Territorial limits on VAT grouping (and on HMRC's power of refusal)

This First-tier Tribunal decision in Barclays Service Corporation and another v HMRC [2024] UKFTT 785 (TC) covered something of a hot topic within the VAT world, namely whether the UK branch of an overseas subsidiary within the Barclays corporate group (Barclays Service Corporation or 'BSC') was eligible to join the Barclays UK VAT group and thereby significantly reduce irrecoverable VAT levels for the group.

Whilst the FTT found that BSC's resourcing at the time of the application was insufficient for a fixed establishment to have existed and the attempt to VAT group was therefore unsuccessful, the decision also shed light on when HMRC can use their protection of the revenue power to refuse an application and in this respect the decision favoured the taxpayer.

Facts

The Barclays Bank group of companies includes Barclays Service Corporation (BSC), a US incorporated company providing services (including IT, HR, strategy and operational) to other companies in various jurisdictions in the Barclays corporate group, including members of the Barclays UK VAT group. Provision of services by BSC to the UK recipients led to significant irrecoverable VAT.

As part of a structural reform programme in 2017, it was proposed that a UK branch of BSC be established, in order to manage delivery of BSC's services to non-US recipients. For VAT purposes, the stated aim was for the UK branch to form a fixed establishment of BSC, allowing BSC to consequently join the UK VAT group and therefore for services provided by BSC to members of the UK VAT group to be disregarded for VAT purposes, leading to significant VAT savings for the UK recipients.

Following establishment and registration of the UK branch at Companies House, an application for BSC to join the UK VAT group was made. HMRC refused the application on two grounds:

• BSC was not eligible to be treated as a member of the VAT group as it was neither established nor had a fixed establishment in the UK (as required by s43A(1) VATA 1994); and
• alternatively, that if BSC did have a fixed establishment in the UK, it was nevertheless necessary to refuse the application for the 'protection of the revenue' (as permitted by s43B(5)(c) VATA 1994).

Issues

The appeal to the First-tier Tribunal (FTT) presented three issues:

1. Did the UK branch of BSC constitute a fixed establishment for the purposes of s43A VATA 1994?
2. Do the UK VAT grouping provisions contain a territorial limitation such that a UK VAT group can not include an establishment outside the UK, and if so, how would this apply to BSC?
3. If BSC had a fixed establishment in the UK, and there was no territorial limitation within the VAT grouping rules, was it the case that HMRC could not reasonably have been satisfied that it was necessary for the protection of the revenue to refuse the application?

Findings

Fixed establishment

The FTT determined that the UK branch was not a fixed establishment at the date of the VAT grouping application as there were insufficient human and technical resources in the UK to make a meaningful commercial contribution to BSC.

HMRC argued that case law relating to fixed establishment in the context of the place of supply rules should be 'imported' into the VAT grouping rules, such that in order for a UK branch of an overseas company to be regarded as a fixed establishment for VAT grouping purposes, it must:

"(i) have a real trading presence in the UK and must supply goods or services in its own right, those goods or services being neither preparatory or auxiliary, but material to the business of the person in question;

(ii) have sufficient permanent resources to be able to supply those goods or services; and

(iii) have sufficient permanent resources to receive the supplies required to enable it to provide those goods or services"

(as argued by HMRC in HSBC Electronic Data Processing (Guangdong) Ltd v HMRC [2022] STC 367).

The taxpayer asserted that a less restrictive interpretation was applicable in the VAT grouping context, albeit that 'place of supply' case law could be taken into account and could 'inform' the definition applicable in the VAT grouping context. The taxpayer contended that the approach in this context should only address whether there is a "sufficient degree of permanence and a suitable structure in terms of human and technical resources".

The FTT found it unnecessary to provide express, detailed guidance on the meaning of fixed establishment, as the FTT felt it was clear in this case that the UK branch had, in practice, insufficient employees (one only) and no formal lease in place in respect of its premises at the time of the VAT grouping application, so that it did not satisfy either test for the existence of a fixed establishment.

This finding was sufficient to dispose of the taxpayers' appeal, but the FTT went on to consider the remaining two issues in any event.

Territorial limitation

The FTT considered whether a 'whole establishment' approach should be taken to the UK's VAT grouping rules – i.e. whether s43A allows the entire eligible non-UK body corporate to be part of a UK VAT group or whether a different approach should be taken, allowing only that part of the non-UK body that is established in the UK (the UK branch in this case), to join a UK VAT group.

HMRC argued that whilst the 'whole establishment' approach has always been adopted in the UK, the CJEU decision in Danske Bank (Case C-812/19) has called this approach into question. In that case, Danske Bank's principal establishment belonged to a Danish VAT group, but it was determined that its Swedish branch could not be regarded as forming part of that VAT group due to the territorial limits of the EU VAT Directive (Art 11), so that the principal establishment and its branch could not be regarded as forming a single taxable person for VAT purposes.

The FTT noted that the obligation to apply a conforming construction of s43A, imposing a territorial limitation as set out in Danske Bank, "was constrained" and "cannot require the courts to make decisions for which they are not equipped or give rise to important practical repercussions which the court is not equipped to evaluate" (citing Vodafone 2 v HMRC [2010] Ch 77).

In this case, the FTT determined that any change to the UK's 'whole establishment' approach would have broad and far-reaching practical consequences, and the FTT was not equipped to evaluate what would effectively be a new regime for VAT grouping in the UK. It therefore concluded that it was not possible for the FTT to give a conforming construction to s43A, and consequently that there was no territorial limitation to the UK's VAT grouping rules and that the 'whole establishment' principle should continue to be applied. HMRC's arguments on this point were dismissed.

Protection of the revenue

The FTT acknowledged that HMRC may refuse an application for a company to be treated as a member of an existing VAT group under s43B(5)(c) if that refusal is ‘necessary for the protection of the revenue’. The Tribunal said that it could not allow a taxpayer's appeal against a 'protection of the revenue' decision from HMRC unless it considered that HMRC "could not reasonably have been satisfied that there were grounds for refusing the application".

The FTT then considered the aim of the VAT grouping legislation; the parties agreed that it was 'administrative simplification' but HMRC contended that this was limited to removing complexity for VAT accounting, whilst the taxpayer asserted that it was a business facilitation measure allowing a business a choice over its corporate structuring, such that complex multinationals could group and be taxed in the same way as a single company organised into divisions. The FTT agreed with the taxpayer.

With this in mind, the FTT noted that it had to consider whether, in this case, "there is any loss of revenue that goes beyond the normal consequences of grouping". The FTT concluded that, had the UK branch been a fixed establishment of BSC, "the VAT savings on its admission to the VAT group would be those that fell within the normal consequences of VAT grouping". Accordingly, the FTT dismissed HMRC's arguments on this issue, determining that it was not reasonable for HMRC to refuse the application on the grounds of protection of the revenue.

Reflections

The taxpayer has appealed the FTT's decision to the Upper Tribunal, which indicates that there will be further consideration of the fixed establishment issue. It remains to be seen whether BSC can convince the Upper Tribunal that the level and nature of the activity being undertaken by the UK branch at the time of the VAT grouping application was sufficient.

We would expect that HMRC will use the appeal to raise again the other issues considered by the FTT, with the focus in our view likely to be on the protection of revenue issue. The FTT's decision on this issue, especially if endorsed by the Upper Tribunal, is likely to be taken by other taxpayers as supportive of their own plans to VAT group overseas subsidiaries.