Kumon: VAT abuse

The First-tier Tribunal held that worksheets supplied separately from a licence to exploit a teaching programme were not elements of a single supply of the right to use the programme nor were the contractual arrangements abusive. The supply of the worksheets was therefore eligible for the zero rate of VAT.

Kumon split its standard-rated and zero-rated supplies between two companies
Kumon Educational (KE) provides education in Maths and English to children in the UK based on a programme that is taught by self-employed instructors. Originally, KE accounted for VAT at the standard rate on the royalty payments it received from the instructors for the licence to exploit the teaching programme and provision of worksheets together.

In order to improve the VAT position, the worksheets were latterly provided separately by a subsidiary of KE, Kumon Book Services (KBS), and the consideration attributed to the worksheets was treated by KBS as chargeable to VAT at the zero rate. The aggregate amount paid by the instructors remained broadly the same, albeit now payable under two agreements instead of a single agreement with KE. The Tribunal considered a number of issues:

Supplies by separate companies cannot be a single supply, absent abuse
The Tribunal concluded that the Telewest decision – that supplies by two separate companies, not being members of a VAT group, could not be treated as a single supply – remained good law. The ECJ judgment in the Italian Part Service case only referred to separate supplies by separate suppliers being treated as a composite supply in cases involving abuse.

Dividing the supplies into two contracts was not a sham
A sham only exists where the parties intend that their real contractual relationship should be something other than what is stated in the contract between them. It is a very narrow doctrine and any artificiality and lack of commercial purpose are not relevant.

The facts here indicated that all parties were eager to understand the true effect of the new arrangements and subsequently acted consistently with them. The arrangements were therefore not a sham.

Contractual arrangements are not abusive if they reflect the economic and commercial reality of the supplies made
The judgment analysed the Newey CJEU decision on VAT abuse in depth, and brought out two particular points: first, that the economic and commercial reality of the transactions, including the reality of who supplies and receives the services, must be considered when determining the VAT treatment or status of transactions; and secondly, wholly artificial arrangements which do not reflect economic reality and are set up with the sole aim of obtaining a tax advantage are an abusive practice.

As the Kumon arrangements were not wholly artificial and did reflect the economic and commercial reality of the supplies made by and between KE, KBS and the instructors. Accordingly, the arrangements could not be redefined as a composite taxable supply.

Following a similar outcome in the DPAS case (see Tax Newsletter – January 2014), taxpayers may feel more confident in actively exploring ways to restructure their supplies to become more VAT efficient, provided always that the contractual position genuinely reflects the commercial and economic arrangements.

Please click on the links below for the other articles in the February 2014 tax newsletter.

• "Salaried Member" rules for LLPs
• Tax avoidance: high-risk promoters and follower penalties
• Marks & Spencer: cross-border group relief
• Southern Cross: compromise agreements with HMRC
• Tax compliance through use of the procurement process
• VAT - changes to zero-rating in relation to student accommodation