Skandia: VAT on intra-entity supplies

The CJEU has determined, contrary to accepted practice, that VAT is due on cross-border payments between an overseas company and its own branch where that branch forms part of a VAT group. This sounds esoteric but is important in a number of outsourcing contexts.

Previously it had been considered that the principle in FCE Bank, i.e. that intra-entity transactions were not supplies for VAT purposes, extended to this situation.

The FCE Bank case

The CJEU, in FCE Bank, decided that services provided between parts of the same legal entity, e.g. a head office and a branch, should be disregarded for the purposes of VAT. The basis of this is that a branch cannot be a "taxable person" as it does not independently carry on an economic activity; it neither bears any economic risk arising from its activities nor has independent capital. Therefore, there cannot be a legal relationship involving reciprocal performance between the supplier and the recipient as is required for a taxable supply.

This principle underlies some of the planning adopted by a number of multinational groups, particularly those with financial or insurance-based businesses, which would otherwise suffer an irrecoverable VAT cost when obtaining third party services such as, for example, the IT services in issue in Skandia. A non-EU group company would acquire the services necessary for the group then supply these on to its EU branch which would be VAT grouped with other local group companies. Following FCE Bank, this supply would be disregarded and the branch could then make further supplies of the services to the companies within the VAT group, again without triggering a VAT liability.

Skandia - the factual background

Skandia America Corp. (SAC) is a US corporation which sourced IT services from outside the EU for the Swedish insurer Skandia's global group. After buying in IT services, SAC would provide these for a 5 per cent mark-up to its branch in Sweden, which was separately registered as a member of a VAT group in Sweden. The branch used these services to make onward supplies of IT services to companies both within and outside the VAT group.

SAC sought to rely on FCE Bank but the Swedish tax authority considered that the intra-entity provision of services was a taxable supply where the branch was a member of a VAT group.

CJEU decision

The CJEU distinguished FCE Bank from Skandia by noting that the effect of a VAT group is that the services are treated as having been supplied to the independent VAT group of which the branch forms part, rather than the branch itself. A VAT group is treated as a separate taxable person and therefore there is the required reciprocal performance between the supplier and the VAT group to ensure that the intra-entity transaction may be a taxable supply.

The consequence of this finding was that the Swedish VAT group was required to account for Swedish VAT by way of reverse charge in respect of the supply by SAC to its Swedish branch, thus rendering the planning ineffective.

Implications

The UK already has provisions preventing effective VAT grouping in circumstances where overseas services are bought in and recharged to a recipient in a UK VAT group, although this does not prevent all branch VAT planning. For example, the provisions do not apply to recharged internal costs. HMRC has announced that it is looking into whether Skandia has any application to UK grouping provisions, with an update promised in "due course". Until then, it remains unclear as to how far this judgment will reach.

It is clear that non-exempt services provided by a company belonging outside the EU to its VAT-grouped branch in the EU will be subject to VAT by way of reverse charge. However, there is no logical reason why the court's rationale should not extend to services provided by the branch to the overseas company, which may actually enable some branches to increase input VAT deductions. Similarly, services provided by EU companies to their branches which are VAT grouped in other Member States also appear to fall within the court's reasoning.

Until HMRC gives some indication of how this judgment may be applied in the UK and whether any legislative changes will follow, businesses should follow existing guidance. However, multinational groups should begin to consider carefully the impact of the decision on any of their cross-border arrangements involving branches, including whether any restructuring may be required.

Skandia America Corp. (USA), filial Sverige -v- Skatteverket (Case C-7/13)

Please click on the links below for the other articles in the October 2014 tax newsletter:

• Vaccine Research LP: R&D partnership scheme
• Bookit: VAT and card handling fees
• BEPS deliverables
• University of Huddersfield: VAT - the abuse principle
• Taylor Clark Leisure: entitlement to VAT repayments