Hastings and the rise of consumer-based taxation

HMRC's arguments in the case of Hastings Insurance Services Ltd are indicative of a growing wider assumption that consumer location equates to a right to tax. In that case, HMRC tried to claim that a UK insurance broker was the fixed establishment of a Gibraltar insurance underwriter; and therefore that the supply of services was from itself as broker in the UK to itself in the UK as fixed establishment of the offshore underwriter.

Its attempted input tax recovery should therefore relate to intra-UK exempt supplies and accordingly be invalid. But there was no suggestion of VAT avoidance, and HMRC lost its case before the First Tier Tribunal (FTT). However, it is widely expected that HMRC will appeal, which could set alarming precedents in other areas of UK taxation. It seems the definition of what is an establishment is being gradually extended for political purposes.

My initial reaction on reading the Hastings case was surprise and bafflement. A quick refresher on DFDS (Case C-260/95) and Welmory (Case C-605/12) then followed, with the main objective of trying to work out how it took the FTT 132 pages of careful factual analysis to reach a conclusion that, in theory, should be perfectly obvious.

The most striking point about the case is that it was allowed to be heard in the tax tribunal in the first place, rather than being thrown out as a waste of court time. To give you context, this is a case where:

• there was no suggestion of VAT avoidance;
• the two entities were independent, although indirectly related parties for part of the time, and common ownership was judged inconclusive to the test;
• the appellant had around 20 other clients;
• all the contracts were on arm's length terms; and
• each party took its own share of genuine commercial risk.

Yet HMRC still attempted to argue that the place of supply was the UK, despite there being a commercial arrangement between two largely independent enterprises, where the business customer was based in Gibraltar and had no connection with the UK except through its broker supplying those very services. 25 years ago an assertion of this kind by HMRC is exactly the sort of point that would be noted as an academic footnote in an opinion but that no-one took seriously as an actual risk. Now we have long, detailed judgments trudging through a factual analysis which note that, if the circumstances were slightly different, the taxpayer would, and may yet, be scuppered. HMRC lost before the FTT but it is widely expected that it will appeal.

The impacts of DFDS and Welmory

So what has changed? Recent developments over the last few years have demonstrated a steady progression of media-led politics influencing tax developments - and not in a way that seeks to encourage positive behaviours by offering incentives. Rather, the line of thinking says: 'They are selling to UK consumers; therefore, they must be subject to UK tax.'

For example, if you look at VAT case law, you can see a slow worrying mission creep in the definition of what is an establishment, which has more to do with politics than legislative interpretation.

DFDS was arguably a political decision aimed at exulting the principle of non-distortion of competition above all others. When asked if the place of supply of the tour operator was its business establishment in Denmark, where the services were exempt, or a potential fixed establishment in the UK, the CJEU chose to put fixed establishment above business establishment. This would actively discourage undertakings trading in one member state from establishing their businesses, in order to dodge taxation, in another member state, which would distort competition. Given this political agenda, the obvious step was to make the concept of fixed establishment wide enough to include the premises of another company; in the case of DFDS, a wholly owned subsidiary in a close contractual relationship with the parent tour operator. However, that opened the door to a broader construction of what constitutes a fixed establishment.

In 2014 the Polish tax authority in Welmory (Case C-605/12) saw the opportunity for a tax grab. It argued that as the overseas business has local customers and the local supplier and overseas business provide the services 'together', the local supplier's services must be consumed by the overseas business in the local jurisdiction by virtue of the local supplier's establishment in its jurisdiction. It was argued that it would be 'irrational' to say that the services are supplied overseas where received in such cases, and thus escape local VAT, despite the fact that is exactly what the B2B place of supply rules say.

HMRC's response

The same argument is the foundation on which HMRC's guidance (VAT Notice 741A para 3.5) is based when it states that a business can have a fixed establishment through its subsidiary: 'an overseas business has contracts with UK customers to provide services; it has no human or technical resources in the UK and therefore sets up a UK subsidiary to act in its name to provide those services. The overseas business has a fixed establishment in the UK created by the agency of the subsidiary.'

And from there it is but a short skip and a jump to Hastings, where HMRC is trying to argue that one largely independent enterprise is somehow the fixed establishment of another. It is easy to see the attraction: a quick twist of EU principles and HMRC has got a tax grab on its hands of mouth-watering proportions. And from its perspective, it should be an easy media win that reads well for ministers - the ultimate consumers of the insurance products are in the UK, so that is where the place of supply of all the related services surely 'must' be in their view.

In the realm of VAT, which is supposed to be a consumer tax, it makes a twisted sort of sense. But you can see the same worrying mission creep in other areas of UK taxation, as well. The much hated diverted profits tax (DPT), for example, is a more flagrant example of consumer based thinking, this time flaunting international law.

The avoided permanent establishment limb of DPT arose from the media's premise that if, for example, you have a warehouse in the UK, and you are an international online seller of goods to UK consumers supplied from that warehouse, you 'must' have a taxable permanent establishment here. The problem is that the premise flies in the face of established precedent - remember the old distinction between trading 'in' and trading 'with'? Also, there are our international obligations to other countries under negotiated conventions that explicitly stop you slapping a tax on a foreign trader just because they are selling to your nationals. You can almost hear the internal discussions at HMRC: 'There's no branch here under the double tax treaty? Never mind, we'll pretend there is one and slap a punitive tax on it. And oh no, that tax is not covered by treaty, because we say it isn't.'

And, as if by magic, what was originally billed as a last resort anti-avoidance measure for the ultimate in cunning but legal tax planning suddenly becomes a go-to bludgeon for any dispute with any taxpayer about their transfer pricing: 'agree it now, or we'll slap a DPT charge on you.' This all stems from an assumption that consumer location equals a right to tax.

The problem with this pace of change, and the twisting or disregard of EU and wider international principles, is that other countries may follow HMRC's example. This should concern not just the taxpayer but also HMRC itself. Right now we have an omnishambles of digital economy proposals in prospect in the UK and the EU which can be seen as the next logical step once you start thinking that consumer-based taxation is a good idea. No-one that I know of has yet done a proper analysis of what user-created value might be, or even proved that it really exists outside the realm of goodwill, and even HMRC agrees there is no issue of non-taxation here. But thanks to misguided media campaigns there is a political cry that something must be done. For 'something' here read 'a great excuse to bite some chunks of tax out of other countries by claiming user-generated value is quantifiable, valuable and taxable here in the UK'.

The problem is that every country will want a bite of that pie. Absent a collective plan from the OECD to rejig the whole global tax base, it is every country for itself in a rush to install 'interim measures' - and that's where things will start to get bloody. HMRC may live to regret snacking on other countries' big tech companies, when those countries start chomping at the British tax base with reference to their users in bigger countries with more consumers, such as the US, India and China. All this, and a weak as custard system for resolving inter-country disputes on double taxation, is a recipe for disaster.

Eloise Walker is a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com. This opinion was first published in Tax Journal on 18 May 2018.