The 2012 Budget introduced long awaited legislation, in the shape of the Finance Act 2012, which allows in principle for universities, further education institutions and schools to share back office services on a VAT exempt basis.
The introduction was hailed by the government as a solution to the “VAT barrier” that was perceived to be the blocker to institutions coming together to create cost efficiencies through the consolidation and centralisation of resources. This article will consider whether a way around the “VAT barrier” has indeed been found, and if problems remain, whether there are any other approaches that may be more likely to succeed.
The cost sharing exemption has been implemented by s.197 of the Finance Act 2012. However, it may be very difficult for a taxpayer to comply with the strict conditions surrounding the exemption. This is because the legislation would appear to require that the services that are to be shared on a VAT exempt basis must be “directly necessary” for the exercise of educational activities . The term “directly necessary” has created some debate in the UK, as there appears to be a risk that the exemption will not extend to sharing “back office” functions that are not exclusively associated with educational activities, but instead are necessary to the running of the institution as a whole (which itself will not deliver wholly exempt or non-business activities).
In order to provide a solution to this issue, HMRC released guidance at the end of August (HMRC Information Sheet 07/12) which provided certain discretionary tolerances in favour of the tax payer which would help to make the exemption more readily applicable. HMRC will allow services to be shared on a VAT exempt basis if the member of the cost sharing group delivers supplies that are greater than 85% VAT exempt or non-business in nature. This would extend the exemption to the majority of universities, further education institutions and schools in the UK. The HMRC guidance seemed to have resolved the problems in using the exemption. However, this has been put in doubt by the action of the European Commission, which has issued infraction proceedings against Luxembourg for putting in place very similar exemption measures to those adopted in the UK. We currently await the outcome of those infraction proceedings and the decision of the European Court of Justice as to the meaning and application of the term “directly necessary”.
This leaves the position of both the UK tax payer and HMRC in doubt for potentially some considerable time. HMRC have promised a transitional period should the European Court’s decision be unfavourable to the UK. However, this might in practice mean institutions withdrawing from cost sharing arrangements implemented on the basis of the cost sharing exemption. The implementation of a cost sharing group to take advantage of the exemption will require significant institutional restructuring, which will no doubt involve resolving issues of procurement, outsourcing , TUPE and possibly redundancy: this will inevitably be a major project involving considerable cost and management time. Institutions should therefore move forward with a degree of caution and ensure that cost sharing structures are not only implemented correctly, but also offer a smooth exit route should the current infraction proceedings prove successful.
Despite these potential problems with the cost sharing exemption, it is possible to arrange an institution’s affairs in a manner which takes advantage of wider VAT legislation that will mitigate the VAT cost of sharing staff without having to rely upon the cost sharing exemption in isolation. It is also possible in certain cases to mitigate in part the VAT cost associated with the sharing of wider resources, such as IT systems, particularly if procured on an outsourced basis. If implemented correctly, such arrangements would achieve many of the potential benefits of the cost sharing exemption should the European Commission be successful in its current infraction proceedings.