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UK taxpayers come up short in European VAT judgement


The Loyalty Management UK and Baxi VAT cases will come back to the UK courts after the European Court of Justice's ruling in the joined litigation last month.

By Ralph Cunningham


The two cases will return to the UK after the ECJ ruled in the joined litigation


The Loyalty Management UK and Baxi VAT cases will come back to the UK courts after the European Court of Justice's ruling in the joined litigation last month.

The court decided that LMUK and Baxi may not be able to recover the VAT paid in the supply of goods by retailers to customers who redeemed their customer loyalty points because they, partly in Baxi's case, were paying "third party consideration".

The taxpayers had to show that it was receiving a clear or separate service or supply. Whether it was or not was a question for a UK court to decide, the ECJ ruled.

As the cases were referred to the European Court by the House of Lords, they will probably be heard by the Supreme Court, which took over the role of the House of Lords as the UK's final court of appeal in civil cases a year ago.

The ECJ's ruling will disappoint the taxpayers, particularly as they had both won their cases in the Court of Appeal in London before they were referred to Luxembourg by the House of Lords.

LMUK operated the Nectar loyalty card scheme where consumers, or collectors, could use the points earned from shopping at various retailers, or sponsors, to obtain products or services from other merchants, known as redeemers.

When members of the public received an item in this way, LMUK paid the redeemer a service fee. LMUK claimed it was entitled to a credit from the tax authorities for input tax on the fees paid to redeemers.

HM Revenue & Customs (HMRC) disagreed because it said redeemers had not made a taxable supply to LMUK. It argued that the redeemers supplied the members of the public and that, as a third party, LMUK paid them for doing so.

The Court of Appeal in London, which decided in favour of LMUK after the High Court had before the House of Lords sent the case to Europe, ruled that the redeemers were making two supplies.

One was the supply of goods to the customer, the other was to LMUK for arranging the service to supply these goods. The Court said LMUK could claim a deduction of input tax for a service for which it paid the redeemers, even though customers were supplied a different service in the same transaction.

The loyalty scheme set up by Baxi, which makes boilers and other heating products, was to encourage customers to buy its products.

Customers in the scheme got points which they could redeem for loyalty rewards, which comprised goods or services, when they purchased Baxi's products, though the case only dealt with goods. Baxi subcontracted the operation of the loyalty rewards scheme at issue to a company called @1.

The ECJ pointed out that one significant difference between this scheme and the one run by LMUK was that @1 chose and bought the loyalty rewards and supplied them to customers.

Consequently, that company was the operator of the customer loyalty rewards scheme and the redeemer. The loyalty rewards were supplied solely in exchange for points. Customers could not buy goods at a reduced price instead of receiving a loyalty reward. Baxi paid @1 the retail sale price of the loyalty rewards and certain charges for specific services.

Baxi sought to deduct the VAT on the amounts which it paid to @1. HMRC decided that there were two supplies in the payments. It allowed a deduction for the supply of services by @1 to Baxi but would not allow a deduction for what it saw as the third-party consideration for the supplies of goods by @1 to the customers.

The taxpayer challenged that decision before the VAT and Duties Tribunal, which dismissed the claim, holding that @1 was supplying the loyalty rewards to Baxi, which then supplied them to the customers without consideration. Baxi could deduct the input VAT charged on the supply of goods it received, but had to account for the output VAT chargeable on the subsequent transmission of the goods to customers.

Baxi appealed that decision before the High Court in London, which held that @1 had supplied the loyalty rewards to customers and not to Baxi, but that @1 had also supplied services to Baxi which included the supply of those goods to customers. The price paid by Baxi constituted the consideration for the supply of that service and Baxi was therefore entitled to treat all the VAT invoiced by @1 as input tax.

This time, HMRC took the case to the Court of Appeal, which held that Baxi was entitled to recover VAT on the whole of its payment to @1 because part of the money Baxi handed over to @1 consisted of the supply of articles to customers, which promoted Baxi, engendering customer loyalty and discharging Baxi from its obligations to the customers under the loyalty rewards scheme.

The tax authorities appealed again to the House of Lords, which referred the case to the European Court.

Giles Salmond, a director in the tax dispute resolution group of Deloitte in London, said the ECJ's decision was significant for any taxpayer that operated a customer loyalty scheme in the UK.

"Manufacturers and retailers operating such [loyalty] schemes will need to review them to see if they can be structured more effectively, or factor the additional irrecoverable VAT into their operating costs," said Lorraine Parkin of Grant Thornton in the UK.

Salmond believes the decision could be important for other situations, too.

"The case may also be significant in determining whether businesses can recover VAT when they make payments for services rendered both to that business and to third parties, for example, as sometimes happens with the payment of professional services provided in the context of M&A activity," he said.

Some UK tax professionals were hoping the ECJ's judgment would support more strongly the principles set out in the Redrow case in 1999, in which the House of Lords held that a taxpayer may be entitled to a VAT refund for the goods or services it pays for, though they are provided by another.

"There are arguments that suggest that Redrow is not fatally undermined by this decision," said Greg Sinfield, of Hogan Lovells, who acted for LMUK. "However, there are some cases that may need to be looked at again, such as the British Airways litigation, which covered the vouchers given to passengers when flights were delayed."

Groupe Aeroplane, the Canadian company that bought LMUK three years ago, said after the judgment that it was prepared for a decision that went against it and had accounted for any VAT payments arising from the litigation.

"The possibility of an adverse judgment was contemplated at the time of the purchase of Loyalty Management Group in 2007 and accordingly the purchase consideration was subject to a holdback of £27.1million ($43 million) which was placed into an escrow account," a company statement said. "This amount will be released to Groupe Aeroplan and used to partially fund the VAT payable. There will be a net one-time non cash charge of approximately £33million which will affect Adjusted EBITDA, reflecting the repayment of historic input tax credits and a £13million one-time cash outflow, which includes interest charges. Groupe Aeroplan Europe is well prepared to mitigate any ongoing increase in the cost base resulting from the ruling," the company added.

Baxi said it had no comment on the judgment.

Greg Sinfield of Hogan Lovells and David Milne QC, of Pump Court Tax Chambers in London represented LMUK. PricewaterhouseCoopers Legal and David Scorey of Essex Court Chambers represented Baxi.

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