Facing the potential of multiple claims if the decision were to stand, HMRC is planning to appeal. As a result the FTT judges, Howard Nowlan and Andrew Perrin, have referred the case to the ECJ for a preliminary ruling on whether the British derogation itself was lawful.

In the case of Avon Cosmetics Ltd [2014] UKFTT 172 (TC), the FTT considered Avon’s argument that the EU derogation applicable to retail sales made through appointed representatives was unlawful and should be set aside or varied by the tribunal.

While the tribunal accepted that the derogation, strictly construed, created a result that was inconsistent with the structure of the VAT system and breached fundamental VAT principles, it did not have the jurisdiction to declare the derogation invalid and considered it appropriate to refer the matter to the ECJ for a preliminary ruling.

The matters in dispute fell into the two categories of, first, whether the taxpayer was right to claim that it was being seriously disadvantaged by the way it was being charged VAT, which it claimed was in breach of at least two fundamental principles of the VAT system; and second, whether the tribunal, or the ECJ, would be able to grant any redress, should the tribunal decide the first matter in the taxpayer’s favour.

The taxpayer’s grievance related to the adjusted way in which VAT was charged, following a derogation authorised by the EU Council in 1985, on companies conducting their sales by selling to non-VAT registered individuals, who in turn sold to the ultimate customers.

The effect of the derogation was to permit the UK to require traders selling through representatives to compute their output tax liability by taking the open market retail sales prices receivable by the representatives in place of the lower consideration actually received on the prior sale to the representatives by the traders. Avon’s grievance was that the derogation completely disregarded any costs incurred by the representatives, and thus disregarded any input tax in respect of these costs which would have been deductible had the representatives been VAT-registered.

The tribunal found that the derogation had wrongly failed to achieve, in a proportionate manner, the very object for which it had been sought. Nevertheless, the UK statutory provision that implemented the permitted derogation was found to be in accordance with the authorisation.

The taxpayer sought that the UK legislation should be interpreted by insertion of a symmetrical requirement that when its output liability was uplifted to the open market retail price, a corresponding deduction should be given for costs at the retail level in respect of which input tax deductions would have been available had the representatives been VAT registered.

Allowance for the relevant input tax would have reduced the taxpayer’s VAT liability by approximately £1.5m in 2011 and by some £14m overall.

The tribunal acknowledged Avon’s business model of selling its products to representatives, referred to as ‘Avon ladies’, who in turn make retail sales to customers. The representatives are given a discount from the brochure prices on their purchases which is, effectively, their gross profit and they are normally not registered for VAT because of the low turnover.

The consequence of this, had the UK not been authorised to introduce a derogation from the normal rules, was that VAT would have been charged only on the consideration received by the taxpayer and no VAT would have been charged in respect of the retail sales themselves.

However, since this was considered to undermine the basic principle of VAT that the tax should generally extend to the retail stage in the supply chain, the UK sought the derogation that allowed HMRC, once it has served a Notice of Direction on a particular company, to compute that company’s VAT liability by reference to the open market retail sales values of its products and not by reference to the company’s actual, usually discounted, sales receipts.

The taxpayer had no objection to its output VAT liability being geared to the representatives' higher retail selling prices, but objected to the derogation potentially creating a problem where the representatives incurred costs on which the VAT would ordinarily have been deductible as input tax had the representatives been registered for VAT.

Although the tribunal agreed with the taxpayer that the terms of the derogation, strictly construed, created an incoherent result that was inconsistent with the structure of the VAT system, it did not have the jurisdiction to declare the derogation invalid. In the opinion of the tribunal, unless the wording of the derogation was amended to conform to a very obvious principle of the VAT system, it should be declared invalid by the ECJ.

 ‘The tribunal was unequivocal in its finding that the long-standing derogation concerning direct selling failed to produce the result intended. However, it did not have the jurisdiction to declare the derogation invalid and chose to refer the matter to the ECJ,’ said Joe Wilkins, tax author, CCH.

‘HMRC has expressed its objections to the case being referred and have stated its intention to appeal to the Upper Tribunal to prevent such a reference. For this reason, the FTT deferred examination of the terms of reference to the ECJ to await a decision of HMRC regarding such an appeal.

‘It is unlikely that the matter will be resolved in the near future as HMRC is aware that any change in the current practice will result in substantial claims from affected taxpayers.’

The judgment is available at http://www.financeandtaxtribunals.gov.uk/Aspx/view.aspx?id=7615