An apparently innocuous announcement late last week from the European Commission may lead to yet more VAT problems for charities planning to establish cost-sharing groups (CSGs).

The Chancellor’s autumn statement last November confirmed that the long-awaited VAT cost-sharing exemption would be introduced in the forthcoming Finance Act 2012, but now proceedings commenced by the Commission in respect of the rules on CSGs in Luxembourg appear to have thrown the proposed new UK exemption into doubt.

Under European law, in order to be exempt from VAT the services provided by an independent group to its members must be directly necessary for those members’ non-taxable or exempt activities.  The interpretation of the term ‘directly necessary’ had been the subject of much comment during HMRC’s consultation on the subject last year.  HMRC has confirmed that where more than 85 per cent of a member’s activities are exempt or non-business supplies, the ‘directly necessary’ test will be met.  

CFDG says that it understands from HMRC that the 85 per cent threshold is one of the most liberal interpretations of the exemption across the EU, and that HMRC insists that it is the loosest it can allow from a legal perspective.

EC intervention

Last Thursday, however, the European Commission officially asked Luxembourg to change its rules on VAT in the case of CSGs, because it says Luxembourg's current rules are incompatible with European Union law. 

Under Luxembourg law, the services provided by an independent group to its members are completely free of VAT provided that the members' taxed activities do not exceed 30 per cent of their annual turnover. 

However, the Commission considers that these arrangements infringe the strict rules set out in European Union law, and has now taken action to require Luxembourg to tighten the conditions it applies to CSGs.

Richard Wild (pictured), director of VAT at PKF, told civilsociety.co.uk that HMRC was aware of the Commission having initiated proceedings against Luxembourg.  “Although Luxembourg’s rules are more generous than the UK proposal, it’s obviously a concern that the UK exemption, if implemented as proposed, may now be challenged by the EU,” he said.

“Alternatively, it is possible that the exemption may be implemented by HMRC in a narrower manner, which would be less favourable for charities planning to set up cost-sharing groups.”

Socrates Socratous, director at SOC VAT Consultants, added that Luxembourg has two months to change its rules, otherwise the Commission may refer the matter to the European Court of Justice.