Potential challenges to cost sharing exemption arrangements

During a recent meeting, HMRC raised concerns around the application of the cost sharing exemption. In particular they were concerned about arrangements where a cost sharing group (CSG) forms a VAT group with one of its members, and that VAT grouped member makes a recharge to the CSG. We believe that most cost sharing within the housing sector, or indeed, across all sectors, follows this same arrangement.

In light of this, it is our view that housing associations involved in cost sharing arrangements should ensure that they understand the arrangements in detail.

What is cost sharing exemption?

The exemption applies when two or more organisations with exempt and/or non-business activities join together to purchase services on a cooperative basis. In doing so, they form a separate entity – a cost sharing group – to supply themselves with qualifying services at cost. This ensures that an undertaking that legitimately purchases services to make supplies under one of the social exemptions is not burdened with additional VAT because it cannot purchase such services entirely on its own.

The CSG is a separate taxable person from its members and is therefore able to make supplies for VAT purposes to them. These supplies will be exempt from VAT if the relevant conditions are met.

The conditions

UK legislation (VAT Act 1994, Schedule 9, Group 16) states that the supply of services by an independent group of persons is exempt where each of the following conditions are satisfied:

1. Each of those persons is a person who is carrying on an activity (‘the relevant activity’) which is exempt from VAT or is not carried out in the course or furtherance of a business.
2. The supply of services is made for the purpose of rendering the members of the group the services directly necessary for the exercise of the relevant activity.
3. The group merely claims from its members’ exact reimbursement of their share of the joint expenses.
4. The exemption of the supply is not likely to cause distortion of competition.

There are essentially two fundamental requirements that must be met in order to qualify for exemption:

• The CSG must consist only of operators carrying out an activity which is exempt from, or not subject to, VAT.
• The group must not exist for purposes of gain, and must only charge its members for expenses incurred by it in order to meet their requirements.

The cost sharing exemption does not therefore cover all shared service arrangements.

Summary of HMRC’s challenge

During our meeting with HMRC Policy, HMRC explained that in order for the cost sharing exemption to apply, all conditions set out above must be met and the CSG must be able to clearly demonstrate that the charges made to it by any entities it is VAT grouped with are an “exact reimbursement” of the costs incurred of the service the CSG requires. HMRC are concerned that “profit” is being extracted from the CSG via intra group recharges.

We explained to HMRC that this can usually be evidenced through the underlying legal agreements or the supporting calculation. Most agreements state that any recharges made to CSG, to help it deliver its services to members, should be at cost, and the calculations are usually sufficiently detailed to be able to evidence that there is no element of uplift/profit.

However, HMRC stated that the issue was potentially greater than simply demonstrating a cost only recharge. They expressed that even if the condition regarding “exact reimbursement” of the costs can be met, it is HMRC’s view that where the CSG forms a VAT group with its members, this could lead to a distortion of competition where any recharges relating to staff are present. 

This is because HMRC consider that there is a “double VAT advantage” as the CSG benefits from “two sets of grouping rules”. The rational being that if the CSG purchased staff or the services of those staff from a third party then it would incur VAT, which would in turn be a cost to the CSG. Interestingly, HMRC also commented HMRC policy has never approved a structure involving a CSG in a VAT group where intra-VAT group recharges are made.

The views and approach of HMRC could be seen as contradictory to their existing guidance and we do not believe that they reflect HMRC’s approach when the exemption was introduced. We disagree that there is a double tax advantage by using such structures and housing associations should start preparing for further HMRC activity.

Our recommended next steps:

• Locate guidance or presentations that were used in 2012/13 when legislation was introduced, and again in 2018/19 when HMRC confirmed that they would continue to allow the sector to utilise the cost sharing exemption regarding VAT grouping.
• Review any historical correspondence and rulings HMRC may have issued regarding the structure.
• Engage with the sector to collate evidence regarding contractual terms and conditions that preclude any form of uplift/profit, and recharges as well as supporting recharge calculations that evidence this.
• If the CSG is part of a VAT group housing associations should review the recharge model, and if you are considering becoming involved in CSG housing associations, consider the above areas of HMRC’s challenge.

Should you have any questions on the matter then please contact us.

RSM is a leading provider of audit, tax and consulting services, with around 3,800 partners and staff in the UK. We're working with our tax advisors RSM to help shape government policy on taxation as it affects the sector and to keep housing associations informed of key issues.