Update: corporate tax

VAT has been called many things, not many of which are printable. One of the phrases it will surely never earn is the tag of 'simple tax', which is what Labour chancellor Tony Barber promised VAT to be shortly before its inception in the UK in 1973.

Unfortunately the latest round of developments will do nothing to aid that cause. However for those of us who inhabit the VAT world, it has been of late an extremely interesting time to be in practice. There have been some key court decisions, which have spawned arguments for claims for overpaid VAT which themselves have run headlong into a bevy of other VAT arguments as to the quantum and form of the claims. All of this relates particularly to the charge of VAT on pension fund management services and whether those services should have been treated as exempt from VAT. While all of these points will have to be unpicked by the courts at some point in the future, this update attempts to present all of this in a digestible form.

The backdrop '“ Claverhouse

JP Morgan Fleming Claverhouse Investment Trust plc v HM Revenue and Customs (HMRC) (Case C-363/05) ('Claverhouse') was a claim for the recovery of VAT spent on the management fees of an investment fund. The taxpayer successfully argued that such services fell within one of the statutory exemptions and as such should not be subject to VAT. HMRC had maintained that the exemption from VAT on fund management services extended only to managers of open-ended investment companies and not close-ended companies. The case was referred to the European Court of Justice (ECJ), which was asked to decide whether the words 'special investment funds', from the (then) sixth EC Directive '“ the enacting legislation of VAT which details the extent of the exemption from VAT for all EC member states '“ should include close-ended investment funds and, if so, whether member states are able to choose, as the UK/HMRC had purported to do, which types of special investment funds in its jurisdiction could benefit from the exemption. The money at stake in Claverhouse, i.e. the amount of VAT claimed to have been overpaid on the provision of the fund management services, was in excess of £2.7m of VAT over a 10-year period.

The ECJ held that although member states have a discretion to decide what falls within the definition of 'special investment funds', they must respect the objective pursued by the relevant legislative provisions, which is to facilitate investment while guaranteeing the principle of fiscal neutrality between funds that are in competition with one another. It was quickly apparent that, at its broadest, the ECJ's decision could be taken to apply to all investment funds and particularly pension funds. If this was/is right, pension funds should have been benefiting from the VAT exemption for management services charged by fund managers. They would also have a claim to recover VAT previously overpaid to the fund managers.

So no problem then '“ pension funds make a claim for overpaid VAT, someone takes a lead case and the funds either obtain a refund or they don't. In keeping with its reputation however, VAT is not that straightforward. The first issue is over who makes the claim for overpaid VAT itself. The method by which a claim for overpaid VAT is made is set out within the Value Added Tax Act 1994 ('VATA'). This states that the claim has to be made by the body who accounted for the VAT issue to HMRC. This is, of course, the fund managers rather than the pension funds.

In fact the fund managers may not be keen on making a claim. If a fund manager's services are exempt from VAT they will suffer a restriction on their right to recover VAT incurred on purchases and expenses. The fund managers will, however be acutely aware that if it is subsequently held that their services should have been exempt from VAT, they could be liable to either a claim under contract or restitution from the pension funds.

'No problem', you might say. 'The pension fund manager just sends in the claim when they know if the litigation is successful.' Ah, that is a lovely thought, and if it were only so simple. This is VAT we are dealing with here! The problem is that there exists in the VAT world a three-year cap on claims for overpaid VAT by virtue of s.80(4) of the VATA. So every month the pension fund manager lets pass before a claim is made is a month lost.

So the prudent pension fund manager and pension fund will have to find a way of working together. This can be done in a variety of ways. They are many and varied and are really beyond the scope of this article. To be frank, it could form a day's seminar in itself for those who could stand it. Suffice to say, co-operation is the key word. The fund managers will also have to step around the unjust enrichment provisions (s.80(3) VATA), which empower HMRC to refuse to repay any claim for overpaid VAT where it considers that the repayment will unjustly enrich the claimant, i.e. where the repayment would be a windfall to the claimant because the VAT cost had been passed on to a third party, namely the pension fund. However if the pension fund manager is undertaking to pay any money claimed to the pension fund, this should be enough to ensure that the unjust enrichment provisions do not bite.

So why the fuss?

You may well now be asking, 'So why the fuss? Pension fund manager makes the claim and pays pension fund with the proceeds. No need to sue each other. Everyone is happy'. Again, that is a very lovely thought. Unfortunately with VAT law as currently cast, as soon as you contemplate making the claim itself you crash into the culmination of a whole load of other recent seminal VAT case law. Actually this could be described as 'fortunate' rather than 'unfortunate', because this bit of case law offers the opportunity of making a claim extending beyond the three years imposed by the capping provisions. Although there is indeed a three-year cap on claims for overpaid VAT, this has been subject to a separate challenge, relating to the way in which the cap was introduced in 1996, which was effectively without any notice to the world at large and crucially without a transitional period to enable businesses to review their VAT affairs and make any outstanding VAT claims for overpayments.

To cut right to the chase, the pension fund managers can make claims beyond three years. There are two approaches. The first follows the decision by the House of Lords in the joint cases of Fleming (trading as Bodycraft) v Revenue and Customs Commissioners and Condé Nast Publications Ltd v Revenue and Customs Commissioners ('Condé Nast') [2008] STC 324. These cases held that the lack of a transitional period on inception of the three-year cap means that it is rendered ineffective from its inception back to the beginning of VAT time, i.e. an uncapped claim can be made for periods from 1 January 1973 until 18 July 1996 in addition to the last three years. That is settled case law and is now a given, although as of 31 March 2009 this will no longer be the case.

The second approach is much less assured and follows the decision made by the VAT Tribunal in Scottish Equitable v Commissioners for HMRC (EDN/02/161). Under this decision a claim could be made for all intervening periods from 19 July 1996 until the current date. Put very shortly, Scottish Equitable suggests that the three-year cap is ineffective in total because of a lack of a transitional period, and will remain so until properly incepted. This case however preceded the House of Lords' judgment in Condé Nast, and it is generally considered amongst the tax fraternity to have been wrongly decided by the VAT Tribunal. The Scottish Equitable case has been appealed to the Court of Session, and forms the subject of a reference to the ECJ on the effectiveness of the introduction of the legislation restricting VAT claims to three years (although the questions referred to the ECJ are not yet publicly available). This will be the first time the ECJ considers the question of the effectiveness of the introduction of the capping time limits by the UK tax authorities, and therefore the court could provide a judgment that contradicts the House of Lords' findings in Condé Nast. This may sound dull, but in the VAT world the potential of this case, if it should go in the taxpayers' favour, is pretty seismic.

Final sting in the tail

But back to the Claverhouse claim '“ pension fund manager and pension fund have agreed to work together; everyone has read the Condé Nast and Scottish Equitable cases and ensured that the claim is sufficiently broad '“ all is well? Nearly '“ a final sting in the tail is the claim itself. For many years, claims under s.80 of the VATA have been made solely by reference to the amount of tax overpaid. Some taxpayers may have gone further and specified a corresponding restriction of input tax (where the claim '“ as is the case with Claverhouse claims '“ is a move from taxable to exempt supplies) but this was borne more for the purposes of completeness, rather than necessity. The requirement of the law, in terms of making a valid claim, was accepted (by both taxpayer and HMRC) to be to specify the amount of the VAT (output tax) overpaid. Not so with Claverhouse claims. HMRC has been routinely rejecting Claverhouse claims on the basis that they do not consider they meet the requirements of s.80 (and particularly, HMRC says, the provision of the relevant subordinate statutory instrument on claims), and are therefore invalid.

Those who are seeking to stake their claim therefore have a choice '“ either make a full calculation of the restriction of input tax the fund manager will suffer if the supply of their supply of fund management services is indeed exempt and deduct that from the amount of output tax claimed (not attractive '“ that is an enormous amount of work for a fund manager of any size), or make the claim in the time-honoured fashion based on overpaid output tax/VAT only, receive the almost inevitable rejection of the claim on technical grounds in addition to the rejection of the Claverhouse claim itself, and have to appeal that additional point to the VAT tribunal. The latter is a slightly higher-risk strategy in that it gives the taxpayer another battle at court should it be held that the services of the pension fund manager are exempt from VAT, although common sense would dictate that it is one which the taxpayer should win.

So once a valid Claverhouse claim has been lodged, and refused by HMRC, it needs to be appealed to the VAT tribunal. The VAT Tribunal has just decided upon a test case '“ there is no procedure within the VAT tribunal to deal with the concept of lead cases '“ more of an informal procedure of one case progressing and others being 'stood over' behind it. The 'stood over' case then happily becomes low maintenance and essentially just waits for the outcome of the lead case. This will probably be some years away.

The author hopes that for those for whom VAT is only of passing interest, this has gone some way to making one part of the tax world slightly clearer. Make no mistake about it, if these claims are successful and have been made properly by the right entity and for the right time periods, the repayments will be very likely to run into millions with current indications that the VAT at stake across the industry amounts to around £100m per annum.