UK: Tax Update - Monday 5 December 2011

Last Updated: 9 December 2011
Article by Richard Mannion

1. General news

1.1. Autumn Statement

Under the Government's Tax Policy Framework the main event in the calendar for tax changes will be the Spring Budget. Consequently there was little new tax news in the Autumn Statement, except the following:

  • The CGT annual exemption has been frozen at £10,600 for 2012/13. This is disappointing but nevertheless it remains a potentially valuable relief worth up to almost £3,000 in tax savings.
  • The planned increase in fuel duty due to take place in January has been cancelled.
  • The bank levy will become a permanent tax set at 0.088%.
  • Following a consultation, Government has announced that there will be a new Seed Enterprise Investment Scheme (SEIS) to encourage investment in new start-up companies. SEIS will provide income tax relief of 50 per cent for individuals who invest in shares in qualifying companies, with an annual investment limit for individuals of £100,000 and cumulative investment limit for companies of £150,000. In addition, there will be a capital gains tax exemption on gains realised on disposal of an asset in 2012/13 and invested through SEIS in the same year.

EIS will be simplified by relaxing the connected person rules and the definition of shares that qualify for relief. The Government will tighten the focus of the schemes by introducing a new test to exclude companies set up for the purpose of accessing relief, exclude acquisition of shares in another company and exclude investment in Feed-in-Tariffs businesses. In addition to these changes that were consulted on, the Government will remove the £1 million investment limit per company for VCTs to reduce the administrative burdens of the scheme.

  • The SDLT first time buyers relief has proved ineffective in its aims and so will end on 24 March 2012.
  • A new 'above the line' research and development tax credit will be introduced in 2013 to encourage research and development (R&D) activity by larger companies. The Government will consult on the detail at Budget 2012 and will ensure that SME R&D incentives are not reduced as a result of this change.
  • Further details of the Patent Box and of its reform of the Controlled Foreign Company rules and R&D tax credits will be published on 6 December 2011.
  • Measures were announced to restrict tax relief for certain asset backed pension contributions (see business tax item 5.5).
  • VAT and cost sharing: legislation will be introduced in Finance Bill 2012 implementing Article 132(1)(f) of the Principal VAT Directive (The VAT Cost Sharing Exemption) into UK law. The mandatory exemption allows businesses and organisations making VAT exempt and/or non-business supplies (such as banks, charities, housing associations, insurance companies, residential care homes, universities and further education colleges) to form groups to achieve cost savings and economies of scale.

2. Private Clients

2.1. Certificate of UK tax residence - new online form available

In order to claim relief or exemption from foreign tax at source under a double taxation agreement, some countries require UK residents to complete a claim form but others ask for a certificate of tax residence status. HMRC has set up a new online form to apply for such a certificate of residence. The form is both completed and submitted online.

2.2. Tax and tax credit rates and thresholds for 2012/13

Alongside the Autumn Statement, HM Treasury published detailed tables of the tax allowances, National Insurance rates and thresholds and Tax Credit rates effective from 6 April 2012 where the amounts are required to be increased in line with either the September Retail Price Index (RPI) or Consumer Price Index (CPI). All other rates, allowances, thresholds for the tax year 2012-13 will be announced by the Chancellor in his Budget 2012.

As announced in the Budget earlier this year the personal allowance is actually increased by £630 to £8,105 rather than the £420 uplift based on the September RPI figure of 5.6%. It should be noted that the basic rate band is being reduced by a similar amount of £630 so that the Basic Rate Threshold remains at £42,475. This will bring more people within the 40% tax band and reduce the effectiveness of the inflationary personal allowance for higher rate taxpayers with income under £100,000.

2.3. Annual allowance - carry forward rules for the transitional years

HMRC has reconsidered its interpretation of how the carry forward rules work for the pension savings annual allowance applies for the transitional years of 2008/09, 2009/10 and 2010/11.

As a result of this review the guidance on how carry forward works for the transitional years has been revised and can be accessed by following the link below. There is no change to the guidance for the carry forward rules outside these transitional years.

If an individual has a pension input amount of more than £50,000 for a tax year from 2011/12 onwards they may still not be liable for an annual allowance charge for that year. They can carry forward any annual allowance that they have not used in the previous three tax years to the current tax year, provided they had been a member of a registered pension scheme at some point in the earlier tax. This amount of unused annual allowance can then be added to the current year's annual allowance. This will give them a higher amount of available annual allowance to off-set against that year's pension input amount. This will depend on the amount of contributions that they have been paying in pension input periods that end in the previous three tax years and the amount of unused annual allowance that they have available to carry forward.

Normally, if one of the previous three years has an input amount of more than the annual allowance then that excess is treated as using up any amount of available annual allowance from the preceding year(s) first and this will reduce the available annual allowance to be carried forward to the current year. However, the position is different for 2008/09, 2009/10 and 2010/11.

If one of the previous three years that has an input amount of more than £50,000 is 2009/10 and/or 2010/11 then that excess is not treated as using up any amount of available annual allowance from the preceding year(s). This is because any amount of available annual allowance from the preceding tax year(s) would not have had the effect of reducing an amount of annual allowance charge for 2009/10 and/or 2010/11.


Bill's pension savings in 2011/12 are £76,000. This is £26,000 more than the annual allowance of £50,000. Bill will have an annual allowance charge on £26,000 if he doesn't have any available annual allowance to carry forward from earlier years.

His pension savings for the previous three years are:

2010/11 - £48,000

2009/10 - £55,000

2008/09 - £25,000

Bill has £27,000 available annual allowance to carry forward to 2011-12 (£25,000 from 2008-09 plus £2,000 from 2010/11). Bill's pension saving for 2009/10 is more than £50,000 so he has no available annual allowance from that year. However, the excess of £5,000 for that year is not treated as using up any of his available annual allowance from 2008/09.

3. PAYE and Employment matters

3.1. Court of Appeal and PA Holdings (restricted share scheme)

HMRC has succeeded in overturning the First Tier Tribunal and Upper Tier Tribunal decisions in the case of the tax treatment of dividends received from a restricted share scheme.

The Upper Tier Tribunal decision (covered at item 2.1 of Informal of 26 July 2010) confirmed the decision of the First Tier Tribunal in relation to income tax that while the dividend income received was clearly linked to services rendered, the treatment of the receipt as a dividend took priority over treatment as an emolument for income tax. They also agreed with the FTT that the same did not apply for national insurance purposes so that the dividend receipt was liable to national insurance.

The Court of Appeal (judgment given by Lord Justice Moses, with whom Justices Lady Arden and Lord Kay agreed) has concluded that the earlier Tribunals erred in thinking the income could be treated as either a dividend or as an emolument. Dividend treatment was only applicable if a distribution could be identified that was subject to dividend treatment. In terms of the legislation applicable at the time, Lord Justice Moses's comment was:

"Schedule F [dividends] does not take priority over Schedule E [emoluments]. It does not charge emoluments at all. No question as to the application of section [ICTA] 20(2) arises. The income never came within section 20 at all.".

In particular Justice Lord Moses commented:

"40) The First Tier Tribunal asked whether the payments were in reference to the services rendered by the employees, as rewards for services past, present or future (Upjohn J's test in Hochstrasser v Mayes [1959] Ch 22 at 33) and concluded the payments were emoluments or earnings falling within the definition in section 19 ICTA. It relied on a number of features which demonstrated the character of the receipts:-

i) The purchase of the shares in Ellastone was funded in full by PA, the employer, the dividends and full value of the shares were transferred at no cost to the employees;

ii) The intention was to motivate and encourage the employees, and payment was represented to them as payment of the bonus for that year;

iii) Those who left, even after PA had funded funds to Mourant were not eligible;

iv) That the employees had no right to the payments was irrelevant.

41) It does not seem to me possible either to impugn the approach of the First Tier Tribunal in law, still less to challenge those findings of fact. That approach owes nothing and need owe nothing to "the law's development, during the past thirty years, in its attitude to artificial tax avoidance" (Tower MCashback v HMRC [2011] 2 WLR 1131 at 1148, [2011] UKSC 19). For at least sixty years courts have identified the character of a receipt in the hands of the recipient by looking at its substance and not its form."

He further commented:

"60) Once that conclusion [ that the employees receipts were emoluments] had been reached, there was no room whatever for any further consideration of a different Schedule. If the payments were emoluments in the hands of PA's employees, they could not be dividends or distributions in the hands of those employees. Any other conclusion offends the basic principle expressed in Fry [Fry v Salisbury House Estate Ltd [1930] AC 432] that if income falls within one Schedule it cannot be taxed under another. The First Tier Tribunal and Upper Tribunal concluded that the payments were from employment, on an analysis of the facts which, as I believe, cannot be impugned. It follows that that income cannot also be charged under any other Schedule, let alone Schedule F."

ICTA s20(2) was written as follows:

"... no distribution which is chargeable under Schedule F shall be chargeable under any other provisions of the Income Tax Acts."

This has now been rewritten and is included in ITTOIA s366(3) as:

"Any income, so far as it falls within- (a) any chapter of this Part [Part 4 ITTOIA – savings and investment income] other than chapters 3 or 6 [dividends from UK resident companies and release of loan to participator in close company], and (b) Part 2, 9, or 10 of ITEPA [employment income, pension income, and social security income], is dealt with under the relevant part of ITEPA."

Similar provisions are included at ITEPA 716A.

"Any income, so far as it falls within (a) Part 2, 9, or 10 of this Act [ITEPA], and (b) Chapter 3 of Part 4 if ITTOIA (dividends etc from UK resident companies etc), is dealt with under Chapter 3 of Part 4 of ITTOIA".

Whether the decision applies to the re-written legislation may be open to question, but if on this decision's rationale a payment was regarded as in substance an emolument, so that whatever form it took it could not be anything other than an emolument, the result would be the same (that it would be taxed as employment income). This would lead to the conclusion that it is necessary to consider the intention behind any series of transactions to determine whether they are taxed as employment income, and it is not clear how far back in the chain of events one would need to consider 'intention'.

The Court of Appeal determined that their conclusion on the emoluments issue was sufficient to deal with HMRC's appeal, so that a consideration of Ramsay was not necessary. It is not yet known whether the decision will be appealed to the Supreme Court.

4. Business tax

4.1. EU Taxation

Commissioner Semeta has spoken about tax reform and made the following points:

  • Tax policy is fundamental for economic recovery;
  • Tax reform must go hand in hand with structural reform if we are to see sustainable public finances and financial stability;
  • Using arbitrary tax rate hikes as the only solution to exiting the financial crisis is neither sustainable nor smart;
  • The under-taxation of the financial sector is difficult to justify when the ordinary citizen is carrying the brunt of austerity measures. The Financial Transactions Tax would redress this imbalance and deliver substantial revenue, without compromising the competitiveness or growth of the European economy;
  • Member States, should first look at how they can improve the systems already in place. Can they broaden tax bases and close tax gaps? As a first step, they should focus on tax breaks, and whether they are really necessary or fair;
  • Shifting the burden away from more distortive taxes on labour, towards more growth-friendly ones such as property and consumption is highly advisable;
  • At EU level, the heavy compliance costs and administrative burdens that businesses face in the Internal Market also need to be eliminated. This is the centre of his proposal for a Common Consolidated Corporate Tax Base, which is on the table now in Council. For the sake of businesses across the EU, he urged Member States to agree on this proposal as quickly as possible;
  • Coordination at EU level is crucial in tackling tax evasion to ensure that aggressive tax planners can't exploit loopholes between Member States' systems;
  • The revised Savings Directive, and proposals for mandates to negotiate on savings agreements with third countries, are in the Council. These will provide strong weapons in the common fight against tax havens and evasion. ge=EN&guiLanguage=en

4.2. Proposed amendments to intangible asset regime and group relief

Errors have been identified relating to section 882(4) of CTA 2009 (application of Part 8 to assets created or acquired on or after 1 April 2002). Errors have also been found relating to sections 132 (Consortium group relief conditions 1, 2 and 3) and 133 CTA 2010. Extracts from the proposed changes (which are issued by HMRC for comment) follow:

Intangible asset regime

Section 882 of CTA 2009 Part 8. is the part of the corporation tax code dealing with the tax treatment of gains and losses made by companies in respect of items referred to in the legislation as "intangible fixed assets".

Part 8 of CTA 2009 is the rewritten version of Schedule 29 to the Finance Act 2002 ("gains and losses of a company from intangible fixed assets"). Section 882 of the 2009 Act is the rewritten version of paragraph 118 of Schedule 29. It provides rules for dealing with case4s where intangible assets are created after 1 April 2002 and where assets existing before that date are acquired by a company after that date from a person who is a "related part".

Before CTA 2009

The intention behind paragraph 118(1)(c) and now section 882(2) is that the intangible fixed asset regime will apply to an asset where the company acquired the asset from a related intermediary party ("the 2nd acquisition") who itself earlier acquired the asset from a third party ("the 1st acquisition) who (i.e. the third party), at the time of that 1st acquisition, was not a related party to the intermediary or, where the intermediary was not a company, a related party company of the intermediary and who is not, at the time of the 2nd acquisition, a related party to the company. The rule seeks to include transfers of assets on or after 1 April 2002 from an unrelated party either to a company or to a group of related companies.

Paragraph 118(1)(c) as expanded by paragraph 118(2) worked correctly. No issue arises as to the way paragraphs 118(1)(c) and (2) operate. The law reflected in those provisions is as intended.

Paragraph 118(2)(b) of Schedule 29 to the Finance Act 2002 provides:

"[Case B] (b) where the asset is acquired from a person ("the intermediary") who acquired the asset after commencement [1 April 2002] from a third person-

(i) who was not at the time of that acquisition a related party in relation to the intermediary or, where the intermediary was not a company, a company in relation to which the intermediary was a related party, and

(ii) who is not, at the time of the acquisition by the company, a related party in relation to the company;"

Subparagraph (b)(i) is looking at the relationship between the intermediary and the third person at the time of the 1st acquisition and subparagraph (b)(ii) is looking at the relationship between the third party and the company at the time of the 2nd acquisition.

After CTA 2009

Section 882(4) of CTA 2009 (the rewritten version) provides:

"(4) Case B is where the asset is acquired from a person ("the intermediary") who acquired the asset on or after 1 April 2002 from a third person-

(a) who was not at the time of the intermediary's acquisition a related party in relation-

(i) to the intermediary, or

(ii) if the intermediary was not a company, to a company in relation to which the intermediary was a related party, and

(b) who is not, at the time of the acquisition by the company, a related party in relation to the company."

As with paragraph 118(2)(b)(i), paragraph (a) is looking at the relationship between the intermediary and the third person at the time of the 1st acquisition and paragraph (b) is looking at the relationship between the third person and the company at the time of the 2nd acquisition.

We are clear that subsection (4)(b) (set out above) of section 882 correctly replicates paragraph 118(2)(b)(ii). However, paragraph 118(2)(b)(i) has been rewritten as subsections (4)(a)(i) and (ii) of section 882 – in other words it has been split into two.....

The law as it is now expressed in section 882(4)(a) operates to treat an asset as not being within the regime in a case where the third person and the intermediary are both related parties in relation to any company and critically not necessarily the company from whom the asset originates. The critical change may be highlighted by considering the relevant sections of each provision in turn:

Paragraph 118(2)(b)(i) stated that an asset would be within the regime "[...] where the asset is acquired from a person ("the intermediary") who acquired the asset on or after 1 April 2002 from a third person [ ...] who was not [....] a company in relation to which the intermediary was a related party [...]" (emphasis added) Paragraph 882(4)(a) now states that an asset will be within the regime "[...] where the asset is acquired from a person ("the intermediary") who acquired the asset on or after 1 April 2002 from a third person [...] who was not [...] a related party in relation [...] to a company in relation to which the intermediary was a related party [...]" (emphasis added)

The related party rule is looking for relationships between companies acquiring the same asset and not more broadly at whether they might be related to each other for other reasons, which may have nothing whatsoever to do with the acquisition of the asset.

Section 882(4)(a) sets out the relationship of the wording of paragraph 118(2)(b) in a slightly different manner. Although the intention was to make the sense of paragraph 118(2)(b) easier to understand the unintentional effect has been to change the way the legislation operates.

The error is potentially unfavourable to taxpayers, but it is theoretically possible, that in certain circumstances it could be favourable to some taxpayers.

The proposed remedy

To remedy the error and restore the effect of paragraph 118 of Schedule 29 to the Finance Act 2002 we propose the following amendment to section 882(4)(a) CTA 2009 to have effect for accounting periods on or after 1 April 2009.:

"Case B is where the asset is acquired from a person ("the intermediary") who acquired the asset on or after 1 April 2002 from a third person—

(a) who was not at the time of the intermediary's acquisition—

(i) a related party in relation to the intermediary, or

(ii) if the intermediary was not a company, a company in relation to which the intermediary was a related party, and

(b) who is not, at the time of the acquisition by the company, a related party in relation to the company."

Group relief

The error relates to the determination of the amount of group relief available to, and the amount surrenderable by, a consortium company that is also a member of a group.

Before CTA 2010

The relevant legislation was at sections 403C and 405 of the Income and Corporation Taxes Act 1988 ("ICTA 1988"). This legislation has been rewritten to sections 143, 144, 148 and 149 CTA 2010.

After CTA 2010

In ICTA 1988 the amount of group relief that a consortium company could surrender or claim was first reduced by any potential group relief claim or surrender within its own group (section 405): the resultant amount was then further restricted by the ownership restriction at section 403C.

Under the rewritten legislation, sections 148 and 149 of CTA 2010 apply the potential group relief restriction previously at section 405 of ICTA 1988, and sections 143 and 144 of CTA 2010 apply the ownership restrictions previously at section 403C. However, these restrictions are applied independently. Whereas in ICTA 1988, the ownership restriction was applied to an amount that had already been subjected to the potential group relief restriction, in CTA 2010 these two restrictions are not linked. This results in a different and higher amount of group relief available for surrender to, and claim by, a consortium company in the rewritten legislation at CTA 2010 than would have been the case in ICTA 1988.

The error is potentially favourable to taxpayers.

The proposed remedy

The proposal is to introduce two new sections 148A and 149A which make it clear that the ownership restriction at sections 143 and 144 CTA 2010 should be applied after the application of the potential group relief restriction at sections 148 and 149 CTA 2010.

A further potential error was discovered in sections 148 and 149. A surrender of, or claim for relief based on "the group condition" (defined at section 133 CTA 2010) in each of those sections arguably means that where a claimant and surrendering company do not form part of the same group, the relevant sections may not apply to the claim/surrender at all. New wording in each section has been substituted to correct this.

4.3. Key IP Ltd – tax deductibility of legal costs of bringing defamation proceedings

Legal costs of £459,924 were paid solely by Key IP Ltd, but both it and its sole director were named as claimants in the defamation proceedings which were the subject of the legal costs. The defamation proceedings alleged that Adventis Group plc had published a defamatory statement to the effect that Key IP Ltd's sole director had lied to clients (institutional investors of Adventis) about the expected removal from the board of Adventis's chairman. The defamation action was settled after the first week of the trial.

The question considered was whether the legal costs of defamation proceedings were "wholly and exclusively laid out or expended for the purposes of the trade or profession" (ICTA s.74, now CTA09 s54).

The Tribunal concluded on the particular facts of this case, that the sole purpose of bringing the defamation proceedings was to protect the business reputation of Key IP Ltd. They found that any personal benefit to the company's director was an effect of, rather than a reason for, the expenditure. The appeal was therefore allowed.

4.4. Asset backed pension contributions (ABC)

HMRC has published a summary of responses to the consultation on asset backed pension contributions, and a tax information note on measures introduced to limit excessive tax relief.

Certain funding arrangements are structured in such a way that the employer receives a deduction for the contribution paid to a pension scheme upfront, but the pension scheme only receives the cash payments over the term of the arrangement. Where the arrangement involves an asset and this asset generates an income stream to the pension scheme, it is possible for the employer to obtain both a deduction for the pension contribution upfront and then receive another deduction for income payments derived from the asset. In other words, unintended and excessive tax relief can arise under such circumstances.

Some asset-backed arrangements provide for a final payment ('final bullet payment') that is made at the end of the arrangement period but only if the pension deficit remains at that time. Under the current legislation, if the final bullet payment is not actually made, or if the value of the final bullet payment is less that the amount of tax relief received upfront, this could mean that the employer will have obtained excess relief at the start of the arrangement.

Legislation will be introduced in Finance Bill 2012 to make changes to FA 2004 as follows:

Where an ABC arrangement is set up with the employer contribution paid on or after 29 November 2011:

  • If the arrangement is accounted for in the accounts of the employer or the special purpose vehicle (if used) as a financial liability such that the Structured Finance Arrangements (SFA – see CTA10 Part 16) rules will apply, then tax relief in the form of an upfront tax deduction will be given for the contribution under the ABC arrangement in the period of account that it is paid. Relief will also be available for the element of subsequent income payments, (if any), that is accounted for as a finance charge in relation to the financial liability recorded in the accounts. In other words, further tax relief on the remaining income payments, excluding any payment of interest charges, will not arise due to the operation of the SFA rules.
  • If the arrangement does not fall within the SFA rules, upfront tax relief will not be available. Relief will only be available for subsequent income payments made to the pension scheme under the arrangement. If an income stream providing the employer with income payments has been transferred to the pension scheme under the arrangement, these income amounts are likely to cease to be chargeable.
  • Where the accounting treatment of an ABC arrangement was initially accounted for as a financial liability (as set out in the first bullet above) and has gained upfront relief, but subsequently changes so that the liability is no longer shown in the accounts or is otherwise reduced by an event other than the making of payments by the employer, then a balancing tax charge will arise to recover tax relief from the employer. This will be achieved by treating the outstanding amount of the financial liability immediately before it is no longer recognised or reduced in the accounts, as a profit or income arising on a loan relationship.
  • An anti-avoidance rule will provide that where after the employer has entered into the ABC arrangement that falls within the SFA rules, the employer becomes a party to an avoidance arrangement where the main or one of the main purposes is to enable the total amount of relief given in respect of the employer's contribution to exceed the total amount of the payments passed to the pension scheme under the ABC arrangement, any excess of the upfront tax relief given will be recovered from the employer. Where the avoidance arrangement is entered into at the same time as the ABC arrangement or earlier, the upfront relief will be denied.
  • Where an ABC arrangement has been set up with the employer contribution paid before 29 November 2011:
  • If the ABC arrangement falls within the SFA rules, the tax treatment will remain unchanged at the commencement of the new legislation. However, if the financial liability recorded for the arrangement is reduced by an event other than the making of payments by the employer and the event takes place on or after 29 November 2011, the recovery provision set out in the penultimate bullet above will also apply.
  • If the ABC arrangement would not have qualified for upfront relief under the new legislation if it was carried out now, deductions will not be available in relation to the income payments derived from the asset that are made on or after 29 November 2011. Also from the same date, any income amounts that would have been charged to tax if not for the ABC arrangement will be brought back into tax as a charge on the employer or a person connected with the employer or other relevant person as appropriate.
  • Where such an arrangement comes to an end, an adjustment will be made so that if the upfront relief allowed exceeds the actual value received by the pension scheme during the arrangement, then any excess of the upfront tax relief will be recovered. This adjustment will take into account the payments made to the pension scheme and the deductions given to the employer before and after 29 November 2011. It will also take into account any payments that could be a finance charge if the arrangement were a SFA and return any relief that would have been denied at or before the end of the arrangement on these "deemed" finance charges under the rule set out immediately above. Where the upfront relief is less than the value received, the employer will be given additional relief for the excess of the value given to the pension scheme.
  • When there is a change to the original arrangement period, then the original ABC arrangement will be treated as ended for tax purposes and any excess of the upfront tax relief will be recovered from the employer.

5. VAT

5.1. VAT and Food Products

Two cases have been heard at the First Tier Tribunal concerning the VAT treatment of food and drink.

Iced Tea

In the case of Thorncroft Ltd HMRC had refused zero rating treatment for a series of iced tea concentrate drinks. The range included Earl Grey, Jasmine, Sencha with Peach flavour, Sencha with Pomegranate flavour, Wittard original (a black tea) with lemon, Chamomile, Roibos (also known as red bush tea), Very Very Berry (a Whittard fruit tea blend), and Nettle.

The production process was similar for all these drinks. A tea will be brewed in the normal way, but about fifteen times more strong than usual. i.e. using 1/15th or less the usual amount of water. Sugar will be added to make syrup. The resultant syrup can be diluted with water, hot or cold to make a tea drink, just as for the original Ginko Green Tea cordial.

The Tribunal decided that although the drinks could be described as a dilute syrupy drink they were indeed made by infusing leaves like ordinary tea or herbal tea and the leaves were a principal ingredient; the drinks were to be marketed or presented like tea and were likely to be regarded by their drinkers as an alternative to tea. They therefore concluded the drinks were teas and qualified for zero rating under VATA Schedule 8 group 1 item 4.

Discos and Frisps

United Biscuits maintained that two of their savoury products ('Discos' and 'Frisps') should be zero rated under VATA Sch8 group 1, while HMRC contended they should be standard rated (as the exception in item 5 for crisps and similar products applied). The Tribunal found it difficult to identify a potato taste due to the presence of other strong flavours. They also noted the potato content of Discos and Frisps (at 27.87% and 22.56% respectively) was significantly lower than standard rated crisps and Pringles (70% and 42%). They also noted there were other significant ingredients in the make up of Discos and Frisps, and therefore concluded they were not similar to crisps and could be zero rated.

5.2. Grattan plc and reference to CJ EU re compound interest

The First Tier Tribunal has now determined the questions to be referred to the CJ EU in the case of compound interest claims by Grattan plc (see the earlier report at item 4.2 in Informal of 31 May 2011). The questions referred are:

If the Court of Justice concludes that the answer to the Question 1 referred in the case of Littlewoods Retail Limited v The Commissioners for Her Majesty's Revenue and Customs (Case C-591/10) is in the negative:

(1) Do the EU law principles of effectiveness and/or of equivalence require the remedy for an overpayment of VAT in breach of EU law to be a single remedy for both the reimbursement of the principal sums overpaid and for the use value of the overpayment and/or interest?;

(2) In circumstances where there are alternative remedies under domestic law, is it a breach of the principles of effectiveness and/or of equivalence for the remedy or remedies not to be in the statutory provisions governing the making of the principal reimbursement claims and the appeals from administrative decisions on those claims?; and

(3) Is it a breach of the principles of effectiveness and/or of equivalence to require a claimant to pursue the principal reimbursement claim and the claim for simple interest in one set of proceedings before the Tax Tribunal and the balance of the remedy required by EU law in respect of the use value of the overpayment and/or interest in separate proceedings before the High Court?

5.3. VAT and partial exemption

HMRC has lost at the Court of Appeal in their case against London Club's International's proposal to base a partial exemption special method (PESM) using floor space rather than using a method based on turnover.

Both the First Tier Tribunal (August 2009) and Upper Tier Tribunal (October 2010) had agreed the method proposed by London Clubs International was fairer than the existing method and dismissed HMRC's appeal. The Court of Appeal in dismissing HMRC's appeal, commented that further work may be required to assess the appropriateness of all the terms of the proposed method, particularly how to consider aspects of a business that are not profitable. This may lead to refinement of the proposed method to more fairly represent the relative contribution each part of the business would make to the overheads. Extracts from the decision are below.

83. Although it is not necessary to express a firm conclusion on the point, I am very doubtful that it would be possible to uphold the Decision of the FTT in the absence of a finding that the respondent's catering activities had the potential to be a source of profit if the relevant overheads were apportioned in accordance with the proposed PESM.

84. As I have said earlier in this judgment, what is or is not a suitable PESM is highly fact specific. Furthermore, as I have also said, in looking at economic reality in this context, profit may be an important factor, but it is not necessarily so, and in some cases it may be entirely irrelevant.

85. On the particular facts of the present case, the absence of a realistic expectation that the respondent's catering activity could produce a profit in the foreseeable future if overheads were allocated in accordance with the proposed PSEM would, in my view, be likely to be a critical factor in favour of the existing method and against the proposed PESM. In the absence of such an expectation, I find it difficult to see how, as a matter of economic reality, any significant weight in support of the proposed PESM could legitimately be given to the avowed strategy of the respondent to run the catering activity as a separate business, making a positive contribution towards overheads.

86. Business is carried on with a view to profit. If the only activity of the respondent capable of generating a profit in the foreseeable future was its gaming activity, then the principal purpose and effect of any other activity capable of generating a positive return, short of profit, would simply be to enable a greater proportion of the profits from gaming to be retained than would otherwise be the case. The only possible purpose of the non-gaming activity would be to help to defray some of the overheads that would otherwise have to be defrayed by the gaming revenue.

87. As the Commissioners have pointed out, that would not mean that the loss-making catering function did not use any residual costs. Plainly, catering would use some of those costs. The issue is whether, on the hypothetical facts, the more fair, suitable and accurate proxy for attribution of those costs between taxable catering activity and exempt gaming activity would be the existing method, based primarily on the standard turnover method, or the proposed floor space PESM. On the hypothetical facts, without the gaming activity there would not merely be no present profit, but, more importantly, no profit in the foreseeable future, and hence no commercial purpose to the existence of respondent. In the absence of some special funding arrangements, it would presumably be insolvent and would have to be wound-up. On the hypothetical facts, the reality, in terms of the true economic use of the relevant overheads, would be that the driver for the catering activity and any expenditure associated with that activity would be the gaming activity and the enhancement of the profits to be made from the gaming activity. Adopting the language and test in paragraph 49 of Aspinall's Club, gambling would be the foundation of the business and it would primarily be the furtherance of that gaming which would cause and would be seen as justifying commercially the decisions to incur the expenditure. It would be the maintaining and enhancing of the gaming profits that would be the principal driver of all the overheads. As it presently seems to me, that would make the existing PESM, under which attribution of residual input tax is primarily related to the respective turnover of the catering and gambling activities, more fair, suitable and accurate than the proposed floor space PESM, under which (on the figures before the FTT) nearly 50 per cent of residual inputs would attributed to the loss-making catering activity.

88. On the hypothetical facts, the proposed PESM would have the startling consequence that the lossmaking catering activity would generate payments from the Commissioners to the respondent for the indefinite future, as a result of the inputs for that activity inevitably exceeding VAT on supplies, thereby further boosting the respondent's profits generated by its profitable gaming activity. That would not in itself be a reason for rejecting the respondent's argument, but would be a reason for examining with particular care the economic reality against which that argument must be tested.

5.4. VAT and MTIC fraud

HMRC refused to refund input tax totalling £113, 665.55 on seven invoices, included in a return submitted by Crucial Components Ltd for the period 08/06 concerning the purchase of Intel CPUs and Apple iPods. It was recognised that the invoices could be traced back to fraudulent MTIC defaulters. The sales by the Appellant were to four overseas companies, one in the USA, one in Taiwan and two in the EU.

There was a lengthy discussion of facts and the relationship between HMRC and the company, but having considered the evidence as a whole and having regard to the objective factors, Customs did not satisfy the Tribunal that through them (HMRC) the Appellant knew that its transactions were connected with the fraudulent evasion of VAT. The Tribunal then considered whether the Appellant should nevertheless have known of the connection with fraud. They commented: Since "should have known" is alternative to actual knowledge, the word "known" is used in the sense of "realised". Another way of putting it is that the connection with fraud should have been obvious to the trader. The company knew of fraud in its sector, but was trading as it always had done, had received no warnings of problems in its supply chains in spite of a large number of visits and all repayment claims had been met promptly. In contrast with many other MTIC appeals the company knew its suppliers well.

Having considered the transactions and the surrounding circumstances and having heard the lengthy crossexamination of the company's directors, the Tribunal were not satisfied on the balance of probabilities that it should have been obvious to them that the only reasonable explanation was that the transactions were connected with fraud. Thus the appeal was allowed.

5.5. VAT treatment of photobook supplies

Harrier LLC submitted a VAT reclaim for overpaid VAT amounting to £545,800 relating to the period 06/06 to 12/09. This was in respect of supplies Harrier made in relation to what are termed "photobooks", Harrier contending that its supplies are of goods, and that those goods are books or booklets and as such the supplies of them are zero-rated within Item 1, Group 3, Schedule 8 of the Value Added Tax Act 1994 ("VATA"). HMRC, on the other hand, contended that, firstly the photobooks in question were not books or booklets for the purposes of the legislation, and secondly that Harrier's supplies in this respect were not properly to be viewed as supplies of goods (the photobooks themselves) but were instead supplies of photographic services which did not fall within the zero-rating provision.

The Tribunal examined Harrier LLC's contracts with Hewlett Packard and Tesco and in both cases found that the contracts were a supply of both goods (the photobooks) and related services (the digital processes to produce the photobooks). They also concluded that the services were ancillary to the main supply of goods, so that the whole supply could be regarded as a single supply of goods.

The Tribunal then examined whether the photobooks met the classification of zero rated books or booklets. The ordinary meaning of "book" refers to an object that has the necessary minimum characteristics of having a significant number of leaves, usually of paper, held together by front and back covers usually more substantial than the leaves. The word "booklet" refers to a thin book, perhaps with a more flimsy cover, having a less significant number of leaves. But in each case those minimum characteristics are not enough. To be a book or booklet the item in question must be one that is to be read or looked at. A diary or address book could not qualify on this basis, because it consisted of blank pages. But books and booklets are not confined to literary works to be read; works comprised solely of images to be looked at can equally be books or booklets.

The Tribunal were unable to follow the decision in the case of Risbey's Photography Limited, Digital Albums Limited v Revenue and Customs Commissioners (22 August 2008; no 20783), where it was determined that wedding books were not zero rated. The Tribunal did not consider that it follows from the application of the description "wedding album" that something has the characteristics of a book or that the item is not a book for VAT purposes. They concluded a wedding album will in many cases not have the characteristics of a book, but if it does, they could see no reason why it should not be a book for these purposes.

In the Tribunal's view the nature of the binding is also an essential minimum external characteristic. They considered that a book or booklet must have a spine, which will be narrower in the case of a booklet than it is with a book. For this reason a product that is simply spiral bound did not in their view have the necessary minimum characteristics.

As far as content was concerned the Tribunal recognised the need for content, but considered that although the nature of the content is not material, it is necessary to consider the internal physical characteristics. The inner leaves of what would otherwise have the external appearance of a book (or booklet) must also, in substance, have the appearance and quality of the pages of a book. This would not, in their view, be the case if those inner leaves merely have the appearance and quality of a series of individual photographs bound together (whatever may be the nature or appearance of the binding itself).

The Tribunal therefore concluded the supply of photobooks was a supply of goods meeting the definition of books and qualifying for zero rating. However they did not comment on the question of unjust enrichment, and the comments of the company's finance director on the Tribunal result (that the company will now be able to produce the photobooks at lower prices), indicates this will be an issue to consider in whether any repayment is actually made.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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