Which comes first? This is the question that faced the Upper Tribunal in respect of the time of supply and VAT grouping rules in Prudential Assurance Company.

Silverfleet Capital Ltd (SCL) had supplied investment management services to The Prudential Assurance Company Ltd (Prudential) while the two companies were members of the same VAT group of which Prudential was the representative member. Prudential had agreed to pay a management fee and a performance fee if certain benchmarks had been met. SCL then left the VAT group following a management buy-out and the parties agreed that only the performance fee would remain payable if the relevant conditions were met. This happened around 7 years later and SCL invoiced Prudential a total of around £9 million plus VAT at the standard rate of 20%.

But was VAT actually due on the performance fee?

Broadly, Prudential argued that, because, in the real world, the management services were supplied while SCL was a member of Prudential’s VAT group, they should be disregarded under section 43 of the Value Added Tax Act 1994. In contrast, HMRC’s view was that, in the VAT world, the supplies must be treated as made after SCL left the VAT group pursuant to the time of supply rules in Regulation 90 of the Value Added Tax Regulations 1995, so they can’t be disregarded under section 43 and VAT is due.

And this is where chicken and eggs come in… As per the Upper Tribunal: “The question of whether the VAT liability on the performance fees is determined by Regulation 90 or by section 43 might at times resemble a choice between the chicken and the egg. Certainly the FTT’s highly discursive analysis indicates some difficulty in coming to a conclusion as to “which came first”.”

At first instance, the FTT had concluded that it was bound to find that the grouping rules took precedence, thus deciding the case in favour of the taxpayer. It concluded that, based on Regulation 90, the supply must be treated as having occurred after SCL had left Prudential’s VAT group. But, given an earlier Court of Appeal decision in the case of B J Rice, that was not the end of the matter. In B J Rice, the taxpayer had supplied certain consultancy services at a time when they were not required to register for VAT, but the services were paid for several years later after they had become registered. HMRC argued that, under the time of supply rules, the services had to be treated as supplied on that later date and, consequently, the services were taxable. The Court of Appeal disagreed by a two to one majority on the basis that the time of supply rules where administrative provisions which pre-suppose the existence of a VAT liability. According to Lord Justice Ward, “The fictions for determining the time of supply for accounting purposes do not…govern the ordinary meaning of the language in [the charging provisions] which make supply by a taxable person a prerequisite of liability.” As the supplier was not a taxable person when the supply was made in the real world, there could be no VAT liability.

The FTT in Prudential Assurance Company considered itself bound by the Court of Appeal’s decision in B J Rice to decide that the application of the time of supply rules could not make services actually rendered between two companies while they were members of the same VAT group taxable.

The Upper Tribunal took the opposite view; it decided the case in favour of HMRC, concluding that, as a matter of statutory construction, the time of supply rules come first and they provide that the time of supply of the services for which the performance fees were paid was when they were invoiced or paid. As the parties were no longer in a VAT group at that time, VAT was due. The UT then considered whether there was anything in the relevant case law requiring modification of this construction and concluded there is not. Unsurprisingly, a key difference in the FTT’s and the Upper Tribunal’s reasoning relates to their assessment of B J Rice. The Upper Tribunal considered that B J Rice could be distinguished; the case is authority for the proposition that “the time of supply rules did not fix the time for determining whether a person was a taxable person for VAT purposes.” But it did not determine the interaction between the time of supply rules and the assumptions and disregards applicable to supplies between members of a VAT group.

Consequently, the Upper Tribunal considered that the question before it was really whether the underlying principle of B J Rice (that the time of supply rules are mere administrative provisions which bite only where the actual supply made in the real world was taxable) should be extended to the Prudential Assurance Company scenario. It considered that Thorn Materials, another earlier case which was similar but not directly on point, was authority for the proposition that the time of supply rules had to be applied before the grouping rules. The Upper Tribunal also made more of Lord Hoffmann’s criticism of the decision in B J Rice. In his dissenting judgment in Thorn Materials, Lord Hoffmann expressed unease at the use of “some kind of meta-rules, derived from fairness, common sense and other such concepts lodged in the judicial bosom… The time of supply rules are in my view the only criteria for deciding whether the transaction is to be treated as having occurred at a time when it was taxable.”

This criticism echoes the dissenting judgment in B J Rice itself. Sir Ralph Gibson considered that the perceived injustice or absurdity of the time of supply rules effectively turning something that both parties had thought to be a supply outside the scope of VAT into a taxable one “does not seem to me to be of such an order that the court should depart from what appears to me to be the plain meaning” of the relevant provisions. In fact, as I read it, an important driver for the majority decision in B J Rice was the perceived unfairness of the situation. Lord Justice Ward considered that, if the HMRC had been right and VAT was due, it was unlikely that the supplier could have on-charged it; so the supplier would have had to bear an additional unexpected economic cost that arose through no fault of their own, but merely because of the recipient’s late payment – and the recipient (if it was registered for VAT and had received the services in the course of their business) could have received a windfall benefit through additional input tax recovery.

In contrast, in Prudential Assurance Company, the supplier was able to on-charge the VAT and both parties were aware that the performance fee would be paid only after SCL had left the VAT group. In this way, the Prudential Assurance Company scenario would not seem to display the same level of unfairness that appears to have swayed the majority in B J Rice. So, the Upper Tribunal’s refusal to extend the principle in B J Rice to the Prudential Assurance Company scenario might be seen as more in line with the rationale of that case than the FTT’s decision to apply it, and it is also in keeping with the notes of caution sounded by Sir Ralph Gibson in the case itself and Lord Hoffmann Thorn Materials.