By far the majority of VAT issues and litigation in the retail sector, it seems, arise directly out of retail promotions, be they interest free credit, money off coupons, promotional vouchers, gift vouchers, part exchanges, manufacturers’ promotions, gifts, points, loyalty cards, linked goods, multi-buys and so on. Hardly surprising in view of the increasing competitiveness in the sector and the pressure on retailers to be innovative in seeking to win or retain market share. Article by Charles Rayment, a Senior Consultant with Ernst & Young. The views expressed are his own.
Published in October 2001 issue of Tax Adviser. The UK retail landscape
Until quite recently, UK retailing was a relatively easy and rewarding sector in which to operate. Net margins were often higher than those of overseas counterparts. The UK was largely immune from foreign competition. The environment was predictable – retailers operated within clearly defined sub-sectors, selling their products through high street stores. Now, however, retailers compete in a global market. Out of town retail parks threaten the existence of traditional high street outlets. There is polarisation into premium brands at the one end and value for money at the other, with retailers in the middle fighting for market share. Traditional sub-sectors are blurred – supermarkets sell designer clothes and financial services whilst petrol forecourts have become convenience stores. Consumers expect retailers to have a multi-channel offering with not only interactive shopping and home delivery but also the ability to buy over the internet. Given this present climate, most retailers are only likely to see sales growth at the expense of competitors and those who lose market share will not find it quick, easy or cheap to regain ground.
Promotions and VAT litigation
The fight for market share in this rapidly changing environment is therefore intense, driving increased promotional activity which in turn drives out VAT issues as retailers to seek to manage their VAT liability more effectively. It is inevitable, then, that there will be, from time to time, conflicting interpretations of the VAT legislation which need to be tested before the Courts.
Much of the significant litigation involving promotional activity can be loosely divided into two categories;
- retail finance
- vouchers and rewards.
Interest Free Credit
A well known furniture retailer claims to have been the first to market with this particular promotion in the early 80’s, presumably in a high street context since “interest free” has been the corner stone of the traditional mail order offering over many years. There are very few complex retail promotional and transactional concepts capable of being expressed in just two words yet remaining readily understood by the target audience. “Interest free” is one of them. Little wonder then that it has endured.
A typical interest free sale involves the customer entering into a loan agreement with a finance company for an interest free loan of the same amount as the advertised price of the goods. The terms of the loan require the finance company to settle the customer’s indebtedness with the retailer. The finance company pays to the retailer the purchase price of the goods less an amount (a “subsidy” or “commission”) representing the finance company’s cost of capital, overheads and profit. In practice the subsidy is variable depending on the length of the agreement and sometimes partially refunded to the retailer in the event that the customer settles early with the finance company.
Of course, most consumers are sophisticated enough to recognise that there is no such thing as “free” in a retail context and that there is an interest charge, ultimately borne by them, in the price paid for the goods. This was the concept pursued by Primback Limited as far as the European Court of Justice (ECJ) in Primback Ltd v C&E Cmmrs (Case C-34/99)  BTC 5,240 where Primback sought to argue that the taxable amount upon which VAT was due in respect of such sales was the amount received from the finance company, not the selling price of the goods.
Key to the decision of the ECJ was that the parties to the sale agreed that the consideration was the advertised price which did not vary whether payment was made in cash or on credit. The ECJ followed its reasoning in Chaussures Bally v Ministry of Finance (Belgium) (Case C-18/92)  ECR I-2871 where the issue was whether the retailer’s taxable amount fell to be reduced by the commission charged to the retailer by a credit card company for the handling of cards. In both Primback and Bally, the customer concluded a contract with a third party finance house which, after deducting the commission or subsidy, paid the price of the goods to the seller. The taxable amount was therefore the full selling price of the goods, the amount paid by the customer.
The future of interest free credit
So where does this leave interest free credit? As a marketing concept, untouched, but many retailers are acclimatised to accounting for VAT on the net amount received and are now faced with a possible, although not in all cases inevitable, clawback in respect of past transactions and a significant cost for the future.
If there is to be a VAT resolution, it will mean finding a way of disclosing a finance charge to the customer on the one hand whilst retaining the “interest free” hook on the other or replacing it with something similar or of equal promotional power. The main hurdle to that arises from the strictures of UK and EU consumer credit legislation intended, rightly, to give protection to consumers against misleading claims by retailers.
The easiest solution, in VAT terms, and one which would clear the way for retailers to make a disclosure of interest to customers, is to wean them away from interest free to interest bearing deals but this will involve a fundamental shift in consumer perception. That will most likely involve an innovative retailer taking the lead.
The fallout from the Primback decision is not necessarily all gloom, however. The case has given fresh impetus to solving the VAT issues connected with retail credit and given rise to new ideas which will perhaps lead some retailers to challenge established practice in the sector. In the coming months we will no doubt see the emergence of innovative and VAT efficient retail financing offerings.
Credit Card Transactions
The issue of disclosure and precision over contractual arrangements, such as that raised in Primback, is a recurring theme in seeking to ensure that the VAT treatment sought is actually achieved. The publication by Customs & Excise (“Customs”) of Press Release 14/01, 12 March 2001, drew attention to another retail financing issue involving the levying of merchant charges by credit card companies on retailers in relation to credit card transactions.
Inherent in a credit card transaction is the commission or acquisition fee payable to the acquiring bank which has contracted with the retailer to facilitate such transactions. Following the ECJ’s decision in Bally, the taxable amount is the full value paid by the customer, not the net sum received by the retailer after deduction of the acquiring bank’s commission. This is on the basis that the subjective consideration received by the retailer is the full amount paid by the customer and the charge by the acquiring bank is consideration for a separate supply to the retailer. However, if the contractual arrangements are such that the acquisition fee is a VAT exempt transaction payable directly by the customer then, clearly, the taxable amount on which VAT is due is the net amount received by the retailer.
It is safe to assume from the tone of Customs’ press release that they disagree with this analysis and no doubt their grounds for disagreement, once in the public domain, will be most informative if not quite as appealing to the emotions.
Vouchers Working Party
This second category of VAT issues arises as a result of the use of vouchers. Recent cases on face value vouchers led to Customs assembling the “Vouchers Working Party” to examine the issues in detail. The Working Party has reported but Customs are still considering their position.
Customs’ main concern appears to arise as result of the loophole created by the interaction of the UK legislation on the sale of face value vouchers and the decision of the ECJ in Argos Distributors Ltd v C&E Cmmrs (Case C-288/94)  ECR I-5311. This is because of VATA 1994 Schedule 6(5) which, in order to avoid the potential for double taxation, disregards the consideration for the sale of a face value voucher:
‘Where a right to receive goods or services for an amount shown on any token, stamp or voucher is granted for consideration, the consideration shall be disregarded for the purposes of this Act except to the extent (if any) that it exceeds that amount.’
However, following Argos, when such a voucher is redeemed against goods or services with the retailer who sold it, the value attributed to the supply of the goods or services is the value of the payment originally received by the retailer for the sale of the voucher, which is not necessarily the same as the value shown on the face of the voucher. It is anticipated that one of the outcomes of Customs’ review will be a measure to prevent the exploitation of this loophole by retailers selling discounted vouchers to a connected company.
When is a voucher a face value voucher?
Not every face value voucher issued as a result of a retail promotion has been held by the Courts to fall within the Schedule 6(5) disregard. For example, in Celtic plc,  VATDR 111 (14762), books of vouchers were sold where each voucher entitled the spectator to admission on a match by match basis. The Tribunal held that the consideration could not be disregarded but was instead a prepayment for the right to attend the match in question.
In F&I Services Ltd v C&E Commrs, CA  STC 939 face value vouchers sold in conjunction with a used motor car were held not to confer the right to a supply of goods and services, but simply allow the holder to claim a discount on a further supply.
In Hartwell plc v C&E Cmmrs  (unreported) the Tribunal held that the sale of a face value voucher with a used car entitling the purchaser to a subsequent MOT was likely to be regarded by the buyer as a means of better enjoyment of the car and therefore ancillary to the supply of the car (following Card Protection Plan Ltd v C & E Cmmrs (Case C-349/96)  ECR I-973).
The application of face value voucher principles to retail promotions is further complicated by the advent of loyalty cards and electronic points. Whilst Customs accept that an electronic version of a face value voucher can fall under Schedule 6(5), they do not do so where the “voucher” is more intangible, in the form of a card recording electronic points acquired by the customer.
Customs might in any event argue that the points were given away free of charge rather than being purchased, seeking to rely on Kuwait Petroleum (GB) Ltd v C&E Cmmrs(Case C-48/97)  ECR I-2323 where customers were awarded vouchers with purchases of petrol redeemable subsequently against gifts (“redemption goods”). In that case the ECJ found that there was no evidence that part of the consideration paid by customers for petrol was attributable either to the supply of the vouchers or to the redemption goods.
Times have changed since the legislation on face value vouchers was conceived in the early 1970s. Technology then would have involved the provision of additional shopping trolleys to customers just to carry round a loyalty card. Now sophisticated smart cards with in-store readers can mean that paper vouchers are redundant. The potential for double taxation remains however.
Watch out for cases in the near future which examine both the application of Schedule 6(5) to electronic points and the nature of the contractual arrangements under which such points are awarded. At the time of writing it is understood that a decision of the VAT Tribunal concerning at least one of these aspects will be released shortly.
Whilst the VAT issues associated with one retailer’s permanently low price policy may not be as complex as another’s strategy of special offers, there are always issues, irrespective of the promotion. Given that all retailers are involved in some form of promotion at some time, from simple discounts to awarding points or vouchers, there are therefore a multitude of opportunities to add value to those promotions either by taking simple steps to eliminate unintended VAT costs or by realigning the contractual arrangements to improve VAT efficiency.
The example cases discussed above lead to the conclusion that even the apparently straightforward “10% off” deal can, if structured differently, be improved upon from the VAT perspective. With innovative and sound VAT planning, then, it ought to be possible to make a significant contribution to the implementation of a retailer’s promotional strategy.
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October 2001 by