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One of my clients has encountered a VAT problem. The company’s income is fully taxable but it acquired all of the shares in a separate company two years ago, which only has exempt income from supplies of vocational training; the training company has never registered for VAT.
The client therefore formed a VAT group, consisting of the two companies, which is partially exempt. This meant that there no VAT leakage on management charges made from the holding company to the subsidiary.
However, it has since emerged that the subsidiary company also has income of about £1,000 a week from a cafe facility on its premises – it supplies hot and cold meals and drink to both staff, trainers and the apprentices being trained. When the subsidiary company traded on a stand-alone basis, this extra income was not a problem because it was less than the annual registration threshold of £90,000 but it is now an issue because the company is a member of the VAT group.
Is there an argument that the catering sales are also exempt, as an incidental source of income to the training fees?
If not, can we form a separate company for the café sales, which will trade below the registration threshold and not lose 1/6 of its sales as output tax. The catering activity has very little input tax because its purchases of food and drink are mainly zero rated.
Query 20,366 – Caterer.
Form company outside the VAT group.
There are two circumstances in which supplies of catering by an educational establishment can be treated as incidental to the exempt education and, therefore, also exempt. The first is set out in VATA 1994, Sch 9 Group 6 item 4: ‘The supply of any goods or services… which are closely related to a supply of [education] (the principal supply) by… the eligible body making the principal supply provided the goods or services are for the direct use of the pupil, student or trainee (as the case may be) receiving the principal supply.’ That exempts the meals served to the apprentices (who receive the principal supply), but it does not cover the meals supplied to the trainers and staff. If the business was not registered, the taxable meals could be ignored; but it is, and they cannot be.
The other situation in which catering can be incidental to education arises when the students are involved in the catering – it is part of their course. See Brockenhurst College (Case C-699/15): the Court of Justice held that supplies of catering to third parties could still fall within the exemption if the provision of the catering was an essential part of the education of the students. Although the catering supply was not made to the people receiving the principal supply, it was, in effect, incidental to the purpose of running a training restaurant. The nature of the training is not described in the query, but Brockenhurst will not normally apply to the regular daily meals supplied by a college canteen.
Forming a separate company outside the VAT group would be a possibility. However, it would only save output tax on the staff and trainer meals; it would also be susceptible to a ‘business splitting direction’ by HMRC under Sch 1 para 1A/2 (even if that seems unlikely). It may be simpler to make sure that the takings for meals can be accurately (or at least fairly) split between the exempt income from apprentices and the taxable income from others, and account for a small amount of output tax. – Gardener.
Be cautious if setting up new company.
The supply of goods or services by an eligible body, which are closely related to an exempt supply of education, can also be exempt from VAT if they are essential and for the direct use of the trainees.
HMRC’s policy is that catering supplied by an eligible body to trainees is closely related to the supply of education and so is also exempt from VAT. If the subsidiary offers vocational training in catering or hospitality, then potentially all the catering supplies could be exempted following the decision in Brockenhurst College, provided the café was staffed by students and not operated as a commercial enterprise. Otherwise, supplies to non-trainees (trainers and staff), are not covered by this exemption.
Sales to the apprentices since the VAT group was formed will be exempt and there is no additional VAT due. However, if any of these supplies would otherwise be zero rated (eg a takeaway sandwich), it would be beneficial to treat them as such.
Presumably a record has not been kept of the split between trainee and non-trainee sales, so a fair and reasonable apportionment should be used, such as a split based on current numbers. The client may wish to agree a method with HMRC beforehand (if not I would recommend that they inform HMRC of what they are doing and why). Going forward, there should be a process in place to identify the split between trainee and non-trainee sales.
With the remaining proportion of non-trainee sales, the client will need to go back and calculate the VAT due and pay it to HMRC. Most of the café supplies will be standard rated, but I expect there will be a small proportion of zero-rated takeaway food and drink. If there are no records a fair and reasonable split should be used to determine this.
There will also be implications on the input VAT recovery on the café expenses, although any adjustment is unlikely to be large as you say most costs are zero rated.
As to setting up a new company to run the café, caution should be taken. HMRC could view this as disaggregation (when a business is artificially split to obtain a tax advantage, such as by operating under the registration threshold). HMRC would be looking for the existence of financial, economic and organisational links. The decision in The Grand Folkestone was similar to Caterer’s proposed arrangement and the taxpayer lost. Alternatively, HMRC could use the abuse of rights principle, as seen in the case of Halifax to argue that, in reality, there was always one business and so all transactions should be interpreted so as to remove the tax advantage. This would enable it to retrospectively attack the new structure and collect the VAT that would have been due otherwise.
As such, I wouldn’t recommend setting up a new company. – Aaron Norman.
