Brief 3/2023 and the special legal regime
This article was originally published in Tax Journal on 14 April 2023 and is reproduced with permission from the publisher.
Local authorities across England, Wales, Scotland and Northern Ireland are set to receive a very welcome and significant financial boost by way of multi-million pound VAT refunds following the publication of Revenue & Customs Brief 3/2023 on 3 March 2023, which confirms that local authorities can apply non-business treatment for VAT purposes to leisure services they provide to members of the public. This outcome is the result of the robust pursuit of litigation on behalf of councils across the three legal jurisdictions of the UK for more than a decade, and it will result in refunds of VAT for retrospective periods dating from c. 2006 onwards (pursuant to claims for overpaid output VAT made within the statutory time limits), as well as prospective savings.
From a practical perspective, the councils have been asked to review their claims previously made and re-submit them with supporting evidence in order to reduce the delay in HMRC authorising repayments. As with any such process, there may be some points of detail to be ironed out between the councils and HMRC in due course.
Whilst the Brief is limited to leisure services provided by local authorities pursuant to the particular statutory framework within which they operate, the question arises as to whether there is scope for other public bodies to argue that supplies they make are undertaken pursuant to a ‘special legal regime’ and that any resulting treatment as non taxable persons would not lead to significant distortions of competition. For these purposes, it is helpful to consider the successful arguments that resulted in the current Brief being published.
Identification of the special legal regime
The local authorities argued that they provided their services, described as ‘leisure services’ in the Brief, pursuant to a ‘special legal regime’ under article 13 of the Principal VAT Directive (PVD) (Directive 2006/112/EC) which, in summary, provides that bodies governed by public law shall not be regarded as taxable persons in respect of the activities or transactions in which they engage as public authorities unless such treatment as non-taxable persons would lead to significant distortions of competition.
The origination of the dispute preceded Brexit so the discussions centred around the meaning and scope of article 13, rather than VATA 1994 s 41A which implemented article 13 in UK VAT law, but nothing turns on this for the future as they were accepted as having the same meaning.
The statutory provisions relating to the councils’ supplies of leisure services varied between the three legal jurisdictions of the UK, so it was necessary for lead cases to be identified for each jurisdiction so that scrutiny could be given to the particular legislative provisions of relevance, as follows:
- HMRC v Chelmsford City Council  UKUT 149 (TCC) – for England and Wales in relation to the Local Government (Miscellaneous Provisions) Act 1976 s 19, the Public Health Act 1936 s 221, the Local Government Act 1999 s 3(1) and the Local Government Act 1972 s 111; and
- HMRC v Midlothian Council  UKFTT 433 (TC) – for Scotland in relation to the Local Government and Planning (Scotland) Act 1982 ss 14–16 and the Local Government in Scotland Act 2003 s 1.
- HMRC v Mid Ulster District Council  UKUT 197 (TCC) – for Northern Ireland in relation to the Northern Ireland Act 1998 (‘NI Act 1998’) s 75 and the Recreation and Youth Service (Northern Ireland) Order, SI 1986/2232 (the ‘1986 Order’), articles 3 and 10:
In all three FTT cases, the judges summarised the following principles which could be drawn from the case law on article 13:
- Any economic activity is normally taxable and thus the PVD has a wide scope.
- As a general rule, the supply of services for consideration, including those supplied by bodies governed by public law, is subject to VAT.
- Article 13 is a derogation from that general rule and so must be interpreted strictly.
- It is not an objection to an activity being carried out under a special legal regime that private bodies can carry out similar activities.
- A special legal regime is not created simply by operating within a statutory framework.
- The activity in question must be carried out in exercise of rights and powers of the public authority.
- The subject-matter or purpose of the relevant activities are irrelevant in deciding whether they were carried out by a body governed by public law under a special legal regime applicable to it.
The first step is to identify the applicable legal regime under which the public body engaged in their activities as article 13 only applies to activities undertaken by a body governed by public law. Taking the Mid Ulster District Council case as an example, the FTT found that article 10(1) of the 1986 Order imposed a duty on local authorities in Northern Ireland to provide the stated leisure and recreational services. Further, the council’s provision of the facilities was not being done because it was going into business as a matter of choice: the onerous requirements surrounding the way in which those services had to be provided (for example, taking account of statutory equality duties under NI Act 1998 s 75) meant that it was clear the facilities would not be provided absent the power/duty in article 10.
The second step is to determine whether the applicable legal regime constituted a ‘special legal regime’. For these purposes, it is necessary to look at whether the legal conditions under which the public body provides its services are different, because of their function as public bodies, from the legal conditions under which their private sector counterparts provide their services. In Mid Ulster District Council, the FTT found that the regime of article 10 was hedged around by a number of constraints (for example, statutory equality duties and the need to set charges by reference to affordability and accessibility). As such, it was determined that the council’s provision of leisure services was being undertaken pursuant to a special legal regime applicable to a body governed by public law.
In this context, it is also noteworthy that, in Chelmsford City Council, the fact that the council was providing its services pursuant to a statutory power rather than a statutory duty did not prevent it from being considered as carrying out the relevant activities under a special legal regime.
Distortion of competition
If it is found that supplies provided by a public body are made pursuant to a special legal regime under article 13, the question then arises as to whether they then fall to be excluded by reason of the second sub-paragraph of article 13.1 (‘13(2)’) which applies where non-taxation is likely to give rise to significant distortions of competition.
In the Chelmsford City Council and Midlothian Council cases, it was agreed between the parties that should consideration of article 13(2) prove necessary, it should be excluded from the scope of the hearing as further evidence would need to be presented. In the Mid Ulster District Council case, the FTT ( UKFTT 434 (TC)) decided that it could determine the issue that there was no risk of significant distortion of competition without the need for the presentation of further evidence, such as expert evidence.
The FTT referred to the guidance provided by the CJEU in Isle of Wight and Others (Case C-288/07) on some of the terms used within article 13(2), in particular:
- It was determined that the expression ‘distortions of competition’ was to be analysed by reference to the activity in question, as such, rather than by reference to the local area where the particular body in question provides its services.
- The expression ‘would lead to’ is to be interpreted as encompassing not only actual competition, but also potential competition, provided that the possibility of a private operator entering the relevant market is real, and not purely hypothetical.
- The word ‘significant’ is to be understood as meaning that the actual or potential distortions of competition must be more than negligible.
Applying the above guidance, the FTT in Mid Ulster District Council framed the question to be evaluated as whether the treatment of the council as a non-taxable person when providing the activities in question would lead to more than negligible actual or potential distortion of competition in the market for such activities in Northern Ireland. In the circumstances, the FTT concluded that there was no distortion of competition as there were no private operators who could provide the same services as the council subject to the same demanding requirements relating to community, equality and integration. Essentially, the FTT considered that the relevant activity had to be defined in a way which took into account the constraints imposed by the special legal regime pursuant to which the council provided its leisure and recreational services.
HMRC appealed to the Upper Tribunal on the issue of distortion of competition, arguing that the FTT had applied the wrong legal test, in particular the meaning of ‘such activities or transactions’ that needed to be compared. HMRC submitted that the FTT should have evaluated whether there was actual or potential competition between the council, which had to provide its services subject to the constraints imposed by the special legal regime, and private operators who were at liberty to design their services without being subject to similar constraints. The Upper Tribunal upheld HMRC’s appeal on this point, determining that it was clear from the CJEU’s judgment in Rank Group v HMRC (joined Cases C-259/10 and C-260/10), which focused on the application of the principle of fiscal neutrality in a particular context, that when assessing whether activities were similar in the context of competition, the perspective of the consumer was the relevant test. It held that the special legal regime was only relevant for the purposes of defining the relevant activity where that regime created a distinction in the eyes of the consumer.
Although Mid Ulster District Council had been granted permission to appeal to the Court of Appeal, HMRC subsequently issued Brief 3/2023 which confirms that allowing local authorities to treat their supplies of leisure services as non-business would not significantly affect competition. Therefore, for the purposes of these specific cases on the leisure and recreational services provided by councils across the UK, further argument on the applicable legal test in respect of article 13(2) does not need to be pursued due to HMRC’s concession that, on the facts, there would be no significant distortion of competition.
The meaning of ‘such activities or transactions’ and ‘those activities and transactions’ in article 13(2) and whether they are to be defined in a way which takes account of the constraints and obligations imposed by the special legal regime is an important issue and one which may be tested before the courts in an appropriate case in the future. For now, the position remains as held by the Upper Tribunal in Mid Ulster District Council, such that the focus is on the nature and characteristics of the activities rather than the legal regime.
Given the wider impact of the underlying principles which led to the Brief, all public bodies should review whether they have been incorrectly charging and accounting for VAT on their supplies and consider making protective claims (given the four year limitation period) where appropriate.
Note: the authors represented Mid Ulster District Council in this case.