VAT exempt bodies given guidance on the VAT cost sharing exemption

Businesses and organisations looking for cost efficiencies often work with others to share costs and resources. Under UK law many of these arrangements result in VAT being charged between the participants. This is not a problem for those participants who can reclaim the VAT on those arrangements but it is an issue for which are unable to recover the VAT in full. This includes charities, universities, banks and insurance companies.

Under the cost sharing exemption once a cost sharing group is formed it is relieved of having to charge VAT on supplies made to its members.

The cost sharing exemption is a mandatory exemption in EU law which had not been implemented in the UK.

In December 2011 the Government published a response to its consultation on a VAT exemption for services shared between VAT-exempt bodies. It also published draft legislation implementing its proposed changes. The draft legislation is due to be included in Finance Bill 2012, which is published tomorrow.

HMRC is carrying out an informal consultation amongst those who have previously responded to consultations on the cost sharing exemption on the draft guidance it has produced on the new exemption.

"The draft guidance is in line with previous indications and should enable bodies to start to plan for cost sharing structures,” said John Christian, a tax expert at Pinsent Masons, the law firm behind Out-Law.com. "There are a number of cost sharing structures already under discussion and it looks as though the VAT barrier to cost sharing is now falling away. The implications for the education sector, for example, are significant in a period of significant revenue and costs pressure."

The draft guidance states that the types of businesses and organisations that might benefit from the cost sharing exemption are charities, banks, education institutions, insurance businesses, social housing organisations, betting and gaming organisations, health and welfare businesses and organisations, financial services businesses, local authorities, government departments and non-departmental public bodies.

In the draft legislation published in December 2011 there are five basic conditions that have to be met before the exemption can apply. These are that there has to be an 'independent group' (a 'cost sharing group' or CSG) supplying services to persons who are members of it; the members have to make exempt and/or non-business supplies; the services supplied by the CSG must be ‘directly necessary’ for the exercise of the members’ exempt or non-business activities; the must CSG only recover, from its members, the members’ individual share of the expenses incurred by the CSG in making the exempt supplies to its members (‘exact reimbursement’), and use of the exemption must not cause or be likely to cause distortion of competition.

The draft guidance confirms that although a CGS must be "independent", a member of the CSG could control it.

"A CSG is an independent group of persons that is separate from its members, but who work together. It is established, owned and operated by the members for their co-operative benefit and is independent of any third party ownership, control or influence. It can be a group of equals or if all the members agree one or more members can have effective control and/or majority ownership of the group." states the draft guidance.

The VAT exemption would not relieve all forms of shared service arrangements from VAT. In particular, commercial outsourced service providers will not be able to provide services VAT-free to their customers, even if those customers come together to jointly procure the services. The draft guidance makes it clear that "the exemption does not apply to outsourced services or arrangements that amount to the provision of outsourced services".

The draft guidance considers whether the behaviour foreseen by the guidance would constitute a distortion of competition.

"A CSG is an aggregated in-house provision (a co-operative self supply)," it says. "It is not an outsourcing arrangement therefore it does not exist or compete in a market. As long as  all the conditions of the exemption are met, particularly that it can only supply it’s members on a ‘direct reimbursement’ basis i.e. it self supplies at cost, there should be little question of the exemption distorting a market and therefore little question of failing to meet this condition." 

"When a CSG begins to acquire ‘the characteristics of an independent operator by seeking a customer base in order to generate profits’ e.g. a commercial outsourcer, it is more likely that the exemption will be applied in a way that may well give rise to a ‘distortion of competition’ and that the condition will be breached," it said.

In an email to those who had taken part in previous consultations HMRC asked for comments on the draft guidance by 18 May. The email wared that "stakeholders are strongly advised not to use this Draft Guidance to make decisions regarding the exemption but to await publication of the finalised Guidance".