Hello and welcome to the Pinsent Masons podcast with me, Matthew Magee. This week, we dig into the implications of the European Union's Artificial Intelligence Act passing the latest legislative hurdle. And we look at the fallout of a UK tax tribunal's answer to the vital question, what is a crisp? But first, some business law news from around the world.
Irish voters will decide whether the country will participate in Europe's Unified Patent Court in a referendum on the first of June. The UPC agreement requires Irish courts to cede some jurisdiction in patent litigation matters to the UPC. This transfer of powers requires a referendum under the Irish Constitution and the date for that has been set as June the first. Patent litigation expert Karen Gallagher of Pinsent Masons said that the UPC offers Ireland a significant commercial opportunity. She said Ireland would hold a significant and unique position, not just through the work of the proposed local division of the UPC in Dublin, but also on the wider EU stage.
More companies in the United Arab Emirates will have to notify the competition authorities of upcoming mergers under a new competition law. A federal decree law on the regulation of competition will come into force after implementing regulations are published. The new law introduces a new annual turnover component to help determine whether a merger between companies needs to be drawn to the attention of the authorities. And it imposes more stringent timelines on companies which will need to notify the ministry ninety days before a merger happens, rather than the current thirty-day requirement.
Early-stage companies seeking investment in Australia could face a reduction in the number of people they can approach without the expensive and time-consuming disclosure documentation needed to seek investment from the public. That documentation is not needed if approaching sophisticated investors, people with assets or earnings above a level that's been static since two thousand and one. Financial regulator the Financial Services Council has recommended raising that threshold, which would reduce the number of people who qualify as sophisticated investors.
If Spider Man taught us anything, it's that with great power comes great responsibility. And there's no greater new power in the world than that of artificial intelligence. So governments around the world are struggling to establish how to do the responsibility bit through laws and regulation. Eyes turn fairly naturally to the European Union, which has led the way in many kinds of regulation of the technology industry, most notably in preventing unfair competition and the protection of personal data. The EU's AI Act, a regulation that will take direct effect in EU countries, so won't need to wait for national legislation, looked to be close to completion. But France and Germany wanted some last-minute changes to the draft text. But agreement was reached very late last week, and the law only needs to get through the European Parliament to pass.
The threat of EU elections in June derailing the process looks to have passed, and companies should now be preparing for the changes ahead. Frankfurt-based technology law expert Nils Rauer will tell us how. But first, I asked him why we're regulating AI at all.
Nils: This is so powerful and it can do so much good, but also so much wrong that you can't just let it run. In the same way as we have decided as a society to regulate the medical sphere as much as we do regulate the use of personal data, these are sensitive areas and the use of AI and what you can do with it and the development of AI.
That also falls into that category of sectors that need some sort of guidance, some sort of regulation and that's why we are not only in Europe, but also in other jurisdictions in the US and elsewhere work on a framework, a legal framework, a practical framework that gives some steering guidance and on AI.
Matthew: Lawmaking in the EU isn't easy. It's a three-way tussle between the executive body, the European Commission, the nations themselves through the Council of Ministers, and directly elected legislature, the European Parliament. Late last week, this law cleared the second of those three hurdles.
Nils: We have now a decision that the council has agreed on the final text of the AI regulation. The final text has been agreed without substantial changes being asked for and therefore it can now continue to be placed with the European Parliament to also have a vote on this final text of the regulation.
Matthew: And there had been a bit of political sabre-rattling in recent weeks. Germany and France were thought to be pretty unhappy with some aspects of the draft text. What did they want, and how has that been resolved now?
Nils: What they wanted to make sure is in particular to generative AI and the large language models which are the foundation, for instance, of chat GPT which we all have heard about and probably have all used and what they wanted to achieve is a more liberal regime on those large language models. We don't know the exact wording yet because we only know that it has been agreed by the member states, but what I expect is that this freedom of innovation of development is now safeguarded to an extent they are happy with.
Matthew: We've seen in some areas, particularly data protection, EU regulation has kind of become a de facto world standard, because people know they have to meet that level if they're going to trade in Europe, so they may as well just behave in the same way everywhere. Do you think that might happen with AI?
Nils: The clear answer is yes. It will come as a role model. I mean, we do have seen in the US President Biden's executive order that was published on the thirtieth of October and there is also a lot of guidance being drawn from that order, but it's not in that detail that we now have with the coming EU regulation. So I do think that it will have a great impact around the world, how AI is developed, how it is deployed, what safeguards are to be built in, how much transparency you need to receive as a user of AI and of course it will not be the only source.
Other jurisdictions will also look at what the US is doing or what Japan is doing, but Europe is not only a very important market, it's also known to be a very sensible legislation that comes from the EU, a very thought through approach and therefore it will stamp the entire world's regulative measures.
Matthew: AI is moving at a frightening speed and that presents a real challenge for legislators, doesn't it? Where it takes any large country, and certainly an international body like the EU, years to come up with a new law. So how do they regulate something that has changed by the time a law is passed?
Nils: I think this is a problem that legislation has faced for the last hundred years. You cannot keep up with the technical development at the same speed and therefore you are always a little bit behind and even if you take into account that if you create a new law, it takes the courts to apply it and to give guidance in how it is to be applied, how to be interpreted, et cetera. So it's not that we are a ways behind with the legislation, the jurisdiction is still to come. However, what they do need to do is and what they have tried to do is to put in language that is future proof so that it allows to evolve, that it allows to be as generic as it can be. So need to be generic and not to focus on what might be a very specific issue today. And if there's a specific issue today, you need to put it into words that allow for this to grow and to develop.
Matthew: And how do you think this regulation, what impact will it have on the development of AI and that industry? How will it shape it?
Nils: There are some precautionary measures built into the regulation. So you need to have an impact assessment, a risk assessment. When you sit down and you want to develop a certain product, think about what it comes with in terms of consequences in first. It is absolutely crucial not to sit back and wait for the final text to be agreed and to be enacted. And what we see from our clients, it's very clear that they have started putting their heads around AI a long time ago.
They are working on AI policies. They are reviewing their contractual agreements, whether they want to a certain extent have more transparency about suppliers when they supply services and goods, whether they use AI or not. Many months ago, the companies were confronted with the question, shall we allow our people to use large language models like ChatGPT? If so, should they use it under a certain company guidance? All this is already now up and running. And so it's not that the companies wait for the legislator to become active. They have become active already.
Matthew: Sensations poppadoms, a snack made by UK crisp giant Walkers, are, for tax purposes, actually crisps. So ruled the UK's tax tribunal a couple of weeks ago in the latest in a long line of decisions that food items are not really what we think they are. So if you can't tell whether something is a cake or a biscuit, or want to know what the sausage life cycle hypothesis is, then London-based tax expert Bryn Reynolds is here to help. UK sales tax, VAT, isn't usually added to food because it's essential. But if something seems a bit luxurious, then VAT, currently at twenty percent, is added on by the shop selling it. The stakes, Bryn says, are high.
Bryn: When you're looking at products whether they're actually subject to VAT or benefit from zero rating is a huge financial implications for companies.
So if you have your product and your product is going to be standard rated subject to VAT you need to charge twenty percent. Now you and me if we go into the shop and a large proportion of the purchasers of food do tend to be private individuals. If we go into the shop and try and buy ourselves some food we get charged VAT on it because it's standard rated that's an absolute cost to us.
Now if instead the product is zero rated the business is still able to recover all of its input tax but in addition it doesn't need to charge VAT on the product so that means that effectively the product can be made you can take off the twenty percent VAT which results in a reduction in the price of sixteen point six recurring percent.
Now the benefit of that is that the company can either reduce the price of its product which means that if it is in competition with other standard rated products it looks significantly cheaper or alternatively it can sell it at the same price and then it will benefit from the additional profit margin it makes on that product.
Matthew: So food makers take any chance they can to argue that their products are essential foods that don't get VAT added, meaning they're zero rated in the industry parlance. If something is standard rated, that means it gets the twenty percent tax added on top. This leads to some pretty fine distinctions.
Bryn: So ice cream is standard rated because ice cream is viewed as a luxury as are ice lollies frozen yogurt and water ices. Yogurt is also standard rated but only when it's unsuitable for immediate consumption when frozen so when you purchase frozen yogurt that will be standard rated if it's designed to be consumed when frozen but if you purchase normal yogurt that is going to be a zero rated product because that's intended for immediate consumption and not viewed as a luxury as you can see that's quite a fine defining line which doesn't particularly have a huge amount of rationale behind it. Flapjacks are a benefit from zero rating but not flapjack type products which contain cereals other than oats which are defined as confectionery. Confectionery is generally going to be standard rated and that includes glass they're crystallized fruits but not drained cherries or candied peels but looking at something like gingerbread so if you purchase gingerbread then that's treated as a cake if the gingerbread is shaped into gingerbread men then that's treated as a biscuit and then if it's covered in chocolate that then means it's standard rated unless the chocolate that's on it is only decorations for the eyes which means it then remains zero rated so you end up with some really niche differences as to what actually constitutes something that's being standard rated or zero rated.
Matthew: So the latest case to be ruled on involves walkers poppadoms, and that was just late last month. So what happened there?
Bryn: So the tax tribunal looked at a number of different arguments as to whether these constituted a potato product similar to potato crisps puffs and or sticks and in looking at how they considered whether they were ready for human consumption and having looked at that they decided actually they were ready for human consumption they could be eaten on their own they looked at whether they were a potato product and the majority of the content was indeed potato not quite the majority but a large proportion of the content was indeed potato.
Looking at them they said that they considered the arguments out whether it tastes like a potato product in that case they said actually the predominant taste was the flavourings included and then there was a number of arguments about whether they were are actually like crisps or not and in that case every time when they looked at it they said actually these products are quite like crisps and I think that makes rational sense to you and me in that looking at them looking at how they're packaged looking at them in terms just when you would actually choose to go and buy them they do feel like a very crisp like product in terms of if you were going to into the supermarket you would be looking for them you wouldn't go and look for them in the poppadum aisle you would go and look for them in the crisps aisle.
Matthew: Courts and tax tribunals can find themselves in a dreadful definitional quagmire. A famous case involved deciding whether Jaffa cakes were cakes, no VAT, or chocolate covered biscuits, the height of luxury, so attracting VAT. A UK tax tribunal said that cakes get harder over time and biscuits go soft. So because Jaffa cakes go hard with time, they had enough of the characteristics of cake to qualify and so retained their VAT-free status. Bryn says that when you walk into a shop to buy sausages in the UK, the situation is even more complicated.
Bryn: There's something I refer to as the sausage life cycle hypothesis if you go into a supermarket and you choose to go and buy some sausages in the cold food aisle those sausages will be zero rated if instead you chose to go up to the counter and purchased some sausages that had been pre-cooked and were hot ready for you to take and they were above the ambient air temperature then those sausages would be standard rated if they didn't have enough sufficient heating apparatus there and those sausages then cool down again from being cooked then they would be zero rated again and then finally if you went and put the little cocktail sausages aisle and went and purchased them there then they would be zero rated again so sausages again if you go into the supermarket just depending on the current stage of cooking and what temperature they are that can then determine their vat liability which seems a slight peculiarity in the legislation the decisions.
Matthew: If you start a food company, decide your food is a staple and that VAT won't apply, and then get a ruling against you ten years later, the backdated VAT bill could put you out of business altogether. So how can food producers make sure they stay on the right side of this heavily litigated line?
Bryn: I think you'll see in the number of cases that go through the tribunal a lot of producers of food where they think there is a potential for their products to fall within the zero rating are now taking those cases as often as possible and trying to ensure their products do fall within it they have now a rather large number of guidelines to try and work out from the historic cases to whether the goods do fall within those zero rating characteristics or not and it's just a case of working within those cases now there are questions around whether really in the creation of new products companies should be looking at the vat cases and vat legislation to try and understand how they can benefit from zero rating but unfortunately the price differential is so significant in terms of the underlying profit margin food not necessarily being a high margin business that the businesses do need to look at it and they are clearly designing their products in cases to try and maximize their chances of zero rating
Matthew: Well, thanks for joining me here again on the Pinsent Masons podcast. I hope you found it useful and helpful, and don't forget to subscribe wherever you get your podcasts and maybe to pass it on to someone else you think might be interested. And remember, our outlaw team of dedicated reporters are covering business law developments all over the world, every day. So to find out more and to make sure you get the news as it happens, sign up for updates at www.pinsentmasons.com/newsletter. Thanks for listening and see you next time.
The Pinsent Masons podcast was produced and presented by Matthew Magee for international professional services firm, Pinsent Masons.
