Euro-Med Preferential Origin

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					                                                                                                      CUSTOMS DUTY


                         Euro-Med
                 Preferential Origin
S
      hould you be concerned if your Norwegian            Bulgarian goods can be given equal standing with
      supplier provides you with a certificate of         Romanian goods when considering whether a
      Israeli origin for goods despatched from            manufacturing process in Romania confers origin
Stavanger? The EU reports that only around 52% of         for the purpose of selling goods into the EU. Of
the goods entitled to claim preferential origin actu-     course in this tripartite relationship, the same con-
ally do so. In part, this is due to the incredible com-   cept applies to whichever party is doing the sup-
plexity of the administration involved in claiming        plying or the manufacturing. This idea is known as
the preference.                                           cumulation of origin and relies on Bulgaria and
    With concepts sporting snappy names such as           Romania executing a parallel agreement between
‘diagonal cumulation of origin with variable              themselves.
geometry’, it is no surprise that very few profes-
sionals – let alone claimants – have any clear idea
                                                                                                                       Phil Challen is
of the rules governing origin within the Euro-Med         Cumulation                                                   a Fellow of
zone.                                                     Cumulation has, for a decade or so, been under-              the Institute,
                                                          stood as applying within each of the three different
                                                          groupings but has not been applicable between                and over the
The origin                                                groupings.                                                   last 18 years
Let’s start at the beginning. Countries can agree             Therefore whereas an Algerian manufacturer
between themselves that goods made in one of the          can treat Tunisian goods as ‘originating’ for the            has split his
countries should be afforded preferential access          purpose of sending goods to the EU, the same is              time fairly
(that is, a lower duty rate – often 0%) to the territo-   not true of Bulgarian goods. Equally, while a
ry of the other. However, to avoid abuse both sides       Bulgarian manufacturer could treat Romanian
                                                                                                                       evenly
need to ensure that the goods concerned are gen-          goods as originating for the purposes of trade with          between
uinely produced in the beneficiary country.               the EU, it could not do the same with Israeli goods,         Customs, the
Accordingly, the agreement will include complex           even though the EU has an arrangement with
rules governing the manufacturing processes that          Israel.                                                      large
confer origin.                                                In all discussions about cumulation, it is accept-       accounting
    Almost all agreements to which the EU is a            ed that a significant manufacturing process has to
party state that simple assembly operations cannot        take place and that the effect of cumulation is to           firms and,
by themselves confer originating status on the fin-       make it more likely that the rules of origin might           latterly,
ished product.                                            be met.
    The EU uses preferential origin agreements to
                                                                                                                       industry.
ease the goods of EU candidate countries into the                                                                      In the second
EU’s free circulation arrangements. As a result, it       Barcelona Agreement                                          of a series of
has the same agreement with lots of separate coun-        In Barcelona in 1995 the EU got together with the
tries. It adopts a similar approach to achieve dif-       majority of countries bordering the Mediterranean            three articles,
ferent ends with different geographies but the            and agreed to work together to strengthen the ties           he discusses
result is that there are distinct groups of preferen-     between them.
tial trade arrangements, with beneficiary countries           By 2010, their aim is to create a Euro-                  the new
within each group sharing the same arrangement            Mediterranean Free Trade Area encompassing                   Euro-Med
with the EU.                                              more than forty states and eight hundred million
    These groups are, broadly: the North African          consumers – one of the world’s largest trading               origin
and Mediterranean countries; the EU Candidate             blocs.                                                       arrangements
countries of Eastern Europe and Turkey; and the               To invigorate trade among Barcelona partners,
EFTA countries.                                           the Euro-Med trade ministers agreed to extend the
                                                          system of pan-European cumulation of origin to
                                                          the Mediterranean partners. A new protocol on
Cumulation of origin                                      rules of origin was agreed in Palermo in July 2003
In the run-up to Accession on 1 January 2007              and all parties to the Barcelona Agreement are
Bulgaria and Romania each have the same agree-            actively setting about revising their old agree-
ment with the EU, under which the goods of each           ments with the EU and each other so that all coun-
can enter the EU at reduced duty rates. Given this        tries share exactly the same origin rules for each
commonality, it makes sense to agree that                 product. They also need to execute any ‘missing’


Indirect Tax Voice, November 2006                                                                                  3
CUSTOMS DUTY
                agreements so that there is a common web of              and the origin rules are met, the country of last
                agreements between all parties.                          manufacture is always the country of origin.
                    Whenever a tripartite origin movement is con-        Otherwise, it is necessary to compare the value
                sidered under the new rules (manufacture in coun-        added in the country of export with the customs
                try A, using goods with a certificate of origin from     values of any originating products. The goods will
                country B, for export to country C), the exporter of     take the origin of the country whose components
                the finished product needs to ascertain whether          or value added represents the highest figure.
                countries A, B and C have all concluded the new              Consider a computer packaged in the UK in
                Euro-Med agreements with each other. To stress           2010 (when all agreements should be in place).
                the point, the new Euro-Med agreements have to           The monitor is from Israel, the main processing
                be in place between A&B, B&C, and A&C. If any of         unit is from Norway and the keyboard is from
                                                                         Algeria. These three components are boxed
                                                                         together in the UK and a manual in book form is
                                                                         added. The manual originates in the UK and costs
  A point to remember is that if cumulation is                           £3, while the customs values of the keyboard, mon-
                                                                         itor and processing unit were £10, £150 and £250,
   used to achieve origin, the countries con-                            respectively. The ex-works price of the computer is
  cerned must be listed in Box 7 of the EUR1.                            £650.
                                                                             The value added in the UK is £240 - the ex-
 This can cause difficulties – especially if, for                        works price of £650 less the £410 customs value of
                                                                         the imported components. Accordingly, the prod-
  example, the sale is to a country that might                           uct originates in Norway for Euro-Med origin pur-
                                                                         poses, because that is the country with the highest
      object to the use of Israeli components.                           proportion of value. Accordingly, the UK supplier
                                                                         can still issue Form EUR1 but must stipulate upon it
                                                                         that the goods are of Norwegian origin – which is
                those agreements is not yet in force, the products       quite a departure from any previous origin
                supplied from the ‘missing’ country count as non-        arrangements. If the UK seller were to increase his
                originating when considering whether to raise a          price to £670 the goods would originate in the EU
                new form EUR1, even if the goods themselves were         and the EUR1 would reflect that fact.
                covered by an origin certificate (which would also           A point to remember is that if cumulation is
                be Form EUR1) when supplied.                             used to achieve origin, the countries concerned
                    By way of example, consider that identical           must be listed in Box 7 of the EUR1. This can cause
                agreements are in place between countries A&B            difficulties – especially if, for example, the sale is
                and A&C. The manufacturer in A buys originating          to a country that might object to the use of Israeli
                goods from a supplier in B, to process and sell the      components.
                finished item to a customer in C. There is an agree-         The EU has produced two valuable guides for
                ment between A&B, so A will receive form EUR1            anyone wanting to know more (and there’s a lot to
                from his supplier, allowing duty-free access. There      know! They are at: http://tinyurl.com/nfjsa and
                is also an agreement between A&C, so A can issue         http://tinyurl.com/pxltk. There is also a table
                an EUR1 if his goods originate. But in deciding          showing who has signed what agreements, and
                whether they do indeed originate, he has to count        when: http://tinyurl.com/rh9qg.
                supplies from B as non-originating, because there
                is no agreement between B&C.
                                                                         Affected countries
                                                                         Partners to the Barcelona Agreement are:
                Determination of Origin                                     * Algeria
                    By and large, assuming that the origin rules are        * Bulgaria
                met, goods will generally originate in the country          * Egypt
                of last manufacture. However, this is not always the        * EU
                case. Under the Euro-Med agreements it is not nec-          * Faroe Islands
                essary for the goods of other Euro-Med countries            * Iceland
                to undergo processing going beyond mere assem-              * Israel
                bly (or even to be processed at all), so there will be      * Jordan
                cases in which the country of last manufacture              * Lebanon
                adds only minimal value. Indeed, because of the             * Morocco
                way the system works, it is possible that goods             * Norway
                originating in Country B, which have been merely            * Romania
                stored in Country A, can benefit from an EUR1 form          * Switzerland
                when moving to Country C.                                   * Syria
                    When the working and processing goes                    * Tunisia
                beyond the minimal operations mentioned in                  * Turkey
                Article 7 of Protocol 4 of the Euro-Med agreements          * West Bank and Gaza Strip.


            4                                                                 Indirect Tax Voice, November 2006
                                                                                 NEWS FROM THE COURTS


Orchestrated
Series of Appeals
Akos Nadasdi & Ilona Nemeth v Vam-es …                      The majority of the Court reasoned that as the
Parancsnoksaga (Hungary), ECJ, Cases C-290/55           managing director was paid and made a signifi-
and C-333/05, 5th October                               cant contribution to running the organisation, the
Environmental car tax required to take account of       orchestra was not essentially run voluntarily and
depreciation on cars from another Member State          hence was not exempt.
Both cases concerned charges levied for registra-           The minority judgment reached the same con-
tion in Hungary of used cars bought in Germany.         clusion but reasoned that the managing director
The Hungarian duty is independent of the value of       was not just an executive but participated in the
the car and is determined by the car’s technical        board decisions.
characteristics, such as engine type, capacity and          Appeal dismissed.
its environmental classification.                           Comment: The Court of Appeal also refused                  As part of his
    Questions arose as to whether this was a pro-       permission for an appeal to it against the High                regular series
hibited customs duty under Article 25 EC, or a tax      Court judgment in Longborough Festival Opera v
on products from other Member States contrary to        HMRC, ChD, 27th January 2006. There it was held                Eamon Mc
Article 90 EC.                                          that a trustee providing non-legally-enforceable               Nicholas,
    The Court held that this was not a customs duty,    letters of comfort to cover shortfalls did not have a
as it was levied because the vehicles crossed a         financial interest, so that the orchestra continued to
                                                                                                                       barrister, of 3
frontier. Secondly the Court held that whilst an        be exempt.                                                     Temple
environmental tax based on objective criteria,                                                                         Gardens Tax
rather than price, was lawful, the duty was propor-     HMRC v Empowerment Enterprises Ltd, Inner Ho.
tionately, in relation to residual value, more heavy    Crt. Session Scot, 11th October                                Chambers,
on used vehicles imported from another Member           Exemption for private tuition not applicable to a              presents
State than vehicles already registered in Hungary.      company
Hence Article 90 precluded a national tax based         The taxpayer provides training courses in cranio-              another
on objective criteria not taking into account the       sacral therapy. It has a director, Mr P, who is also the       round-up of
depreciation of the vehicles.                           one permanent member of staff (as well as being
    The Court also held that this was not a turnover    himself a registered sole trader). The company
                                                                                                                       recent cases.
tax.                                                    occasionally engages other staff. It was accepted              The views
    The Court declined to temporally limit the          that under domestic law (Item 2 of Group 6 in
                                                                                                                       expressed
effect of its judgment, under Article 234 EC.           Schedule 9), the tuition provided by the company
                                                        through Mr P was not exempt, as it was not provid-             are general
Bournemouth Symphony Orchestra v HMRC, CA,              ed by a teacher acting independently of an                     and not
9th October                                             employer.
Paid managing director meant orchestra not                  On appeal the issue was whether Article                    intended as
managed voluntarily and so taxable                      13.A.1(j) of the Sixth Directive (tuition given pri-           advice.
The taxpayer is a well known orchestra operated         vately by teachers) exempted the tuition provided.
through a company limited by guarantee, which           HMRC argued that whilst generally the legal form               (email
pays the wages of the musicians and administra-         of the provider of a service did not change the tax            Eamon@
tive staff. The board of directors which manages        status, here the Sixth Directive made the exemp-
the company is composed of persons participating        tion available only to a provider acting in a partic-
                                                                                                                       EamonMcNic
on a voluntary basis except, that is, for the manag-    ular form and that ‘privately’ meant the teacher               holas.com; tel
ing director. He is a paid employee.                    was acting in a personal capacity.                             020 7583
    The question arose as to whether the orchestra          The Court agreed, holding firstly that this made
was exempt or not. The points of law in dispute         sense of the distinction between private tuition in            6264)
arise from Article 13.A.1(n) and 2.(a), third indent,   Article 13.A.1(j) and the services provided by
of the Sixth VAT Directive 77/388/EEC, which pro-       bodies governed by public law in Article 13.A.1(i).
vide for the exemption of cultural bodies governed      Secondly, this interpretation was supported by the
by public law which are managed and adminis-            meanings in several other language versions of the
tered on an essentially voluntary basis by persons      Sixth Directive. Thirdly, the Court rejected the tax-
having no interest in the activities concerned. This    payer’s submission that privately connoted a legal
is transposed into national law in Note (2)(c) to       or physical specificity (so that a public lecture for
Group 13 in Schedule 9 to the Value Added Tax Act       which admission was charged would be different
1994.                                                   from a teaching class).


Indirect Tax Voice, November 2006                                                                                  5
 VAT AND PROPERTY
                          The Court also rejected an alternative argu-          22,000 properties across 31 local authority areas.
                       ment that the word ‘teacher’ could be extended to        Income is principally from tenants’ rents and
                       include a limited company.                               grants.
                          Hence Article 13.A.1(j) only applies to tuition           The issue arose as to whether the building of a
                       provided by a teacher acting in a personal capaci-       new regional office in Leicester could be zero-
                       ty and does not cover a teacher acting as an             rated under Item 2 of Group 8 in Schedule 8, VATA
                       employee.                                                1994 for the construction of a building for a chari-
                          The Court declined to make a reference to the         table purpose. Under Note 6 this in turn depended
                       ECJ, as it held the matter was sufficiently certain.     on the use of the building other than in the course
                          Appeal allowed.                                       of a business.
                                                                                    The Court held that the term ‘business’ had a
                       Riverside Housing Association v HMRC, ChD, 3rd           wide meaning and did not depend on the making
                       October                                                  of a profit. On the evidence the Tribunal had been
                       Housing association a business, so construction of       entitled to find that this was a business, even
                       regional office taxable                                  though Riverside did not set out to, nor could it,
                       The taxpayer, a charity, is a housing association        maximise profits and that much of its income
                       and registered social landlord providing housing         derived from housing benefit or grants.
                       for the disadvantaged. It manages more than                  Appeal dismissed.




                                           VAT and Property
                                             Developments
                       I
                          n the area of VAT and Property there have been        ly or almost wholly’. HMRC says, however, that it
                          proposals for legislative change and case law         will continue to apply the provision as meaning use
                          developments.                                         for 80 per cent or more for eligible purposes.
                                                                                    A further consultation document was produced
                                                                                by HMRC in December 2005 relating to paragraph
                       Legislative change                                       8 of Schedule 10, the provision relating to cases
                       As regards legislative change, the principal             where legal and beneficial ownership of land is
                       change to be made is that there is to be a rewriting     split.
 This article is       of the option to tax provisions in Schedule 10 to the        HMRC announced in July 2006 that it would not
 adapted from          Value Added Tax Act 1994. FA 2006 contains               now be making any changes to paragraph 8.
      the notes        enabling legislation permitting the change to be
                       made by Treasury Order (section 17). The order
 produced by           has not yet been published.                              The option to tax
   David Goy               Discussion about possible changes is contained       If there are not as yet any legislative changes to
                       in a consultation document published on 5                refer to there have been cases concerning the
 QC, of Grays          December 2005. New legislation will: ‘introduce          option to tax that are relevant.
        Inn Tax        appeal rights and make some minor changes to                 The first is a case called Marlow Gardner and
                       improve practical administration’.                       Cooke Ltd (High Court judgment June 2006) and
   Chambers,               Provisions concerning the now redundant              was concerned with the mechanics of exercising
         for the       developer’s self-supply provision are to go.             the option.
     Institute’s           The detail of the new order will have to be              Marlow Gardner reemphasises the two-stage
                       looked at to see precisely the changes made and          process in the making of an election. First, an elec-
Indirect Taxes         their impact. On the basis of the consultation doc-      tion must be made, which can have effect from the
Conference in          ument the substantive changes to be made to law          day on which it is made or a later date specified in
                       will be slight. They include:                            the election (paragraph 3(1) of Schedule 10). What
   September               (i) a right of appeal against a decision of the      is clear is that an election cannot be made to have
           2006        Commissioners under paragraph 3(9) to withhold           effect retrospectively. There is no provision as to
                       permission to make an election;                          how an election is to be made.
                           (ii) legislative confirmation of the decisions in        In this connection it should be remembered
                       SEH Holdings and PJG Developments;                       that in certain cases where the person wishing to
                           (iii) modification of the definition of ‘exempt      elect has made or is to make exempt supplies prior
                       land’ in the disapplication provisions so that           to the date the election is to have effect, such per-
                       instead of it referring to land being used ‘wholly or    son cannot make an election without the permis-
                       mainly’ for eligible purposes, it will refer to ‘whol-   sion of HMRC. Automatic permission is given


                   6                                                                 Indirect Tax Voice, November 2006
                                                                                              VAT AND PROPERTY
where certain conditions specified in paragraph          vening supply – in this case an outright sale –
5.2 of Notice 742A are met. In other cases express       rather than merely a letting at a rent.
permission is required.                                     This case clearly highlights in an extreme case
    The second stage of the process is that of notifi-   the retrospective effect that a notification can have.
cation of the election to HMRC. Paragraph 3(b)
requires written notice to be given to HMRC not
later than 30 days after the making of the election,     Library
or such longer period as HMRC may allow.                 The second case to be referred to relates to the
    It is clear that while an election only has effect   disapplication of the waiver of exemption and is
if notification is given, once proper notification is    the Newnham College case [2006] STC 1010. This
given the election has effect from the time of the       case was concerned with an arrangement to cir-
making of the election, not the time of notification.    cumvent the disapplication provisions. Newnham
Notification can have the effect of retrospectively
validating an election.
    This retrospective effect of notification is high-      It appeared to be accepted by all parties
lighted in the Marlow Gardner case.
    In that case the vendor of property had, through        that an election could have retrospective
its period of ownership, let the property and
charged VAT on the letting. On the vendor selling
                                                            effect. Thus, if an election is made on day
the property it sought to charge VAT but this was           one and notification is made on day 30, it is
resisted by the purchaser (who was not in a posi-
tion to recover the VAT), on the basis that no elec-        clear that supplies made in between are
tion had been made by the vendor. It was accept-
ed that by the time of completion notification of the       made retrospectively taxable as a result
election to HMRC had not been made, even assum-
ing an election had been made. Subsequent to
                                                            of the notification.
completion the vendor wrote to HMRC and this let-
ter was treated and accepted by HMRC as late noti-       College wished to renovate and extend its library.
fication.                                                Had it done so and continued to operate as before,
    Two issues arose in the case.                        it would not have been able to recover the VAT on
    (i) Was a valid election ever made?                  the cost of such works, it being an exempt supplier
    (ii) Could a notification be effective where it      of education. It therefore carried out the works,
was made by the vendor only after it had parted          having waived exemption, and let the improved
with the land?                                           library to a subsidiary company. Rent charged
    As to the first issue, the Court emphasised that     would be taxable if the waiver was effective, there-
the legislation contains no provision as to how an       by enabling the VAT on the cost of the works to be
election is to be made. The Court said that:             recovered. The disapplication provisions would
    ‘What must be required in accordance with the        prevent this being the case if the land was ‘exempt
normal principle of acts said to be an election, is a    land’ as defined in paragraph 3A(7) of Schedule
sufficiently clear indication of intention which is      10. This provides that:
sufficiently manifested or communicated.’                    ‘… land is exempt land if …
    The Tribunal had concluded that on the bal-              ‘(a) the grantor
ance of evidence an election had been made and               ‘(b) … or
Mann J was unwilling to overturn that conclusion.            ‘(c) a person connected with the grantor …
The principal evidence was simply that the vendor            ‘is in occupation of the land without being in
had charged VAT on its letting of the property and       occupation of it wholly or mainly for eligible pur-
sought to recover input tax.                             poses …’
    As to the second issue, the oddity was that on           For present purposes, ‘eligible purposes’ can
the basis that the election was made by the vendor       be taken to mean taxable purposes.
on acquisition of the property back in 1998, notifi-         The question that arose on the facts was
cation to HMRC did not take place until 2004.            whether Newnham College was to occupy the
Could the notification retrospectively validate the      library once the lease was granted. On the facts,
election all the way back to 1998, in particular         and reversing the Tribunal, the Court of Appeal
when it was made after the vendor had completed          held that it would not be. While the subsidiary
its sale?                                                company was to provide taxable library services
    It appeared to be accepted by all parties that       to the College, the College itself was no longer to
an election could have retrospective effect. Thus, if    have control over the library. The library staff,
an election is made on day one and notification is       while continuing to be employed by the College,
made on day 30, it is clear that supplies made in        were seconded to the company and the Court of
between are made retrospectively taxable as a            Appeal concluded that the company was to control
result of the notification. As a consequence of this     them, not the College. The absence of control over
the judge was unwilling to say that the position was     the premises precluded occupation by the
altered merely because of the nature of the inter-       College.


Indirect Tax Voice, November 2006                                                                                 7
VAT AND PROPERTY
                      In this respect the position was contrasted with          HMRC views paragraph 8 as only applying
                  a somewhat similar arrangement used in the                where there is a separation of the legal and bene-
                  Brambletye School Trust case 17688 (2002), which          ficial ownership of land (most obviously in a nomi-
                  concerned a sports hall let to a subsidiary compa-        nee situation). What appeared to lead to their pub-
                  ny of a school where the teachers and employees           lication of the consultation document was concern,
                  of the school had control over the sports hall for a      in particular, that the Tribunal in the Abbey
                  large part of the time while the hall was in use. The     National litigation had suggested that it could
                  school was regarded as remaining in occupation.           apply without such separation. HMRC says in the
                  There was no secondment arrangement.                      consultation document that the widening of the
                      Of interest was the fact that it was candidly         measure would open up the potential for tax avoid-
                  admitted in the Newnham College case that the             ance. It is noteworthy that HMRC does not say what
                                                                            this avoidance would be.
                                                                                The consultation document suggested a
    Of interest was the fact that it was candidly                           redrafting of paragraph 8 so as to clearly limit its
                                                                            application to cases where there is a beneficial
   admitted in the Newnham College case that                                owner of an interest who does not make a grant – in
                                                                            other words, limiting it to nominee situations.
     the arrangement was adopted to avoid the                                   In July HMRC announced that no changes would
anti-avoidance provisions of Schedule 10. That                              be made to the paragraph at present, although the
                                                                            provision would be kept under review in particular
           this was so did not dictate the result.                          to see whether it is used for tax avoidance. The
                                                                            result of this is that we are left with a provision that
                                                                            remains uncertain in its operation in a range of sit-
                  arrangement was adopted to avoid the anti-avoid-          uations.
                  ance provisions of Schedule 10. That this was so              One point made specifically in the announce-
                  did not dictate the result.                               ment in July is that HMRC says that it is satisfied
                                                                            that the assignment of a rental scheme in a securi-
                                                                            tisation is not a supply of land and is unaffected by
                  Beneficial ownership of land                              paragraph 8.
                  Paragraph 8 of Schedule 10 provides that:
                      ‘Where the benefit of the consideration for the
                  grant of an interest in, right over or licence to occu-   Virtual assignments
                  py land accrues to a person but that person is not        The true nature of a leasing or letting for VAT pur-
                  the person making the grant                               poses has come under detailed scrutiny in the
                      ‘(a) the person to whom the benefit accrues           Abbey National litigation. The upshot of that litiga-
                  shall for the purposes of the Act be treated as the       tion, as a result of the Court of Appeal’s decision, is
                  person making the grant; and                              that it is fundamental to a leasing that a right of
                      ‘(b) to the extent that any input tax of the person   occupation is given. No appeal is being made
                  actually making the grant is attributable to the          against the Court of Appeal’s decision.
                  grant it shall be treated as input tax of the person           What the litigation was concerned about was a
                  to whom the benefit accrues.’                             sale and leaseback transaction of most of Abbey’s
                      In general terms, this paragraph is intended to       property portfolio. The transaction was with a
                  apply where the legal and beneficial interests in         Mapeley company. The VAT implications of this
                  land have been separated and has the effect that in       were straightforward where there were completed
                  such circumstances it is the beneficial rather than       sales and leasebacks but in many cases this did not
                  the legal owner who is treated as making the grant.       happen. Many of the properties were relatively val-
                  It is, however, a paragraph which carries with it         ueless leasehold interests where completion of
                  uncertainty. Some of these uncertainties are              assignments was not thought practicable by the
                  referred to in HMRC’s recent consultation paper on        intended completion date. In such situations the
                  the subject.                                              agreement between the parties sought to put them
                      In particular, the paragraph refers to ‘the per-      in the like situation economically as would have
                  son to whom the benefit accrues’ – but what does          occurred had there been a completed assignment
                  this mean? For example, what is the position where        and leaseback without there in fact being any actu-
                  land is held on trust and income is to be enjoyed         al assignment of the legal or beneficial interest in
                  by a life tenant but capital by other beneficiaries.      the property.
                  If a lease is granted both at a premium and rent               Thus, it was agreed that the ‘virtual assignee’,
                  does the paragraph apply? In the circumstances it         the Mapeley Co, became responsible for the man-
                  may be appropriate to apply paragraph 7 only to           agement of the property and everything to do with
                  bare trusts. But even with bare trusts the position is    it, including the payment of rentals to the landlord.
                  unclear. Let us suppose there is a unit trust with        In return, the assignee was paid a fee by Abbey in
                  many unit-holders. Does paragraph 8 have the              respect of its occupation and in addition became
                  effect that each of the unit-holders is treated as        entitled to all profits derived from any exploitation
                  making a supply if the trustees let land?                 of the land, be it from underletting, surrender or


              8                                                                  Indirect Tax Voice, November 2006
                                                                                                VAT AND PROPERTY
assignment. Mapeley was appointed the agent of            argued that all rents received by Mapeley under
Abbey and given a power of attorney so that it            the underleases were consideration for agency
could deal with the lease in all respects as if it were   and management services performed by Mapeley
the leaseholder.                                          to Abbey. Both the Tribunal and Hart J held, howev-
    The principal issue that arose was whether VAT        er, that paragraph 8 of Schedule 10 applied so that
was payable in respect of the fee paid by Abbey to        Mapeley rather than Abbey was to be treated as
Mapeley. If it was, the burden fell on Abbey and the      making supplies of land. This point was not the
VAT would, because of Abbey’s principally exempt          subject of appeal by HMRC to the Court of Appeal.
status, be largely irrecoverable. HMRC claimed                The oddity of the position arrived at is that
that the fee was paid in part to discharge the lease      where Abbey is in occupation, some of what it pays
rentals (and was outside the scope) but as to any         is for agency and management services supplied
excess was paid in return for agency and manage-
ment services and was subject to VAT. Abbey
claimed that the commercial and economic posi-               The oddity of the position arrived at is that
tion arrived at was identical to that where comple-
tion had occurred and the position should be treat-
                                                             where Abbey is in occupation, some of what it
ed likewise as involving supplies of land so that            pays is for agency and management services
exempt transactions only would take place (save
where an option to tax had been exercised).                  supplied by Mapeley. Where, however,
    The Tribunal’s decision in favour of HMRC was
reversed by Hart J but upheld by the Court of                sub-lettings exist and like sums are received
Appeal. The essence of the Court of Appeal’s deci-
sion was that a leasing or letting for Sixth Directive
                                                             by Mapeley from third-party undertenants,
purposes has as its essence the granting of a right          nothing received from such tenants is for such
of occupation. No such right was ever granted by
Abbey to Mapeley and hence it could not be said              services and payments received are in their
that Mapeley gave to Abbey any right of occupa-
tion.                                                        entirety in respect of supplies of land.
    Abbey’s argument was to the effect that a leas-
ing could occur even if no right of occupation was        by Mapeley. Where, however, sub-lettings exist and
granted if a right was given to enjoy the income of       like sums are received by Mapeley from third-
the property (for example, from an underletting).         party undertenants, nothing received from such
Such a view was accepted by both the Tribunal and         tenants is for such services and payments received
Hart J. It was not accepted by the Court of Appeal,       are in their entirety in respect of supplies of land.
which said that the decisions of the European
Court were clear on the point.
    One difficulty of the Court of Appeal’s approach      Assignments of rental streams
is to deal with the position were actual sale and         HMRC, in its July statement, says that the assign-
leasebacks are completed, or where reversionary           ment of a rental stream in a securitisation is not a
leases are assigned, which carry no immediate             supply of land and is unaffected by paragraph 8. In
right to occupy. In the former case only in a strict-     the light of the Court’s decision in Abbey it is diffi-
ly legal sense does the assignee grant a right of         cult to say that such an assignment itself is an
occupation where there is a leaseback. In reality,        exempt supply of land. What may be said, howev-
the original owner never parts with such right. In        er, is that it is an exempt supply of money falling
the latter case the holder of the reversionary lease      within the exemption for financial transactions.
obtains no immediate right of occupation and may              The further question that arises is whether,
never obtain any right of occupation at all if the        once the rental stream has been assigned, para-
underlease continues beyond the term of the               graph 8 has the effect that the assignee in future is
reversionary lease.                                       to be regarded as making exempt supplies of land
    The Court of Appeal’s answer to such problems         rather than the assignor. HMRC says not. For my
was to rely upon the existence of at least the con-       part, and depending on how the documentation is
tingent right to occupy if the underlease falls.          drafted, I do not believe that it is necessarily cor-
Whether such contingent rights of the sort referred       rect to say this. If, for example, a securitisation doc-
to are the sort of rights that the European Court         ument were to declare that the assignee would
would consider to be relevant rights of occupation        thenceforth hold the benefit of the underlease
is open to doubt. Nevertheless, the Court of Appeal       rentals on trust for the assignee the position would
so concluded.                                             be on all fours with the Abbey case.
    There is another aspect of the Abbey litigation           The oddity of this, however, is, assuming it to be
which is relevant. With certain of the premises           correct that a landlord previously making exempt
which were the subject of virtual assignments sub-        supplies of land would cease to do so, that the
lettings existed and the documentation provided           assignee would commence to make such supplies
that in such a case Abbey would hold the benefit of       without the intervening transaction comprising
such sub-leases on trust for Mapeley. HMRC                any supply of land.


Indirect Tax Voice, November 2006                                                                                    9
 CHARITIES


                                      Opportunities for
                                     Charitable Reform
                    I
                        rrecoverable VAT costs UK charities between          to an anomalous situation where non-business
                        £400 million and £500 million a year. Studies in     activities of local authorities are VAT-recoverable
                        the UK, Ireland and Denmark have indicated           under the special provisions of section 33, but not
                    that charities pay around 4 per cent of total expen-     where the same services are performed by chari-
                    diture on VAT and for some charities the percent-        ties and funded through local authority grants.
                    age is much higher. Action for Blind People pays             The solution would be for the Government to
                    5.8 per cent of its total expenditure on VAT and         compensate charities for all the irrecoverable VAT
                    even a charity like the RNLI, which benefits signif-     they pay in pursuit of their charitable objectives
                    icantly from special zero-rating for lifeboats and       and specifically on their non-business activities by
                    equipment, spends 3.2 per cent on VAT. The bur-          returning sums equal to the VAT to the charitable
                    den of the irrecoverable VAT was increased signif-       sector in the form of a matching grant-in-aid. The
                    icantly by the near doubling of the VAT rate to 15       proposal is that charities who can document from
                    per cent in 1979 and the further increase to 17.5        their audited accounts the amount of irrecoverable
                    per cent in 1995.                                        VAT that they have incurred on their non-business
                        The simple solution to the problem would be to       charitable activities would be entitled to a refund
                    change the law on VAT and allow charities to             by matching grant proportional to that VAT tax bur-
                    reclaim the VAT on their non-business inputs – in        den. This approach was recently endorsed by the
                    other words, the VAT they incur in pursuit of their      EU tax commissioner Laszlo Kovacs as entirely
                    charitable purposes and their fund-raising activi-       compatible with the EU single market VAT rules in
Peter Jenkins,      ties. However, the essential basis of a VAT system is    a speech in September 2005 to a conference in
                    that VAT incurred on inputs can be offset only           Brussels organised by the European Charities
     of Ernst &     against VAT charged on outputs and zero-rating is        Committee on VAT in which he stated: ‘the more
   Young LLP,       in breach of this principle.                             feasible option is to address the problem outside
     prepared           The UK had to fight hard to keep its zero rates in   the VAT system. This is an approach that has been
                    the intensive negotiations to harmonise European         adopted in some Member States, which have put in
   these notes      VAT law in 1977, when the Sixth VAT Directive was        place mechanisms for reimbursing to charities
         for the    adopted. The price for keeping zero rates justified      some or all of the VAT they have been charged.’
                    by a social purpose and for the benefit of final con-        He went on to stress that: ‘the decision to set up
     Institute’s    sumers was that there would be no new zero rates.        such a refund mechanism is strictly a national bud-
 2006 Indirect      This agreement effectively rules out the extension       getary issue over which the Commission has no
                    of the zero rate to charities. In any case there is no   say or influence.’
          Taxes     compelling case for relieving charities from the             The Charities Tax Reform Group, recognising
Conference in       VAT they incur in respect of their business activi-      budgetary constraints, has put forward four priori-
                    ties where these are exempt. Here charities are          ty areas where a matching grant scheme is most
  September.
                    getting exactly the same treatment as persons or         needed. These are:
                    companies who also have irrecoverable VAT on                 * VAT on social welfare services where chari-
                    inputs to an exempt business activity. It would not      ties are complimenting or substituting for state
                    be realistic to expect any different treatment.          provision
                        However, where charities are spending money              * VAT on fund-raising costs, which could be
                    and incurring VAT in pursuit of their charitable         reinvested directly in further fund-raising
                    purposes and are unable to recover it because                * joint ventures and shared services – for exam-
                    their output is free or heavily subsidised, there is a   ple, where one charity supplies services to anoth-
                    strong moral case for finding a way to relieve their     er to meet a common objective and incurs a VAT
                    input VAT, since purely charitable activities are not    penalty in doing so
                    in competition with business and will be meeting             * repair, construction and maintenance of social
                    social needs that would otherwise be a burden on         welfare housing and all charitable buildings.
                    the public purse (for example, social welfare pro-           In addition, the refund could be limited to a set
                    vision in homes for the elderly or the Lifeboat          percentage of the VAT incurred if affordability was
                    Service). In many cases social services are con-         the critical issue.
                    tracted out by local authorities to charities                The objections put forward by the present gov-
                    because they are more effective and efficient in         ernment to the matching grant proposal are bud-
                    performing them and meeting the needs of local           getary and political rather than practical. HMRC
                    communities than Government bodies. This leads           has conceded that there would be no insuperable


               10                                                                 Indirect Tax Voice, November 2006
                                                                                                                  CHARITIES
monitoring or policing problems in running a            diate link between inputs used in PFR and the uni-
matching grant refund scheme for charities based        versity’s other economic activities leading to tax-
on their audited accounts. From the point of view of    able or exempt supplies, and it had failed to do
charities the preparation of schedules showing          this.
their irrecoverable VAT on non-business expendi-
ture would present some administrative burden           D’Ambrumenil Dispute Resolution Services Ltd
but the information required is readily to hand         ECJ, Case C-307/01
from existing VAT invoices and accounts which           This decision reached by the European Court in
they are obliged to keep. Schemes of this kind have     November 2003 has important implications for the
been successfully run in other VAT/GST jurisdic-        scope of exemption from VAT for medical services.
tions – for example, Canada and New Zealand.            HMRC had ruled that services provide by a doctor
                                                        in conducting medical examinations, paternity
                                                        testing, issuing medical certificates, assessing
Recent case law                                         insurance claims and preparing medical reports
The University of Southampton                           for personal injury and medical negligence cases
[2006] EWHC528 [CH]                                     were exempt under Group 7 of Schedule 9 to the
This was an appeal from the decision dated 8            Value Added Tax Act 1994. The doctor appealed,
March 2005 of the VAT and Duties Tribunal, which        contending that these services should be treated
had dismissed an appeal by the university that          as taxable to allow him to recover the related input
publicly funded research (PFR) undertaken by it         tax. The ECJ held that the exemption laid down by
was not a business activity and so there was no         Article 13A.1(e) applied to medical examinations
entitlement to input tax credit on related expendi-     and tests only where those services were intended
ture. The university had argued that the expendi-       principally to protect the health of the person con-
ture was incurred for the purpose of its business,
even though the research was publicly funded. The
Tribunal had held that publicly funded research            The solution would be for the Government to
does not result in the making of any taxable sup-
plies and is not predominantly concerned with the          compensate charities for all the irrecoverable
making of taxable supplies to consumers for a con-
sideration.                                                VAT they pay in pursuit of their charitable
    Although he rejected the appeal, Mr Justice
Warren gave careful consideration to the ECJ case
                                                           objectives and specifically on their
of Kretztechnik AG Case C-465/03 in reaching the           non-business activities by returning sums
conclusion that the appeal should be dismissed.
He noted that in that case, the cost components of         equal to the VAT to the charitable sector.
the share issue (itself not an economic activity
falling within the scope of the Sixth Directive), had
a link to the company’s economic activity, because      cerned. Exemption did not apply to medical exam-
the aim of the operation was to increase its capital.   inations conducted with a view to preparing med-
Kretztechnik did not carry out other non-commer-        ical reports regarding issues of liability and the
cial activities having an object separate from the      quantification of damages for individuals contem-
company’s business. The case therefore estab-           plating personal injury litigation, or professional
lished that a cost will be a general overhead where     medical negligence for individuals contemplating
it is incurred solely for the benefit of the trader’s   litigation, or to certificates as to a person’s medical
economic activities in general but does not cover       condition for purposes such as entitlement to a war
the position when the activities to which the inputs    pension. The key point from the judgment was that
relate have a result which is achieved for its own      exempt medical care only extended to medical
sake but which at the same time benefits the tax-       interventions with a therapeutic purpose, whether
able person’s other economic activities – for exam-     curative, diagnostic or prophylactic.
ple, by enhancing the reputation of the university          The implications of this case are still being con-
in the present case. In the Judge’s view the costs      sidered by HMRC following responses to their con-
incurred in carrying out PFR could not realistically    sultation about the scope of exemption from VAT
be regarded as a general overhead cost of activi-       medical services (see Business Brief 04/2006).
ties producing taxable or exempt supplies,              One of the major difficulties will be establishing a
because PFR was an activity carried for its own         tenable borderline between medical interventions
sake and in its own right as an important aspect of     with a therapeutic purpose and those with a cos-
the university’s activities. PFR did not form part of   metic purpose ranging from face lifts to body tucks
the university’s business and was not an activity       to hair removal. An issue to be resolved is the
which could sustain recovery as an overhead of          extent to which the therapeutic purpose can be
that business. These were conclusions that the          psychological rather than necessarily therapeutic
Tribunal could properly reach on the facts they         from a strict clinical point of view.
had found. To win the case, the university would
have had to show that there was a direct and imme-         To be completed in the next issue


Indirect Tax Voice, November 2006                                                                                 11

				
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