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HMRC internal manual

VAT Groups

Anti-avoidance legislation in Schedule 9A, VATA 1994: background

HM Revenue & Customs consider schemes that exploit the “disregard” provision, which applies to supplies between group members, as tax avoidance, if the main purpose of the arrangement is to reduce the amount of irrecoverable VAT incurred on purchases from external supplies. Such schemes include “entry” and “exit” schemes explained in the statement of practice in VGROUPS08000.

In the scheme operated by the Thorn group, input tax on cars was recovered, which, if the company purchasing the cars had remained in the group, would not have been recoverable.

A brief summary of the Thorn case

Thorn Materials Supply Ltd and Thorn Resources Ltd -v- the Commissioners of Customs & Excise, HL [1998] STC 725

M Ltd, R Ltd and H Ltd were all treated as members of a VAT group, of which T Plc was the representative member. Under an agreement dated 29 November 1993, M Ltd agreed to supply goods to H Ltd for 105% of the VAT exclusive cost to M Ltd of purchasing the goods from a third party.

90% of the consideration was to be paid immediately and the remainder on delivery of the goods. H Ltd made the 90% prepayment to M Ltd on 29 November 1993. On the same date M Ltd lent H Ltd this amount over three years with interest of 5.44%. On 6 December 1993 M Ltd left the VAT group and registered for VAT in its own right. M Ltd then purchased the goods and delivered them to H Ltd and H Ltd paid the remaining 10% of the consideration for the goods.

The appellants M Ltd and R Ltd argued that the prepayment created a tax point which was disregarded. Output tax was only due on the 10% paid after M Ltd had left the group.

The Commissioners maintained that VAT was due on the entire consideration, as the two parties were members of the same group at the time that the prepayment was made, and no tax point had arisen. The first tax point arose when the goods were made available to H Ltd, when M Ltd had ceased to be a VAT group member. Thus the transaction fell within the scope of VAT.

The Tribunal upheld the companies’ appeals, but the Court of Appeal and House of Lords rejected them. The House of Lords held that VAT was due on the whole of the consideration for the supply (including the prepayment), when M Ltd made the goods available to H Ltd. The prepayment did not create a tax point as it was made whilst both parties were members of the same VAT group and the transaction was completely disregarded for VAT purposes.

This scheme may be run in reverse if a company, having purchased the goods or services and recovered the input tax in full, enters a group or transfers its business and assets to a partially exempt company which is already in the group (although some of these types of schemes may also be caught by the VAT Act 1994, section 44 and by the Capital Goods Scheme).

Because of concerns about the outcome of this case (before the final House of Lords decision) the Finance Act 1996, section 31 and Schedule 4 introduced a new subsection 9 into section 43 of the VAT Act 1994 and a new Schedule 9A. This gives HMRC extensive powers to issue notices of direction to:

  • include a company in a VAT group
  • exclude a company from a VAT group, or
  • overriding the VAT group disregard of intra-group supplies to bring back within the scope of VAT, a supply made by one member of a VAT group to another member of the same group.

The decision in the Thorn case concerned an exit scheme involving goods, but a somewhat similar decision had been made in Svenska International Plc -v- the Commissioners of Customs & Excise, which was an entry scheme involving services.

A brief summary of the Svenska case

Svenska International Plc (S) was a UK subsidiary of a Swedish bank, which established a branch in London in 1987. S supplied management services to the London branch for which it would raise an invoice. This supply included staff, use of shared premises, office services and legal and accounting services. S then contracted with a third party for the provision of these goods and services, which it supplied on to the London branch. These were continuous supplies of services, to be treated as supplied when a relevant invoice was raised or payment made.

In August 1991, before S had raised any invoices or the London branch had made any payments, S and the bank formed a VAT group. S then issued an invoice for the management services for that year and did not account for VAT.

In July 1993, Customs concluded that S had not made any taxable supplies before joining the VAT group and could not make taxable supplies to the London branch of the bank within the group. The supplies bought in by S, and input tax incurred and recovered before joining the group, should therefore be treated as attributable to the exempt supplies made by the London branch of the bank to third parties outside the group.

The Tribunal dismissed S’s appeal and was upheld by the Court of Appeal and House of Lords, who held that for VAT accounting purposes, S was to be treated as having used or at least appropriated for use, the bought in supplies to make the London branch’s partly exempt supplies to third parties. S had therefore to account to Customs for that proportion of the input tax incurred in the period before August 1991, which was attributable to the London branch’s exempt supplies.

JP Morgan Trading & Finance and BUPA Purchasing Ltd

These were exit schemes similar to Thorn Material, but involving services: there was a large prepayment when the supplier company was in the VAT group, followed by small residual payments to the supplier after it left the group. The suppliers accounted for a small amount of output VAT on the residual payments, but sought to recover input tax credit on the whole cost of buying in the services from third parties.

In these cases the VAT Tribunal and High Court respectively concluded that such a result would be contrary to VAT neutrality and that the input tax claim should only be allowed insofar as the input was used to make the output on which VAT was charged.

These four decisions, together with our Schedule 9A powers mean that we are now in a position to combat such entry or exit schemes.