A UK court has provided guidance on the meaning of use and enjoyment and on what constitutes legitimate expectation regarding changes to the basis of the VAT calculation, in the context of mobile phone and related supplies outside the EU.

What was the case about?

Telefonica obtained an agreement from the UK tax authorities (HMRC) that it could calculate VAT on phone charges using the "revenue method". Under this method, Telefonica used the proportion of the network access charges paid by the customer for non-EU use in comparison to the total use. Since services effectively used and enjoyed in a non-EU country are outside the scope of VAT, the apportionment was used to determine how much of the income was subject to VAT.

HMRC subsequently challenged the method used on the basis that the calculation produced a favourable though inaccurate result, as what the customer paid for non-EU supplies was higher than for EU supplies. HMRC also claimed that Telefonica should calculate the VAT payable on the basis of actual usage (the usage method).

Telefonica sought judicial review of the HMRC's change of approach, arguing that (i) there was no provision in the VAT Directive or under UK Law that permitted a method based on use; and (ii) that it had legitimate expectation based on correspondences with HMRC which stated that Telefonica could continue to use the revenue method until any change in the law or to its business model.

The Tribunal decision

The UK Upper Tribunal dismissed Telefonica's claims, on the basis that:

  • the usage method was not unlawful and was the appropriate methodology for calculating the extent to which the network access was effectively used and enjoyed outside the EU;
  • the effective use and enjoyment of a supply means actual use rather than the right to access services that are not used;
  • the legitimate expectation principle requires clear and unambiguous evidence, and HMRC did not make clear that Telefonica could apply the revenue method indefinitely;
  • even if there was legitimate expectation, HMRC was entitled to review its position due to the extent of accuracy of the methods and the public interest involved.

What to expect next?

It is likely that Telefonica will appeal to the Court on the basis that the Upper Tribunal decision is wrong in law.

Thus, as a prudent course of action, businesses in the telecoms industry should consider undertaking a review of their calculation method to identify any potential VAT exposure and determine next steps, including seeking an express agreement from HMRC.