for samples says that only the first sample can be VAT free. Before 2003 it said that a sample could only count as such if it was in a form not available to the public.

The ECJ ruled that this was too restrictive a definition of samples.

"Goods, distributed as samples, which are identical to the final product to be placed on the market are, it is true, liable to be the subject of final consumption," it said, final consumption meaning the process which attracts VAT.

"That fact cannot, however, justify an exemption in respect of samples covering only those specimens which differ from the product represented, given that, in many cases, making available specimens which correspond to that product in its final form is a necessary prerequisite for the process of assessment," said the ruling.

"In order to allow the goods supplied to be assessed as ‘samples’, those goods must have all the essential qualities of the product which they represent, in its final form," said the ECJ. "While, in some cases, the specimens may have all the essential qualities of the product represented without being in the final form of the product, it may prove necessary, in other cases, depending on the nature of that product, for the specimens to correspond exactly to the final product, so that those qualities can be demonstrated to the potential or actual buyer. "

The Court heard that hundreds, even thousands, of copies of an album can be distributed to promote it. Record labels use firms of 'pluggers' who receive up to 600 copies of a release for further distribution to music industry professionals, the Court heard.

The ECJ said that even in these cases, VAT is not necessarily payable.

"In certain cases, the distribution of several or even a significant quantity of specimens of the same product to a given recipient may be necessary in order to meet the objectives of distributing samples," it said. "Thus, in the case of recorded music, it may be necessary, for the purposes of critical assessment and the promotion of a CD, to give many copies of that CD to intermediaries so that they can subsequently forward those copies to targeted individuals on the basis of their ability to promote sales of recorded music."

The Court said that the right of a label to distribute music VAT-free through pluggers was not even eroded if those pluggers are found to abuse the right and distribute that material to consumers. It did say, though, that countries would be permitted to pass laws demanding that labels take action to prevent that happening.

The Court also considered whether or not UK laws limiting the exemption for business gifts of small value to those under £50 was justified. It said it was.

"This judgment does not mean that all the UK’s legislation on samples and business gifts is wrong," said an HMRC statement on the ruling. "In principle they are relieved from VAT, and the ECJ has not ruled against restricting the scope of that relief where appropriate."

"We will need to carefully consider the judgment and determine the extent to which UK legislation may require amending," said HMRC.

A tax expert said that the ruling was a major change, though, and that companies should act on it immediately.

"[This] will impact many businesses both in the UK and across the EU which distribute samples or gifts of small value," said Giles Salmond of accountancy firm Deloitte. "Businesses which have accounted for VAT, or not reclaimed the appropriate VAT on samples or business gifts, should consider submitting retrospective claims as soon as possible, if they have not already done so."