Impact on existing cost share groups following changes to HMRC’s policy (VAT information sheet 02/18)

This information sheet tells you about the changes to HMRC’s policy that affect existing cost share groups following recent judgments made by the European Court of Justice.


Article 132(1)(f) of the Principal VAT Directive (2006/112) provides an additional exemption for certain activities that are in the public interest.

The exemption allows persons who carry on these activities to join together to form a cost share group (CSG) so that they can acquire services and recharge their members for their use of the services at cost without incurring any additional sticking VAT. This exemption allows small providers who cannot afford to acquire assets on their own account to benefit from the same overall VAT position as larger providers who can afford to purchase the assets themselves.

The directive exemption is reproduced in Item 1 of Group 6 to Schedule 9 of the VAT Act 1994. There has previously been some uncertainty over what exactly the exemption was intended to cover, but this has now been clarified by the European Court of Justice in the cases referred to in Revenue and Customs Brief 3 (2018).

The findings in the cases

Luxembourg applied the cost sharing exemption (CSE) to services supplied by a CSG which were used by members of the CSG for both:

  • exempt and non-business transactions
  • taxable transactions for which the exemption was not available

Luxembourg allowed the CSG to exempt its supplies even when the member’s taxable transactions were up to 30% (or in some cases 45%) of its total turnover. The European Court of Justice decided that the CSE did not apply in those circumstances. But it held that members of a CSG that also carry out taxable activities could qualify for the CSE, but only because the services received were directly necessary for the members’ exempt or non-taxable activities.

HMRC has adopted a similar policy in the UK to Luxembourg (see the VAT Cost Sharing Exemption Manual, CSE3740), but limited taxable transactions to a maximum of 15% of total turnover. HMRC is now considering how to bring its policy into line with the judgment in that case.

In the Aviva and DNB Banka cases, the European Court of Justice decided that the CSE only applied to activities covered by Article 132(1) of the Principal VAT Directive and not to activities covered by Article 135 such as insurance and finance. This was also the court’s conclusion in the German infringement case, where the Germans had applied CSE too narrowly and not to all of the social exemptions.

The Advocate General concluded in her Opinions in the Aviva and DNB Banka cases (paragraphs 65 and 47 respectively) that the CSE only applied to services which a group supplies to its members within the same member state. HMRC has concluded that it’s the correct analysis of the position under UK law as well.

In DNB Banka, the Advocate General considered that the CSE could not be applied to any services where an uplift was applied, regardless of whether or not this was a transfer pricing adjustment required under the legislation of the member state concerned.

The changes in policy applicable with effect from the date of the brief and this VAT information sheet

The following changes are effective from the date of the Revenue and Customs Brief 3 (2018) (but see section 4).

(a) The CSE is restricted to CSGs whose members engage in the exempt activities listed below. The activities are those which are covered by Article 132(1) of the Principal VAT Directive. The corresponding exemptions in Schedule 9, VAT Act 1994:

  • postal services (Group 3 )
  • education (Group 6)
  • health and welfare (Group 7)
  • subscriptions to trade unions and professional bodies (Group 9)
  • sport (Group 10)
  • fund raising by charities (Group 12)
  • cultural services (Group 13)

(b) The CSE is restricted to members and CSGs located in the UK.

(c) The CSE isn’t allowed where an uplift has been charged on transactions for any purpose (see section 8).

The judgments do not cover non-business activities and therefore members engaged in these activities are unaffected by the changes in this VAT information sheet.

Transitional arrangements for existing CSGs

This section explains the transitional arrangements that apply to existing CSGs that have correctly applied the guidance in the VAT Cost Share Exemption Manual (referred to as transitional arrangements).

Those CSGs will be allowed to apply and rely on the previous guidance until 31 May 2018.

But these transitional arrangements cannot be applied or relied on in cases of tax avoidance or where there’s likely to be a distortion of competition. Distortion of competition in this context includes any arrangement which seeks or sought to exploit tax mismatches arising between CSGs or members located outside the UK – see section 7 as that wouldn’t have met the condition in Item 1(d) to Group 16 of Schedule 9 to the VAT Act 1994.

Any services that are invoiced or paid for before 31 May 2018 will only benefit from the transitional arrangements to the extent that they’re performed before that date (specifically the basic tax point under section 6(3) of the VAT Act 1994 will apply). Where prepayment or invoices cover services to be performed both before and after that date, then a reasonable apportionment will be required.

Where an existing CSG has applied the previous guidance correctly, and foresees a significant difficulty in applying these transitional arrangements in the permitted timeframe, they should contact HMRC by 1 May 2018. These CSGs will need to explain the circumstances and provide evidence of any particular difficulties they foresee. HMRC will then consider each case on its own merits. If HMRC aren’t contacted by 1 May 2018 the revised policy must be applied from 1 June 2018.

Current arrangements for housing associations

HMRC is considering how the European Court of Justice judgments impact on CSGs set up by housing associations and will give more guidance at a later date. The previous guidance continues to apply to those CSGs that applied it correctly until HMRC gives more guidance later in the year. Any changes will include similar transitional arrangements to those in section 4 but these may be applied if necessary to the period from the date of this brief.

Test for directly necessary services (the treatment of minor taxable use)

In the VAT Cost Sharing Exemption Manual, CSE3740, where a member of a CSG has either exempt or non-business activities, or both of these that form 85% or more of their total activities, all the supplies they receive from their CSG are treated as being directly necessary for their exempt or non-business activities. The successful infringement proceedings by the EU Commission in the Luxembourg case means that HMRC must now consider what changes need to be made to the guidance to comply with that judgment. As stated in CSE3720, that consideration will include consideration of transitional arrangements to facilitate an orderly transition. For now, CSGs can continue to apply the 85% test.

CSGs or members located outside the UK

One of the legal conditions for use of the CSE is that the exemption must not be likely to cause distortion of competition. In both Aviva and DNB Banka, the Advocate General considered that CSGs (or their members) located in other EU member states or countries outside the EU cannot take advantage of the CSE because of the potential for different tax treatment and HMRC’s limited ability to police other jurisdictions is likely to cause a distortion of competition. HMRC shares this view.

HMRC’s previous guidance excluded CSGs and members located in countries outside the EU. But it allowed them to be located in other member states subject to the other conditions being met. As stated above, the CSE will now be restricted to UK based CSGs and members. But, CSGs and their members located outside the UK but within the EU may be permitted to apply the transitional arrangements under section 4 but only where all of the following conditions are met:

  • a CSG is located in another member state
  • the CSG has implemented the exemption in accordance with HMRC’s previous guidance (where this is different in the member state where it’s located)
  • the CSG can demonstrate to HMRC’s satisfaction that there’s no distortion of competition arising, for example because of a mismatch in tax treatment between the UK and the member state in which the CSG is located - any CSG affected that wants to take advantage of the transitional arrangements should write to HMRC by 1 May 2018 setting out their cross-border arrangements

Uplifts of value of supplies made by CSGs for transfer pricing adjustments and for other purposes

The CSE only applies where there’s exact reimbursement of the costs incurred by the CSG on behalf of its individual members. This automatically excludes any uplift for transfer pricing as the Advocate General pointed out in DNB Banka. It also excludes any uplift made for other purposes.

Amendments to the published guidance

These are outlined in Appendix A to this VAT information sheet.

Contact HMRC

CSGs should contact HMRC if they need more information or are asked to do so in this information sheet.

Appendix A: list of changes to the VATCost Sharing Exemption Manual

The following changes and updates will be made to the manual. All references to ‘exempt supplies’ and ‘exempt activity’ should now be read as ‘relevant exempt supplies’ and ‘relevant exempt activity’. The relevant supplies and activities in question are defined in CSE3660.

CSE1050 Introduction - what the cost sharing exemption is

New sentence: This will now refer to the relevant exempt supplies as listed in CSE3660 and non-business activities.

CSE1250 Introduction - what the conditions of the exemption are

Point 2 is amended to: All the members must carry on an activity that is exempt from VAT under one of the Groups listed in CSE3660 (a ‘relevant exempt activity’), or is a non-business activity.

CSE1350 Introduction - CSG making supplies to non-members

A CSG can make supplies to non-members, but these supplies, unless covered by another exemption, will be taxable. The normal place of supply and reverse charge rules apply to all supplies that are made across international borders.

CSE1400 Introduction - the types of businesses and organisations that can benefit from the exemption

Any business or organisation that is capable of meeting the relevant criteria or conditions to use the exemption to their benefit. The types of businesses and organisations that might benefit are those making supplies in the following exemption groups:

  • postal services (Group 3)
  • education (Group 6)
  • health and welfare (Group 7)
  • subscriptions to trade unions and professional bodies (Group 9)
  • sport (Group 10)
  • fund raising by charities (Group 12)
  • cultural services (Group 13)

These are referred to as ‘relevant exempt activities’ and the supplies arising as ‘relevant exempt supplies’ in this manual (CSE 3660).

Social housing associations remain eligible for exemption if the conditions are met, until further guidance is issued.

The following types of business are excluded from the exemption with effect from the date of issue of Revenue and Customs Brief 3 (2018):

  • banks
  • insurance businesses
  • betting and gaming organisations
  • financial services businesses
  • land and property
  • investment gold

CSE2300 General provisions - UK established CSG members in other member states (OMS) and can a UK business or organisation belong to a CSG established in OMS

The exemption cannot be applied to cross-border transactions of any kind. This applies whether the CSG or member is established in the UK or another EU member state.

CSE2350 General provisions - Do the normal place of supply rules apply

CSGs and their members cannot use the exemption for cross border supplies. Any taxable cross border supplies will be subject to the normal EU place of supply rules, see VAT Notice 741A: place of supply of services.

CSE2400 General provisions - what the input tax treatment in relation to supplies to overseas customers is


CSE2450 General provisions - what it means in relation to supplies received by a UK member of a CSG based in another member state

The cost sharing exemption does not apply to services received from another EU member state. If the person in the UK is receiving the supply in relation to a business, the place of supply is the UK and the reverse charge will be applicable as the supply is not exempt.

If the person in the UK is not in business for VAT purposes the place of supply will be the member state where the supplier is established.

CSE2500 General provisions - EU Procurement Directives

The EU Procurement Directives apply to procurement by public bodies. Therefore, if the purchaser is a public body, as defined by the EU Procurement Directives, it will have to consider whether or not its purchases are subject to the rules set out in those directives.

CSE3460 How the conditions are to be interpreted, number of members and memberships - who’s responsible for the CSG’s VAT affairs - the members or the CSG

As a single taxable person it’s the CSG itself (not its individual members) that’s responsible for its VAT affairs. But, the application of the exemption is dependent on the use to which the recipient members put the services received from the CSG. This is different from many other VAT exemptions where it’s the nature of the supply or the nature of the maker or receiver of it which determines its tax treatment. CSGs must make sure that adequate controls exist to get the information necessary to correctly determine its VAT liability. It should be able to demonstrate to HMRC, when required to do so, that all the conditions of the exemption have been met by all of its members.

The exemption does not apply where supplies involve persons established in other countries.

HMRC are not prescriptive about how CSGs should arrange themselves, because different CSGs will want to do so according to their members’ wishes and requirements. But, HMRC will expect any system that’s put in place to provide a clear audit trail of how the services received from the CSG are used by those individual members in their operations.

CSE3520 How the conditions are to be interpreted, number of members and membership - what the qualifying supplies are

Qualifying supplies are services which are directly necessary to allow a member of the CSG to participate in the relevant exempt and/or non-business activity for which the services are supplied. The relevant exempt activities are referred to in CSE3660.

CSE3600 How the conditions are to be interpreted- relevant exempt or non-business activities - contents

‘Relevant’ is added to ‘exempt and/or non-business activities’ in this section.

CSE3660 How the conditions are to be interpreted - relevant exempt or non-business activities - what the relevant exempt supplies are

Relevant exempt supplies are those falling within the following Groups of Schedule 9 to the VAT Act 1994:

  • postal services (Group 3 )
  • education (Group 6)
  • health and welfare (Group 7)
  • subscriptions to trade unions and professional bodies (Group 9)
  • sport (Group 10)
  • fund raising by charities (Group 12)
  • cultural services (Group 13)

CSE3720 How the conditions are to be interpreted - directly necessary services - what ‘directly necessary’ services are

First paragraph changed to: Article 132(1)(f) requires that supplies made by CSGs to their members must be directly necessary for their relevant exempt or non-business activities. If they’re not the exemption does not apply and the supplies are subject to normal VAT rules.

The ‘Note’ has changed to: Businesses and organisations considering forming CSGs should note that recently the EU Commission was successful in its infringement proceedings against Luxembourg for, among other things, their application of the directly necessary condition, which is similar to the simplification option offered by HMRC in this guidance. (See CSE3740)

While the UK remains a member of the EU it remains bound by the decisions of the European Court and so a challenge to the UK’s implementation of the exemption cannot be ruled out.

HMRC is currently considering what changes it needs to make to this guidance and more information, including transitional arrangements, will be issued at a later date.

CSE3740, CSE 3760, CSE 3780, CSE 3800 and CSE 3848

In each case references to ‘exempt supplies’ reads ‘relevant exempt supplies’. The following footnote has been added ‘The guidance on this page is being reviewed – see CSE3720’.

CSE4000 How the conditions are to be interpreted:

The Heading now reads: Direct reimbursement of costs: Do the direct tax transfer pricing rules will preclude the use of the exemption as affected transactions may not comply with the ‘exact reimbursement of costs’ rule?

The Advocate General in her Opinion in the Aviva case (C-605/15) considered that pricing or repricing transactions under the direct tax transfer pricing rules would preclude the use of the exemption. HMRC considers that the Opinion was the correct analysis because the parties involved in transfer pricing are connected parties and aren’t independent persons for the purposes of the cost share exemption.

HMRC has therefore changed its policy with effect from the date of the Revenue and Customs Brief 3 (2018).

Where a CSG has both unconnected and connected members for transfer pricing purposes, the unconnected members can still receive qualifying supplies and benefit from the exemption as long as there’s no margin or mark-up.

CSE4120 How the conditions are to be interpreted -distortion of competition - how the exemption can lead to ‘distortion of competition’

The Advocate General in her Opinions in DNB Banka (C-326/15) and Aviva (C-605/15) considered that the cost share exemption was restricted to the territory in which the group was established. HMRC considers that this was the correct analysis because it ensures that there was no distortion of competition caused by divergence of treatment in the different countries.

Published 22 March 2018