Exact reimbursement condition in VAT cost sharing exemption must be properly evidenced, says Tribunal

The decision means that the partnership will be subject to VAT on the contributions made by its non-profit making members to its running costs. 

West of Scotland Colleges Partnership (WOSCOP) was set up by a group of colleges of further and higher education to access grant-funding on behalf of all the colleges, rather than each college having to do this itself. Each member contributed the same amount to WOSCOP's operating costs. HMRC said that these equal contributions did not satisfy the conditions of the VAT cost sharing exemption, which requires each member to make “exact reimbursement of [its] share of the joint expenses”.

The VAT cost sharing exemption applies where two or more organisations with VAT exempt or non-business activities join together on a co-operative basis to form a separate, independent entity, called a cost sharing group, to supply themselves with services at cost price.  Without the exemption, there would be a VAT charge on the services supplied by the cost sharing group to the members, which the members would not be able to recover because of their VAT exempt status. The exemption is commonly used by universities, colleges and other not for profit organisations.

Ian Hyde, a tax expert at Pinsent Masons, the law firm behind Out-law.com, said: "Those involved in outsourcing welcomed the introduction of the cost sharing exemption in 2012 as one way to stop VAT being a barrier to outsourcing. However, this case illustrates the practical difficulties in implementing cost sharing arrangements."

WOSCOP argued that, in its case, the equal contributions satisfied the "exact reimbursement" condition, as its activities were for the benefit of all its members and time spent on behalf of one member benefitted all members. However, it was unable to produce detailed records substantiating this.

Tribunal Judge Kenneth Mure QC said "at least some effort or attempt has to be made to differentiate the interests of and benefits accruing to each of the members in assessing their shares of the joint expenses.  Each of the Colleges is of a different size and offering a different variety of courses.  Account, however, may be taken of fluctuating needs and benefits over an extended period."

The tribunal said that the burden of proof in showing that the conditions of the exemption were met rested with WOSCOP.  The judge said that, as there was only limited documentary evidence available, "this raises doubts in our view as to whether there were even detailed deliberations, far less a considered agreement as to the apportionment of expenditure.  The oral evidence falls short of this:  it tends to support simply some agreement as to sharing expenditure, perhaps reflecting largely a degree of goodwill.  The evidence does not seem even to support an awareness at the material time of the true nature of the test."

Ian Hyde said: "This a harsh decision for the colleges involved, but reliefs and exemptions are interpreted strictly. The case shows that even if you are within the spirit of an exemption and are not exploiting it, HM Revenue & Customs (HMRC) will still apply the conditions strictly and deny the exemption where you do not satisfy the precise requirements or where you have not kept the necessary records to evidence your entitlement"

The cost sharing rules have applied since 17 July 2012, but this is believed to be the first time they have been considered by a court or tribunal.

"The cost sharing exemption is a piece meal reform. We need a complete review, as proposed by the European Commission, to properly resolve the VAT inefficiencies in this area," said Hyde.

In October 2013 the European Commission launched a review of the VAT legislation on public bodies and tax exemptions in the public interest. This acknowledges that with increasing private sector involvement in public services, the current VAT rules are outdated and may be counterproductive to the efficient provision of public services. The consultation paper suggests how the VAT treatment of public bodies might be reformed. The consultation period closed on 25 April and the Commission's response is awaited.