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HMRC internal manual

VAT Cost Sharing Exemption Manual

HM Revenue & Customs
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How the conditions are to be interpreted: Directly Necessary services: What are ‘directly necessary’ services?

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

The word ‘necessary’ used alone could be interpreted on the basis that any supplies used for a CSG member’s exempt and/or non-business activity would be entitled to exemption. However, the word ‘necessary’ is, in this case, qualified by the use of the word ‘directly’ meaning that the supplies received from the CSG must relate ‘directly’ to the exempt and/or non-business supplies made by the CSG member in their own right.

HMRC has adopted a methodology for identifying services that are ‘directly necessary’ which has been developed with stakeholders during the consultation process in order to provide a simple and pragmatic way of identifying qualifying supplies.

If CSGs wish to suggest alternative methodologies HMRC will give them full consideration but must be satisfied that there is a direct and exclusive link with the exempt or non-business activity on which the qualification depends.

Note - businesses and organisations considering forming CSGs should note that recently the EU Commission have commenced infraction proceedings against Luxembourg for, among other things, their application of the ‘directly necessary’ condition, which is similar to the ‘simplification’ option offered by the HMRC in this guidance. (See CSE3740)

The Commission are seeking to establish the principle that ‘directly necessary’ services are those that are used ‘exclusively’ by CSG members for their exempt and/or non-business activity. The matter has been referred to the European Court and timing is now in their hands. It could perhaps take several years to come to a conclusion, although it may conclude sooner.

The EU Commission have currently decided only to commence infraction proceedings against Luxembourg in this respect although a number of other Member States have also adopted a similar approach. However further challenges cannot be ruled out.

Decisions of the European Court are binding on Member States.

HMRC will monitor the process and consider whether or not at any stage any changes need to be made to this guidance. Should changes prove to be necessary, then transitional arrangements, as far as possible, will be put in place to facilitate an orderly move to the revised position.