Why contract details matter for VAT
By Vaughn Chown
Vaughn Chown explains how the VAT liability of a transaction is determined.
The correct VAT liability of a transaction can often be difficult to determine and if the contractual detail does not reflect what is happening in practice, how is the VAT liability to be determined? The Court of Justice of the European Union (CJEU) have provided the answer.
Newey t/a Ocean Finance (C-653/11)
A UK business that was unable to reclaim its input tax due to it making exempt supplies set up a Jersey subsidiary to receive advertising services without the addition of VAT from a Jersey supplier.
The Court was concerned with the arrangements put in place by the taxpayer.
To determine the correct rate of VAT for the transaction, it was first necessary to determine the relevant facts, such as the identity of the customer, the nature of the supply, the country in which the supply is made, and so on. The terms of a written contract are a good guide, but should not be overly relied upon, according to the CJEU.
The VAT legislation refers to the facts of a transaction, not to a contract written to reflect it. Sometimes a transaction can be significantly different in practice to what was envisaged in the contract.
The CJEU explained during the case that “sometimes, certain contractual terms do not wholly reflect the economic and commercial reality of the transactions… in particular if it becomes apparent that those contractual terms constitute a purely artificial arrangement which does not correspond with the economic and commercial reality of the transactions”. In the Ocean Finance case, the CJEU was concerned only to focus attention on the arrangements put in place by the taxpayer.
The details of the case are that a Jersey business supplied advertising services to a Jersey subsidiary of the taxpayer. The taxpayer made exempt supplies for VAT purposes in the UK and would therefore have suffered an irrecoverable VAT charge if he had purchased the advertising services direct from the Jersey business.
Despite the CJEU reverting the case to the national court to determine the facts, it did consider how the transactions should be ‘re-established’ if the national court did find that an abusive practice had occurred. The CJEU stated: “the Commissioners … could legitimately regard Mr Newey as actually being the supplier of the loan broking services and the recipient of the supplies of advertising services at issue in the main proceedings”.
However, the basis upon which the national court could re-establish the transactions was only an observation made in passing by the CJEU. While no determination was made by the CJEU as to whether the circumstances were abusive, it did comment that “contractual terms, even though they constitute a factor to be taken into consideration, are not decisive for the purposes of identifying the supplier and the recipient of a ‘supply of services’”. Effectively contracts can be set aside if they do not reflect the commercial and economic reality. So while not categorically stating the arrangements were abusive, the CJEU adopted the position of economic reality.
Subsequent to the CJEU observation, HMRC issued the following statement in their Revenue & Customs Brief dated 9th July 2013: “The guidance from the CJEU confirms HMRC’s view that economic reality must be considered and that contractual relationships do not necessarily determine VAT issues. HMRC will continue to mount in-depth investigations where we believe that a tax advantage may have been claimed artificially.”
This is a far more general issue than the abuse of practice point. It is not only those businesses trading with offshore parties that should review the substance of their transactions. Businesses of all kinds should consider whether their transactions differ in practice from their contractual terms. If differences are found, the business should review their VAT position and consider whether a different rate of VAT might apply.
Contracts should reflect the actual arrangements and only then will they stand up to scrutiny in determining the VAT liability of a transaction.
Published February 2014