Taxation – Budget bombshell: VAT grouping hit

Although VAT was barely mentioned in the chancellor’s speech, thetion. devil, as ever, was in the detail contained in the news releases and budget notices issued by Customs & Excise as soon as he sat down.

The single most important and far-reaching proposal on VAT was contained in a brief news release, headed ‘VAT Group Treatment – Consultation’. The wording of the release was interesting: it said the consultation would ask for views on the possible restriction of VAT grouping to fully taxable companies.

It said the aim would be to achieve a better balance between the revenue cost to the Exchequer and the compliance cost to business and – almost as an afterthought – to minimise tax avoidance opportunities.

However, the release then went on to say Customs would soon be publishing a consultation document which would set out a specific proposal to restrict grouping to fully taxable companies. Businesses would then have three months in which to make representations.

The significance of this proposal to businesses cannot be underestimated.

If it were implemented, the cost of restricting VAT grouping to fully taxable companies, that is, those companies which can recover in full all of the VAT on their costs, would run into many hundreds of millions of pounds.

Since the Budget, Customs & Excise officials have unofficially admitted the purpose of the proposal is to raise revenue and a figure of more than #400m per annum has been mentioned.

How will this affect grouping?

First, it would enable Customs to deal once and for all with the issue of VAT recovery by holding companies. Holding companies, as well as captive insurance companies, treasury and finance companies and property holding companies, are either exempt or partly exempt for VAT purposes.

By forcing these companies to leave VAT groups, it is likely the VAT on the cost of company restructuring, mergers and acquisitions will no longer be recoverable.

The position is even worse for the finance and insurance sectors. Almost all companies in these sectors are fully or partly exempt and have to form VAT groups in order to avoid artificially creating VAT on staff and other costs which are used for common services.

This has been a common and accepted practice since VAT was introduced 25 years ago. Customs are now, it seems, effectively re-characterising this as VAT avoidance. The proposal would force a finance or insurance VAT group to break up and as a result it would either have to face significant additional VAT costs or the companies concerned would have to restructure themselves, wind up their central services companies and employ their own administrative staff directly.

Cost of compliance will soar

In addition, compliance costs will increase for all groups of companies.

There will be many more VAT registrations and returns. Transactions previously disregarded because they took place within a VAT group will now be subjected to VAT and errors will occur. Assessments, penalties and interest will follow the errors.

It seems surprising therefore that having told us what they propose to do, Customs are intending to consult. A cynic might say that the consultation exercise will have no real purpose but is merely intended to take the political sting out of what is a very unpopular proposal.

I, however, take a different view. While Customs have drawn a line in the sand on groups, I believe they know that they will not be able to hold this line because they realise that the proposal will be totally unacceptable to business.

The consultation exercise will therefore give them an opportunity to gauge just how serious the opposition to the proposal is and a better understanding of where they might find a tenable fall-back position. The consultation document is expected to be published early in April.

I strongly advise all financial directors to obtain a copy of this document, to study it carefully and to make representations directly to Customs and through their trade associations. Unless businesses are prepared to stand up and be counted, VAT grouping as we know it, and the benefits which flow from it, will disappear.

Related reading

aidan-brennan kpmg