Disaggregation – One business or two?

Disaggregation – One business or two?

Rules surrounding Disaggregation and whether there is one business or two are important to consider.

This can lead to the correct person not recognising the correct amount of turnover especially where one or both businesses is not VAT registered.  We have had a number of calls centred on Disaggregation – One business or two? and whether the disaggregation rules are at issue.  That is to say whether HMRC could force VAT to apply to different trading entities as if they were all part of one entity.

A good example call concerned one individual director working via three separate companies and claiming to supply three different services, each of which were below the VAT registration threshold.  The added rub was that a sale by all three companies was typically made to the same customer; by the same (and only active) director; on the same occasion albeit for three different products under three different contracts.

Can VAT possibly be safe? 

How did his accountant come to advise that the VAT disaggregation rules did not apply?  Our view is that this is not a resilient structure.

Deciding what is being supplied and who is supplying it is a key element in arriving at how VAT should be applied.  This approach involves forming a view on the economic and commercial reality viewed objectively from the standpoint of the supplier, the customer and also an on-looker.  What would any sensible person think what happening if Mrs Jones, the customer, signed three contracts all presented to her by Mr Smith sat on her sofa during a single meeting?

Not only could all three companies find themselves subject to a disaggregation notice from HMRC bringing them together for the future; the bigger issue is that they could face being VAT registered as one single business as far back as 20 years.

The disaggregation rules

The rules rest on HMRC’s ability to issue a notice but the real risk in these segregated situations lies where arrangements are regarded as abusive because then VAT can be collected retrospectively.  One case centred on this issue was heard in the First Tier Tribunal involving Snow Factor Ltd and Snow Factor Training Ltd [2019] TC 07439.  Here the FTT found that the essential aim or purpose of the arrangements was to reap a VAT advantage.  The VAT saving was attempted by applying VAT exemption on tuition and training services which the tribunal decided represented an abusive practice within the scope of the Halifax principle.  Essentially any contractual arrangements that are wholly artificial must fall to be ignored.

There was quite a lot of untidiness in the arrangements between the two companies which undoubtedly undermined the argument.  For example what purported to be a joint employment contract (to avoid VAT being charged on the salary shares) was drafted in the name of ‘the company’.  All tills and machinery was owned by one company and set up to recognise standard rated and exempt sales as though by the same entity.  The tuition fees were treated as being exempt but the till receipt given to the customer was from the VATable trading company.

The tribunal upheld HMRC’s view that the commercial reality was Snow Factor Ltd supplied tuition services so that VAT was due and the exemption fell to be disallowed under the general principle preventing abuse of rights.  The tribunal examined the contractual framework and concluded that both companies were under common control and had diverted one income stream.  The contract of employment was mere window dressing and there was no evidence of any of the supposed reasons for making the change to split into the two company structure other than securing the VAT saving.

The Halifax principle

The Halifax principle dictates that any contractual arrangements that are wholly artificial must fall to be ignored.  As introduction of the training company was only to achieve a VAT advantage by securing VAT exemption, whereas in reality the tuition services were provided by the trading company that was not an eligible body, all services being supplied were VATable.

The case really rests on it never being sufficient to paper over the cracks in an attempt to create a separate trade or supplier.  The arrangements have to have real substance and be for commercially solid reasons.  To succeed a multi-party trading structure needs to respect the separate accounting, marketing, delivery, contracts, staffing and all other arrangements that any separate trading entity ought to have in place.  Key will always be to have the commercial and economic reality reflecting why an operation is following a particular path.  Reducing VAT otherwise payable will never be adequate justification.  So disaggregation – one business or two?  Please don’t make optimistic assumptions, it is very easy to get this wrong.

We solve all kinds of VAT and Customs problems so please call us on 01438 716176 if you need help.

Posted in VAT Appeals.