VAT and value shifting: new guidance

In January 2021, HMRC published a consultation document, "VAT and Value Shifting", consulting on changes which the government proposed to be made to the way in which the consideration for a bundle of separate supplies is apportioned for VAT purposes. Given concerns that the rules allowed manipulation of the values apportioned to the different elements of the bundle to achieve inappropriate VAT savings, the government proposed introducing more prescriptive rules to prevent such manipulation. For further details of the consultation, see “VAT and value shifting”.

Revenue and Customs Brief 2 (2023) has now announced that no legislative changes will be made. Instead, HMRC has concluded that the most effective way to address valuation concerns is to provide businesses with practical guidance on apportionment methods. This is through Guidelines for Compliance and improvements to other guidance.

Guidelines for Compliance explain HMRC’s view on complex, widely misunderstood or novel risks that can occur across tax regimes and help you avoid non-compliance. HMRC has now published a Guideline for Compliance about VAT and valuation called ‘Help with VAT apportionment of consideration’. In addition, other HMRC VAT guidance has been updated to encourage businesses to first consider a selling price method, where appropriate and available, before considering a cost price method or any alternative. The guidelines and guidance deal principally with how to apportion consideration in the case of retail bundles.

Background

The current VAT rules in VATA 1994 s.19(4) provide that where "a supply of any goods or services is not the only matter to which a consideration in money relates, the supply shall be deemed to be for such part of the consideration as is properly attributable to it." Accordingly, where there is a bundle of supplies for a single consideration, the consideration must be apportioned between the supplies properly. The apportionment of the consideration to the various elements is particularly important where those elements have different VAT liabilities.

The current law does not prescribe that any particular method should be used. HMRC policy is that businesses can use cost-based methods, (actual) market value-based methods or any other method that produces a "fair" result. However, this can lead to different tax results for very similar bundles. In particular, HMRC guidance specifically deals with two methods of apportionment: one is based on cost and the other on market value. However, the consultation noted that HMRC had become concerned that cost-based apportionments can be manipulated to increase the cost of the zero rate, reduced rate or exempt supplies in order to reduce the amount of VAT accounted for on the bundle. In addition, where businesses use estimates of the market value of items, which are not sold separately, and therefore have no actual sale price, it can be difficult to demonstrate the true market value of the items, leading to significant uncertainty.

Guidelines for compliance

The guidelines focus on selling price and cost-based apportionment methods, as these are the most common approaches. However, HMRC continue to accept that other apportionment methods may also be appropriate in specific circumstances.

The guidelines indicated that where each item in a bundle is also sold separately by the business, an apportionment based on the selling price of each item in the bundle is a low tax compliance risk approach. In situations where the bundle is sold for a discounted amount, HMRC would expect the discount to be applied proportionally to the normal selling price of all the goods and services in the bundle. A business would be expected to evidence the normal selling price of each supply. The guidelines point out that other apportionment methods for discounts (such as attributing it to one item or based on RRP) are likely to give rise to higher compliance risks. The guidelines include a number of other examples of scenarios that might give rise to higher compliance risk.

The guidelines suggest that where bundled goods or services are not all sold separately, it may be necessary to base the apportionment on the cost price of those goods or services. The guidelines highlight the importance when applying a cost-based apportionment to make sure that all ‘relevant’ costs are included. In straightforward cases it will be possible to identify the costs wholly attributable to the supplies within the bundle. However, there may be cases where some costs cannot be wholly attributed to one specific item. These costs would include overheads, some of which are general overheads such as lighting, rental of premises, telephone bills, but some of which may directly relate to the processing or alteration of the supplies within the bundle such as running costs of machinery or staff. Again the guidelines give examples of attribution based on cost and where those examples might include higher compliance risks.

Further examples and guidance are also included in the HMRC VAT Valuation Manual.

Comment

The decision not to proceed with the original proposal to introduce new legislation to prevent inappropriate value shifting is not fully explained. However, it is likely that any such rules would have been complex and the decision to deal with the issue through additional guidance is to be welcomed. It was far from clear that a "mechanical" set of rules would have operated more fairly and would not have been equally open to manipulation.

Businesses should now pay close attention to the new guidelines and examples in order to lower their tax compliance risk and avoid potentially costly disputes with HMRC.