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M H CUSTOMS & EXCISE A DIGEST OF NEWS FOR BUSINESS AND SPECIALIST SUBSCRIBERS - ' ~~ ^ 19/93 28June 1993 VATAVOIDANCE GUIDANCETOTHEPUBLIC : ACONSULTATIONDOCUMENT ANational Audit Office report hasrecommended Customs and Excise should publish broad guidance on its approach to VAT avoidance. Customs has prepared the attached draft on howsuch guidancemight lookifwritten along the lines suggested by the National Audit Office, and we are now inviting comment. The report,"HM Customs and Excise; Countering VAT Avoidance" was publishedon23 October 1992. It suggests guidance should be in the form ofa policy statement which would detailthehallmarksoftheavoidancepractices,followingthosesuggestedbythe Institute ofTaxation in its submission to the NAO, without producing a rigid definitionofVATavoidance. Available bysubscription fromthe Central OfficeofInformation, Room236, Hercules House, Hercules Road, London SE1 7DU. PrintedimagedigitisedbytheUniversityofSouthampton LibraryDigitisationUnit Theguidance shouldalso explainthefactors consideredbytheCommissioners ofCustoms and Excisein deciding whetherto challenge anavoidance scheme andgiveexamplesofavoidanceschemeswhichhavebeenormaybecountered. ItwouldalsorefertootherDepartmentalpublicationsexplainingCustoms'view on howtraders are meant to arrangetheir affairs in orderto comply with the law. ThePublicAccounts Committee's report"CounteringVAT Avoidance" (HC 330), published on 22 April 1993, offered a guarded welcome to this approach. TheCommitteecommented "We recognise that this [the production of guidance] could be of considerable value to traders and their advisers, providing them with clearer information on the Department's approach and thus helping them to organise their affairs to best effect. It will be important, however, to ensure that the guidancedoesnotappeartohavetheforceoflaworshouldinanywayappear to threaten. We emphasise that traders should not be discouraged from pursuing actions which arepermissible underexistinglegislation, and that itis for the courts and ultimately Parliament to decide on the acceptability of particularavoidanceschemes". Thisreservation reflectsconcerns expressedbysometrade representatives and professional bodiesthatguidance could effectivelybullytradersinto accepting Customs'decisions. Customshavethereforedecided to consultwidelywithallinterested partiesto establishwhetherguidanceofthiskindiswanted and ifso whatformitshould take. To focus views on this second question Customs have prepared the attached draftofwhatguidancemight lookifwrittenalongthelines suggested bytheNAO. PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit Comments andviews shouldbesentto, VAC3, HMCustoms and Excise, 4W NewKing'sBeam House, 22 Upper Ground, London SEl 9PJ, by 31 August 1993. VATAVOIDANCE THEGENERALAPPROACHOFHMCUSTOMSANEXCISE (Adraftofpossiblefutureguidancetopromotediscussion) Background TheNational Audit Office(NAO) reportHM Customs &Excise : Countering VATAvoidance" saidthatHMCustoms & Excise should publishguidanceon itsapproachtoVATavoidance. The NAO recommended that, as part of Customs' obligations under the Taxpayer's Charter, this guidance should include its view ofwhat constitutes unacceptable avoidance, how it differs from tax mitigation, and its general approach to the issues involved. The Public Accounts Committee gave a qualifiedwelcometothisproposal. ThisBusinessbriefprovidessuchguidance. Itsannexliststhemainareaswhere VAT avoidance may occur, and the technical guidance published by Customs givingitsviewofthecorrecttreatmentoftheseareas. Introduction Taxpayers have the right to arrange their affairs so as to minimise their tax liabilityunderthelaw. TheCommissionersofHMCustoms&Excisehowever, have a statutorydutyofcare and managementwhich requires them to protect theintegrityoftheVATsystem;thisincludeschallengingtransactionsarranged PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit insuchawayastounderminetheintentionofthelaw(astheyperceiveit), and soattackthetaxbase. If unchecked, large scale avoidance would erode Government revenue and create distortions in competition inthe marketplace: Customs is committed to maintaininganequitabletaxundertheTaxpayer'sCharter. This document sets out what Customs regards as the hallmarks of VAT avoidance,whentheDepartmentis likelytowishtotakeaction, andwhatthat courseofactionmightbe. Ofcourse, itisultimatelyfortheindependent VATTribunalsandtheCourts todecide whetheranyparticularsetofVATplanningarrangementsarelegal HallmarksofVATAvoidance The PublicAccounts Committee accepted that it would not be appropriateto produceanyrigiddefinitionofVATavoidance. TheInstitute ofTaxation, inresponsetothequestionsposedbytheNAO, has suggested that there may be certain characteristics oftax planning which are indicativeoftaxavoidance. Thesewouldbearrangementswhich:- (a) arebytheirnaturedesignedtoavoidor reduceliabilitytothetax; (b) arebroughtintoexistencesolelywiththatendinmindandnotwith a view to achieving some other commercial purpose of the business, even though they might be carried out in an overall commercialcontext;and PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit (c) canberecognised (evenifnot describedin advance) as outsidethe broadintentionofthelegislation. DepartmentalAction Ifthe Department decides to counter VAT avoidance, it has two courses of action. Itcan;- (a)wherethe Commissionersdisputeaninterpretationofthelaw, issue an assessment for the VAT which has been avoided by an individual business;or (b) where the Commissioners accept that the present legislation facilitatesavoidance, proposelegislative counter-measures, eitherunder itsownpowerstomakeregulationsorbyadvisingMinisterstopropose achangeinprimarylegislation. CriteriaforIssuinganAssessment Under the Value Added Tax Act 1983, assessments have to be made to Customs'bestjudgement, and canonlybeissuedwheretheCommissionersare advisedthattheirinterpretationofthelawiscorrect. Businessesthenhavethe righttoappealtotheVATTribunalorCourts. In some cases, when, having made every other effort to establish the legal position, the Department accepts that a point oflaw is unclear, it may, after consultation with the business involved, issue an assessment so that the point can be tested before the VAT tribunals or the Courts. In such cases, the Department may waive the normal requirement for the assessment to be paid beforetheappealisheard,andcanmeetthewhole,orpart,ofthecosts. PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit In deciding whether to raise an assessment, the Commissioners will take the followingcriteriaintoconsideration;- ThestrengthofCustoms'case TheprobabilityofaVATTribunaland theCourtsupholdingCustoms'interpretationofthelaw. Equity. The Commissioners are committed to maintaining the VAT system in such a way that the VAT burdenfalls equally on all similar businesses operating in similarcircumstances;theDepartmenttherefore needs to consider whether an avoidance scheme, ifunchecked, would distortcompetitioninthemarketplace. Revenueinvolved. TheactualamountofVATindispute. ArtificialSeparationofBusinessActivities Generally, Customshaveno wishto interfereunnecessarilywithan individual's right totrade in whichever capacity is chosen. However, where a business is artificially separated into independent parts in order to avoid a liability to registerforVAT,andCustomsaresatisfiedthatthisisthecase,theymaydirect thatallthepersonsinvolvedregisterandaccountfortaxasasingleperson. CriteriaforProposingLegislativeCounter-Measures If Customs believe that a particular avoidance scheme cannot be checked throughissuingindividual assessments(orthatthe schemeinanycasedemands achange inlegislation), the Commissioners may advise TreasuryMinisters to bringforwardlegislativeproposals. Before proposing legislative counter-measures, the Department will consider thesecriteria;- PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit PotentialRe\^enueInvolved. The long-term effect on the tax base of allowinganavoidanceschemetocontinueunchecked. DegreeofContrivance. Howfarthe avoidance scheme deviates from normal commercial practice, from the intention ofthe UK law (as the Commissioners interpret it), and fromthe principles ofVAT set out in ECDirectives. Equity. (Asabove.) Compliance costs andsimplification. The Department will consider the effects of a legislative change on the compliance costs of all registeredbusinesseseffected. Amongotherpolicyconsiderations,theDepartmentgivesgreatweight tokeepingVATassimpleaspossible. Customs' policy is to try to counter those arrangements which bear the hallmarksofavoidance,andwhich,inthelightofthecriteriagiven above, itconsiderstobeunacceptable. However,in doingsotheDepartmentwill continueto attach greatweight to keeping the tax simple, and to minimising the compliance costs of businesses; counter-action against avoidance which may increase compliancecostswillthereforeonlybetaken ifitconsiders theintegrity of theVATsystemtobeseriouslycompromised. Thisstatementandalloftheguidanceaccompanyingitareadministrative guidelinesand do nothavelegalforce; they do notin anywayrestrictthe right oftraders to challenge any assessment or other decision before the VATtribunalsortheCourts. PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit ANNEX TYPESOFVATAVOIDANCE Tradersgenerallyarrangetheirtaxaffairstosecurethemaximumtaxadvantage. Thismaybethrough: a)increasedrecoveryofinputtax; b)reducedliabilitytooutputtax;or c)improvedcashflow. Over the years, within these broad categories, Customs has encountered a varietyofdifferent schemes. Thesearrangements havemainlyfallenunderthe followingheadings:- REGISTRATION : By 1986 the practice of disaggregation (the artificial fragmentation of business to avoid registration for VAT) had become widespreadandwascostingtheExchequersubstantialamountsofVATayear. Schedule 1totheVATActwasthereforeamendedtoenableCustomstodirect that persons carrying on the constituent parts of an artificially separated businessregisterandaccountfortaxasasingletaxableperson. Customs and ExciseNotice 700, paragraph 11 gives guidance on registration anddisaggregation. PARTIAL EXEMPTION : Traders incurring input tax which relates to exempt supplies are partly exempt. As aresult ofthis theymay notbeableto reclaimalltheinputtaxtheyincur. The 1987 Finance Act made provision to close a numberofpartial exemption loopholes, and more changes were made to the VAT regulations in 1992 to reducetherevenueatriskinthisarea. PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit Customs and ExciseNotice 706 explains whichtraders are affected by partial exemption,andgivesguidanceonhowtheyshouldcalculatetheirinputtax. TAXPOINTSAND VAT PAYMENTPERIODS : Sometraders canobtain acashflowadvantagebyalteringtaxpointsortheirpaymentperiod. Customs and Excise Notice 700 (The VAT Guide) explains the rules for workingoutthedate ofthe supplyofgoods orservices(thetaxpoint) andthe dateonwhichtaxisduetobepaidorrepaid(theVATpaymentperiod). LAND AND PROPERTY : In April 1989 certain building and land transactionswhichhadpreviouslybeenzero-ratedbecamestandard-rated,while othersbecameexempt. Inaddition,fromAugust 1989tradershavebeenableto exercisean"optiontotax" (i.e.waiveexemptionandtaxatthestandardrateall suppliesthey make ofspecific buildings and land and asaresultbe entitled to input tax deduction). A selfsupply charge onbuildings was also introduced. Though still early to draw firm conclusions. Customs is concerned that new avoidanceschemesarealreadybeingmarketedtoexploitloopholesinthisarea. Thesechanges(introducedinthe 1989FinanceActandtheVAT[Buildingsand Land] Order 1991)areexplainedinCustomsandExciseNotice742A(whichis intended for developers and explains how VAT applies to newly-constructed buildings),Notice724B(whichisintendedforlandlordsandexplainshowVAT applies to transactions in land and existing buildings) and Notice 742C, which explainstheVATlawinthisarea. MIXED SUPPLIES : Customsregardsomegoodsand serviceswhensupplied together as a single indivisible supply to be treated as standard rated, even thoughcertainelements, ifsupplied separately, wouldbezero-rated orexempt. Recently this view has been challenged by traders seeking to divide such supplies into zero or exempt component parts and thereby reduce their tax liability. Customswill challenge sucharrangementswheretheybelieve thereis oneindivisiblesupply. PrintedimagedigitisedbytheUniversityofSouthamptonLibraryDigitisationUnit EvenwhereCustomsacceptmixedsuppliesaredivisible,tradersmayattemptto attribute ahighervalueto the exempt orzero element; Customswill challenge valuationswhichtheybelievetobeerroneous. Customs and Excise Notice 700 paragraph 17 gives guidance on what the Departmentconsiderstobethecorrecttreatmentofmixedsupplies. NON-BUSINESSUSE : Registeredtradersmay only recoveras inputtaxthe VATchargedonitemspurchasedinthecourseoftheirbusiness. Legislation has been introduced in this year's Finance Bill to bring more objectivity into the test for input tax in respect ofluxuries, amusements and entertainment,whicharetheareasofgreatestconcern. CustomsandExciseNotice700paragraph39andAppendixJexplainCustoms' viewofhowtotreatinputtaxattributabletonon-businessuse. ISSUEDBY: HMCUSTOMSANDEXCISEPRESSOFFICE NEWKING’SBEAMHOUSE 22UPPERGROUND LONDONSEl9PJ TELEPHONENO: 071 8655468/5469/5470/5471. 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