HMRC has announced its intention to implement the Court of Justice of the European Union (CJEU) decision in the Skandia case from 1 January 2016. In 2014, the CJEU ruled that services supplied from a head office to its overseas branch can, in some circumstances, be a supply for VAT purposes – see the October 2014 issue of Business Edge. Multinationals that operate cross border branch structures are likely to face increased VAT bills and higher compliance costs.
Historically, charges between a head office and its overseas branches have been ignored for VAT purposes as the courts have consistently ruled that it is not possible to make a supply between two parts of the same legal entity. Historically, many partly exempt businesses have relied on this to reduce VAT costs by importing services via an overseas branch and a number of EU member states, including the UK, have blocked this specific form of VAT planning through anti-avoidance legislation.
In Skandia, the CJEU ruled that where an overseas branch is a member of a VAT group registration, it should be treated for VAT purposes as if it were a separate taxable person. According to the CJEU, services provided from a head office to an overseas branch that is in a VAT group are a supply which is within the scope of VAT. As a result, the VAT group is liable to account for reverse charge VAT on the costs recharged to the branch by its head office. This VAT is not recoverable by partly exempt businesses.
How will the Skandia rule be implemented?
In HMRC’s view, the VAT treatment set out in Skandia only applies where the VAT group is in a country that operates an ‘establishment only’ VAT grouping model, ie countries that treat only the branch as part of the VAT group. The Skandia treatment doesn’t apply where the whole company, including overseas establishments, is treated as part of the VAT group.
HMRC expects the Skandia interpretation to apply where an overseas establishment is VAT grouped in Belgium, Czech Republic, Denmark, Estonia, Hungary, Latvia, Slovakia, or Sweden. It could potentially also apply in Spain, which has two separate VAT grouping schemes, and in Germany, Cyprus, and Finland, which have yet to confirm their approach. HMRC believes the other EU member states are excluded, either because they don’t use an ‘establishment only’ grouping model or don’t operate VAT grouping at all.
HMRC says that it is the responsibility of individual businesses to confirm the correct VAT treatment of these supplies with the tax authority of the member state concerned. The changes do not apply to businesses whose only VAT group is in the UK and not in any other EU member state.
The UK already had anti-avoidance legislation in place to prevent businesses from using overseas branches to bring services into a UK VAT group VAT free, but the Skandia decision is expected to widen the scope of charges that are affected, affecting businesses with no UK VAT group.
Under the old rules, a UK reverse charge liability applied when services are bought-in by a head office or branch outside the UK, but only to the extent they are supplied onward by a UK branch to other entities within the VAT group.
Going forward, the Skandia judgment is expected to apply UK VAT to all taxable intra-entity charges where they are made to a UK branch or head office by an overseas head office or branch and the latter is located in an EU country which has adopted Skandia type VAT grouping. This will include services that are used only by the UK establishment itself and recharges that may relate solely to internally generated costs, such as salaries. Where the recipient branch is in a UK VAT group, reverse charge VAT will apply even if the services are used wholly within the branch and not recharged to other VAT group members.
The most profound effect of the decision will be on exempt and partly exempt businesses, such as banks or insurance companies. Any additional reverse charge VAT payable will increase VAT costs.
A fully taxable business can recover this reverse charge VAT but may suffer an additional administrative burden as it will be necessary to determine the correct VAT treatment of internal recharges. These changes may create also partial exemption issues where the recharges in question are VAT exempt.
What happens next?
HMRC’s ‘solution’ has been designed to limit the impact of Skandia on businesses operating in the UK as far as possible but will be difficult to apply in practice, not least because it effectively applies different rules to different member states. Meanwhile, not all member states have yet decided how they will apply Skandia and a study at EU level is still considering the full implications of the CJEU’s decision. It is, therefore, unlikely that HMRC’s latest brief will be the last word on the matter. Nevertheless, unless and until the EU reaches a firm conclusion to the contrary, it looks like UK businesses will have to work with HMRC’s interpretation for the foreseeable future.
Businesses with branches or a head office that are members of a VAT group in other EU member states should immediately take steps to identify any transactions that might be affected by the new rules, determine how those states are responding to Skandia, and, if appropriate, consider restructuring their current cross border operations.
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