The nuances of input VAT recovery
23 May 2017
by Prem Mehta, senior manager - indirect tax and Prinal Nathwani, manager -tax disputes
Central to the operation of the VAT system is the fundamental principle that a fully taxable business has the right to recover the VAT that it incurs. In short, it should not have to face the burden of irrecoverable VAT.
But is applying this as straightforward as it sounds for those operating in the oil & gas and mining sector?
Notwithstanding the importance of this right to deduct input VAT, the exact circumstances when this can be exercised have been the subject of much debate over the years.
Guidance has been formulated following seminal Court judgments, giving some comfort to businesses seeking to apply this principle in the context of their commercial activities. Specifically, the Courts have determined that VAT recovery is possible when there is a “direct and immediate link” between the VAT incurred and the business’ activities. This concept of “direct and immediate link” has received consideration at both a UK and European level, and although there have been differences in applicable facts and the scope of questions addressed, broad areas of discussion and direction can be identified.
Within the UK, the recent focus has been on the VAT recovery position of holding companies and, specifically, the features that must be evident to HMRC in order to allow holding companies to recover VAT. Most recently, HMRC have issued updates to their internal manual on input VAT recovery, to clarify further their view on VAT recovery for holding companies. From a practical standpoint, the guidance has been helpful in providing a useful point of reference for businesses seeking to implement commercial arrangements.
Drilling this down for oil & gas and mining firms
For the oil & gas and mining sectors in particular, it has at times proved difficult to follow through the guidance in totality given the nature of the industry and how costs are incurred when sourcing natural resources. This can lead to disputes in cases where the practical arrangements do not conform to the guidance. Although elements of the guidance have proved difficult to address in practice, the updates to the manual do reflect closely the principles held in recent UK and EU case law1.
An important trend that seems to have become apparent at a European level is the variable messaging from the CJEU as to the extent to which the failure or otherwise to meet formal requirements can impact the degree to which fundamental VAT principles and reliefs are applicable. For example, in Case c-21/16 Euro Tyre BV, the CJEU came to the view that a taxpayer’s failure to meet the formal requirements laid down by the Member State did not preclude VAT relief being granted, as long as the objective characteristics for the granting of relief set out in the Principal VAT Directive were met. This can be contrasted with the decision of the CJEU in the Hungarian reference of Case C-564/15 Tibor Farkas where, at its simplest, the taxpayer’s failure to comply with the formalities the Hungarian authorities had put in place prevented an action in the first instance against the tax authorities.
What is clear from the above is that although the right to deduct is a fundamental principle, its exact application is subject to various different factors.
The developing case law will shape the extent to which these factors (e.g. the application of formal requirements) apply and it is therefore important for businesses to monitor these developments and proactively consider their position.
As we write this, the Court of Appeal proceedings in Norseman Gold are ongoing and it remains to be seen whether these will chart a different course or not.
1 - examples of this include the decisions of the Court of Justice of the European Union (CJEU) in Case C-108/14 / Case C-109/14 Larentia and Marenave Schiffahrt and Case C-28/16 MVM Magyar Villamos Muvek Zrt