Watch out for the tripartite VAT trap

Paying for a service doesn’t automatically mean you have the right to reclaim the associated VAT. Businesses involved in tripartite agreements often wrongly make this assumption, only to face an HMRC challenge.

For VAT purposes, agreements between two parties are relatively straightforward as the identities of the supplier and customer are clear. “When three parties are involved, however, the identity of the customer – and thus the party entitled to reclaim VAT – can be a cause of dispute between taxpayers and HMRC,” says Robert Facer, VAT expert at Moore Stephens. “Tripartite agreements therefore set the alarm bells ringing in the VAT world.”

The Airtours case, recently heard in the Court of Appeal, is a classic example of how disputes arise. When seeking to renegotiate its bank finance, Airtours was required by the banks to obtain a report on its financial position. PwC was engaged to provide this report. “PwC’s engagement letter was with the banks and Airtours – it was a tripartite agreement,” says Robert. “The engagement letter stated that both the banks and Airtours would receive a copy of the report, and Airtours would be responsible for paying the firm’s fees.”

When Airtours later sought to reclaim the VAT incurred on PwC’s fees, however, HMRC disallowed the claim. HMRC argued that PwC had actually supplied its services to the banks – and therefore only the banks could treat the VAT on those fees as their own.

The case made its way to the Court of Appeal. “The court found that Airtours was party to the agreement with PwC,” Robert says. “Airtours therefore had a contractual relationship with PwC, had received a copy of the report and had paid for PwC’s services. Despite that, the court focused on PwC’s letter of engagement and found that PwC’s obligations were really to the banks. It was the banks that received PwC’s services and, therefore, the VAT charged by PwC belonged to the banks.” This in effect rendered the VAT irrecoverable, given that banks generally cannot recover much, if any, of their VAT on costs incurred.

“Such tripartite situations can arise in other sectors as well, such as property,” Robert notes. “A landlord may wish to take legal advice on an issue, but require the legal fees to be paid by the tenant. The tenant may want to reclaim the VAT. Whether they can do so depends on whom the lawyers supplied their services to; only that person can treat the VAT as their own.”

Misunderstanding this requirement creates a common trap for many businesses. “You may pay for a service, but that doesn’t mean the VAT is yours to reclaim,” Robert stresses. “What matters is who received the service. The wording of the contract will be key.”

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