There was relatively little mention of VAT in the Budget but there were some potentially significant announcements regarding perceived VAT avoidance in relation to cross-border arrangements involving connected parties. These are explained below.

1. VAT grouping via a UK establishment and "bought in" services

The Chancellor expressed his desire to end the practice of services being purchased via overseas branches, supposedly in order to avoid VAT. This announcement is not hugely surprising and the measures announced as part of the Budget largely formalise recent HMRC practice which has seemingly been prompted by the decision of the CJEU in Skandia.

In the case of Skandia it was held that supplies made by the US headquarters of a company to its Swedish branch - which was a member of a Swedish VAT group - fell to be taxed in Sweden. This was on the basis that the Swedish branch effectively took on the identity of the Swedish VAT group so that the US headquarters and the Swedish branch fell to be treated as separate taxable persons. 

HMRC take the view that the Skandia decision does not apply with respect to UK VAT groups because of differences between the UK and Swedish VAT-grouping rules. However, the decision in Skandia appears to have prompted HMRC to re-examine the circumstances in which they will accept that an entity which has establishments both in the UK and overseas is entitled to join a UK VAT group as well as the circumstances in which they will accept that supplies made from an overseas establishment into a UK VAT group fall outside the scope of VAT.

As part of the Budget the government has announced its intention to:

• broaden the definition of "bought in" services which are effectively subject to the reverse charge when supplied by one VAT group member to another, having first been acquired from an overseas supplier;
• publish renewed guidance (which seemingly would amount to a new policy) regarding the use of HMRC’s power to refuse VAT grouping for the protection of the revenue where supplies are made from an overseas establishment of an entity into a UK VAT group of which that entity is a member; and
• publish renewed guidance concerning the requirement for an entity to have an establishment in the UK in order to be included in a UK VAT group.

The content of the renewed guidance will be of interest to many taxpayers, not least those who are currently involved in disputes with HMRC regarding entities which have historically been registered as members of UK VAT group but whose entitlement to be VAT-grouped is now being challenged.

The decision in Skandia caused a great deal of concern when it was released, particularly for financial services institutions, but that concern abated to a large extent when HMRC published their interpretation of the decision. The new approach being adopted by HMRC - which amounts to a re-interpretation and tightening of UK rules which pre-date the Skandia decision - will resurrect many of the previous concerns.

Businesses that are considering putting in place arrangements which would involve VAT-grouping an entity which has one or more establishments outside the UK will need to take into account HMRC’s emerging policy. Businesses which already have such arrangements in place should consider how likely the arrangements are to be challenged, what the quantum of any resulting liability might be and what steps might be taken to reduce the risk of challenge.

2. Offshore looping in the insurance industry

The government has announced that the Specified Supplies Order - which gives suppliers of VAT-exempt financial services the right to recover VAT to the extent that their customers belong outside the EU - is to be amended with effect from 1March 2019. This is to counter the use of arrangements in the insurance industry which involve an "offshore loop".

Under the revised version of the order, insurance intermediaries will only have the right to recover VAT on their costs to the extent that the recipient of the intermediary’s service belongs outside the EU and the recipient of the underlying insurance service belong outside the UK.

The second part of this test is new and is being introduced to counteract arrangements which effectively give providers of insurance services to UK customers the ability to recover VAT on their costs by "looping" the supply to the end customer via an offshore entity.

HMRC were recently unsuccessful in their attempt defeat such an arrangement using existing law in the case of Hastings but have appealed the decision.

HMRC published draft legislation in July 2018 which would have restricted the application of the Specified Supplies Order in relation to all financial services and not just insurance. This would have had far-reaching and apparently unintended consequences with regards to many "business as usual" services such as those provided by investment banks in relation M&A transactions, IPOs and bond issues. HMRC’s decision to adopt a more targeted approach in the final version of the legislation will come as a great relief to many financial institutions.