Let's talk tax

During 2011, several potentially significant VAT discussion papers or consultations have come out of the European Commission. But do these papers and consultations mean anything? This article seeks to consider this question and initially focusses upon one document in particular, ‘VAT in the public sector and exemptions in the public interest,’ released in March this year.
    
As a member of the European Community, the UK, like all other member states, is obliged to implement into national legislation the VAT Law determined by the European Parliament. The current iteration of the EU VAT legislation is the VAT Directive (2006/112/EC).
    
Where the UK has failed to properly implement the relevant EU VAT legislation, a taxpayer in the UK can rely on either the UK legislation or the EU legislation, whichever is the most advantageous.
    
The principle of EU VAT law is that businesses must generally charge VAT on their supplies to customers and account for it to the national fisc. Where they charge VAT, they are entitled to recover most of the VAT incurred on their costs. Generally it is the end consumer who suffers the financial burden of VAT.
    
There are certain notable exceptions. Supplies such as insurance, and banking. The insurers and bankers do not generally charge their customers VAT and can therefore not recover the bulk of the VAT on their costs.
    
Another situation where a VAT registered trader cannot recover VAT on its costs is where the costs relate to non business activities. Where local authorities, schools, government bodies amongst others incur VAT in relation to their public duties, that is deemed non business and there is no right to recovery of VAT incurred on their costs under EU Law.

SECTION THIRTY THREE
However,  Parliament in the UK has incorporated into UK VAT legislation a provision not found in EU VAT law. This is the well known basis of VAT recovery in the UK public sector, namely section 33.
    
The European Commission has been aware for some time of this anomaly in UK VAT Law. In view of the fact that the ‘breach’ only applies to public bodies, means to date it has not been overly concerned about distortion of competition within the EU, and has to date adopted a light touch.
    
However, the Commission intrinsically dislikes turning a blind eye to breaches of the European VAT system. For that reason, it has chosen now to consider what, if anything, should be done about the above anomaly and commissioned the aforementioned report which runs to a jaw dropping 192 pages.
    
The Commission is advised in that document that the general exemption for public bodies does, in fact, lead to a distortion of competition in two ways.
    
Firstly, where public bodies cannot recover input VAT, there is a financial disincentive to outsource services, as VAT will be incurred on costs currently attracting no VAT, such as wages.   
    
Secondly, where the public body ‘competes’ with the private sector, the private sector is disadvantaged by having to charge VAT.

FINDING THE SOLUTION

The paper estimates that efficiency gains from outsourcing by public bodies across the EU would be in the region of 5 billion euros per annum. To adopt a refund scheme, like the UK system, across Europe it estimates would redistribute funds to public bodies to the tune of 100 billion euro. Large numbers indeed.
    
However, it notes that refund schemes do not address the competition issue. There would also be an unknown compliance cost inherent within any refund scheme that would reduce the benefits, possibly totally they say. Given the UK experience, it seems bizarre that the cost could be that significant but whilst HMRC are not universally loved in the UK, at least they are one of the more efficient administrations around EU member states in administering VAT.
    
For those reasons, it recommends moving to a full taxation solution, whereby the public body in question charges VAT on all its supplies and recovers VAT on its costs. It suggests that there would be an additional 195 billion euro revenue for member states, that would allow them to drop their standard VAT rates by up to 20 per cent (i.e down to 16 per cent in the UK).
    
Does this mean that you should immediately start re-modelling your financial plans? Fortunately not. In the same vein, it has also just finished a consultation into the Future of VAT, and whether or not the exemptions and zero rating provisions allowed for in EU or national law should be done away with, and there is little danger of imminent change.       
    
Whilst many EU decisions can be taken on the basis of qualified majority voting, taxation is one area where no change can be made unless there is unanimity amongst the 27 member states, which is no quick process.
    
So it is suggested that whilst there is no need for immediate panic, you would be well advised to monitor developments.
    
The EU report mentions outsourcing and notes that in territories where there is no VAT refund scheme for public bodies, there is a VAT cost disincentive.
    
Whilst the current UK system allows outsourcing and cost sharing between local authorities and other designated organisations set out in section 33 of the UK VAT Act, the noted VAT disadvantage does raise its head when other bodies in the public interest, such as medical organisations, universities, colleges, and charities become involved.  
    
Those bodies ought to be able to benefit from another provision within the EU legislation, an exemption from VAT known as the cost sharing exemption.
    
This exemption is enjoyed in many member states, but not in the UK because it has not been transcribed into national VAT legislation. Equally, when organisations try to rely upon the direct effect of EU legislation, HMRC interpret the wording of the EU legislation in such a way that means they believe it can never apply in practice.

UK LAW
As a consequence of the EU Commission having become aware of the inability of UK organisations to be able to rely on this provision, HMRC has stated it will consult on the possible implementation of the provision into UK law. However, this consultation has been progressing slowly as HMRC are concerned about abuse of the provision.
    
Part of the difficulty faced by HMRC is to properly understand the current environment faced by section 33 bodies. With the increased focus and constraints on costs, all bodies are looking to increase efficiency through aggregation in centres of excellence or share systems, such as finance, HR and IT.
    
Many of these processes and systems could be enjoyed by charities and other non section 33 bodies for the general good of the UK. Accordingly it would be very helpful to all those organisations working in the public interest if this area could be advanced.
    
One of the other responses to the current economic climate is to re-evaluate your organisations appreciation of the VAT risk it faces. Historically VAT risk has been thought to be limited to making sure the right number is on the right VAT return. That is still important but just that is not enough these days. VAT risk encompasses everything from inputting into the decision making process of new ideas and proposals, to ensuring that what was said to happen does in fact happen.

Equally, changes in legislation, or case law, can render inefficient ventures or arrangements that were previously viable. So both positive or adverse current and prospective changes in VAT law also need to be reviewed regularly as part of sensible risk management. Do you know how you empirically measure the aggregate VAT risk faced by your organisation? If you set out all the actual, prospective and historic VAT risks you face, you will probably be surprised at the aggregate value.