Feature / Clear road ahead?

NHS bodies recover the VAT they are eligible to reclaim from HM Revenue and Customs (HMRC) through the VAT return. The NHS can recover two types of VAT. First, there is input tax – the VAT relating to their taxable business activities. And second, there is contracted-out services VAT – an amount equal to the VAT incurred on purchases used for their non-business activities (the statutory provision of healthcare). It is this second area – the contracted-out services VAT – that has come under scrutiny from HMRC.

There was a time when the VAT treatment of lease cars was straightforward. The NHS provided cars to employees in one of three ways:

1. Net pay deduction: output tax was chargeable on the net pay deduction
2. Gross pay deduction (or salary sacrifice): no output tax was chargeable
3. A combination of net pay and gross pay deductions with VAT being charged on the net pay deduction, but not on the gross pay deduction.

NHS bodies normally recovered the VAT they incurred on the lease cars, whether the car had been provided via a net pay deduction or a gross pay deduction. They did this under the contracted-out services refund scheme. Although this was not technically correct for the net pay deduction (a proportion of the VAT should have been recovered as input tax), HMRC recognised that there was no loss of revenue to the Treasury and did not challenge the VAT accounting process.

Then everything changed. The Court of Justice of the European Union (CJEU) ruled in a case involving Astra Zeneca UK (Case C-40/09) that VAT was chargeable on vouchers provided to employees under a salary sacrifice arrangement where input VAT had been reclaimed on the purchase of the vouchers concerned. The ruling in the case has had a significant impact on the NHS, especially in relation to lease cars, which previously enjoyed full VAT recovery under the contracted-out services refund scheme and upon which no output tax was charged.

In its decision, the CJEU held that, as Astra Zeneca sought to reclaim the VAT charged to it (on retail vouchers that were provided to staff under a salary sacrifice scheme) then output tax must be paid to HMRC. Therefore, if an NHS body provides goods (or services) to an employee through a salary sacrifice scheme output tax must be charged where it is due.

Although the position is clear for schemes involving car parking (standard-rated), or nursery vouchers (exempt), the position in relation to cars is not.

HMRC has concluded that the VAT accounting position mentioned earlier (full contracted-out services VAT recovery, output tax on net pay deductions, no output tax on gross pay deductions) can no longer be applied and a new way is required.

A point to note at this time is that where an NHS body provides a car to an employee at or above cost then output tax is due on the full amount paid by the employee and the VAT incurred on the lease of the car is eligible for recovery as input tax. Contrast this with the position where, to reflect expected use of the car for NHS activities, the NHS body bears some of the cost of the lease and charges the employee an amount that is below cost.

To explain the impact on the NHS, we first need to consider the legislation that is already in place covering services outside the contracted-out services regime.

1. VAT (cars) order (SI 1922/3122) This statutory instrument (SI) effectively states that where an employer provides a car below cost to an employee, no VAT is chargeable to the employee. However, where a car is provided at or above cost VAT is chargeable in full.
2. VAT (input tax) order 1992 (SI 1992/3222) This SI, commonly known as the ‘blocking order’, effectively states that where the car is provided below cost, then the input tax is blocked from recovery (currently 50% of the lease cost), and the residue is then recoverable in proportion to the taxable activities of the employer.
3. VAT (treatment of transactions) order 1992 (SI1992/630) This SI covers the situation where an employee is given the option of receiving:
   a) A particular rate of wages, salary or emoluments, or
   b) A lower rate of wages, salary or emoluments and, in addition, the right to the private use of a motor car provided by the employer.

The SI directs that where the employee chooses option b the provision to the employee of the right to use the motor car privately shall be treated as neither a supply of goods nor a supply of services. And VAT cannot be charged if there is not a supply. 

SI 1992/630 deals with the treatment of ‘salary sacrifice’ and makes it clear that salary sacrificed is not a ‘consideration’ for VAT purposes, while SI1992/3122 covers the treatment of cars made available to employees more generally.

Following the decision in Astra Zeneca, HMRC released two briefs. Brief 28/11 stated that ‘HMRC will not require output tax to be accounted for on taxable benefits provided under salary sacrifice schemes, until 1 January 2012.’ In an annexe it added: ‘Most businesses are prevented from recovering VAT in full on the purchase and leasing of company motor cars. The input tax block on cars (100% on purchases and 50% on leasing) means that employers do not account for output tax when cars are made available to employees. Where VAT recovery is restricted and output VAT is not due the judgment has no direct impact.’

As NHS bodies were able to recover the VAT they incur under the contracted-out services refund scheme, the input tax block on cars did not apply. The risk was that following Astra Zeneca, NHS bodies would have to charge VAT to all employees, where there was a deduction from gross salary.

Ultimately, HMRC recognised that in requiring output tax to be charged from 1 January 2012 there would be a conflict with some of the contractual positions and as a result some parties would be detrimentally affected.

In response, it released HMRC brief 36/11, where the stance was softened so that output tax would only become due on 1 January 2012 where the contract had been entered into on, or after, 28 July 2011. For contracts entered into prior to 28 July 2011 output tax would only become due where one of the timing conditions were met:

1. The date that a fixed term agreement expires or the fixed number of salary sacrifice payments specified within the agreement are completed (if the agreement expires before 1 January 2012 any agreement subsequently entered into should follow the VAT treatment described in section 3 below); or
2. The date of an employee’s annual salary/benefits review. HMRC will regard any salary sacrifice arrangements put in place after that date as a new agreement for VAT purposes which should follow the treatment described in section 3 below. This will be the case even if the employee continues to receive the same taxable benefits as before the review; or
3. The date of any other review or renegotiation that leads to a change in the provision of benefits under a salary sacrifice agreement or to a change in an employment contract. 

The ‘blocking provision’ that applies to commercial companies is worth further examination. If a company leases a car and provides it to an employee who is permitted to use it for private purposes, it can only recover 50% of the input tax on the lease rentals. Any exempt use of the vehicle (where the employee uses the vehicle in the course of the employer’s exempt business) will further reduce the amount of input tax eligible for recovery.

As the majority of NHS lease cars are made available for private use, this is an issue, one which is difficult to get around, and which could effectively mean:

1. Where an NHS body charges an employee for a lease car and that charge is below cost, no output tax is due as per SI1992/3122.
2. If no output tax is charged, a block on the input tax has to be made to reflect the private use of the vehicle.
3. This would mean a 50% block on the input tax by every NHS body.
4. The residual 50% would then have to be applied to the taxable activities of the NHS body to determine the input tax due.
5. This would result in the majority of NHS bodies receiving approximately 1% of the VAT it incurs on lease cars as a refund.

Arguably, any non-business use of the vehicle (where the employee uses the vehicle in the course of the employer’s non-business activities) must be assessed before the blocking provisions are applied. This means that a three step calculation would be required:

1. Apportion the VAT incurred between business and non-business use, recovering the non-business element under contracted-out services.
2. Restrict 50% of the residue for private use.
3. Apply the residue (amount left after applying the 50% block) to the taxable percentage.

Given the confusion and the different approaches by different NHS bodies, the HFMA VAT Committee has attempted to identify different options to arrive at a common way forward, which could be discussed with HMRC. Please note, options 2 and 3 below only apply to vehicles that are provided below cost.

Option 1

Trusts could argue that as the VAT (treatment of transactions) order 1992 is still in force, any deductions made under salary sacrifice for cars are outside the scope of VAT. Therefore, the VAT incurred is not input tax and providing the supply is an eligible contracted-out service, the VAT is recoverable in full.

This argument would allow NHS bodies to recover the VAT incurred on all leased and maintained cars (an eligible vehicle) provided to employees in salary sacrifice schemes under the contracted-out services refund scheme. HMRC has confirmed it would robustly challenge this treatment.

The HFMA VAT Committee did not favour this option.


Option 2

Each vehicle could be considered in its own right, with the three-step VAT recovery procedure noted above applied in each case. This would require the NHS body to maintain a register of cars and assess each car separately. It would need to consider an estimated usage at the outset and then review this annually to obtain the actual use and pay back or recover the VAT difference as necessary.

The HFMA VAT Committee did not favour this option due to the administrative burden and the high risk of getting it wrong.  The NHS body may have to complete a calculation based on the expected use of the vehicle and then, later on, carry out another exercise on the actual use, paying back or recovering the difference (unless a fleet sampling option was available).


Option 3

Option 3 is for all NHS bodies to be able to recover 70% of the VAT incurred on eligible cars under the contracted-out services refund scheme and 30% of the VAT on those cars to be disregarded. This would cover cases where the NHS body supplies to its employees cars under either salary sacrifice or net pay deduction (or a combination of the two).

The following points should be noted:

1. No output tax would be due on the payroll deductions, whether from gross pay or net pay.
2. Output tax will be due on vehicles provided above cost. Input tax will be recoverable in full on these vehicles.
3. The cost of the vehicle will be the amount charged by the leasing company.
4. The amount paid by the employee will be the total of:
   a) The charge for the vehicle (through net or gross pay deduction) and
   b)Any administration charge applied.
   However, it will not include items that are paid for separately by the NHS body, such as insurance and road fund licence, even where these are charged to the employee.
5. Any share of savings, such as the NHS body sharing its employer’s national insurance savings with the employee to reduce the cost of the car, will be disregarded when calculating the amount paid by the employee.

It is expected that only an employee that is an essential user or a regular user would be able to receive a car below cost as it is expected that NHS bodies will recoup the cost of the vehicle in full where there is no NHS business use. In contrast, the NHS body will bear some of the cost of the car where it expects it to be used for NHS business use.

An employee who uses a vehicle for NHS use irregularly would be expected to be recompensed through mileage rates in place.

The risk for the NHS body is that more than 70% of the time the vehicles are used by staff could be on NHS non-business activities. 

Richard Sharp is an HFMA VAT Committee member and CIMA council representative on the Treasury/Revenue and Customs joint VAT consultative committee. Technical input to this article was provided by Steven Rourke, Deloitte, and David Webb and Karen Pittis, HMRC (Policy)