Basically an anti-avoidance provision, this rule is aimed at preventing avoidance of VAT by the maintenance or creation of any ‘artificial’ separation of business activities carried on by two or more persons. Schedule 1 to Value Added Tax Act 1994 (VATA 1994) deals with disaggregation of businesses as follows:
Para 1A(1): Paragraph 2 below is for the purpose of preventing the maintenance or creation of any artificial separation of business activities carried on by two or more persons from resulting in an avoidance of VAT.
Para 1A(2): In determining for the purposes of sub-paragraph (1) above whether any separation of business activities is artificial, regard shall be had to the extent to which the different persons carrying on those activities are closely bound to one another by financial, economic and organisational links.
Para 2 specifies the impact upon the constituent members of the businesses caught by these rules as follows:
a) The taxable person carrying on the specified business is registrable in such name as the persons named in the direction jointly nominate in writing within 14 days of the direction. Otherwise the taxable person is registrable in such name as may be specified in the direction.
(b) Any supply of goods or services by or to one of the constituent members in the course of the specified business is treated as a supply by or to the taxable person.
(c) Any acquisition of goods from another EU country by one of the constituent members in the course of the specified business is treated as an acquisition by the taxable person.
(d) Each of the constituent members is jointly and severally liable for any VAT due from the taxable person.
(e) Without prejudice to (d) above, any failure by a taxable person to comply with any VAT requirement is treated as a failure by each of the constituent members severally.
(f) Subject to (a)–(e) above, the constituent members are treated as a partnership carrying on the specified business and any question as to the scope of that business at any time is determined accordingly.
That brings us to the question as to what exactly is ‘artificial separation of business’? Well, artificial separation arises where the entities, closely bound to one another by financial, economic and organisational links, disaggregate businesses with a view to avoiding VAT. In order to prove artificial separation generally at least one link needs to be established under each head:
- Financial Links include providing financial support to one entity by the other, common financial interest in the proceeds of the business or the mere fact that one entity wouldn’t be financially viable without financial support from the other.
- Economic Links arise where the same economic objective is pursued by the constituent business entities, where the activities of one part benefit the other or where both supply the same circle of customers.
- Organisational Links could be established by having a common management or common employees
HMRC’s view on what constitutes disaggregation of businesses to avoid VAT is contained in VAT notice 700/1. Generally, HMRC would look at striking at least one link each under financial, organizational and economic heads before proceeding to issue a direction. That said HMRC, as a general rule, would view the following to be a single taxable entity:
- Two businesses owned by same persons where one VAT-registered entity sells only to VAT-registered customers, and the other entity, not registered for VAT, sells only to customers not registered for VAT.
- The premises and/or equipment are shared; something common with businesses such as launderettes and takeaway food supplies
- Splitting up a single supply for e.g. bed and breakfast business where one supplies the bed and another the breakfast.
- A number of businesses owned by the same person making the same type of supplies.
Here are some examples, where the businesses were held to be artificially separated with a view to avoiding VAT:
- Husband and wife acting as tax consultants, operating from the same office (Osman v C & E Commissioners 1989)
- A company operating a fitness club and a director and his wife operating a beauty salon in partnership from the same premises (West End Health and Fitness Club)
- A company operating a service station and a director’s son running a video club at the same premises (Old Farm Service Station Ltd & L Williams)
- Married couple providing computer programming services via a partnership and supplying computer hardware via a limited company (A & S Essex (t/a Essex Associates)).
- Bed & Breakfast business carried on by one who is also partner in farm with onther – Self-catering accommodation part of farm business (Patric and Patric V HMRC [2011] UKFTT 865 (TC)
What this brief discussion aims to convey is that businesses are unlikely to be caught by these rules where employees, premises, equipment are NOT common and where the business and customers are different. It must, however, be noted that the INTENTION where apparent also plays a crucial role in determining whether the disaggregation is artificial or not.
