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Is the arms length principle about to enfold VAT?

19 March 2019

The UK First-tier Tax Tribunal is preparing to hear an appeal that will explore the interaction between valuation rules for VAT and transfer pricing purposes.

The Jupiter Asset Management case concerns a management charge between members of a corporate group which HMRC argued had been undervalued for VAT purposes.  The tribunal is expected to consider whether the arm’s length principle, and the OECD transfer pricing guidelines thereon, are an appropriate means to determine open market value of a management charge for VAT purposes.

If the tribunal finds that to be the case, corporate groups who use cost as a basis for valuing such intercompany charges may be required to charge a higher amount. Where the recipient of the charge is not entitled to recover all the VAT it incurs on its costs, for example because it is partly exempt for VAT purposes, this may increase its irrecoverable VAT burden. 

In a procedural hearing, the tribunal judge noted that there is currently no case law from the Court of Justice of the European Union (CJEU) on the relationship between the Principal VAT Directive and the OECD guidelines, so there was a possibility that questions on this point may be referred to the CJEU.  Uncertainty over the precise terms of the UK’s withdrawal from the EU may mean this appeal will be considered in the UK courts rather than the CJEU, but this could still lead to some changes in how management charges, and possibly other income stream recharges, are valued for VAT purposes.

While initially designed for valuing intercompany transactions to determine profits for corporate income tax purposes, the arm’s length principle and OECD guidelines are increasingly referred to in other valuation exercises. The tribunal’s findings on the extent to which they might be used in VAT disputes could extend their influence yet further, into indirect taxes. 

Businesses who make or receive similar management charges should therefore watch out for the tribunal’s decision on this point.