The proceedings concerned the UK’s value added tax (VAT) treatment for certain terminal markets, with the decision falling in the EC’s favour. This article looks at the existing VAT regime for terminal markets, its importance for precious metals markets and what the CJEU decision means.
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1. Terminal Markets Order
What is the existing VAT framework?
The original Value Added Tax (Terminal Markets) Order (TMO) was published in 1973 to classify certain commodities exchanges as “terminal markets”. The TMO means certain transactions between members of these terminal markets can be zero-rated for VAT purposes.
In the UK, supplies of goods or services can be subject to VAT in three ways:
- Standard-rated VAT at 20%;
- Zero-rated VAT at 0%;
- Exempt from VAT.
Under the TMO, supplies between terminal markets’ members are subject to 0% VAT. This differs from being exempt from VAT as zero-rated supplies are still taxable. However, input tax can be reclaimed by the supplier and no output tax is payable for zero-rated supplies. Alternatively, VAT exempt supplies are not considered taxable supplies therefore input tax cannot be deducted or reclaimed.
What is the purpose of the TMO?
Since its publication in 1973, the TMO sets out a simplified system of controls to reduce the VAT administrative burden for certain terminal markets in order to maintain their competitiveness, particularly with regard to non-EU markets. Aside from precious metals, other terminal markets include the London Metal Exchange, the London Coffee Terminal Market and the London Sugar Terminal Market.
How were precious metals markets included in the TMO?
- 1973: The original TMO listed the London Silver Market as a terminal market.
- 1980: The Value Added Tax (Terminal Markets) (Amendment) Order 1980 added the London Gold Market as a terminal Market.
- 1987: The Value Added Tax (Terminal Markets) (Amendment) Order 1987 added the London Platinum and Palladium Market as a terminal market.
- 1999: The outdated references to the London Silver Market and the London Gold Market were updated by the Value Added Tax (Terminal Markets) Order 1999 which renamed the former Markets to the London Bullion Market.
What does the TMO mean for the precious metals markets?
VAT treatment for investment gold is EU-wide: the EU’s 2006 VAT Directive (2006/112/EC) authorises members to “suspend” the taxation of investment gold, meaning it is equivalent to zero-rating (rather than an exemption) under the TMO framework.
For all other transactions, the Memorandum of Understanding (MoU) between LBMA, LPPM and HMRC sets out how each precious metal is treated depending on the type of trade and between whom the trade is made. As per the MoU, the TMO is currently applied to the following types of trades between members:
- Spot or forward sales of unallocated & allocated silver, platinum and palladium;
- Futures contracts of unallocated and allocated silver, platinum and palladium;
- Option contracts over physical Silver, Platinum and Palladium (premium charges);
- Exchange traded funds (ETFs), where the custodian of the metal is an LBMA/LPPM member;
- Metal overdrafts.
Zero-rating is applied to transactions where the metal remains in the custody of a member, meaning it is important to understand when “physical delivery” occurs for VAT purposes. For example, if metal moves between member vaults, the metal remains within the member’s custody therefore this does not represent physical delivery for VAT purposes. Only when metal leaves the custody of a member and the non-member takes custody, or it leaves the UK, the transaction would be considered physically delivered and no longer zero-rated for VAT.
2. Infraction Proceedings Against the UK
What are infraction proceedings?
Under the Treaty on the Functioning of the European Union (TFEU), the EC can begin infraction proceedings if it “considers that a Member State has failed to fulfil an obligation under the Treaties”.
What prompted the proceedings?
The EU’s 1977 VAT Directive (77/388/EEC) allows Member States to relax their application of certain EU VAT legislation in order to operate its own taxation framework for terminal markets, whilst maintaining respect for single market rules.
Under the 1977 VAT Directive, any proposed extensions to Member States’ VAT regimes must be put to the EC and the European Council to decide whether to permit the extension. This approval process was established because, without the relevant EU permissions, amendments to Member States’ VAT regimes could fragment the EU’s shared VAT system and could potentially create an unfair advantage to a Member States’ VAT treatment of certain terminal markets. This approval process was then transposed into the 2006 VAT Directive.
In March 2018, the EC issued a notice to commence proceedings against the UK for its VAT treatment of “certain commodity derivatives”. The EC believed the UK had not complied with the 2006 VAT Directive and had not respected single market rules. The EC argued that the UK had broadened the scope of the TMO without permission which in turn created “major distortions of competition to the detriment of other financial markets within the EU”. In January 2019, the EC announced that the matter had been referred to the CJEU.
When did the UK allegedly broaden the scope of the TMO without permission?
In a letter to the EC on 23 December 1977, the UK notified the EC of a number of special measures relating to “futures contracts” traded on the 11 terminal markets listed in the TMO. These had been in force from January 1977, before the 1997 VAT Directive was introduced in May that year.
These special measures meant that “transactions on the 11 “futures” markets involving defined market members” were zero-rated for VAT purposes. The letter clarified that this particular zero-rating extended “only to “futures” transactions on a commodity which involves a member of the relevant market and agency charges by market members in connection with these transactions”. Normal VAT rules would apply if “a “futures” contract runs to maturity and delivery of the goods takes place where a non-market member is involved the supply of both the goods and any agency service by a market member.”
The measures set out in the notification were then accepted by the EC and the Council. The EU then introduced the 2006 VAT Directive. Following the implementation of this legislation, the EC believed that the amendments made since the 1977 notification constituted “new ‘special measures for derogation’ … since they extend the scope of the derogation resulting from the notification made in 1977”.
What did the EC argue in the proceedings?
The EC believed that any addition to the list of terminal markets in the original TMO (as amended by the Value Added Tax (Terminal Markets) (Amendment) Order 1975) “must be considered to be a substantial amendment giving rise to an obligation to give notification”.
The EC therefore claimed the TMO “had been extended, in particular, when, in 1981 and 1987 respectively, the International Petroleum Exchange of London and the London Platinum and Palladium Market were added to that list” with both terminal markets remaining in the TMO’s scope today.
The EC also highlighted the temporary inclusion of ICE Futures and APX Power as terminal markets. These markets covered natural gas, electricity and carbon emission allowances (from 1997, 2004 and 2005 respectively). The EC stated that these additions “were capable of having an effect that was more than merely negligible on the overall amount of UK tax revenue collected at the stage of final consumption.”
The EC argued that the 1977 notification letter “specifically covered transactions carried out on the 11 commodity futures markets … whereas the contested measures not only removed certain transactions covered by those measures but also added a series of transactions.” The EC concluded that such additions went beyond the scope of measures notified in the 1977 letter and the justifications provided at the time therefore required the approvals set out in the 2006 VAT Directive.
What did the UK argue in the proceedings?
The UK argued that its 1977 notification letter covered “a specific type of commodities market on which futures contracts were traded (as well as options and some spot transactions between members of those markets) and that the special measures notified applied exhaustively to all of the 11 commodity futures markets operated in the United Kingdom at the time.” The UK highlighted that the amendments contested in these infraction proceedings were put in place only to ensure “transactions of the same type as those identified in 1977 [would] be treated in the same way” as those already in place in 1977.
The UK believed “it was not required to make a fresh notification” to the EC as the amendments were “substantially the same” as those included in its notification letter. As the amendments were put in place to “simplify the VAT treatment of all transactions on UK terminal markets, as long as they fulfilled the substantive conditions set out in the original notification, and to avoid market distortion”, the UK did not believe it had to notify the EC of the contested amendments. This was because the importance of the simplification measures did “does not differ depending on what commodity is being traded.”
What did the CJEU decide on 14 May?
The CJEU found that, by broadening the TMO’s scope to include several terminal markets not included in the original TMO (as amended in 1975), the UK had breached its obligation to only make such changes with the Council’s approval under the 2006 VAT Directive.
The judgement highlighted that, since the 1977 notification letter, the UK had “not only removed certain transactions covered by those measures … but also added a series of transactions”. In the judgement, the EC is referenced as “not taking issue with mere changes of name”. Instead, its complaints concerned “only the markets and exchanges added to the list of terminal markets covered by the 1973 Order, as amended, which were still trading.”
In its conclusion, the CJEU noted that “the obligation to give notification at issue does not in any way prejudge whether or not the Council will adopt a positive position in any future decision it may issue”. It went on to state that therefore the UK’s “line of argument in which it alleges that the markets and exchanges affected by the contested amendments will be prejudiced if they are not subject to zero-rating” is ineffective. This suggests the CJEU is providing the UK with a chance to retroactively obtain the necessary approvals for the changes made to the TMO post-1977.
The decision has been published here.
3. Potential implications for LBMA/LPPM Members
What is the effect of these infraction proceedings?
In a recent statement, HM Treasury (HMT) have stated they are “reviewing the decision of the Court and will provide further details on next steps in due course.” HMT have confirmed that past and current trading activity under the TMO is not affected by the proceedings and UK tax law stands “while the UK considers next steps in the light of the ruling.” Members should therefore continue “business as usual”.
It is worth highlighting that the case primarily concerns the UK’s failure to notify the EU on amendments made following 1977 to the markets listed in the TMO and the kind of transactions traded between members of the market.
Additionally, as the 2006 VAT Directive governs the treatment for investment gold, the TMO applies only to certain transactions involving silver, platinum, palladium and non-investment gold between LBMA and LPPM members under the TMO’s provisions.
What would be the effect of the TMO’s withdrawal?
If LBMA and LPPM were no longer considered terminal markets under the TMO, the precious metals market may face significant risk. The standard rating of VAT between LBMA/LPPM members could potentially create additional VAT costs, to the business itself and to customers. There may also be a significant impact on cash flow in order to cover the delay between payments and the associated refund from HMRC.
Members have also highlighted that creating additional VAT in supply chains involving precious metals could increase the risk of VAT Missing Trader fraud, which is currently mitigated by the zero-rating arrangements under the TMO.
How does this decision fit in with Brexit?
Following the UK’s exit on the UK, the UK will be under no obligation to comply with the CJEU decision nor the single market rules of the EU. However, in its decision, the CJEU noted that EU law continues to apply in the UK until the end of the transition period, in accordance with the Withdrawal Agreement, unless it is extended.
Can the UK Government challenge this decision?
The appeals process does not apply to proceedings of this kind. Instead, the EC must write to the UK to set out requirements for compliance with the CJEU decision. The UK must then take action to comply with the judgment, according to standard EU procedure. HMT will then determine the best course of action, which may involve submitting a notification of amendments, reviewing the TMO for possible amendments, or taking no action. HMT will likely establish a consultation process and will involve industry bodies. If the UK takes no action, the EC can refer the UK back to the CJEU, at which point financial penalties may apply.
What is LBMA doing to help?
LBMA is working with industry experts and HMT to determine next steps in accordance with the CJEU decision and clarify any potential implications on the precious metals markets.
LBMA has also agreed to participate in any consultation process with HMT following the amendment requirements being provided by the EC. LBMA will also be working with its Committees and Working Groups to analyse the risks associated with this decision in preparation for engagement in the consultation process.
If you have any questions or would more information on the MoU, please contact Ed.Blight@lbma.org.uk.