Contractual terms are not decisive for VAT purposes

The CJEU appears to have confirmed what many practitioners have often suspected: VAT is, quite literally, a law unto itself!

To determine the correct rate of VAT for a transaction, it is first necessary to determine the relevant facts, such as the identity of the customer, the nature of the supply, the country in which the supply is made, and so on.  The terms of a written contract are a good guide, but sometimes practitioners and even some HMRC Officers become overly reliant on the terms written into a contract.

The VAT legislation refers to the facts of a transaction, not to a contract written to reflect it.  Sometimes a transaction can be significantly different in practice to what was envisaged in the contract.

In the case of Newey t/a Ocean Finance (C‑653/11, published on 21 June 2013), the CJEU explained that “sometimes, certain contractual terms do not wholly reflect the economic and commercial reality of the transactions … in particular if it becomes apparent that those contractual terms constitute a purely artificial arrangement which does not correspond with the economic and commercial reality of the transactions”.

In this case, the CJEU was concerned to focus attention on the arrangements put in place by the taxpayer.  A Jersey business supplied advertising services to a Jersey subsidiary of the taxpayer.  The taxpayer made exempt supplies in the UK and would therefore have suffered an irrecoverable VAT charge if he had purchased the advertising services direct from the Jersey business.

The CJEU left it to the national court to determine the facts of the case, but then considered how the transactions should be “re-established” if the national court did find that an abusive practice had occurred: “the Commissioners … could legitimately regard Mr Newey as actually being the supplier of the loan broking services and the recipient of the supplies of advertising services at issue in the main proceedings.”

However this was only an observation made in passing by the CJEU.  Its ruling was that “contractual terms, even though they constitute a factor to be taken into consideration, are not decisive for the purposes of identifying the supplier and the recipient of a ‘supply of services’.”

This is a far more general point.  It is not only those businesses trading with offshore parties which should now review the substance of their transactions.  Businesses of all kinds should consider whether their transactions differ in practice from their contractual terms.  If differences are found, the business should further consider whether this might lead to a different rate of VAT being applied.

For further information on the VAT rules for cross-border transactions, or for support in interpreting contracts and transactions from a VAT point of view, please contact the TaxDesk on 0845 4900 509 and ask for Kevin Hall.