Article 132(1)(f) of the principal VAT directive (2006/112) provides an additional exemption for certain activities that are in the public interest, to allow small providers who cannot afford to acquire assets on their own account to benefit from the same overall VAT position as larger providers who can afford to purchase the assets themselves.

The exemption allows persons who carry on these activities to join together to form a cost share group (CSG) so that they can acquire services and recharge their members for their use of the services at cost without incurring any additional sticking VAT.

The directive exemption is reproduced in Item 1 of Group 16 to Schedule 9 of the VAT Act 1994. There has previously been some uncertainty over what exactly the exemption was intended to cover, but HMRC says this has now been clarified by the European Court of Justice (ECJ) in four cases outlined in its briefing note.

In the first case, Luxembourg applied the cost sharing exemption (CSE) to services supplied by a CSG which were used by members of the CSG for both exempt and non-business transactions, and for taxable transactions for which the exemption was not available.

Luxembourg allowed the CSG to exempt its supplies even when the member’s taxable transactions were up to 30% (or in some cases 45%) of its total turnover. The ECJ decided that the CSE did not apply in those circumstances.

However it held that members of a CSG that also carry out taxable activities could qualify for the CSE, but only because the services received were directly necessary for the members’ exempt or non-taxable activities.

HMRC has adopted a similar policy in the UK to Luxembourg, but limited taxable transactions to a maximum of 15% of total turnover. HMRC is now considering how to bring its policy into line with the judgment in that case.

In the Aviva and DNB Banka cases, the ECJ decided that the CSE only applied to activities covered by Article 132(1) of the principal VAT directive and not to activities covered by Article 135 such as insurance and finance. This was also the court’s conclusion in the separate German infringement case, where the Germans had applied CSE too narrowly and not to all of the social exemptions.

The Advocate General concluded in the Aviva and DNB Banka cases that the CSE only applied to services which a group supplies to its members within the same member state. HMRC has concluded that this is the correct analysis of the position under UK law as well.

In DNB Banka, the Advocate General considered that the CSE could not be applied to any services where an uplift was applied, regardless of whether or not this was a transfer pricing adjustment required under the legislation of the member state concerned.

As a result, HMRC has made a number of policy changes, which are effective from publication of the brief and VAT information sheet.

The CSE is restricted to CSGs whose members engage in a list of exempt activities. These are: postal services, education, health and welfare, subscriptions to trade unions and professional bodies, sport, fund raising by charities, and cultural services.

The CSE is restricted to members and CSGs located in the UK, and is not allowed where an uplift has been charged on transactions for any purpose.

HMRC says the judgments do not cover non-business activities and therefore members engaged in these activities are unaffected by the changes.

Transitional arrangements mean CSGs will be allowed to apply and rely on the previous guidance until 31 May 2018.

Any services that are invoiced or paid for before 31 May 2018 will only benefit from the transitional arrangements to the extent that they are performed before that date. Where prepayment or invoices cover services to be performed both before and after that date, then a reasonable apportionment will be required.

Where an existing CSG has applied the previous guidance correctly, and foresees a significant difficulty in applying these transitional arrangements in the permitted timeframe, they should contact HMRC by 1 May 2018.

HMRC is considering how the ECJ judgments impact on CSGs set up by housing associations and will give more guidance at a later date.

Revenue and Customs Brief 3 (2018): changes to the VAT exemption for cost sharing groups is here.

VAT Information Sheet 02/18: impact on existing cost share groups following changes to HMRC’s policy is here.

Report by Pat Sweet