The VAT cost-sharing exemption applies to services provided by collective groups of service providers, including charities, where those organisations might not otherwise recover all the VAT they incur on an individual basis. Jonathan Brinsden reviews the hurdles to be overcome before the benefit of the exemption may be secured.
The Finance Act 2012 sets out the carefully defined and narrow circumstances in which independent entities which make exempt supplies or carry on non-business activities may benefit from sharing costs without bearing a VAT cost. Welcome as this is, the restrictions placed on its application are considerable (more so when considering all of the related legal and operational complications) so charities will need to be able to prepare a worthwhile business case in which all the benefits are fully weighed up against the complications before setting up the relevant structures.
Nonetheless, charities which are potentially moving, via closer working relations, towards possible merger will be particularly interested. It will also interest like-minded charities which have decided to remain separate and independent, but are aware of the need to rationalise their back office costs.
The conditions for implementation exist on two basic levels: overall conditions, and detailed conditions. The former are set out in legislation, and the latter in HMRC guidance.
First, the overall conditions:
- exempt shared services can only be provided by a separate special purpose vehicle (SPV), and this will usually, but need not, be a company limited by shares;
- only ‘members’ of the group may benefit from exempt supplies from the SPV;
- members generally have to be independent of each
- other, but will all have a legal interest in the SPV, and no non-member may have a legal interest;
- the members will all have at least a minimum level of exempt or non-business activities;
- the SPV services which qualify for exemption must
- be ‘directly necessary’ for the members’ fulfilment of their non-taxable (that is, exempt or non-business) activities;
- the charges made by the SPV must be such as only to reimburse the costs it incurs,with no profit element;
- the arrangement must not distort competition by competing directly with taxable commercial outsource service provision.
HMRC’s guidance provides further clarification of these concepts, though some aspects are likely to remain flexible in principle. It is as yet unclear whether this guidance will have the necessary legal ‘teeth’ to be effective, although it is in the interests of charities to help HMRC to make the policy work effectively. In addition, the new legislation allows the Treasury to make regulations as and when it deems them necessary, and certain interpretations could change because a decision is awaited from the European Court.
Put succinctly, and at risk of glossing over contentious points of interpretation, the conditions are:
- to be a member, the proportion of your supplies which are taxable cannot exceed 95%; and
- to qualify for the exemption, the services supplied by the SPV must be ‘directly
- necessary’ for the member to carry out its exempt and/or non-business activities; but
- if at least 85% of your total activities are exempt and/or non-business, all supplies from the SPV will be regarded as ‘directly necessary’ and therefore subject to the exemption;
- the position of the 15% or less of supplies which are non-exempt will usually be based on the residual VAT recovery rate enjoyed by the member (although no VAT recovery is possible for a non-registered member);
- if a member fails to receive any qualifying supplies from the SPV during any 12 month period, it will cease to be eligible for membership. However, if it can demonstrate to HMRC that it intends to receive qualifying supplies in the near future, its membership can continue; and
- if the member no longer qualifies to remain in the group, it must dispose of its legal interest in the SPV (failing which, the SPV is no longer a qualifying provider). In those circumstances, there must be at least two remaining eligible members for the exemption to continue;
- HMRC will not apply the rule that mere cost reimbursement is required in such a way as to preclude covering overheads or future investment in delivery mechanisms, but they will expect proof that the medium term outcome is solely to break even, and may ‘hunt’ for examples of covert surplus distribution;
- HMRC is likely to monitor the way the membership of this group is ‘held out’ to ensure that it is not sufficiently commercial in character to trigger disqualification under the distortion of competition criterion.
The need for a separate vehicle could give rise to problems in realising the benefits of the exemption. There is no benefit if the SPV purchases services on which it pays VAT that it cannot reclaim. If it buys staff resource from a member, it will incur VAT which cannot be reclaimed. This can be obviated by making the SPV the employer (or a joint employer) but this causes other complications. An alternative could be to ensure that one of the members (perhaps the largest or most resourced) holds a majority of the shares, by virtue of which the SPV can group VAT-register with that member. On that basis, that member can supply staff to the SPV without VAT being incurred. Clearly, however, other members will seek assurance that the majority shareholder will not use its power to its own unfair advantage.
Taken as a whole, this is a significant development which will probably prove workable for those groups of organisations that are prepared to take time and care in implementing it.