CONFIDENTIAL
OWML Board Paper 06-10 – 18 June 14
VAT Update
Open Water Market Ltd is not currently VAT registered.
This paper summarises the current position, and advice
received to date. The directors are asked to consider
whether appropriate external advice should be sought to
clarify the current position and help define the strategy for
phases 2 and 3.
Executive Summary
1. OWM Ltd still needs to clarify the VAT position. There is a risk that without a fully
considered position OWM Ltd could unnecessarily be adding 20% to the costs of
setting up the Market operator during phase 2. We need to find an urgent solution as
the phase 2 funding requests, by way of licence, may need to include VAT for
funding companies to reclaim. OWM Ltd would need to be VAT registered for this is
be possible, retrospective VAT reclaims are not always possible.
2. Receiving direct advice from HMRC, or via Ofwat, is not possible. Potential solutions
include a bilateral agreement with a VAT advisor or a collaborative approach with
members of the industry. The fall back position is for OWM Ltd to remain not
registered for VAT and continue to add the additional cost to the industry, and
customers. The recommended way forward is to engage a VAT advisor, with the
industry, to clarify the current VAT position and recommend the strategy for phases 2
and 3 of the programme.
3. The board is asked to note the risks and agree the recommended way forward.
Progress will be reported at the next board meeting.
Background
4. From an early stage following the incorporation of OWM Ltd VAT treatment has been
considered and discussed, including at both the April and May board meetings. This
paper summarises the current position and advice received to date.
5. OWM Ltd is not currently VAT registered. Businesses where the goods or services
provided are classified as 'taxable supplies' have to register for VAT where turnover
for the previous 12 months is above the 'VAT threshold' (currently £81,000). OWM
Ltd income in phase one is by way of donation and it is difficult to demonstrate that a
taxable supply is being received by companies in exchange for their voluntary
contribution. On this basis, supply by OWM Ltd would be considered “exempt” from
VAT and OWM Ltd cannot register for VAT.
6. Exempt supplies are not taxable for VAT and therefore VAT should not be charged
on any sales invoices raised. Where there are only exempt supplies the business is
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classified as an exempt business and they cannot register for VAT or recover any
VAT incurred on purchases of goods or services
7. Income in phase two will be met under a licence condition. OWML’s work will be
delivering an obligation under legislation, similar to Ofwat, but as the strategy of
OWM Ltd is defined it should be considered whether there will be any link between
expenditure during phases 1 and 2 and possible future taxable supplies.
Current Position
8. Despite seeking preliminary external advice, and advice directly from HMRC, there
remains a degree of uncertainty regarding the requirement for OWM Ltd to register
for VAT and its ability to therefore recover VAT on costs of setting up the Market
Operator.
9. Tax planning is an integral part of business strategy and is part of the prudent
preparatory work for which OWM Ltd is established. Advisors work with HMRC at a
policy level to ensure VAT is correctly charged and collected, rather than to minimise
the Tax bill of companies. Tax planning schemes have to be disclosed at the earliest
possible stage.
External VAT Advice
10. Ahead of phase 1 funding letters being issued to WaSCs and WoCs preliminary
external advice was sought and the key points are summarised in the following
paragraphs.
11. In the advisor’s experience of working with bodies in other regulated industries they
know that there is a risk that companies set up to discharge regulatory functions and
obligations may be viewed as carrying out non-business activities. In such an
instance, that company may not therefore be seen to be making taxable supplies and
hence would not be entitled to recover input tax on costs incurred to carry out its
activities
12. If OWM Ltd could demonstrate to HMRC that it is in business, there remains a risk
that any funding provided by market participants under voluntary agreements would
not be seen as being paid in return for a supply by OWM Ltd. Whether the funding
by the market participants to OWM Ltd is consideration for a taxable supply is likely
to be impacted by the exact wording in any agreement between the market
participants and OWM Ltd.
13. From the early review the advisor could not comment on whether there will be any
link between expenditure during phases 1 and 2 of the Open Water programme and
possible future taxable supplies, given the uncertainty around whether OWM Ltd will
evolve in to the market operator or how IP and any assets relating to the central
market infrastructure systems would transfer to a new market operator. Even if there
was a genuine expectation at this stage that OWM Ltd was to continue in the role as
market operator, there are still questions as to what the VAT treatment of its services
would be and whether this is business/non-business activity, taxable or exempt
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14. The advisor also wanted to consider market participants (and members of OWM Ltd)
own recovery of input tax on Open Water related costs, which will depend on the
specific arrangements in place between the parties.
15. It was recommended as a next step for the advisor to understand what additional
information is available for review to then provide a more detailed analysis, with
comments on the VAT implications and potential options for structuring the
arrangements so as to try and best mitigate VAT costs for all involved parties.
16. It was recommended at the 15 April 2014 OWM Ltd board meeting that OWM Ltd
waits for the pronouncement by ONS regarding public designation before further
reviewing VAT registration.
HMRC VAT Advice
17. As part of the public designation work stream Ofwat preferred to directly liaise with
HMRC using their existing contact to provide reassurance that the VAT treatment for
OWM Ltd was correct and that it would not be possible to register for VAT and
therefore reclaim any VAT on purchases.
18. As OWM Ltd is not a government department the VAT liaison team were unwilling to
provide any advice or confirmation of application of VAT rules and referred Ofwat to
take the query to the normal employers VAT helpline. This is not practical for the
potential scope of the OWM Ltd VAT situation.
The Ofwat VAT Position
19. If OWM Ltd is designated as a public body, and accounts are consolidated with
Ofwat, their VAT position is relevant to the treatment at OWM Ltd.
20. Ofwat recovers VAT on a small proportion of its total spend, estimated to be currently
around 6% of all expenditure. Licence fee income is classified as “non-business”
income delivered by a regulatory obligation under legislation, therefore VAT is not
attributable to annual licence fees invoices.
21. Ofwat is registered for VAT due to Government departments having been
encouraged to contract out services to the private sector which had traditionally been
performed in house. It was recognised that many of these services would be subject
to VAT and where they are acquired for “non-business purposes” the nonrecoverable VAT could act as a disincentive to contracting out. The Treasury decided
to compensate government departments by a direct refund mechanism, which is
provided for in section 41(3) of the VAT Act 1994 (contracting out directive). Under
this provision Ofwat is able to recover VAT on areas of expenditure that include
professional advice or opinion but unable to recover VAT where the scope of work is
classified as an activity i.e. interim staff.
Next Steps
22. Uncertainty remains regarding the requirement for OWM Ltd to register for VAT. Not
only is it advantageous to be registered but the directors have a responsibility to
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ensure registration where the goods or services provided are classified as 'taxable
supplies'.
23. If OWML is unable to recover input VAT it will effectively add 20% to the costs the
industry must bear including most significantly the cost of procuring the market
systems.
24. Direct contact with HMRC through their VAT helpline is not suitable and therefore a
form of external advice is suggested. As the VAT treatment of OWM Ltd affects the
position of members and ultimately customers of the market participants, advice at
an industry level would be advantageous.
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