The UK Gov has introduced Terminal Markets Order, which allows for a range of transactions to have a zero rate of VAT.
In March 2018, the European Commission notified the UK Government of its intention to instigate infraction proceedings against the UK in relation to the zero rated VAT treatment of certain commodities transactions, specifically certain derivative transactions. We understand this to be based on the Commission view that the UK has extended the scope of the original derogation allowing the zero rating, such that it is now ultra vires.
Following a challenge by the UK, the Commission has now decided to make a reference to the Court of Justice of the European Union (CJEU).
In the oil and gas sector in particular, this has the potential to impact all businesses trading on the intercontinental exchange (ICE).
The UK has, since the introduction of VAT, operated a specific VAT regime for transactions in commodities that take place on the various London commodities markets.
This legislation, known as the Terminal Markets Order (TMO), allows for a range of transactions to be subject to VAT at the zero rate where the commodity transaction involves a trade on the relevant market.
Transactions treated as covered by the TMO include derivative transactions like futures (and options on) commodity contracts.
Currently, the UK interprets the TMO as permitting zero rating for future transactions between two market members as well as those between a market member and non-market member, provided the transactions do not lead to physical delivery. For options, zero rating applies where the option is exercisable at a future date provided the commodity is ordinarily dealt with on a terminal market listed under the TMO.
This VAT treatment has been allowed under Article 394 of the Council Directive 2006/112/EC; however, Article 394 is a standstill provision, allowing Member States to retain special arrangements aimed at simplifying the collection of VAT or preventing tax evasion or avoidance, if these arrangements were applied at the point of implementation.
The Commission claims the UK has made at least eight amendments to the original derogation, broadening the application of the zero rating, without notifying the Commission – this includes extending the TMO to cover relevant trades on ICE.
The Commission has decided to refer the matter to the CJEU, which is the last step of the infringement procedure provided for by Article 258 of the Treaty on the Functioning of the European Union. If the CJEU rules against a Member State, the Member State must take all measures necessary to comply with the decision.
The referral of the UK to the CJEU follows the “Letter of Formal Notice” issued by the EC on 8 March 2018, to notify the UK of the infraction proceeding; and the “Reasoned Opinion” issued by the EC on 19 July 2018, requesting the UK to bring legislation in line with EU VAT law.
The referral does not have any immediate effect on UK tax law and UK’s tax treatment of commodity derivatives.
This will remain unchanged, unless and until such time as it is deemed by the UK Government necessary for it to be changed. Accordingly, no immediate action is required to continue business as usual trading.
We have limited information as to the extent of the challenge to the TMO by the Commission. However, whilst we anticipate that the UK will vigorously defend its position to maintain the status quo, should the CJEU hold in favour of the Commission, our expectation is that a large number of trades in commodities which benefit zero-rating (including all of those traded on ICE, and related brokerage fees) could become subject to VAT at the standard rate (20%) or become exempt from VAT (potentially impacting a business’ partial exemption status/calculation, and therefore the amount of VAT incurred on its purchases which it can recover as input tax).
Therefore, some businesses are currently undertaking impact assessments and exploring possible mitigation measures, to prepare for an eventuality whereby the CJEU decides against the UK. Given the potential negative impact, depending on the number of relevant trades a business makes, we highly recommend carrying out this exercise.
It is also, of course, necessary to consider this issue in the context of Brexit. Any implications of the CJEU decision will depend on the negotiations of the Brexit deal: based on the draft Brexit Withdrawal deal made public on 14 November 2018, the CJEU judgment would be binding in the UK if made before 29 March 2025. In addition, while the decision will, in the first instance, impact the UK alone, a judgment by the CJEU on what the “correct” EU treatment has always been, may impact the VAT treatments applied across Europe – potentially giving rise to a domino effect.
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