Market Failure?: Can the traditional market survive? - Communities and Local Government Committee Contents

Memorandum by Local Authority National VAT Consultative Committee (MARKETS 28)

By Ian Harris, VAT & Taxation Advice Officer, Leicester City Council

  I refer to the Committee's current enquiry into traditional retail markets and, in particular, the question of what can be done to ensure their survival, something which, I believe from the evidence so far, is agreed to be desirable.

It seems generally agreed by respondents to date that one of the key factors in ensuring the flourishing and survival of traditional retail markets is the need for local authority market operators to invest in their market facilities. The point of this response is to draw the attention of the Committee to a major constraint in VAT law, as interpreted and applied by HMRC to local authorities, that acts as an effective barrier to such investment.

  I am the VAT and Taxation Advice Officer at Leicester City Council—which, incidentally, runs one of the largest markets in the UK—but also a member of the CIPFA VAT Committee, a high level body by which senior local authority VAT practitioners meet quarterly with senior staff from Policy HQ Division of HMRC. For completeness, I am also chair of the Midlands Unitary Authorities VAT and Tax Group and the Leicestershire Local Authorities VAT Group, being thereby a member of the Local Authority National VAT Consultative Group and, ex-officio, of both the Central Counties VAT Liaison Group and the West Midlands Local Authority VAT Group. I would, therefore, claim to bring considerable expertise and experience to this subject in the widest national context.

  The attached paper, completed after some two years of research, was submitted by me to HMRC under the auspices of the CIPFA VAT Committee in September 2007. The paper considers the effective barrier to investment in detail, including a possible resolution thereto. For simplicity, however, the position may be summarised as follows.

  The issue concerns the ability of a local authority to fully recover VAT on expenditure incurred in connection with the operation of its market, both on day-to-day running costs and, more pertinently, on capital investment costs.

  A local authority is permitted to recover, from HMRC, VAT incurred on expenditure in the following three circumstances:

    1. where it is incurred in connection with the making of VATable supplies of goods or services—this is the "normal" VAT position familiar in the private sector;

    2. where it is incurred in connection with the carrying out by a local authority of its statutory public service functions other than by way of business—this is further to a political commitment made by the Government on the introduction of VAT that it would not fall as a burden on the Rates (sic); and

    3. where it is incurred in connection with the making of supplies of goods or services which are exempt from VAT ("VAT-exempt" supplies), providing such "exempt-attributable VAT" incurred is "insignificant"—HMRC interpret this to mean:

    — less than £7,500 per annum, providing this is less than half of all the VAT incurred by the local authority, or

    — less than 5% of all the VAT incurred by the local authority,

    whichever is the greater.

  These latter limits, however, are de-minimis limits resulting in effective "cliff edge" impact where breached; where exempt-attributable VAT incurred by the authority remains below the limit it continues to be fully recoverable but if exempt-attributable VAT incurred by the authority exceeds the limit, all exempt-attributable VAT incurred thereby is then irrecoverable.

  For most local authorities to breach the de-minimis limit is prohibitive in terms of the consequent cost of irrecoverable VAT which would then arise. Consequently all local authorities invest considerable time and effort in managing the position, in particular closely monitoring expenditure—especially capital expenditure —to be incurred in connection with the making of VAT-exempt supplies in order to ensure exempt-attributable VAT remains below the de-minimis limit. And there are examples of local authorities choosing not to pursue desirable projects as the result would be to breach their de-minimis limit.

  In the context of markets, the problem arises because HMRC view the granting of a right to stand a stall in a market as amounting to a licence to occupy land and, as such, exempt from VAT. Accordingly, all VAT incurred by a local authority in connection with its market is exempt-attributable and so counts against its de-minimis limit.

  Whilst VAT on day-to-day running costs of a local authority market are generally containable, it is less likely that VAT on significant capital investment costs at a market can be contained within the authority's de-minimis limit. As a consequence, local authorities have been forced to downgrade, defer over a longer timescale or even cancel altogether desired capital investment works designed to improve their markets in order to ensure that the de-minimis limit is not breached (the attached paper gives examples at Leicester and Northampton).

  HMRC's response to this is that the local authority can exercise what is called an option to tax on its market. This "converts" the erstwhile VAT-exempt licence to occupy land into a VATable supply. Consequently, VAT then incurred on the market—including on capital investment—is fully recoverable as relating to the making of VATable supplies.

  However, opting to tax a market also results in market stall tolls then becoming liable to VAT. Evidence suggests that only a minority of market traders are registered for VAT and thus charging VAT on their stall tolls amounts to an increased cost likely to drive the trader to relocate to an alternative unopted (and so unimproved) market if not to cease trading altogether. Alternatively, if tolls are "pegged", the local authority loses that proportion of income from stall tolls declarable as VAT, currently approximately 13% (15/115ths) which is equally undesirable if indeed financially viable at all.

  Whilst some local authorities have opted their markets as a consequence of desired on unavoidable improvement works being undertaken and the absence of any alternative mitigation strategy, this has invariably been done on the insistence of the finance function and against the opposition of the market manager.

  The solution identified in the attached paper relies on the fact that a local authority undertaking its statutory public service functions other than by way of business may fully recover all associated VAT incurred.

  To be treated as a non-business activity in this context, it is established case-law—including under the jurisprudence of the ECJ—that three criteria must be met:

    1. The activity must be undertaken by a body governed by public law (a "public body")—this is taken as read for a local authority.

    2. The activity must be subject to a special legal regime, ie it must be governed by specific statutory or regulatory powers applicable to a public body but which would not apply to a private sector entity seeking to undertake that activity.

    3. Treatment as non-business must not lead to a significant distortion of competition with the private sector undertaking comparable activities.

  It is submitted in the attached paper that there is a clear special legal regime governing the operation of a market by a local authority. Even if Charters and historic local Acts of Parliament are not accepted to constitute such—and this is arguable—most, if not all, local authority markets are now run under Part III of the Food Act 1984. This refers explicitly to the "market authority", defined in Section 61 to mean any local authority which maintains a market established or acquired under Section 50 or the corresponding provisions of any earlier enactment (eg Section 13 of the Markets and Fairs Clauses Act 1847 or Section 49 of the Food and Drugs Act 1955). And, for the avoidance of doubt, "local authority" is further defined as meaning a district council (including a metropolitan borough or non-metropolitan unitary district council), London borough council or parish or community council.

  It appears clear to the author, therefore (and to most other local authority VAT practitioners), that local authority markets are subject to a special legal regime.

  As to the question of significant distortion of competition, as other respondents have stated in evidence already, there is much to suggest that markets are in fact complementary to other parts of the retail sector and not in competition therewith.

  Certainly in the narrower context of competition for the provision of facilities to trade, it is argued that there cannot possibly be said to be competition between a market trader seeking to stand a market stall and a shopkeeper seeking the lease of a shop unit.

  These submissions put, however, were rejected by HMRC last year. It is the view of most local authority VAT practitioners, however, that HMRC's rejection of the arguments were and are ill-founded and susceptible to challenge. To date, no such challenge has been pursued due to other developments in the local authority VAT field; it is though possible that this situation may be about to change with a number of authorities desirous either of instigating significant capital investment on their markets or securing a retrospective refund of VAT declared on opted markets contemplating litigation.

  The purpose of this submission, therefore, is to apprise the Committee of an effective barrier to much desired investment in local authority markets arising as a result of HMRC's interpretation of VAT law, a interpretation which is nonetheless open to question but which, it seems, will require litigation to resolve.

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