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HMRC internal manual

VAT Valuation Manual

Special valuation provisions: connected persons - Paragraph 1, Schedule 6, VATA 1994

Paragraph 1 of Schedule 6 to the VATA 1994 makes the following provisions for valuing supplies made between connected persons:

1-(1) Where -

(a) The value of a supply made by a taxable person for a consideration in money is (apart from this paragraph) less than its open market value, and

(b) The person making the supply and the person to whom it is made are connected, and

(c) If the supply is a taxable supply, the person to whom the supply is made is not entitled under sections 25 and 26 to credit for all the VAT on the supply, the Commissioners may direct that the value of the supply shall be taken to be its open market value.

(2) A direction under this paragraph shall be given by notice in writing to the person making the supply, but no direction may be given more than 3 years after the time of supply.

(3) A direction given to a person under this paragraph in respect of a supply made by him may include a direction that the value of any supply -

(a) Which is made by him after the giving of the notice, or after such later date as may be specified in the notice, and

(b) As to which the conditions in paragraphs (a) to (c) of sub-paragraph (1) above are satisfied, shall be taken to be its open market value.

(4) For the purposes of this paragraph any question whether a person is connected with another shall be determined in accordance with section 1122 of the Corporation Tax Act 2010.

(5) This paragraph does not apply to a supply to which paragraph 8A or 10 below applies.

The criteria contained within (1)(a), (1)(b) and (1)(c) of paragraph 1 of Schedule 6 must all be satisfied before it is possible to issue a Notice of Direction.

  • The consideration given for the supply must be wholly monetary. If all or part of the consideration is non-monetary, you cannot issue a Notice. In such a case, the supply can only be valued under S19(3).
  • The consideration must be less than the open market value. Occasionally, HQ has been asked whether a Notice can be issued to reduce an over-inflated consideration - it cannot.
  • The recipient of the supply and the supplier must be connected. In simple terms, this usually means that the parties to the transaction have to be related or are companies controlled by the same person or persons. The full explanation of what satisfies the connection criterion is set out later in this paragraph.
  • The recipient of the supply, when this is taxable, must not be entitled to recovery of all of the input tax associated with the supply. In practice, this occurs when the recipient is not registered, is wholly or partly exempt, or has non business activities. A Notice cannot be issued when the recipient only makes wholly taxable supplies.

The paragraph only states that a Notice “may” be issued when the above criteria are satisfied. Issue of a Notice is not compulsory. This paragraph is specifically intended to counter tax avoidance. If a supply between connected persons is made below open market value for a legitimate reason that the trader can substantiate, and which is unconnected with avoidance, then we have discretion not to issue a Notice.

When a supply is made at an artificially low value and the recipient, although connected, is entitled to deduct all of the input tax charged to him on the supply, we are not concerned that the price is abnormally low. The recipient only receives a lesser input tax deduction than might otherwise have been the case, and, there is neither a loss nor a gain to the revenue.

An example of where a real revenue loss could occur would be the situation where an exempt or partly-exempt group of associated companies set up a wholly taxable company outside the group and that company makes a minimal management charge to the group in respect of supplies of large quantities of office equipment which it has purchased and recovered input tax on.

A Notice can also cover exempt supplies. This may be necessary when the value of exempt supplies is understated so that a partly-exempt supplier can increase his input tax deductions beyond a level that would have been possible under a partial-exemption calculation employing a realistic value for the exempt supplies. For example, a partly exempt company making a minimal charge for an exempt supply to an associated company would appear to be making a higher relative proportion of taxable supplies and so would raise its level of input tax deductions.

A company could achieve the same result as that arising through artificially lowering the price of exempt supplies by over-inflating the price of taxable supplies made to the associated company. A Notice could not be issued in such a scenario because the value of the supplies exceeds their open market value. There would be little advantage in doing this when the associated recipient company is exempt or partly exempt because it would be unable to recoup all of the excessive VAT charged to it on the supply as its own input tax.

It will not always be easy to establish the open market value of the supply in question. Since the provision is intended to prevent the manipulation of value so that otherwise non-deductible input tax becomes recoverable, our main concern is to ensure that the supply is valued at no less than the cost actually incurred by the supplier. This enables us to “claw-back” any input tax over-deducted by the supplier.

Sub-section (2) of paragraph 1 of Schedule 6 requires any direction to be given by notice in writing to the supplier. A specimen Notice can be found below. A Notice can be issued up to 3 years after the time of supply.

Sub-section (3) of paragraph 1 of Schedule 6 allows us to issue a Notice stipulating that future supplies to a connected person are to be valued at their open market value.

Note: You cannot issue a Notice that only covers future supplies. Notices issued can therefore only relate to a past supply alone or a combination of past and future supplies together.

Sub-section (4) of paragraph 1 of Schedule 6 refers to section 1122 of the Corporation Tax Act 2010 as the provision by which you determine whether two persons can be treated as connected.

There are different requirements for connection according to whether the taxable person is an individual, partnership, trustee or company.

A person can be connected with:

  1. a spouse, civil partner, relative, or relative of a spouse or civil partner, or
  2. anyone with whom he is in partnership or who is a spouse or relative of his partner.

A trustee of a settlement (in his capacity as trustee) is defined as being connected with any settlor of a settlement, if they are connected to any individual who is a settlor, person connected to that individual, close company trustees, non-UK company trustees, controlled body corporate of the close company or non-UK company trustees, if trustee of any related principal or sub-fund settlements.

A company can be connected with:

  1. another company if the companies are under the control of the same person or under the control of connected persons or under the control of groups of connected persons, or
  2. another person if that person has control of it or if that person and persons connected with him controls it.

Steele v EVC International NV (STC 785 1996) provides that the definition of control of a company is

control at the level of general meetings of shareholders as control at that level carried with it the power to make the ultimate decisions as to the business of a company and in that sense to control its affairs.

The main implication of this is that even where companies are connected by virtue of S839 paragraph 5(a), where Company A does not control the affairs of Company B at shareholder level, then they are not seen as connected as such we cannot authorise a Notice of direction.

For the purposes of the provision, “relative” means a brother, sister, ancestor or lineal descendant. It does not cover all family relationships and, in particular, does not include nephews, nieces, uncles or aunts. VATVAL07400 has an extract from the ICTA 1988 where this definition is explained.

Sub-section (5) of paragraph 1 of Schedule 6 means that Notices cannot be issued in respect of supplies of catering or accommodation made by employers to their employees.

You should always obtain authority from the VAT Supply Policy Team before issuing a Notice of Direction under Paragraph 1 of Schedule 6.

All evidence of the proper authorisation should be retained on the traders records for at least as long as the direction stays in force.

The UK has authority to issue Notices of Direction in respect of connected persons cases because derogations were obtained under Article 27 of the Sixth EU VAT Directive. These are now incorporated into Article 80 of the Principal VAT Directive (Dir.2006/112).