VAT cost sharing exemptions and the ‘85% directly necessary work’ test

Published: 1st April 2013 Category: Highway Code Download Article as PDF

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Steve Butcher, Head of Procurement at the Higher Education Funding Council for England, says that he expects several universities to announce their own “cost sharing groups” (CSGs) when rules about VAT exemption are clarified in May.

Also, beyond the HE sector, VAT cost sharing exemption groups are likely to begin to appear as shared service vehicles, when the consequences of the new rules in the 2012 Finance Bill come into play this year.

HMRC refers to them as CSG (Cost Sharing Groups) and just to remind you, they are made up of non-vatable organisations who come together to develop shared service activities.

The sectors that probably most interest a Shared Service Architect or Practitioner are :
● Housing
● Further Education
● Higher Education
● Health
● Charities
● Voluntary Groups
● Some Social Enterprises

HMRC makes it clear that a key factor for CSGs is that the services they provide to their members must be ‘directly necessary’ for their exempt and/or non-business activities.

If they are not, the exemption does not apply and the supplies are subject to normal VAT rules.  Although the brief from HMRC is reasonably clear, it was written back in 2012.  All evolving tax law is subject to clarification and sometime change. So you should seek professional tax advice to ensure you are up to date with the newest interpretation of the law.

How ‘necessary’ is ‘necessary’?

Much of the following detail about what is necessary, is taken directly from the Revenue & Customs Brief 23/122 and explains the addition of the new Group 16 to Schedule 9 of the VAT Act 1994.

So, what do HMRC say in their briefing note about what ‘necessary’ means?:

The word ‘necessary’ used alone could be interpreted on the basis that any supplies used for a CSG member’s exempt and/or non-business activity would be entitled to exemption.

However, the word ‘necessary’ is, in this case, qualified by the use of the word ‘directly’ meaning that the supplies received from the CSG must relate ‘directly’ to the exempt and/or non-business supplies made by the CSG member in their own right.

Fortunately, HMRC has adopted a methodology for identifying services that are ‘directly necessary’ which has been developed with stakeholders during the consultation process in order to provide a simple and pragmatic way of identifying qualifying supplies.

If CSGs wish to suggest alternative methodologies HMRC will give them full consideration but will want to be satisfied that there is a direct and exclusive link with the exempt or non-business activity on which the qualification depends.

HMRC stresses that: …businesses and organisations considering forming CSGs should note that recently the EU Commission have commenced infraction proceedings against Luxembourg for, among other things, their application of the ‘directly necessary’ condition, which is similar to the ‘simplification’ option offered by the HMRC in this guidance.

The Commission are seeking to establish the principle that ‘directly necessary’ services are those that are used ‘exclusively’ by CSG members for their exempt and/or non-business activity. The matter has been referred to the European Court and HMRC suggest, “It could perhaps take several years to come to a conclusion, although it may conclude sooner.”

They go on to say that they will, “…monitor the process and consider whether or not at any stage any changes need to be made to this guidance. Should changes prove to be necessary, then transitional arrangements, as far as possible, will be put in place to facilitate an orderly move to the revised position.”

This emphasises the point that in a fluid development of tax law, professional advice will be required. Hopefully this can be acquired through sector-shared procurement of tax advice, thereby reducing legal fees.

HMRC will accept services are directly necessary if they are identified using the following methodology:
1. Only supplies of services received from a CSG that can be ‘directly attributable’ (using partial exemption methodology) to the member’s exempt and/or non-business activities will be regarded as ‘directly necessary’ and therefore qualify for the exemption.
2. Expenditure on services received from a CSG that is attributable to both taxable and exempt and/or non-business activities will not qualify as being ‘directly necessary’ as they are NOT linked exclusively to the exempt and/or non-business activities of CSG members and will consequently be subject to their normal VAT treatment.
3. On an, optional, simplification basis, where a member of a CSG has wholly exempt and/or non-business activities or low levels of taxable activity, all the supplies they receive from a CSG will be regarded as ‘directly necessary’ for those exempt and/or non-business activities.
4. A low level of taxable activity for the purposes of this test is less than 15%, so, where a member of a CSG has exempt and/or non-business activities that form 85% or more of their total activities, all the supplies they receive from their CSG will be regarded as ‘directly necessary’.

A member receiving supplies from the CSG of which they are a member will have to:
● have made 85 per cent or more exempt and/or non-business supplies in the immediately preceding 12 months
● or completed partial exemption year end prior to their membership of a CSG (the backward look),
● or have a intention in the 12 months immediately following joining a CSG to make 85 per cent or more exempt and/or non-business supplies (the forward look)

Once this test has been met the qualifying member will be entitled to receive all of their supplies from the CSG exempt for as long as their level of exempt and/or non-business supplies remains at 85 per cent or more.

Setting up your CSG checklist…

An option for you, is, with professional tax advice, to set up a checklist of qualifying criteria for your CSG. We have created an example on the opposite pages. It is only an example and should not be adopted by you verbatim for two reasons: Firstly, your partnership must work to co-create a checklist. It is part of the importance of joint working and the process of gaining partner buy-in. Imposing a checklist on a partnership can be ineffective and they are most likely only attribute value to one they have contributed to.  Secondly, by the time you read this article the law may have moved on and therefore the HMRC quotes above, may no longer be accurate.

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