Barclays Plc, HSBC Plc, and NatWest Plc are facing potential U.K. tax liabilities of 586 million pounds ($745 million) as the result of a widening crackdown on a pervasive, and long-tolerated, structure used to minimize payments of value-added tax on internal transactions.
The three banks could be just the start. More financial services firms could be caught in similar tax disputes with Her Majesty’s Revenue and Custom, tax advisers say. The three banks are all appealing their tax bill, with HSBC leading the charge.
The government is using an obscure power known as “protection of the revenue” to pursue the cases, and a February preliminary court ruling diminished the banks’ chances of limiting HMRC’s use of that power to alleged incidents of tax abuse.
“It is not known how widely HMRC intends to use this power in future, but their willingness to apply it in a case against a high street bank might suggest that HMRC have been weighing up this power and intends to use it more often in future,” said Kevin Hall, VAT partner and financial services tax expert at accounting firm Wright Hassall.
A preliminary hearing last year set out several legal questions that needed to be answered before HSBC’s case could be heard. The Upper Tier Tribunal that heard the case released its judgment in February, with the full hearing expected later this year.
NatWest declined to comment beyond what what it disclosed about its potential liability in its annual report. HSBC declined to comment while the case was ongoing, and Barclays didn’t respond to a request for comment.
Irrecoverable VAT Costs
Most transactions, even intra-company transactions, in the U.K. are subject to VAT, a tax on consumption that is paid by the end consumer. However, at each stage of the supply chain companies are allowed to recover the VAT they paid, to ensure only the final consumer pays the tax.
Unlike most businesses, financial services firms are barred from recouping VAT expenses . This means that every year they accumulate large amounts of irrecoverable VAT expense, particularly when a group is providing services to itself.
To help recoup this expense, most U.K. financial services groups use an administrative simplification known as VAT grouping. It allows them to treat numerous corporate entities as if they were just one company for VAT purposes. No VAT is charged within a VAT group.
“It means that you don’t then manufacture any VAT on intracompany charges within the group,” said Anne Holt, a indirect tax partner at RSM UK.
Many firms go a step further and include overseas subsidiaries that provide back-office services into their U.K. VAT groups. They do this by creating a local branch that is allowed into the VAT group.
Large banks use VAT groups extensively because they recover as little as 5% of their annual VAT expense, said John Forth, an indirect tax partner with accounting firm RSM UK. “There is a bigger prize for them because they recover so little of their VAT costs,” he said.
This practice continued for many years until, in 2018, HMRC began challenging the VAT groups of several financial services firms and expelling some of their overseas members, citing authority in the tax code to remove any member of a VAT group if the HMRC deemed it was important for the “protection of the revenue.” Removal means that the financial services firm becomes liable for all the VAT it had not charged while the overseas entity was a member of the VAT group.
“As part of normal compliance activity, HMRC will remove companies from VAT groups if it’s considered that they don’t meet the eligibility rules,” a spokeswoman for HMRC said.
The tax office declined to comment on individual taxpayers.
Legal Challenges
The tax office hadn’t previously challenged these structures, said Nick Skerrett, head of contentious tax at Simmons & Simmons LLP, that represents some of the financial services firms targeted by HMRC.
“It’s a totally benign, run of the mill structure that’s widely used. So HMRC’s challenge is going affect how these VAT grouping rules are applied to these structures going forward and people’s branch operations for that globalization of service delivery,” he said.
HSBC estimates that the bank has accumulated 135 million pounds of irrecoverable VAT since the removal of these overseas entities in 2018, that it will seek to recover if it wins its appeal.
Some of these financial services companies brought legal challenges against HMRC, with many of the appeals lining up behind a test case brought by HSBC.
The judge in HSBC’s case ruled that HMRC wasn’t limited to using it protection of revenue powers in cases where there is aggressive tax avoidance or evasion, and that instead the power applies broadly.
“HMRC has been told that it can behave as it chooses with respect to an entire section of tax law, rendering it ineffective,” said Hall.
The tax office also attempted to introduce a new argument during the trial, suggesting that VAT groups membership should only be limited to businesses that are territoriality in the U.K.
Ultimately the Upper Tier Tribunal court blocked HMRC’s efforts to introduce the issue, but experts believe it could be re-introduced in other cases.
“It would mean firms would only be allowed to recover VAT on the services that were performed in the U.K. that are disregarded,” Skerrett said.
This could have much further reaching consequences than HMRC using protection of the revenue powers if it succeeds, he said.
“Any industry using VAT groups should now be looking over its shoulder at whether HMRC will choose to break them apart, potentially leading to millions of pounds in extra VAT charges and resulting in inefficient, impoverished supply chains,” Hall said.