23 October 2019 - Article
As promised in the 2010 and 2011 Budgets, HMRC have launched a public consultation on the VAT cost-sharing exemption (‘the exemption’). The general aim of the exemption is to reduce VAT exposure where organisations and businesses carrying out exempt and/or non-business activities share costs. This will be achieved through the creation of a cost sharing group (‘CSG’) which makes VAT-exempt onward supplies of jointly funded services to its members. The exemption will apply to any VAT-exempt and/or non-business activities and therefore its use is not limited to charities. However, the exemption will only be available where all the conditions are met.
The exemption is a creation of EU law and is to be implemented by each EU nation. However, there is no common framework for implementation and there are currently infraction proceedings pending against some other EU countries for alleged mis-implementation. The purpose of the consultation is ‘to invite comments on a possible model for a cost-sharing exemption that could be introduced in the UK’.
The exemption is contained in Article 132 (1) (f) of the Principal VAT Directive:
‘The supply of services by independent groups of persons, who are carrying on an activity which is exempt from VAT or in relation to which they are not taxable persons, for the purpose of rendering their members the services directly necessary for the exercise of that activity, where those groups merely claim from their members exact reimbursement of their share of the joint expenses, provided that such exemption is not likely to cause distortion of competition.’
HMRC have identified five key characteristics of the EU legislation on CSG systems.
- CSG members must be an “independent group of persons”
HMRC’s view is that the CSG should be a separate entity from its members, and able to register for VAT in its own right in case any of its activities fall within the scope of VAT. EU law does not appear to require a formal entity and so the CSG may not need to have legal personality.
The CSG must have more than one member. Members can be natural persons, such as individuals, or legal persons, such as companies. In principle, foreign members and cross-border supplies would be permitted. Organisations can be members of more than one CSG.
The CSG must be independent from its members and cannot be controlled by one member, or by connected members. Members should be independent of each other. It should be noted that where members supply services to each other, the exemption will not apply. The services must be provided through the CSG itself.
The CSG must not be operated on a commercial basis. To this end, it is expected that CSGs will be transparent in respect of managerial matters and that they will not have ‘characteristics of an independent operator seeking a customer base in order to generate profits’. CSGs should not market their services outside of their membership. CSGs may contract with third parties to provide services to the CSG itself.
- The group members must be engaged in “non-taxable activities”
The exemption will not be available where members are “non-taxable” solely on the basis that they carry out taxable activities below the compulsory VAT registration threshold. The members must also engage in some level of exempt and/or non-business activity at some time. In order to become a member where there is no immediate need for exempt services from the CSG, the member must have a clear intention to make exempt and/or non-business supplies at some point in the future.
In principle, persons carrying on a mixture of taxable and exempt activities would be eligible for the exemption. However, HMRC is considering whether a specific threshold or other test should be introduced in order to prevent use by predominantly taxable persons. For example, should a certain proportion of the member’s activities be exempt and/or non-business activities for it to be entitled to use the exemption?
- The services provided through a CSG must be “directly necessary” to members’ non-taxable activities
HMRC emphasise that it is difficult to define the precise scope of ‘directly necessary’ without detailed guidance from the European Court. In the absence of such guidance, HMRC are trying to devise an approach which is ‘as far as possible, compliant with European law, clear, workable and pragmatic.’
The inclusion of ‘directly’ means that not all supplies used for a member’s exempt and/or non-business activities will automatically be treated as exempt. Being a necessary supply will not be sufficient without there also being a direct causal link.
HMRC’s preferred approach is to accept that ‘all supplies received by members from CSGs can be treated as ‘directly necessary’ where those businesses and organisations have wholly exempt and/or non-business supplies or negligible levels of taxable supplies.’ HMRC suggest that an organisation might have negligible taxable supplies where exempt or non-taxable supplies account, for example, for more than 85% of the total supplies by value.
Other approaches are suggested, such as drafting a list of specific qualifying services, although these also have their pitfalls. HMRC welcome comments and suggestions as to how this aspect should be defined.
- The CSG structure must only receive “exact reimbursement” of relevant costs and must not make profits
Members are to pay their share of the joint expenses of the CSG. The CSG must not make any profit for itself but the creation of a surplus will not be objectionable if it can be shown to be a fund intended as a provision against legitimate future expenses.
CSGs can charge members for their share of the general overheads, either by using an annual subscription fee or by incorporating it into the cost of each supply. Costs must not be inflated so as to manufacture non-taxable income.
Timing differences between CSG income and expenditure will not matter, provided that exact reimbursement can be demonstrated over a ‘reasonable period of time’.
- The operation of the CSG must not be likely to cause distortion of competition
HMRC is seeking opinions on this aspect of the exemption but is of the opinion that the fact that members receive supplies at cost and free of VAT cannot in itself cause unlawful distortion of competition.
Impact on the Charitable Sector
Whilst the exemption may be open for use by charities, it is uncertain whether they will utilise it to the extent hoped by the charity sector. The main drawback is likely to be the necessity of forming a separate entity to provide the shared services. This adds a layer of costs which may discourage smaller charities and negate some of the saving. The fact that the exemption will not apply to services provided by one charity to another will surely reduce the potential impact of this exemption on the charitable sector.
HMRC’s consultation ends on 30 September 2011. A summary of the responses received is expected in Autumn 2011. The full consultation document can be accessed here.