HM Revenue & Customs (HMRC) have a published Extra Statutory Concession (ESC) covering how a tax charge applicable to VAT groups should be calculated (ESC 3.2.2). HMRC is reviewing all its ESCs following the Wilkinson decision (R v HM Commissioners of Inland Revenue ex p Wilkinson  UKHL 30). ESC3.2.2 is not 'Wilkinson' compliant. The Government intends to legislate to give statutory effect to ESC 3.2.2. This Brief sets out how the ESC should be applied in the interim.
This ESC affects UK VAT groups with an overseas member that buys services from persons outside the VAT group and uses them to make supplies to the UK members.
A VAT group comprises two or more corporate bodies under common control within a single VAT registration. A VAT group can contain members that are established overseas provided that they are also established in the UK. Transactions between members of a VAT group are normally disregarded for VAT purposes.
In the mid-1990s a VAT avoidance scheme allowed partly exempt VAT groups to avoid paying VAT on certain services they bought in. The services involved were those where the VAT is accounted for by the customer. Services used in the UK would be bought by a VAT group member abroad so that UK VAT would not be charged (the supply being made outside the UK and thus outside the scope of UK VAT). The services would then be routed to the UK user via an intra-VAT group charge. As intra-VAT group charges were ignored for VAT purposes no VAT was chargeable at that point either. The net result was VAT-free services.
The legislation applied the tax charge to the whole intra-group transaction whereas the avoidance scheme only related to services bought in from third parties.
The ESC works by restricting the tax charge to the value of reverse charge services bought in by the overseas member. These services were listed in Schedule 5 VAT Act 1994.
On 1 January 2010 the POSS rules changed. The general rule determining where a supply was made for business to business transactions changed from the place where the supplier belongs to where the customer belongs. As a result of this change, Schedule 5 became redundant and was repealed.
Where a group makes use of this ESC, it should be applied in a way that maintains its intended effect. To achieve this, the reference to Schedule 5 should be read as a reference to the new general rule for supplies to businesses, in VATA 1994 s7A(2)(a). The ESC will continue to allow VAT groups to value the tax charge by reference to the services the overseas member has bought in that would now be treated as subject to UK VAT if the UK group member bought them direct. Evidence of the value of the services bought in, and that they have not been undervalued, will still be needed.
The Government will commence a technical consultation with stakeholders in May 2011.