Reform of the TMO: consultation

The government has published a consultation on reforming the application of the Terminal Markets Order 1973 (TMO) so that it operates more flexibly in future. It does not involve significant changes to the scope of the TMO but rather updating the existing legislation to better reflect current practice and ensure that it can be kept up-to-date more easily in future.

Background

The TMO came into force in 1973. It provides a VAT zero rate for certain wholesale commodity transactions made by members on named commodity exchanges or market associations. These markets are listed by name in Article 2(1) of the TMO legislation and are defined as "terminal markets". The commodities traded under the TMO originally included precious metals and agricultural goods. This was later expanded to cover energy products (e.g. oil, electricity, and gas), and certain carbon emissions trading.

Following EU exit, the government is taking the opportunity to reform the TMO, by updating the legislation to provide greater clarity and certainty in relation to the VAT treatment of commodity transactions traded on commodity exchanges or market associations.

Consultation

The government does not intend to make fundamental changes to the current TMO policy or extend the current scope of the TMO. Rather the purpose of the consultation is to seek views on proposals to make changes to the TMO to reflect modern market practices, and to make it simpler to update the TMO in the future. The government's aims in putting forward the proposed changes are to:

• Preserve the existing benefits of the TMO, including ensuring market liquidity, reducing administrative burdens and reducing scope for VAT fraud;
• Update and modernise the legislation, so that it reflects and supports the markets as they operate today;
• Move to a principle-based approach by introducing specific criteria which provide greater certainty over the VAT treatment of commodity transactions traded on commodity exchanges or market associations; and
• Respond more quickly and flexibly to developments in the market, without requiring frequent and time-consuming updating via legislation as new markets emerge.

In particular, the consultation notes that the government wishes to ensure that the UK's tax code keeps pace with the evolving nature of the commodity markets and, as such, is exploring a move away from list-based legislation and adopt a principle-based approach to the TMO.  

Defining a recognised TMO commodity exchange or a recognised market association

Currently, the TMO lists the exchanges and market associations to which it applies in legislation. This list can only be changed via secondary legislation.

To meet the aim of making the TMO legislation more flexible and adaptable to future market changes, the government is proposing to move away from maintaining a list of named exchanges and market associations to a more principle-based approach, defining the exchanges and market associations in scope of the TMO by reference to specific criteria.

Currently, a commodity exchange or market association needs to meet the following minimum criteria to be included under the scope of the TMO:

• accounting for VAT in the usual way would hinder the effective operation of the market by making administration and accounting for VAT impracticable due to the large volume and high frequency of transactions;
• Transactions are futures, forwards, options or spots, or certain transactions between members of the commodity exchange or market association;
• Commodity contracts must be actioned by a member under an agreement with the commodity exchange or market association;
• The commodities should be traded on the commodity exchange or market association in specified quantities and standards;
• The commodity contract is capable of physical delivery (i.e. the contract expressly provides for physical delivery of the underlying commodity. In the case of, emissions contracts this means where there is transfer of title of the allowance within the emissions trading registry); and
• The commodity contract would otherwise be taxable under the normal VAT rules, and therefore the effect of applying the TMO zero rate will be revenue neutral.

The government intends to define a recognised TMO commodity exchange or a recognised market association based on these criteria. Alternatively, the government could maintain a list of exchanges and market associations in scope of the TMO in a VAT Notice based on suggested criteria, which would have the force of law. However, the consultation notes that to maintain an up-to-date list might be challenging because markets frequently rename, re-structure or merge.

Defining a member of the market

The TMO defines a member of a market as including any person ordinarily engaged in dealings on the market. That definition was derived at a time when dealings on the market were conducted on a controlled trading floor or by phone. The membership of exchanges and market associations to which the TMO applies have changed substantially since the TMO was first introduced and trading is largely now online.

The government proposes to introduce a more flexible definition of member based on the following principles. Firstly, only trades between members of the market or between members and non-members that do not go to actual physical delivery, are covered by the TMO. Secondly, the right to trade on the market, which underpins the definition of 'member' for TMO purposes. Each market typically has different levels of membership, but only certain members are entitled to trade 'on the market' itself. This is determined by the rules set down by the relevant exchange or market association.

Since the government considers that the current definition of member for the purposes of the TMO has the potential to be confused with the various categories of membership of the markets, the government proposes to define 'persons ordinarily engaged with dealings on the market'. Alternatively, the government could maintain a list of member classes within a VAT Notice that would have the force of law. Such a list would only include the members that the government recognises as dealing on the market.

Defining qualifying transactions that fall under the scope of the TMO

The current legislation does not specify the types of contracts currently used by commodity exchanges and market associations. This can cause confusion as to which commodities the TMO applies to and to what extent. Accordingly, the government proposes adopting a principle-based approach by defining the transactions which will qualify for the zero rate. The definition is likely to include the following criteria, all of which must be met for a transaction to fall within the TMO:

• Futures, forwards, options and spot contracts, which are exercisable at a date later than that on which it is granted;
• A wholesale trade between businesses;
• Expressly provides for the physical delivery of the underlying commodity (or provide for an option on such a contract);
• Transactions traded on a recognised commodity exchange or recognised market association; and
• The transaction is effected by a member of the market who is entitled to trade under the TMO.

The government does not intend to include transactions that are exclusively cash settled, where the purchaser is required to pay the difference in price between two opposing transactions.

Specifying commodities traded on terminal markets

Currently, the TMO legislation lists the commodity exchanges and market associations to which the TMO applies. The review does not intend to change the TMO policy on the scope of the commodities within scope, but simply to specify them within the legislative framework (rather than adopting a principle-based approach in this case). The commodities that are currently traded under the TMO are:

• Precious metals, including gold, silver, platinum and palladium;
• Agricultural goods, including cocoa, coffee, and sugar;
• Energy products, including crude oil, electricity, and natural gas;
• Mandatory compliance carbon emission allowances (i.e. UK ETSs).

The consultation notes that these commodities were identified as suitable to fall under the TMO, as the trades would be taxable supplies if made under the normal operation of VAT law, meet specific standards that are recognised internationally and are in sufficiently high value and volumes to warrant simplification and/or to prevent VAT fraud.

The government proposes that these principles would also be set out in the legal framework to form the basis by which the government could decide to include other commodity trades under the scope of the TMO.

Investment gold

The consultation notes that the legislation concerning investment gold is set out in VATA 1994 Schedule 9 Group 15 and Articles 4 to 7 of SI 1973/173. The government does not propose to make any changes to these provisions under this review, as it does not believe wholesale gold trading has fundamentally changed since this legislation was introduced in 2000.

Comments

The consultation is open for responses until 12 September 2023. Responses should be submitted to reformvatterminalmarketsorder@hmrc.gov.uk

There is no mention of the potential need to reassess industry Memoranda of Understanding on the operation of the TMO in the consultation, such as in relation to supplies between non-members of an exchange that was recently considered in R (on the application of Glint Pay Services) v HMRC [2023] EWHC 1621.