How should a cost sharing group (CSG) be set up for public bodies that wish to share services amongst themselves? For example, Public Body A wishes to share consultancy services with Public Body B, without paying VAT either on secondments or on the services supplied. It wishes to achieve this by means of a CSG (because VAT grouping and joint contracts of employment are neither feasible nor desirable). However, according to HMRC, such a CSG has not yet been successfully implemented by a public body. Why is this? And what are the practical considerations for setting up a CSG in this situation?
Answer
The EC introduced the cost sharing legislation in 2006, to enable groups of exempt or non-business entities to engage in ‘cooperative self-supply’ arrangements without incurring additional VAT. The EU legislation (Council Directive 2006/112/EC article 132(1)(f)) was finally introduced into UK law by FA 2012. The resulting Group 16 of VATA 1994 Sch 9 exempts the supply of services from a CSG to its own members.
Conditions for exemption
To access the exemption (or be mandatorily included in the exemption), the following conditions must be met.
First, there must be an independent group, legally separate from its members. The UK specifies that the CSG should have a distinct legal personality separate from its members, although this is not a requirement in a number of other member states. In practice, the majority of CSGs are companies limited by shares, due to their ability to accommodate different levels of ownership, although any legal form is permitted.
Second, the members (owners) of the CSG must be carrying out exempt or non-business activities. HMRC has introduced a de minimis test of 5%; although in practice, the majority of bodies looking to take advantage of CSGs would be above this threshold.
Third, the services supplied by the CSG to which the exemption applies must be ‘directly necessary’ for use by the members in their own exempt or non-business activity. For organisations where activities are more than 85% exempt or non-business, all costs are deemed to be directly necessary. This easement has been key to enabling true ‘back office’ costs (such as finance, HR, etc.) to be outsourced, because these functions will also support taxable activities. However, similar provisions are being challenged by the European Commission. If the CJEU follows the advocate general’s opinion in Commission v Luxembourg (Case C-274/15), it is probable that the 85% test will be removed, further limiting the opportunity for public sector bodies to take advantage of the exemption.
Fourth, the group claims from its members an exact reimbursement of their share of the joint expenses. This means that the CSG cannot seek to make a profit, although timing differences are acceptable.
Finally, there must be no distortion of competition. As these cooperative arrangements and recharges are at cost, HMRC considers it unlikely that a CSG would ever cause a distortion, because it does not exist or compete in a market. However, care would need to be taken when a CSG is looking to expand in terms of how it attracts new members. Normal procurement procedures, including Official Journal of the EU procedures, would also need to be considered.
Practical difficulties
Why do public bodies and other organisations with charitable activities find it difficult to access the cost sharing exemption? From our experience, it is usually a combination of the following challenges.
Control: Many organisations are keen to share costs but wish to do this by making their services available to others. There is often little appetite for relinquishing control.
Multi-service CSGs: The introduction of the cost sharing exemption led to a number of sector bodies funding feasibility studies, with a view to identifying pilots that could be rolled out as a template for cost sharing across the relevant sector. These often involved sharing multiple major back office functions. The cost of harmonising systems and processes on such a scale would be a complex task with very significant set up costs, whilst the savings for the more efficient members may not be large. As these prospective members withdrew, it became harder to reach the necessary economies of scale.
Restrictions on third party ownership: A key driver for sharing services is to reduce overall costs. To deliver savings, the shared service entity would benefit from being managed by a specialist provider. To maximise the savings, most outsourcers would expect part ownership of the shared services function, which is precluded under the cost sharing legislation. The additional cost of operating on a ‘manager only’ basis affected the overall financial viability.
Investment and risk for early adopters: Many organisations recognise that setting up a CSG takes considerable investment and carries a degree of financial exposure, particularly in respect of ‘joint and several liability’ to any VAT exposure. The founders of such CSGs rightly want to ensure that members joining later will bear some of these costs. However, achieving this can be difficult, in the context of the CSG criteria regarding exact cost reimbursement.
Staff issues: As was alluded to in the question, the key to a CSG delivering VAT savings is to ensure that its cost base is largely non-VATable. This often necessitates a transfer of staff into the CSG, unless one of the members owns a controlling share of the CSG and can form a VAT group, or if one of the other staffing reliefs is available. This creates issues in terms of TUPE and pensions.
Public bodies such as local authorities and the NHS benefit from more favourable VAT regimes than education providers, housing associations and charities. This limits the benefits to be gained from the cost sharing exemption and, in particular, has made it difficult to meet the 85% easement under the ‘directly necessary’ test. Combined with some of the practical difficulties highlighted above, this has resulted in low levels of interest. While there are numerous examples of cost sharing being used by education institutions, housing associations and charities, these tend to be smaller scale and involve just a few institutions sharing a single service. It has not been utilised by a large group that is sharing multiple office functions, as some had hoped may be achievable when the legislation was first introduced.
How should a cost sharing group (CSG) be set up for public bodies that wish to share services amongst themselves? For example, Public Body A wishes to share consultancy services with Public Body B, without paying VAT either on secondments or on the services supplied. It wishes to achieve this by means of a CSG (because VAT grouping and joint contracts of employment are neither feasible nor desirable). However, according to HMRC, such a CSG has not yet been successfully implemented by a public body. Why is this? And what are the practical considerations for setting up a CSG in this situation?
Answer
The EC introduced the cost sharing legislation in 2006, to enable groups of exempt or non-business entities to engage in ‘cooperative self-supply’ arrangements without incurring additional VAT. The EU legislation (Council Directive 2006/112/EC article 132(1)(f)) was finally introduced into UK law by FA 2012. The resulting Group 16 of VATA 1994 Sch 9 exempts the supply of services from a CSG to its own members.
Conditions for exemption
To access the exemption (or be mandatorily included in the exemption), the following conditions must be met.
First, there must be an independent group, legally separate from its members. The UK specifies that the CSG should have a distinct legal personality separate from its members, although this is not a requirement in a number of other member states. In practice, the majority of CSGs are companies limited by shares, due to their ability to accommodate different levels of ownership, although any legal form is permitted.
Second, the members (owners) of the CSG must be carrying out exempt or non-business activities. HMRC has introduced a de minimis test of 5%; although in practice, the majority of bodies looking to take advantage of CSGs would be above this threshold.
Third, the services supplied by the CSG to which the exemption applies must be ‘directly necessary’ for use by the members in their own exempt or non-business activity. For organisations where activities are more than 85% exempt or non-business, all costs are deemed to be directly necessary. This easement has been key to enabling true ‘back office’ costs (such as finance, HR, etc.) to be outsourced, because these functions will also support taxable activities. However, similar provisions are being challenged by the European Commission. If the CJEU follows the advocate general’s opinion in Commission v Luxembourg (Case C-274/15), it is probable that the 85% test will be removed, further limiting the opportunity for public sector bodies to take advantage of the exemption.
Fourth, the group claims from its members an exact reimbursement of their share of the joint expenses. This means that the CSG cannot seek to make a profit, although timing differences are acceptable.
Finally, there must be no distortion of competition. As these cooperative arrangements and recharges are at cost, HMRC considers it unlikely that a CSG would ever cause a distortion, because it does not exist or compete in a market. However, care would need to be taken when a CSG is looking to expand in terms of how it attracts new members. Normal procurement procedures, including Official Journal of the EU procedures, would also need to be considered.
Practical difficulties
Why do public bodies and other organisations with charitable activities find it difficult to access the cost sharing exemption? From our experience, it is usually a combination of the following challenges.
Control: Many organisations are keen to share costs but wish to do this by making their services available to others. There is often little appetite for relinquishing control.
Multi-service CSGs: The introduction of the cost sharing exemption led to a number of sector bodies funding feasibility studies, with a view to identifying pilots that could be rolled out as a template for cost sharing across the relevant sector. These often involved sharing multiple major back office functions. The cost of harmonising systems and processes on such a scale would be a complex task with very significant set up costs, whilst the savings for the more efficient members may not be large. As these prospective members withdrew, it became harder to reach the necessary economies of scale.
Restrictions on third party ownership: A key driver for sharing services is to reduce overall costs. To deliver savings, the shared service entity would benefit from being managed by a specialist provider. To maximise the savings, most outsourcers would expect part ownership of the shared services function, which is precluded under the cost sharing legislation. The additional cost of operating on a ‘manager only’ basis affected the overall financial viability.
Investment and risk for early adopters: Many organisations recognise that setting up a CSG takes considerable investment and carries a degree of financial exposure, particularly in respect of ‘joint and several liability’ to any VAT exposure. The founders of such CSGs rightly want to ensure that members joining later will bear some of these costs. However, achieving this can be difficult, in the context of the CSG criteria regarding exact cost reimbursement.
Staff issues: As was alluded to in the question, the key to a CSG delivering VAT savings is to ensure that its cost base is largely non-VATable. This often necessitates a transfer of staff into the CSG, unless one of the members owns a controlling share of the CSG and can form a VAT group, or if one of the other staffing reliefs is available. This creates issues in terms of TUPE and pensions.
Public bodies such as local authorities and the NHS benefit from more favourable VAT regimes than education providers, housing associations and charities. This limits the benefits to be gained from the cost sharing exemption and, in particular, has made it difficult to meet the 85% easement under the ‘directly necessary’ test. Combined with some of the practical difficulties highlighted above, this has resulted in low levels of interest. While there are numerous examples of cost sharing being used by education institutions, housing associations and charities, these tend to be smaller scale and involve just a few institutions sharing a single service. It has not been utilised by a large group that is sharing multiple office functions, as some had hoped may be achievable when the legislation was first introduced.
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