The case of Hastings v HMRC

The case of Hastings v HMRC: can a service provider also be the recipient of its own services for the purposes of value added tax?

To someone not versed in the vagaries of VAT in the EU this might sound like a strange question. 

However, in the world of VAT the place where a supply is treated as being made is of central importance to analysing the VAT costs of cross-border business arrangements, particularly in the insurance and finance industries.

This is because the 'place of supply' helps determine (1) whether 'output' VAT must be charged on that supply (although this is of secondary importance in cases such as Hastings' where the supplies of insurance intermediary services would be exempt in any event) and (2) whether the supplier can recover 'input' VAT that the supplier has borne on supplies that it has received. 

For VAT purposes business-to-business services are generally treated as supplied in the country where the service recipient is headquartered (its 'business establishment'), or, if the services are supplied to or used by a branch of the service recipient in another country, the country in which the relevant branch of the service recipient (the relevant 'fixed establishment') is situated.

So far so straightforward. However, there are cases in which tax authorities in the EU member states argue that a service provider constitutes a fixed establishment of the service recipient for the purposes of receiving the service provider's supplies and so determining the place of those supplies for the purposes of VAT – i.e. that the service provider is in effect supplying its services to itself as an extension of the service recipient. The case of Hastings v HMRC is one such case. Happily, the tax authority did not prevail.

The background to the case

In Hastings Insurance Services Limited v HMRC, the UK court had to consider the arrangements between Hastings, Advantage Insurance Company Limited, and UK customers obtaining motor insurance.

Advantage is a personal lines insurer based in Gibraltar, underwriting motor and home insurance for UK customers. Advantage and Hastings had either substantially common shareholders or were (as they are now) indirect, wholly-owned subsidiaries of a common parent company.

Hastings is a UK-based insurance services company, which arranges motor and home insurance policies between UK customers and a panel of insurers, which includes Advantage.

When a customer obtains insurance through Hastings, as well as the contract of insurance they enter into with a panel insurer, the customer also enters into a number of related transactions which may include: (1) contracts with other insurers for ancillary products; and (2) a credit agreement with Hastings, if the customer elects to pay by instalments.

Whether a customer obtains insurance through a price comparison website, the Hastings website or over the telephone from Hastings' call centres, Hastings is acting as an intermediary on behalf of the relevant panel insurer. To enable Hastings to provide these intermediary services, panel insurers provide Hastings with 'rating tables' – arrays of 'net premiums' for different risks (combinations of underwriting criteria, such as customer postcode, age and vehicle model). The net premiums represent the amount that the insurer has calculated that it needs to charge to underwrite a particular risk and make a profit while spreading its risk.

Generally an automated pricing system used a customer's information to generate net premiums from the insurers' rating tables. The most competitive net premium was used by Hastings to generate the 'gross premium', which, together with the insurance premium tax was the price offered to the customer for the insurance policy. The difference between the gross premium and the net premium represented Hastings' commission from the insurer. Hastings applied algorithms to determine the optimum commission to charge, having regard to the value of a customer (e.g. the other income Hastings may earn through commissions on ancillary products and interest on instalment finance); this could include charging a negative commission, but in all circumstances Hastings had to account to the insurer for the net premium (plus the insurance premium tax).

Hastings' services for Advantage also included claims handling and underwriting analysis – technical support to assist Advantage when making its net premium pricing decisions. The relationship between Hastings and Advantage was governed contractually by services agreements. During the period in dispute Hastings did not provide claims handling or underwriting analysis services to other panel insurers. Although Advantage was not obliged to use Hastings exclusively, throughout the period in dispute all of Advantage's policies were issued by Hastings (or by sub-agents of Hastings) on Advantage's behalf and all the claims made under Advantage's policies were handled (to a greater or lesser degree) on an outsourced basis by Hastings.

The court was required to determine whether Hastings was entitled to credit for input VAT attributable to its supplies of services to Advantage. This depended on whether Advantage received those services at its business establishment in Gibraltar or at a fixed establishment in the UK. It was common ground that Hastings' services would fall within the VAT exemption for insurance intermediary services and so carry no entitlement to input VAT credit if supplied in the EU. However such supplies would be 'exempt with credit' (i.e. give rise to an entitlement to input VAT credit) if supplied outside the EU (which for these purposes Gibraltar is).

Since Advantage did not have any presence of its own in the UK, HMRC's contention was that Hastings itself constituted a fixed establishment of Advantage in the UK, both in relation to Advantage's supplies of insurance to UK customers and in relation to Hastings' supplies of insurance intermediary services to Advantage.

EU VAT regulations provide that a fixed establishment is an establishment (other than a person's business establishment) which is:

'characterised by a sufficient degree of permanence and a suitable structure in terms of human and technical resources' (when looking at the recipient) 'to enable it to receive and use the services supplied to it for its own needs' (or, when looking at a service provider) 'to enable it to provide the services which it supplies'.

Was Hastings Advantage's UK fixed establishment for supplying insurance?

The court approached the question of determining whether Hastings was a fixed establishment of Advantage for the purposes of Advantage's supplies of insurance to UK customers by considering two aspects of the fixed establishment test developed in the European case law that underpins the rules referred to in the preceding paragraph:

1. Did the resources provide what was necessary or adequate for the provision of the services on an independent basis?
   
   The key issue which the court had to consider was how to assess the concept of 'necessary' or 'adequate' for the purposes of this test. On a strict interpretation, an insurance company could never have a fixed establishment as the head office would be required to some extent to meet regulatory requirements and raise capital. On the other hand, the court was not persuaded that it was sufficient that the potential fixed establishment performed all the customer facing functions. The court considered that what constitutes the necessary resources will vary according to the particular context and the court's role was to assess the particular supplies made by Advantage and determine which resources were 'directly involved'. On its analysis, the resources of Advantage in Gibraltar which determined what risks to insure and priced those risks were such a key element of the supply of insurance that it was not necessary to look to the other functions performed by Advantage. Without those resources, there would have been no Advantage insurance policies for Hastings to sell. Hastings could not be said to have the necessary resources and for that reason no UK fixed establishment could exist for the purposes of Advantage's supplies of insurance to its UK customers.
2. Did the resources have a sufficient degree of permanence?
   
   The court considered permanence both a temporal requirement (which was accepted as satisfied) and a requirement that Hastings' resources were under some degree of Advantage's control. The court analysed the contractual arrangements to establish the degree of control or independence of the potential fixed establishment. The court did not accept that commercially agreeing the scope of the service provider's functions necessarily amounted to the required retention of control or lack of independence - closer analysis of precisely what level of control the business retains as a result of the setting of the parameters and of the functions carried out within those parameters is required. On a detailed review of the evidence, the court concluded that Hastings carried out its functions independently of Advantage, as a separate commercial enterprise.

Did Advantage have a UK fixed establishment for receiving Hastings' services?

The finding that the permanence requirement discussed above was not satisfied would have been sufficient for the court to conclude that Hastings was not a fixed establishment of Advantage to which Hastings' insurance intermediary services were supplied. The court also concluded that since it had determined that Advantage's business establishment made the insurance supplies, the resources of Hastings could not be said to represent an establishment with a suitable structure to receive and use Hastings' insurance intermediary services for its own needs.

Rationality

Even if a service provider is found to be an EU fixed establishment of the recipient for the purposes of the service provider's supplies of services to the recipient, the European case law provides that the business establishment of the recipient is to be preferred as the primary point of reference unless that leads to an irrational result or creates a conflict with another EU member state. Given the court's conclusion that Hastings was not Advantage's fixed establishment, its commentary on this point was not a decisive part of the judgment. However, aspects of its approach may be of interest to taxpayers, given VAT operates on a real-time basis and they need clear rules to determine the place of supply. Uncertainty in the system creates time-consuming administrative complexity.

• The court had doubts that the test of rationality should be interpreted as one of 'fiscal rationality' – i.e. just because there might be VAT savings if the services are treated as supplied to the recipient's business establishment, this alone is not a reason to treat those services as being supplied to a fixed establishment of the recipient.
• Where the use of the relevant supplies at the fixed establishment was not predominant, the use of the services at the business establishment could not be disregarded.
• In circumstances where services were used in an unidentifiable and unquantifiable manner between a business establishment and a fixed establishment of the recipient, guidance in EU VAT rules could be applied to treat the services as supplied to the business establishment.

Implications

The decision in Hastings was at the first stage of the UK court system; given the importance it can be expected that HMRC will appeal. In the meantime, insurers based outside the EU should consider whether their arrangements with UK service providers would, on a review of the arrangements, also satisfy the UK court's concepts of independence or control. These issues may also be relevant to non-UK investment and other entities which outsource material business functions to UK service providers. Given the detailed findings of fact by the court, businesses should be wary of suggestions that the decision in Hastings' favour represents a silver bullet.

Businesses establishing new cross-border arrangements with UK elements will also need to consider whether those arrangements give rise to any disclosure obligations under HMRC's new disclosure regime for VAT and other indirect taxes (DASVOIT), in particular whether the arrangements fall within Hallmark 6 (offshore supplies – insurance and finance) or Hallmark 7 (offshore supplies – relevant business person).

Finally, as it is not yet clear whether the UK will leave the EU VAT area as part of Brexit, nothing useful can be said about what, if anything, will change at 11pm on 29 March 2019 or, if relevant, at the end of any 'transition period'. 

Ashurst has acted for Hastings on the dispute with HMRC since November 2014.