Branching out: what the Barclays case means for UK VAT grouping

VAT grouping – the basics

The UK’s VAT grouping rules allow two or more “bodies corporate” to register as a VAT group if:

• each body is established, or has a fixed establishment in the UK; and
• one controls the other or they are under common control, for example a parent and its subsidiaries.

Group companies established overseas can join a UK VAT group provided they have a fixed place of establishment in the UK. Compared to many EU Member States, the UK is unusual in that it applies what is (somewhat confusingly) known as a “whole establishment” approach to VAT grouping, meaning that the whole entity (and not just the UK establishment) is treated as being within the VAT group. Consequently, supplies between any non-UK establishments of a UK VAT-grouped entity are disregarded where the recipient is a member of the VAT group, such that the recipient is not required to self-account for VAT. There is no statutory definition of “fixed establishment”, so its meaning has been developed from case law – often in the context of the place of supply rules.

In many cases, joining a VAT group will offer significant administrative, accounting, and VAT benefits. Supplies between members of the group are disregarded for VAT purposes so they are not subject to VAT, and group members are generally treated as a single person so allowing the representative member to submit VAT returns on behalf of the whole group. It is common, for example, for UK financial services businesses to employ staff through a group company which supplies the services of those staff to regulated entities in the group that make VAT-exempt supplies. Without VAT grouping such arrangements would generate irrecoverable VAT within the corporate group.

A company can only be a member of one VAT group at any given time and group membership is not automatic. An application to join (or leave) a UK VAT group must be made, and accepted, by HMRC. HMRC may refuse an application if one of the formal requirements is not met, for example if the relevant companies are not under common control or are not established in the UK, or if refusal is necessary for “protection of the revenue”.

Because of this, the decision in Barclays Services Corporation v HMRC on the tax authority’s refusal to allow a US company to join a UK VAT group via its UK branch, has important implications for multinational enterprises with UK branch operations.

What happened?

Barclays Execution Services Ltd (BESL), the representative member of a UK VAT group in Barclays' corporate structure, applied to HMRC for Barclays Services Corporation (BSC) to join its group. BSC is a Delaware corporation with limited liability operating primarily in the US but also with a branch in the UK.

At the time of the VAT grouping application, the UK branch was not fully operational. Although contracts of employment had been signed, only one employee had started working there. There was no evidence of any formal agreement that the branch was permitted to occupy the office space it was using.

HMRC refused BESL’s application on the grounds that BSC did not have a fixed establishment in the UK. HMRC also claimed that it was necessary to refuse the application for the protection of revenue. The taxpayer appealed HMRC’s decision.

The First-tier Tribunal (FTT) held that BSC did not have a fixed establishment in the UK and so could not join Barclays' UK VAT group. The branch had insufficient human and technical resources in the UK to make any meaningful commercial contribution to the activities of BSC.

That conclusion was sufficient to determine the appeal, but the FTT also considered two other questions:

1. Should it apply a conforming construction to the UK rules to reflect the CJEU decision Danske Bank with the effect that only the UK branch should be admitted into the VAT group? The FTT said that UK legislation did not permit this.
2. Could HMRC refuse the grouping application on the basis that this was necessary for protection of revenue? The FTT rejected this argument, arguing that any VAT saving would be a normal consequence of joining a VAT group.

BESL and BSC appealed to the Upper Tribunal (UT) on the fixed establishment issue. HMRC cross-appealed on the Danske Bank and protection of revenue points.

The UT agreed with the FTT’s conclusions on fixed establishment. BSC’s UK branch had insufficient ownership or control over human and technical resources in the UK at the date of the VAT grouping application.

Whether HMRC was entitled to refuse the VAT grouping application on the ground of protecting revenue then became an academic question. The UT nevertheless offered its view saying that if it had been necessary to decide the issue the UT would have disagreed with the FTT for two reasons. First, because the anticipated annual VAT savings were very considerable while the resources of the branch were “skeletal”. Secondly, because the timing of the VAT grouping application was driven by the opportunity to generate an additional £21m of tax benefits.

On the Danske Bank question, the UT noted that HMRC’s argument appeared at odds with its publicly stated position that the UK adopts a whole establishment approach to VAT grouping. The UT accepted that HMRC was entitled to raise the issue as a matter of statutory construction but concluded that it is a “fundamental feature” of the UK’s VAT grouping rules that they apply to the “entire body corporate which is grouped”. Consequently, a conforming construction would “clearly be contrary to the underlying thrust of the legislation and its fundamental features”.

What does it mean?

The decision confirms that for an overseas company to make an application to join a VAT group via its UK branch, the applicant must be able to demonstrate that the fixed establishment test is satisfied from the date of the application. An intention to form an establishment that meets the test is not sufficient. Concerning the meaning of “fixed establishment” in this context, the UT found that while place of supply case law on the meaning of the term should not simply be transposed into the equivalent test for VAT grouping, that case law was relevant and account should be taken of it. The circumstances in which HMRC is entitled to refuse an application for protection of the revenue have long been unclear and the subject of debate. However, the UT’s decision suggests that any significant imbalance between the anticipated VAT savings and the resources and substance of the UK branch will be a relevant factor.