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Flat rate scheme – associated persons

2nd Sep 2016
VAT Consultant
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iStock_Olivier Le Mole_VAT

One of those details of the FRS is that a person is ineligible to join the scheme if he is ‘associated’ with another person. This is provided for in VAT Regulation 55L (d)(iii). And, this is defined in Regulation 55A(2):

a person is associated with another person at any time if that other person makes supplies in the course or furtherance of a business carried on by him, and—

(a)     the business of one is under the dominant influence of the other, or

(b)     the persons are closely bound to one another by financial, economic and organisational links.

One reason for this provision is to prevent a business being split artificially so as to gain an unfair advantage by using the scheme. Having said that, most instances I come across are quite innocent situations.

I found a Tribunal case from 2007 which addressed this situation. HMRC ruled that the taxpayer was never eligible to join the scheme. The decision was taken some 2 years after the taxpayer joined the FRS, and resulted in a re-calculation of the VAT Returns, with over £20,000 assessed.

The Tribunal decision explains the background facts. The Appellant company Welshback Exercise Ltd, leased its premises and gym equipment from WB Clubs Ltd, a company with common Directors. The arrangement between the companies was clearly very close. Para 23 of the decision lists the facts relied on by HMRC when making its decision:

  1. The Appellant was the management company for the gym. WB Clubs Limited owned the assets and the equipment.
  2. WB Clubs Limited leased the gym equipment and the property to the Appellant. WB Clubs Limited had collected no rent and no charges for the property and the equipment from the Appellant. WB Clubs Limited would recoup this income once the Appellant became commercially viable.
  3. WB Clubs Limited collected direct debit membership fees on the Appellant's behalf, which was then repaid to the Appellant, either weekly or monthly, plus a bit extra to help the Appellant with its cash flow and bank balance. The Appellant was unable to set up a direct debit arrangement with its bank, and, therefore, reliant on WB Clubs Limited for this facility.
  4. WB Clubs Limited often bought goods and consumables for the Appellant, posting the expenditure to a loan account with no expectation of repayment.
  5. The entry described as "Downs Running Costs" in the accounts of WB Clubs Ltd for year ending 31 December 2004.

The HMRC Officer actually made the comment that the Appellant company could not function without assistance from WB Clubs Ltd. HMRC therefore held that there were “financial, economic and organisational links” as required by the legislation.

It should be noted that, where HMRC deny or withdraw use of the FRS, an Appeal against the decision will only be successful if HMRC have been unreasonable in reaching their decision. It is not enough that the Tribunal think HMRC’s decision to be wrong. (Although this would not have applied in this case!)

Interestingly, when the taxpayer had first applied to use the FRS, HMRC had expressed some concern as to their eligibility, but taxpayer correspondence had satisfied their concerns. At the time of their decision to withdraw use of the scheme, HMRC re-visited the correspondence, and came to the conclusion that the taxpayer made a ‘false statement’ in relation to the arrangement between the companies. Regulation 55P allows HMRC to withdraw use of the scheme where the taxpayer has made a false statement. As a matter of detail, HMRC did not use this ground to withdraw use of the scheme, but did maintain the ‘associated person’ ground. Although the Tribunal thought the information provided was incomplete, it did not amount to a false statement.

The Tribunal concluded (at para 44):

 “Our findings of fact confirm Mr Hart's conclusion that the Appellant was associated with WB Clubs Limited. The findings establish that there were close organisational links between the companies in that they had the same shareholders with Mr Wells playing a significant strategic role in both companies. The close financial links were evidenced by the financial dependency of the Appellant upon WB Clubs Limited which subsidised the Appellant's activities directly and indirectly by not collecting the rent and leasing charges. WB Clubs Limited also supplied the means (direct debit and credit card facilities) by which the Appellant collected its income. The Appellant had been denied these facilities by its bank. The companies shared close economic links, securing mutual benefits from their association. The financial support of WB Clubs Limited enabled the Appellant to continue in business. The Appellant's assumption of responsibility for the upkeep of the premises and gym equipment preserved the value of assets of WB Clubs Limited and in turn WB Clubs Limited avoided significant maintenance costs.

The Tribunal also noted the absence of documentation evidencing the relationship between the two companies, and the lack of transparency in their dealings. This undermined the taxpayer’s statements that the two companies operated at arms’ length.

The Tribunal concluded that the two companies were ‘closely bound by financial, economic, and organisational links.

The full decision is here:


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