Is VAT only on the margin?

The decision of the First Tier Tribunal in a case involving Reed Employment Limited has sparked a major debate over whether employment businesses should only be accounting for VAT on their margin. The Tribunal concluded that the economic reality was that Reed was supplying introductory services and not staff. As a consequence, the value of Reed’s supply for VAT purposes was held to be its margin, i.e. the amount paid by a client less the amount paid by Reed to the temp worker.

VAT averse organisations, such as those in the financial services sector, are seeking to use this decision to reduce their VAT bills on temporary staff engaged through employment businesses. Many have already written to employment businesses requesting partial refunds of VAT previously charged, stating that VAT should only be charged on the commission element going forward and intimating they may engage other suppliers if the business does not agree to apply VAT only to the margin.

So should an employment business acquiesce and charge VAT only on its margin?  As matters stand today, those that do may face a significant VAT bill and penalties as the decision in Reed does not create a legally binding precedent. Accounting for VAT on the margin will only be safe if HMRC revise their policy or if Reed is appealed and then upheld by the Upper Tribunal.  Even then, the decision may be of limited benefit as the period in dispute in Reed was prior to the introduction of the Conduct of Employment Agencies and Employment Businesses Regulations 2003. The Tribunal said that although the regulatory framework was not determinative it could affect the way in which business was conducted and so impact on the nature of the supply. Accordingly, changes resulting from those regulations may alter the analysis of what a business is seen to be supplying for VAT purposes.

So what should employment businesses do? If the economic reality is that they have been providing introductory services, they should consider lodging claims to HMRC for repayment of the relevant VAT charged over the last four years. If HMRC refuse the claim there is 30 days in which to appeal that decision to the Tribunal. Unless a lead case develops each business may need to argue its own case before the Tribunal, with the attendant cost implications.  It could also mean a number of years before there is certainty in this matter.

By Marc Welby, VAT Partner at BDO LLP