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Weekly Tax Brief 4 August 2010

George Bull
Senior Tax Partner

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Welcome to this edition of Baker Tilly’s weekly round-up of the most important tax news:

  • 1. ECJ confirms that VAT is due from employers

    On 29 July the European Court of Justice ruled that employers must account for output tax on the supply of salary sacrifice retail vouchers to employees. 

    It is believed that, although many employers recover VAT charged to them when they buy retail vouchers, it is likely that some of those that do not account for output tax on the provision of the retail voucher to the employee. Now that the ECJ has followed the Advocate General’s opinion, which was delivered in April, it is likely that HM Revenue & Customs will begin to assess employers for the output tax due on retail vouchers.

    Many employers were shocked at the AG’s opinion delivered in April but have waited until this judgement was released before looking at their own salary sacrifice schemes. Now that this judgement confirms their fears in respect of retail vouchers, we recommend that employers look at all their salary sacrifice arrangements. Although the ECJ’s judgement is clear that its conclusion is partly based on the fact that the burden of the VAT on the provision of those vouchers is borne by the employee, HMRC may take the view that all salary sacrifice arrangements are affected. 

    Employers therefore face a period of uncertainty until the UK Court delivers its final judgement and HMRC publish their policy.

  • 2. PAYE discussion paper: government departments should talk with each other more

    PAYE was introduced in 1944 as a mechanism for collecting income tax throughout the year. While its underlying principles have remained unchanged since then, the surrounding processes such as BACS, CHAPS, payroll software, emailed payslips and online banking would be unrecognisable to the recipient of a wage packet 66 years ago. Indeed, today’s payroll processes would be unfamiliar to a wages clerk in the 1980s.

    Is it time, then, to bring the collection process (which brought in £249bn in the last tax year) into the 21st century? The Government thinks so and is consulting on ways in which it can streamline the process and make it more responsive to changes in employees’ circumstances. 

    Its idea is ‘Real Time Information’ which effectively requires monthly returns from employers: a practice that already applies to contractors within the construction industry. HMRC believes that with more, and more up-to-date, data then it can operate the system more accurately and link it to the benefits system as well.

    We welcome any attempts at improvement and the ‘blue-sky thinking’ which improvement often involves. We also agree that the tax system needs to keep pace with the external environment and the expectations of those who operate it. However, we’re compelled to point out that the author of the discussion paper takes a rosy view of the current administration of the system. Many practitioners may wonder whether providing HMRC with more information will improve anything and instead may consider that more attention to detail in the designing and commissioning of new software would reduce the workload for both HRMC and employers. HMRC’s systems patently cannot cope with the current demands: millions of incorrect PAYE coding notices this year bear witness to that fact, as do penalty notices for late returns issued simply because the post containing the returns was not even opened for over a month, or because the online data collection systems cannot transfer data to the processing systems without manual intervention. It must be questionable whether a department suffering from further manpower reductions and squeezed IT budgets could deliver and operate what is suggested.

    If radical changes are being considered, the complete integration of the rules for identifying earnings on which income tax, national insurance contributions, tax credits, other State benefits and the National Employment Saving Trust (the new personal accounts pension scheme), would be one minimum option to consider. They currently rely on separate legislation and an individual can have different ‘earnings’ for different purposes. But this would require Government departments to co-operate in the interests of the citizen. The departments would also have to have inter-operable IT, which seems unlikely to be achievable when HMRC’s internal systems can’t even communicate with each other in a timely manner.

  • 3. Tax relief for expenditure: an issue in urgent need of attention by the Office of Tax Simplification

    The need to ensure that the UK has a highly skilled and flexible workforce is often not helped by the irrational rules that often govern the deductibility of expenses.
     
    While the decision to create an Office of Tax Simplification on 20 July 2010 was rightly welcomed, there are clearly some fundamental issues that should be looked at as a matter of priority. 

    In a recent case (Revenue and Customs Commissioners v Banerjee), the Court of Appeal concluded that a doctor was entitled to claim tax relief for certain costs of being trained. As this decision is at odds with the decision of the Courts in similar earlier cases, it is likely that HMRC will take this case to the Supreme Court.

    In the context of a 'Big Society' which needs to encourage and develop a highly skilled, flexible and mobile workforce, HMRC’s argument against allowing tax relief for certain categories of expenditure on training and equipment is difficult to justify.

    This case highlights the need for clarity on the meaning of what otherwise are normal, non-technical words and phrases and on the rationale for drawing a distinction between one group of taxpayers and another.

    Typically, where the costs of training are met by an employer, the employer gets tax relief and the employee is not taxed: the assumption appears to be that there is unless the employer is patently not expending the money for business purposes, there should be no adverse tax consequences. 

    Where the person is self-employed, then the same test is applied to determine the 'purpose' of the expenditure. The basic test that the expenditure has to be 'wholly and exclusively for the purposes of' the business raises difficult questions.

    Even more problematic is the phrase 'for the purposes of': what are the purposes of the activity and what purposes can be considered to sufficiently incidental so as to permit them to be ignored? These questions undermine the certainty that all taxpayers crave.

    Where the taxpayer is an employee the restrictions are even more demanding. Not only does the expenditure have to be 'wholly and exclusively', but it also has to be 'necessarily' incurred 'in the performance of the duties'. The necessity has to come from the performance of the duties and not any contractual obligation that may be imposed. This may prohibit tax relief any expenditure where the taxpayer may achieve a significant further benefit, such as to be better qualified.
     
    While this case was concerned with tax relief for training expenditure, similar issues arise in the context of travel and equipment. Why, for example, should someone be able to get tax relief for travel just because they choose to live some considerable distance from their place of work? There surely has to be a better way. 

  • 4. Controlled Foreign Corporations (CFCs): the next step

    While we welcome the government’s continuing intention to simplify the existing CFC regime and its willingness to consult with the tax profession and industry, the date by which this process is due to be completed has been put back another year, from 2011 to 2012.

    This means that it will be five years from the launch of the reform process in 2007 until completion in 2012. That is simply too long, and business has been lost from the UK in the intervening period. While interim measures to provide some relief in the meantime are better than nothing, they are no substitute for comprehensive reform and it is to be hoped that there will be no further delays in this already long overdue process

    It remains to be seen how these interim improvements (and the full CFC reform in 2012) will comply with existing ECJ rulings on the UK’s CFC rules. Despite the stated intention that the new regime will be EU compliant, it is clear that there is reluctance on the part of the UK authorities to accept and incorporate these judgements into the new rules. Clarification by the UK authorities of when they will consider groups’ arrangements to be 'wholly artificial' and thus within the UK CFC regime, will then become a crucial aspect of any consultation on improvements to the CFC rules. The government must bear this in mind, along with other areas of legislative reform such as the taxation of branch profits, to prevent their intentions to simplify the CFC rules from being derailed.

  • 5. Businesses finally receive some positive news in compound interest appeals

    Last week businesses finally received a ruling in their favour in their fight to receive compound interest on overpaid VAT. The Court of Appeal found that the motor dealer claimants in the group litigation known as the Compound Interest Project group (CIP group) were in time to lodge their appeals to the Tribunal.

    This follows the bad news delivered by the Court of Appeal in March in respect of another compound interest group action (known as the VIC GLO) which cast doubt on the right to receive compound interest at all under EU law. The Judge believed a reference to the European Court of Justice would be necessary in future to finally determine this issue. This will certainly happen as the High Court judge who heard the recent Littlewoods Retail case, where there is more than £1 billion of compound interest at stake, has now recommended some questions for referral to Europe.

    This judgement, released on 30 July, does not confirm that the claimants have a right to compound interest, either via the Tribunal route or via a High Court claim for restitution. What it does mean is that the motor dealer claimants submitted their appeals in time, should the eventual finding of the ECJ be that the Tribunal has jurisdiction to award compound interest, then they should receive interest.

    However, struggling motor dealers who are pinning their hopes on receiving this money will still have several more years to wait as any ECJ judgement is unlikely to be released before the end of 2012.

  • 6. Recycling taxes and asset destruction

    It’s interesting to see that the recycling of tax ideas continues. New Labour borrowed the idea for the non-dom regime and the remittance basis charge from the Conservatives, and we now see its frontrunner for leader adopting the Liberal Democrat idea of a mansion tax as his own. Meanwhile, some Coalition Government ideas on new taxes seem to have been short-lived. For example, the graduate tax rose and fell with alarming speed, while talks of a new bank levy have been brushed under the carpet.

    Asset destruction, in whatever form it takes, is never a pretty prospect. The Gulf of Mexico oil spill crisis provides a very visible example of this with recent debate focusing on how much BP must pay for its mistakes. The answer is $20 billion which is to be committed to an escrow fund, with the possibility of a further $20billion payable in penalties. While the damage inflicted in the Gulf of Mexico is appalling, it is dwarfed by the damage to the world economy arising from the irresponsibility of some of those within capital markets. Attempts have been made to evaluate that damage, which brings us back to taxes. Instead of families paying the bankers’ bills through rising taxes, what if the banks were also required to redress the balance by creating escrow funds?