Constable VAT Focus 22 August 2019

Thank you for subscribing to our VAT Focus. This edition provides the usual updates of HMRC news as well as coverage of some of the more recent developments in the Tribunals and Courts. This version discusses the rulings in Pertemps and Koolmove. Pertemps revolves around whether a salary sacrifice scheme offered to employees constitutes an economic activity. Koolmove relates to the recovery of pre-incorporation input VAT.


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We have recently published a new VAT & Charities Newsletter which is available to read here. In this edition we cover the following recent VAT developments in the Courts and Tribunals:

  1. VAT Welfare Exemption: Supplies Closely Connected
  2. University of Cambridge
  3. Partial Exemption “Direct and Immediate Link”
  4. Zero-Rating Construction: Relevant Charitable Purpose, Business or Non-Business
  5. Glasgow School of Art
  6. Call for Evidence: Simplification of Partial Exemption and the Capital Goods Scheme



Upper Tribunal


1. Salary Sacrifice Schemes: Economic Activity?

In this case, HMRC appealed against an FTT decision in favour of Pertemps Ltd (Pertemps) which held that a salary sacrifice scheme operated by Pertemps was not an economic activity and, therefore, that no VAT was owed by Pertemps.

Pertemps employees were offered the option of being paid a salary, out of which they would have to meet any travel and subsistence expenses, or participating in the scheme under which their expenses would be paid but they would receive a reduced salary. The advantage of using the scheme is that expenses are reimbursed tax-free. HMRC considered that Pertemps was making taxable supplies to its employees and assessed for the perceived VAT debt. On appeal, the FTT held in favour of Pertemps as it held that whilst it was supplying services to its employees, it was not doing so by way of an economic activity and therefore the scheme was outside the scope of VAT. HMRC appealed this decision to the UT.

The UT agreed with the FTT that the correct approach to take was to apply to Wakefield tests; does Pertemps make a supply of services for consideration and is the supply part of an economic activity? In order to establish whether an undertaking is economic in nature, the entire circumstance must be analysed but the essential test is whether a supply is made for the purpose of obtaining income on a continuing basis.

Following the case of Banque Bruxelles Lambert SA, one of the factors to be considered when reaching a conclusion of this nature is whether the services identified were offered on the general market or likely to be carried on by a private undertaking. The Tribunal considered this and agreed with the FTT that through operating such a scheme, Pertemps was acting as an employer in making deductions of tax and NIC in accordance with the law; it was not carrying on this scheme with a view to generating income; any income generated was merely incidental. Indeed, it was observed that “The fact that other employers offered schemes similar to the MAP does not show that there is a general market but many individual markets because each employer could only offer the scheme to its own employees”. After reflection, the UT was in agreement with the FTT that whilst a service was being provided, there was no economic activity and, accordingly, dismissed HMRC’s appeal.

Constable Comment: This case is useful in demonstrating the ways in which the Wakefield judgment is applied by the Tribunal in the context of establishing what is an economic activity. Whilst a supply in return for a consideration is normally indicative of a business activity, there is no specific test and the judgment highlights the importance of having regard for the whole situation rather than just the accounting entry. What constitutes a business activity for VAT purposes can be a particularly difficult concept to define which is why there is no specific test and may explain why this issue arises so frequently.


2. Recovering Pre-Incorporation VAT

This appeal related to the denial by HMRC of a claim for input VAT repayment relating to legal costs incurred by Mr McKee in defending himself against a claim made by a third party, Jumar. Mr McKee worked for Jumar and during his employment he privately worked on software known as “The McKee Software”. After Mr McKee left his employment at Jumar, Jumar sought to sue him for infringement of copyright, breach of confidence and breach of contract. Jumar believed he was going to develop a product which infringed it’s copyright.

Mr McKee won those proceedings on various grounds. In defending himself he incurred significant legal costs and sought to recover the input VAT from HMRC through the new company he established to exploit the software after winning the case. To do this he relied on the legislation which allows a business to recover input VAT incurred for business purposes six months prior to its incorporation. HMRC claimed that the services were provided to Mr McKee in his personal capacity as his new company had not yet been formed at the time of the legal proceedings. It also asserted, in support of its argument, that the engagement letter with the lawyers was with Mr McKee and not his new company.

Mr Mckee mounted the argument that defending himself against the claims made by Jumar were business costs as he intended to sell his software through a limited company (Koolmove, The Appellant) which he incorporated as soon as was reasonably practicable following his success against Jumar. He stressed that had he not intended to commercialise the software in the future, he would have simply conceded to Jumar and sought employment elsewhere. He also highlighted that he did not incorporate Koolmove until after the proceedings as, if he had lost, it would have been a pointless exercise. Owing to the lack of incorporated company, the engagement with the lawyers was, necessarily, with him directly.

The Tribunal accepted Mr McKee’s argument and agreed that there was a direct and immediate link between the services supplied and the business to be carried on by Mr McKee. Therefore, they allowed his appeal and Mr McKee is allowed to recover all of the input VAT incurred on these legal costs in the six months prior to incorporation of Koolmove.

Constable Comment: This is an interesting area of the law which has generated many shades of grey and a deep collection of caselaw. In this instance HMRC relied on the fact that the supplies of the lawyer’s services were made to Mr McKee and not Koolmove. The Tribunal observed that, whilst this is the case, HMRC seems to have lost sight of the fact that the whole point of the regulation at hand is to allow VAT on services supplied, in broad terms, to the incorporator prior to the incorporation (but for the benefit) of the limited company and for the purposes of the business to be carried on by it. The Tribunal remarked on HMRC’s lack of understanding of this area of the law and noted that the case mounted by HMRC was “somewhat confused”. The whole area around the recovery of VAT incurred prior to VAT registration (pre-registration input VAT) was subject to much discussion a few years ago as HMRC appeared to be revisiting a long-standing policy. HMRC sought to clarify its position with the issue of HMRC Business Brief 16/16.

This newsletter is intended as a general guide to current VAT issues and is not intended to be a comprehensive statement of the law. No liability is accepted for the opinions it contains or for any errors or omissions. Constable VAT cannot accept responsibility for loss incurred by any person, company or entity as a result of acting, or failing to act, on any material in this newsletter. Specialist VAT advice should always be sought in relation to your particular circumstance.