The UK tax authority, HM Revenue and Customs (HMRC), has clarified important changes to the way businesses in the financial industry with operations within and outside the UK calculate value-added tax.
The draft legislation, announced as part of the 2015 Budget in March 2015, will result in an amendment to UK VAT Regulations and will mean that supplies made by foreign branches can no longer be taken into account when calculating how much VAT incurred on overhead costs can be deducted by partly-exempt businesses in the UK.
Why Is The Government Making The Change?
The Government expects the new measure to simplify the tax system and make it fairer by mitigating the risk that some partly-exempt businesses could artificially increase the amount of input tax that they are entitled to deduct. It also implements a 2013 decision of the Court of Justice of the European Union (CJEU), which we will discuss below.
The Existing Rules
Some services, including financial services, are exempt from VAT. This means these services are not taxable for VAT purposes and there is no right to deduct VAT on related costs. A business providing exempt services to customers within the UK and the EU cannot therefore deduct VAT incurred by it on costs related to the provision of these exempt services. However, exempt financial services provided to customers outside the EU are treated as taxable for the purposes of input tax deduction and so the related VAT on costs may be deducted.
A business that makes both taxable and exempt supplies has to work out what proportion of VAT on its costs can be deducted. The calculation for this is known as a ‘partial exemption method’.
Up to now, UK law has allowed partly exempt UK businesses to recover VAT on overhead costs used to support foreign branches by reference to supplies made by those branches. However, the Government is aware that under these rules, a business could artificially increase the amount of input tax it is entitled to deduct by over-allocating overhead costs to its non-EU foreign branches.
The Credit Lyonnais Decision
In a dispute between Credit Lyonnais and the French Budget Ministry, referred to the CJEU by the French Government, the Court found that the EU VAT Directive could not be interpreted so as to allow a company to take into account the turnover of its EU or non-EU foreign branches when calculating how much input tax it can deduct in the Member State where it has its principal establishment.
Implementing this decision in the UK means that UK businesses will not be able to take into account supplies made by foreign branches when carrying out their partial exemption calculations irrespective of any special method agreed with HMRC. The Government believes that this change will simplify the calculation for businesses and also mitigate the risk of some businesses manipulating the amount of VAT they can recover.
At the time of the announcement it was intended that this measure would have effect on and after 1 August 2015, but where 31 July 2015 falls within the VAT longer period of accounting for a business, it will not have effect until the first day of the next longer period that applies to that business. There have however been delays in enacting the amended VAT regulations and the confirmation of the operative date is still awaited.