New proposed legislation to provide legal certainty for UK VAT regime

Understanding the VAT regime in the UK has become an increasingly complex exercise since the UK left the EU. The knowledge of the active provisions and interaction of at least the European Union (Withdrawal) Act 2018 (interpretation of retained EU law) (EUWA) and the Taxation (Cross-Border) Trade Act 2018 (TCTA) is necessary.

The complexity in this area will soon increase with the Retained EU Law (Revocation and Reform) Act 2023 (REULA) and new draft legislation published by HM Revenue & Customs (HMRC).

Under the current regime, EUWA provides the framework for EU-derived legislation and related case law to continue to apply in the UK legal system after Brexit, though with some limitations. Section 42 of the TCTA then carves out the ‘abuse of law’ principle from those limitations, so that it would continue to operate in the context of VAT litigation.

The abuse of law principle comes into effect where arrangements fulfil the requirements of the applicable legislation whilst producing a tax advantage that is contrary to the purpose of the legislation. Where the essential aim is to acquire that tax advantage, then the arrangements are redefined.

With REULA becoming effective soon, the continuity approach of EUWA will come to an end. With effect from January 2024, REULA restricts the use in the UK legal system of special features of EU law, such as supremacy and general principles, in the interpretation and application of EU-derived legislation.

HMRC’s draft legislation on the interpretation of VAT and excise legislation is specifically set to mitigate the impact of the REULA reforms. Like the TCTA before it, the stated objective of this legislation is to provide legal certainty and ensure the stability of the UK’s VAT and excise regime, by preserving key elements of existing EU-based case law and shielding them from some of the REULA reforms. Without this new draft legislation, well-established principles and positions could be brought back into dispute – notably, the abuse of law principle.

Development of VAT case law

VAT is a uniquely European tax compared to the other major UK taxes. UK VAT turned 50 this year. The European Communities Act 1972 provided for the supremacy of EU law and made the Court of Justice of the European Union (CJEU) in practice often the final arbiter on the interpretation of VAT and excise law for the life of the tax.

EU case law is integral to the development of UK VAT case law. Many of the most significant case law developments are either based on preliminary rulings from the CJEU or by the UK courts construing national legislation in accordance with EU law. 

The possibility of this vast body of case law and attendant principles being washed away post-REULA was understandably concerning to the UK government. A UK tax referral to the CJEU in the years before Brexit was typically the result of years of intense litigation between the taxpayer and HMRC. The principles established, including those of abuse, in several significant cases would be painful to relitigate. This proposal by HMRC will instead result in, at the most, a gentle erosion of EU case law.

The case known as Newey, in particular, took over 10 years to go through the courts with hearings at the First-Tier Tribunal (FTT) and the Upper Tribunal (UT) in the UK, CJEU and Court of Appeal before ultimately being remitted back to the FTT. The new provisions in fact expressly cross-refer to section 42 of the TCTA, which preserved the effect of the abuse of law principles in the Halifax and Kittel cases set down by the CJEU. HMRC noted that even where proposed arguments have limited legal merits, the delay involved in litigating the points could have a deleterious effect. 

The new draft legislation

The legislation is described as a "bespoke approach" for VAT and excise legislation so that they should continue to be interpreted as parliament intended. This approach has been facilitated by the changes since the REULA reforms were first proposed. The move from the original “sunset” approach scrapping all retained EU law provisions has transitioned to a more nuanced approach whereby only specific provisions are revoked.

Despite this, REULA will still remove the supremacy of EU law and repeal any directly effective rights from EU treaties and directives as well as general principles of EU law. The new proposals will instead preserve directly effective rights, retained general principles of EU law and the principle of supremacy of EU law solely for the purpose of interpreting UK VAT and excise legislation. The caveats to this are that the supremacy of EU law cannot operate to quash or disapply UK legislation for incompatibility with retained EU or assimilated law and that higher courts may depart from retained EU case law. The principle of consistent interpretation continues to apply to any decision made up to 31 December 2020.

This means that the abuse of law principle, alongside any other relevant general principles of EU law, will continue to be applied by the courts in relation to VAT cases, just as it was before Brexit.

The legislation also confirms that claims based on direct effect of EU Treaty or Directive provisions can no longer be made to override the provisions of domestic legislation. HMRC may specifically be targeting the ability of taxpayers to make VAT claims based on ‘San Giorgio’ rights in the circumstances identified by the UK Supreme Court in the 2017 Investment Trust Companies case. So-called San Giorgio rights allow taxpayers to claim reimbursement of VAT which was wrongly charged by a supplier from HMRC. HMRC’s view, as set out in Revenue and Customs Brief 4/22, is that this right was extinguished on implementation period completion day, which was 31 January 2020, but it may consider that this legislation further clarifies the position. 

Future divergence in UK and EU case law?

To those involved in tax disputes, one of the interesting aspects of the development in the UK is the ability to depart from retained EU case law. The Court of Appeal’s judgment in the Target case in 2021 referenced this power, and it is understood to be the first UK VAT case to reference the issue. The court and parties decided in that instance not to consider submissions on the point until after the judgment was delivered on the main grounds and therefore it did not form a substantive part of the decision. The subsequent Supreme Court decision did not reference the issue so we can assume substantive submissions were not heard on the point in that appeal either.

The draft legislation affirms the principles set out in section 6 of REULA which applies to the role of the courts. Previously the standard set in the EUWA was the same as the test for the relevant court to depart from its own case law. By contrast, REULA allows the court to have regard to the fact that decisions of the CJEU are not binding, any changes in circumstances that are relevant to the retained EU case law and the extent to which any retained case law restricts the proper development of domestic law.

Similar principles apply to retained domestic case law to the extent it has been determined or influenced by retained EU case law. This could be relevant where a domestic court has implemented a preliminary ruling of the CJEU.

It may take a while for a relevant case to arise, but taxpayers with live or potential VAT disputes should be actively considering the extent to which either their own or HMRC’s case relies upon retained EU case law, particularly if there is any prospect of the dispute reaching the Court of Appeal or the Supreme Court. The number of areas where UK VAT legislation cannot be construed in accordance with the EU position, such as the insurance intermediary exemption, are expected to increase due to continued divergence in UK and EU law.