VAT specialist Nick Warner comments on the effect of the Skandia case and the cost to EU branches with a VAT group.
Following the European Court decision in Skandia America Corporation
(C-7/13) the UK financial services industry has begun to count the potential VAT cost.
The case decided that supplies by an offshore head office (HO) to a VAT-grouped, on-shore branch were received by the VAT group (as a single taxable person) and not the branch. As a result the supplies will be liable to the reverse charge, and subject to the VAT group’s partial exemption method.
The case was taken by the Swedish tax authorities because they viewed it as third party IT services being purchased VAT-free by the Skandia HO in the US, re-supplied free of VAT into the Swedish branch, and then consumed, at least in part, by the rest of the partly-exempt VAT group. In the UK, this would have been caught by the VAT Act s43 (2A) anti-avoidance provisions, and to be fair to the UK, it intervened (unsuccessfully) in the deliberations of the court to promote this position as the best outcome.
This is essentially a ‘VAT grouping’ issue and, although the decision applies across the EU, individual member states have different approaches to grouping (some don’t have it at all), which means that the impact and any partial solutions could be different for each country. This commentary for now focuses solely on the consequences for the UK.
Where this case bites
Third party services bought in by an offshore HO and then supplied to a UK branch were previously not considered to be a supply. However, under the Zurich decision, there has always been an argument that the external supplier might be providing services directly to the UK branch if that is the most closely associated recipient (based on a number of established tests). This would result in a reverse charge.
In addition, if the bought-in services were supplied to the UK branch and then other members of the VAT group benefitted from them, the anti-avoidance provisions would apply, in effect creating a reverse charge to the extent of other VAT group use.
now also brings into the reverse charge net are:
- Bought-in HO to UK branch supplies that the branch itself is going to use.
- In-house HO costs that are recharged or allocated to the UK branch.
- Recharges by a UK HO (that is part of a VAT group) to an EU branch (reverse chargeable upon receipt in that country). This was not covered in the judgement, but is implicit in the decision.
Point 2 (above) is considered to be the largest cost, and this is exactly what the UK’s intervention was trying to avoid. This discriminates against multi-national groups who, for example, commonly set up an IT centre of excellence in one location for the benefit of the whole group, or regularly provide staff from one location to another. However, there is unlikely to be the same level of sympathy from the EU Commission that we saw with the Andersen case. Therefore, change for the worse is inevitable, and the UK’s room for manoeuvre potentially restricted.
It is probable that HMRC will consult on the impact of this case, and it is therefore likely that it will be implemented in the UK from a date in mid-2015. It is certain that there will also be a Revenue & Customs Brief setting out HMRC’s position.
What should you do now?
Given the publicity of this high profile case, business affected by the decision will need to be able to estimate the potential cost for their management. This will also be necessary in the event of any consultation exercise. The basic starting position is:
a. For charges received by a UK branch from its HO, the cost will be 20% of any services that are not exempt, excluding any reverse charge already accounted for (less any recovery under your partial exemption method).
b. For charges made by a VAT-grouped UK HO to an overseas EU branch, this will be the value at the local VAT rate less any recoverable under local partial exemption conditions.
(If you wanted an upside, you could add in the value of the charges under b) above into your UK partial exemption method and see how much your recovery rate improves.)
What can you do in the long-term?
In my opinion, there is little merit in embarking upon any major restructuring until we know precisely how the case is to be implemented.
case did, in theory, uphold the basic principle established in the previous FCE Bank decision that supplies between the same legal entity were not taxable – they only now become so as a consequence of VAT grouping. This means that if your branch is not VAT grouped, the supply by the HO to it is capable of falling outside of the VAT net. This may be relatively straightforward for a small fixed establishment, but for a large UK branch de-grouping could have significant financial consequences within the UK. (It should be a point in any consultation that HMRC will not invoke a protection of the revenue argument for branches that wish to de-group as a consequence of this decision.)
Driven by regulatory reasons, most insurance groups operating in the UK will have a service company within the VAT group. If the branch is de-grouped, it will be essential to establish whether or not the services charged to it by the service company are capable of VAT exemption, as if these were liable to VAT, the cost could outweigh the cost arising from the HO charge.
Many HO charges comprise a wide-range of service types, and it will be sensible to identify and categorise these, together with any contracts, to establish if any are capable of exemption as insurance-related or zero-rating (e.g. travel). It may also be the case that the HO is merely making a payment on behalf of the branch, although this might still result in a reverse charge for the recipient.
Charges from an offshore HO to a UK branch in respect of staff working in the UK can possibly be managed through amendments to how they are contracted for and remunerated through the payroll system. As a small saving, the recipient country should ensure that it arranges for the travel costs to be billed to it directly rather than be included in a recharge from the HO.
If you have a UK branch of a non-EU regional HO in your VAT group, and it receives charges from it, it may be possible to directly attribute the potential reverse charge to non-EU business. More widely, when costs are received and then recharged, it may be possible to mitigate the exempt VAT through a more sophisticated partial exemption method that takes account of the fact that outputs that were previously not considered to be supplies are now potentially taxable supplies. This is particularly relevant where you have a UK HO charging its EU branches.
More generally, there may be opportunities to mitigate the cost of the reverse charge through the partial exemption method. For example, in the case of the Skandia branch in Sweden, the recharge of IT to recipients outside of the VAT group would have been taxable, and increased its recoverable proportion.
If you would like to discuss the impact and practicalities of any of these points, please contact Nick Warner.