HM Revenue and Customs (the Revenue) have failed in their challenge to the recovery by a UK broker of the VAT attributable to the supplies made to its affiliated underwriter in Gibraltar. While this challenge was defeated, this was on the basis of the substance of the Gibraltarian operations. Other groups should look to their structures to see if they are equally robust.
The facts were as follows. Hastings, a UK insurance services company, sought to recover input VAT attributed to the supply of broking services made to Advantage, a Gibraltar-based underwriter of UK motorcar and motorcycle insurance. Hastings’ supply of services to Advantage was made in accordance with the terms of a services agreement. Hastings and Advantage had, at different times during the relevant period, common shareholders and a common corporate parent.
Hastings argued that the input tax attributable to its services was recoverable because the services were supplied to Advantage in Gibraltar. It was common ground that Hastings would be able to recover input tax if the services were supplied to a taxable person “belonging” outside the EU member states. Gibraltar is outside the EU for VAT purposes.
The Revenue disputed that the VAT was recoverable and argued that Hastings in fact constituted a fixed establishment of Advantage in the UK, such that VAT was not recoverable. The argument ran as follows:
- Advantage had a UK fixed establishment, comprising Hastings’ own human and technical resources;
- Hastings’ supply of insurance services was made to that fixed establishment in the UK; and
- that fixed establishment in the UK should be regarded as the place of supply for VAT purposes (rather than Gibraltar) such that VAT was not recoverable.
In other words, the Revenue argued that Hastings’ own human and technical resources comprised a fixed establishment of Advantage in the UK, such that VAT recovery by Hastings on, essentially, a supply to itself was not permissible.
Held
After a detailed consideration of the available evidence, it was held that the resources of one entity (Hastings) did not in this case comprise a fixed establishment of a related entity (Advantage) because each entity in fact operated a separate business with its own commercial imperatives and financial risk taking.
Reasons
This finding that Hastings and Advantage operated separate businesses was based on an examination of the factual matrix concerning the relationship between the two companies. A number of indicative factors were identified.
Ownership
In the case of related entities, common ownership may indicate dependence of one entity on another but, crucially, it is not conclusive. A close analysis of the arrangements between the parties and how they operate in practice is required.
Corporate governance
Each of Hastings and Advantage was run separately by its own board according to its own commercial aims, profit targets and budgets. Both entities had separate management structures and no mutual directors. Their respective boards operated independently of each other, notwithstanding some exchange of information and employee interaction.
With respect to staffing, Hastings had autonomy to determine the number of employees it required without reference to Advantage.
Commercial relationship
Despite being related entities, the service agreements between Advantage and Hastings were in fact negotiated on an arm’s length basis and the contractual arrangements were determined commercially, as if the parties were independent of each other.
It was significant that Advantage could have chosen to use a different service provider if it was not satisfied with Hastings; the fact that it chose not to do so was a commercial determination based on the belief that Hastings was the best. Similarly, Hastings could and did in fact act as a broker for other insurers, even though the majority of its motor insurance business was for Advantage.
Division of functions
Under the contractual arrangements, the insurance business functions were split between Hastings and Advantage. Advantage acted as underwriter, entering into policies with customers, deciding what risks to insure at what price, determining reserving philosophy and claims handling guidelines, and dealing with, among other things, large loss claims, reinsurance and the making of actuarial reserves. Hastings, on the other hand, dealt with the customer facing side of the business, in selling insurance policies on behalf of Advantage and handling small claims in accordance with the claims guidelines, for which it received performance related commission.
It was at all times made clear to intermediaries that Advantage was the insurer. Policies issued to customers set this out clearly.
Independence
The fact that the parties operated in close cooperation as part of a single economic activity was not conclusive as to whether Hastings formed a fixed establishment of Advantage. Two mutually dependent businesses may nonetheless still exist in fact as separate businesses with their own independent commercial interests and risk assessments.
Similarly, the fact that the parties were often able to resolve pricing conflicts by agreement did not mean they were not each acting in their own best commercial interests at all times.
Regulation
Advantage remained at all times licensed and regulated by the Financial Services Commission (FSC) in Gibraltar, which permitted it to provide insurance contracts, with no concerns ever raised by the FSC or UK authorities. According to evidence from the former CEO of Advantage, Advantage was established in Gibraltar to take advantage of lower capital requirements and corporation tax rates. It was not established in Gibraltar for the purposes of VAT recovery.
Given the facts, it is not a surprise that the taxpayer succeeded in this case, although it may be appealed. It does reinforce the message that groups should ensure that their non-UK affiliates operate independently and with substance. This is increasingly the case for direct tax purposes; this case shows how important it also is for VAT purposes.
