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Avoiding a VAT trap on employee salaries

Usually, VAT isn’t part of the equation on staff salaries. However, where they work for more than one of your businesses and costs are shared, VAT can come into play. What steps are needed to prevent this?

Employment rule

On the face of it you might easily conclude that VAT ought to be due on the wages you pay your employees because they supply services to your business in exchange for payment and with a view to making a profit, i.e. they’ll get paid more than it costs them to do their job. That sounds like a typical supply for VAT purposes, but UK and EU rules say that services supplied under a contract of employment are “outside the scope of VAT” . Despite this the tax tribunal came to a different conclusion and decided VAT applied.

Shifted workers

The facts in the case of CGI Group (Europe) Limited v The Commissioners for HMRC (CGI v HMRC) were that CGI shared its IT workers with one of its sister companies. It paid the employees’ wages and charged the other company for part of this cost. CGI thought that it wouldn’t have to charge VAT on this because HMRC’s guidance (Notice 700/34) says that where there’s a joint employment, one company can pay the wages and receive reimbursement from another without VAT being involved. That seemed to be the case for CGI, so why did the tribunal rule that VAT was payable?

Contract v facts

CGI and its sister company are big organisations which drew up very extensive agreements regarding the joint arrangements for its employees. Yet with all the expertise they presumably had on hand, they made a simple error. What they had wanted was a joint employment scheme where they shared the cost of the wages etc. But the contracts and actual transactions resulted in an arrangement where CGI recovered part of the employment costs by making a management charge to the other company.

Trap. Even where management charges are designed to do no more than recharge expenses incurred by one company on behalf of another, they’re subject to VAT even if the companies are connected.

Tip. If your company makes management charges to a connected company, you won’t have to charge VAT if you register as a VAT group. But check all the consequences before you sign up for this because where one of the companies makes VAT-exempt supplies, this can affect the right of all companies in the group to reclaim VAT on purchases. That’s why CGI and the joint employer decided not to form a VAT group.

Employment morals

The lesson is that if you’ve decided on a VAT or other tax-saving plan, make sure the corresponding contract reflects exactly the transactions you’ll carry out, otherwise the scheme can be open to attack from HMRC. And on the specific point of sharing employees with a sister company, have an agreement between them which clearly says that employment costs should be shared. And where one company meets the cost initially, the other(s) will reimburse it.

Please give us a call if you would like further information or advice. 

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