HMRC has issued its response to the recent, and much talked about, decision of the CJEU in the Skandia case. As anticipated it is very much an instruction to UK businesses to “wait and see.” Before we look at HMRC’s response it is useful to give a quick update on the case.
The Skandia group used a familiar VAT mitigation strategy in the FS sector. Skandia America Corp, a US company acted as the global procurement company for the group. It sourced global services such as IT (the service in question in the case) from third party suppliers based in the US. As the services were supplied between US companies VAT did not arise on the supply. Skandia America had branches in the EU and these branches were included in VAT groups with the local trading entities. The costs of the third party services were recharged to the branches in the member states. The CJEU has previously confirmed that there cannot be a supply of services for VAT purposes between establishments of the same legal entity and therefore the branch recharge fell outside the scope of VAT and no reverse charge obligation arose. The branch then on-supplied the service to the local entity and as both were in a VAT group, VAT grouping relief applied to ensure there was no VAT on the onward supply. The net result was that the partially exempt EU trading entity did not pay VAT on the purchase of the IT service.
For further information the Skandia case, please see our earlier briefing on VAT on cross border internal recharges.
What is a VAT group – a national matter?
The success of this mitigation strategy relies on the fact that there is no supply for VAT purposes between a head office and a branch. Although this is a basic principle of EU VAT law, the EU Commission and certain Member States have often suggested that the rule does not apply where either the branch or head office is part of a VAT group. The logic behind this is that the group becomes a separate taxable person from the companies that comprise it and as a separate “taxable person” it could receive supplies from non grouped head offices located in a different country.
The UK has always taken a different (and in our view a more logically coherent) approach that as a branch and a head office are simply two parts of the same entity if the branch is in the VAT group the head office must also be in the VAT group.
The CJEU however appeared to agree with the Commission’s view and held that as a VAT group was a separate taxable person any supplies made to the branch were to be treated as supplies to the VAT group of which the branch was part. Therefore a reverse charge will arise in the VAT group return on the recharge of the services from the US head office to the EU branch.
We say “appeared” because the wording used in the Swedish language version of the decision is slightly different to the wording in the English language version. However slight differences can be important. In the English version of the case the CJEU used the phrase “as that company and that branch cannot be considered to be a separate taxable person.” In the Swedish version the wording was “under the premis that the company and its branch cannot be treated as a separate taxable person.” Swedish law only permits the branch to be admitted to the VAT group. Therefore it is arguable that the decision only applies where the domestic law is similar to that in Sweden, i.e. stating expressly that only local branches and not head offices can be in the VAT group. UK Law treats, or purports to treat the entire legal entity, both head office and branch as being in the VAT group.
If this interpretation is right it would mean that the ruling would not necessarily apply in the UK. That’s a big “if”. There is no doubt the wording is different, between the versions but the real question is the extent to which you can isolate the wording from the rest of the decision. The decision very much references the Directive rather than the Swedish law. It refers to the VAT group as being a single entity based on the Directive. The expression “on the premis that” seems to be referring to the premis the Court had set out in its earlier paragraphs and not to any specific premis set out in Swedish law. In truth it is difficult to know whether the Court was basing this decision purely on Swedish law but the uncertainty gives Member States that don’t wish to implement the ruling the wriggle room not to do so.
The importance of geography
The UK authorities have issued a response to the decision in R&C Brief 37 and have as expected said they are considering their position and that businesses in the UK should carry on as normal. However even as a holding brief it suggests that HMRC are of the view that the case may be specific to the VAT grouping rules as enforced in Sweden and does not necessarily apply to the grouping rules in the UK.
The UK tax authorities are of the view that under UK grouping rules if a branch is in a UK VAT group the head office is also in the VAT group. As discussed above Swedish rules specifically provide that only the branch can be in a Swedish VAT group. HMRC appear to see this as a key distinction in the application of the decision in a UK context. If this is indeed HMRC’s position the logic is questionable both on the impact of the Directive and on the nature of the question considered by the Court.
The question asked by the Swedish Court was generic in nature rather than being directed specifically at the provisions in Sweden’s law. Furthermore the Court answered the question in terms of the Directive and not in terms of the specific grouping rules in Sweden. HMRC’s basic tenet that the Court was considering specific rules in Sweden rather than an overarching principle of EU VAT law does not seem to be supported by the reasoning in the decision handed down.
However the distinction as drawn may be enough to allow HMRC to at least significantly delay changing current UK policy and could (depending on the outcome of its deliberations) de facto result in HMRC ignoring the decision unless and until the Commission decides to take infraction proceedings.
Given HMRC’s focus on the differences between the UK and Sweden’s VAT grouping provisions the question arises whether HMRC would need to amend UK grouping rules in order to implement the decision. Again its not clear cut but certainly an argument can be made that HMRC has done all that it needs to do by having VAT grouping rules in the first instance, and that all this decision does is to clarify the extent of a VAT group once bought into national law.
Obviously each member state will have its own analysis of the impact of the decision and where you have branches in other Member States you should also factor in how those Member States will implement the decision.
However, for the moment at least, in the UK the message is very much “steady as she goes.”
What should businesses consider?
We expect that the tax authorities in all Member States, where the national VAT Grouping rules are similar to those in place in Sweden, will thoroughly review the ruling and implement it, increasing the VAT burden within the financial sector. It is important to point out that there isn’t yet full clarity for taxpayers on how the tax authorities in different Member States will implement and apply the ECJ decision. From a UK perspective, we understand that any changes in the nature or interpretation of UK law will be prospective only. International Financial service groups with VAT grouped branches should review their existing business flows and start thinking about which services might be affected.