The application of GST to tripartite agreements is complex. The position in the UK is no different. If anything, more so.
The recent decision of the UK First Tier Tribunal in Adecco Uk Ltd v Revenue & Customs  UKFTT 600 illustrates the difficulties with tripartite agreements. The Tribunal had to decide whether the applicant was liable to pay VAT on the full charge paid by its clients for the services of non-employed temps provided to those clients or only on the element of the charge retained by it (i.e. the commission or gross profit element).
As observed by the Tribunal (at ), the question for the Tribunal was simple in essence. What did Adecco supply to its clients? The answer was not so easy.
The Tribunal ultimately found that Adecco was liable to pay VAT on the whole charge, but doing so required a decision running to some 314 paragraphs, taking the reader on a detailed journey through the minefield that is the world of tripartite supplies and the various decisions of the UK courts and the ECJ that have considered the issue.
Adding to the confusion, the Tribunal concluded that it would not follow a decision of the First Tier Tribunal in 2011 that came to the contrary view on the same issue and almost identical facts.
No doubt there will be an appeal – indeed, the Tribunal effectively invited an appeal so as to allow a higher authority to clarify the VAT issues.
The background to the proceeding
Adecco was the provider of recruitment services. The issue involved the provision of “non-employed temps”, being persons who are on the books of Adecco but are not considered to be employees. Adecco may introduce them to clients looking for a temporary worker to undertake an assignment. The temps are not obliged to accept any assignment offered and Adecco is not obliged to find them an assignment. Nevertheless, Adecco undertakes with these persons to pay them for the work they do for Adecco’s clients. Adecco’s payment by its clients will be periodic and normally calculated as an amount representing the payment Adecco must make to and on behalf of the temp plus a commission element.
Adecco accounted for VAT on the full charge paid by its client for the services of the temps – i.e., it accounted for VAT both on the element of the charge paid by the client which was equivalent to or represented the wages paid to the temp (including amounts paid in tax) and it accounted for VAT on the element of the charge effectively retained by itself (ie the commission or gross profit element).
In March 2011 the First Tier Tribunal handed down its decision in Reed Employment Ltd  UKFTT 200 (TC) (‘Reed Employment’). In that decision the Tribunal found that the employment bureau appellant in that case providing non-employed temps to its clients was making a supply of introductory services to its clients in return for its commission. It was therefore not liable to account for VAT on the element of the charge representing the wages which it received from its clients and paid to the temps. The Revenue did not appeal that decision.
Following this decision, Adecco requested a refund of GST. The Revenue rejected the claims, on the basis that Adecco supplied the services of the temps and was not merely supplying the service of introducing temps to its clients.
The conclusions on the contractual position
The Tribunal observed (at ) that while the contractual position may not determine the direction of the VAT supply, it is the starting point when determining whether and to whom and of what a supply is made.
The conclusions of the Tribunal as to the contractual position were as follows:
- on assignment, the worker did the job that the client asked it to do and all the day to day contact by the temp was with personnel of the client – but both parties accepted that there was no contract, actual or implied, between the temp and the client
- the arrangements between the temp, Adecco and the client worked perfectly well without a contract between the temp and client: the temp contracted with Adecco, and Adecco contracted with the client. There was no need for a contract between the temp and client in order for the client to have the benefit of the temps’ work.
- under its contract with the temp, Adecco was liable to pay the temp the agreed payment for its services in undertaking the assignment for the client. The client had no contractual obligation with either the temp or Adecco to pay the temp for its work in undertaking the assignment. The client’s only obligation to pay for the work was an obligation to pay Adecco the agreed fee. In other words, under the contracts, the client was obliged to pay Adecco for the work, and Adecco was obliged to pay the temp for the work
- there was no legal relationship between the temp and the client arising out of the temp’s performance of the work: there was no liability for the client to pay the temp arising out of contract or out of a quantum meruit
- an interpretation of the contract which meant that Adecco was only paid the commission element of the fee in its own right and was merely paid the wages element of the fee as a disbursement would be quite inconsistent with the legal position between Adecco and the temp on one hand, and the temp and the client on the other hand.
- further – it would also be quite inconsistent with Adecco’s commercial interests. If Adecco received only the commission element of the fee in its own right, and received the wages element as a disbursement, it would have no legal right to insist on being paid the major part of the charge as that money would never belong to it. So if its client went into liquidation, on this interpretation, Adecco could only prove in the insolvency for the commission and not the disbursement element even though of course, it would still be liable to pay the temp.
The Tribunal made the following observation on the characterisation of the contractual arrangements between the parties (at ):
Mr Grodzinski’s view was that what the appellant actually did was merely introduce the temps to its clients and take on the obligation to the temps of paying them even if the client did not pay Adecco, but that taking on this latter obligation did not convert an introductory service into a contract to provide staff. It did not, in his view, fundamentally change the nature of what Adecco did. I am unable to agree. If Adecco merely introduced the temp to its client, it would be for the client to enter into a contract with the temp to take him on as a worker, and if the client did so, then the client would have a direct obligation to the temp to pay him for the work. It is a very different position where the contracts between Adecco and its clients are such that the client gets the benefit of the work of the temp but without any contractual relationship with the temp and without any obligations to the temp and in particular without the obligation to pay the temp for the work. Instead, the temp’s contractual relationship is with Adecco. So Adecco was not merely providing introductory services, indeed it was not really providing introductory services at all: it was not introducing persons with the intention that those persons enter into a legal relationship. What the client got was workers who would carry out the assignments but to whom it owed no responsibilities such as payment; Adecco supplied the work of the workers, not an introduction to them.
In considering the above extract, one can see how enterprises in Australia such as Uber and AirBnB will seek to characterise their contractual arrangements as one where they merely introduce the service provider (be it a driver or a room owner) to a member of the public, who is then free to enter into a contractual relationship with the service provider (or not) – meaning that GST will only be payable on the fee retained by the facilitator and not on the entire payment received from the customer.
The lack of a contractual relationship between the temps and the clients
The lack of any contractual relationship between the temps and the clients appeared to be fatal to Addecco’s claim. The Tribunal observed as follows (at ):
So the contractual position without doubt, in my view, was that the temp worked for payment from Adecco, and Adecco provided that work to its client in return for payment by the client. Contractually, it is impossible to argue that what Adecco did was mere introduction, as that would make a nonsense of the legal position viz-a-viz the client and the temp, and the temp and Adecco. Yet the appellant’s case seemed to be not only that the VAT supply position was determined by what it saw as economic reality, but the contractual position was also so determined. So in the appellant’s view, because the temp carried out the instructions of the client when working on an assignment, I must see the contract between Adecco and the client as one of introduction only. But if I accepted that, the only logical corollary would be that there was a contractual obligation between the temp and the client for the performance of the work by the temp: but there was not, and the appellant accepts that.
The Tribunal distinguished the case from the decision of the Supreme Court in Revenue & Customs v Secret Hotels2 Ltd  UKSC 16 (see my analysis of that decision here). The Tribunal noted that the conclusion of the court in that case was that the taxpayer (sitting between the owner of the hotel and the hotel guest, as Adecco could be said to sit between the temp and the client, who consumed the temp’s services) effectively merely introduced the hotel owner to hotel guest, acting as an intermediary. In Secret Hotels2 the court was able to and did conclude that the taxpayer acted as an agent and that a contract was thereby created between hotel owner and hotel guest. But here, because there was no contract between temp and client, the only possible contractual route for the temp’s services was for them to be supplied by the temp to Adecco and by Adecco to its clients.
Contractual position is not necessarily determinative of the VAT position
The conclusions made by the Tribunal on the contractual position did not favour Adecco’s contention that the supply was made by the temp to the client. Nevertheless, Adecco contended that the contractual position did not dictate the VAT position. The Tribunal accepted this to be the case.
Adecco contended that the “economic reality” of what Adecco was doing under the contracts was providing a service of introducing candidates for temporary roles to its clients and that its consideration for doing this is the commission element of the payment paid by its client – the element which represents wages which the company passes on to the temp is not consideration for any supply made by Adecco.
The case on economic reality was based on the following factors:
- There was no mutuality of obligation between Adecco and the temp worker; in particular Adecco was not obliged to find work for the temp to carry out and nor was the temp obliged to accept any offered;
- Where a temp did accept the work offered, the temp was under the control, direction and supervision of the client and not Adecco;
- Other factors such as (a) Adecco did not review appraise or discipline the temp workers; (b) Adecco had no exclusivity over the temp and (c) the client appraised Adecco on the basis of its introductory service and not on the basis of the temp’s performance.
The Tribunal (at 178]) took the view that the question to be addressed was whether the economic realities of the whole situation meant that the contractual position (as outlined above) did not reflect the VAT supply position.
Decision in Reed Employment
The Tribunal considered the earlier decision of the Tribunal in Reed Employment that concerned the same tax issue and similar if not completely identical facts – in that case the Tribunal concluded that Reed was supplying only introductory services together with certain administrative services to its clients and was entitled to repayment of VAT it had accounted for on the sums which it had received from its clients in respect of the gross wages of its temps.
The Tribunal found that it could not accept the reasoning of the Tribunal in Reed Employment, which appeared to be based on the following two factors:
- a lack of mutuality – Reed and the temp owed each other no obligation to offer or to accept assignments; and
- a lack of control by Reed over the temp’s work at any time.
Other cases on tri-partite agreements
The Tribunal conducted a detailed review of the leading authorities on VAT supplies in tri-partite situations. In doing so, the Tribunal sought to understand what is meant by “economic reality” and when the economic reality trumps the contractual position.
The Tribunal observed that the nature of the supply made by Adecco depended on the identity of the recipient of the temp’s services – was it Adecco or the client?
The answer provided by Redrow was to “follow the money” – the person who is liable to pay the consideration receives the supply. The Tribunal referred to the following statement of Lord Millet:
… one should start with the taxpayer’s claim to deduct tax. He must identify the payment of which the tax to be deducted formed part; if the goods or services are to be paid for by someone else he has no claim to deduction. Once the taxpayer has identified the payment the question to be asked is: did he obtain anything – anything at all – used or to be used for the purposes of his business in return for that payment?
On this basis:
- Adecco’s client had entered into a contractual obligation with Adecco to pay Adecco – Adecco made its supply to its client.
- Adecco had entered into a contract with its temps under which it agreed with its temps to pay them for the work performed for its clients – the temps supplied their services to Adecco
However, the Tribunal acknowledged that Redrow was not the only authority on tripartite contractual situations and economic reality must now be considered.
Tolsma – CJEU decision
This was a case about a busker who was given gratuities by passers by. The Revenue sought to impose VAT on those receipts. The CJEU said no and demanded a legal relationship exist under which the services were provided for consideration. The Tribunal noted that this was in effect exactly what the House of Lords said in Redrow – liability to pay (in other words, consideration) determines whether and to whom there is a supply.
Loyalty Management/Aimia – the CJEU decision (LMUK)
In this case, retailers contracted with LMUK to be a part of the LMUK ‘nectar’ scheme which gave rewards to loyal customers. Retailers could buy ‘points’ from LMUK to issue to their loyal customers. LMUK kept its side of the bargain by contracting with ‘redeemers’ to provide goods and services in exchange for the points cashed in by the retailer’s customers.
It was accepted that the payments to LMUK by the retailers were subject to VAT as in consideration of a taxable supply of services of participation in the loyalty scheme; the question was whether the payments by LMUK to the redeemers were for a taxable supply made to LMUK.
The House of Lords referred the matter to the CJEU. The Tribunal observed that while they did not expressly say so, the CJEU’s approach appeared to entirely reject the Redrow analysis of identifying the nature of the supply by following the liability to pay – instead, the CJEU considered the provision of goods to be a supply by the provider of the goods to the recipient; there was, said the CJEU, consideration, because in exchanging the points for the goods and services from the redeemers, the customer gave rise to the redeemer receiving payment from LMUK.
The Supreme Court’s decision (my analysis of the decision can be accessed here)
The Tribunal observed that, at first glance the decisions in Redrow and the CJEU decision appear unreconcilable. When the Supreme Court considered the matter, the Court did not accept that Redrow was wrongly decided and instead it considered that the CJEU in LMUK had been asked, and answered, the wrong question.
What the Supreme Court did say was that, while Redrow was correctly decided, Lord Millet’s proposition outlined above did not amount to an absolute rule – the direction was a relevant consideration but the overall situation had to be considered. The majority stated as follows:
 …it is also necessary to bear in mind that consideration paid in respect of the provision of a supply of goods or services to a third party may sometimes constitute third party consideration for that supply, either in whole or in part. The speeches in Redrow should not be understood as excluding that possibility. Economic reality being what it is, commercial businesses do not usually pay suppliers unless they themselves are the recipient of the supply for which they are paying (even if it may involve the provision of goods or services to a third party), but that possibility cannot be excluded a priori. A business may, for example, meet the cost of a supply of which it cannot realistically be regarded as the recipient in order to discharge an obligation owed to the recipient or to a third party. In such a situation the correct analysis is likely to be that the payment constitutes third party consideration for the supply.
The Tribunal then asked the question – where does the Supreme Court’s decision in LMUK leave the appeal in this case? The Tribunal noted that the economic reality in LMUK was found to be consistent with the contracts into which LMUK had entered. So the VAT analysis followed the contracts.
However, the implication of the Supreme Court decision was that in some tripartite instances the application of economic reality would mean that the direction of the supply would not always follow the contracts and the legal liability to pay.
Baxi Group – CJEU
The Tribunal observed that position in Baxi was very similar to that in LMUK other than that the roles of promoter and redeemer were both held by a company called @1. In other words, it was a tri-partite and not a 4-party arrangement. Baxi promoted its products and sought customer loyalty by giving its customers ‘points’ with their purchases. Baxi purchased the points from @1. The customers redeemed the points with @1 who supplied the customers with the goods they selected. Baxi paid @1 a fee for its services which included an amount to reflect the value of the goods given to Baxi’s customers.
The conclusion of the CJEU was that @1 made two supplies; one was a supply to Baxi’s customers of the free gifts and the other was a supply of promotional services to Baxi. The fee paid by Baxi was seen by the CJEU as split between these two supplies.
The Tribunal considered that the relevant part of the CJEU’s decision was its conclusion that @1 made a supply of the free gifts to Baxi’s customers in return for the rest of the fee paid by Baxi, which it described as third party consideration. The Tribunal stated that “As with LMUK, Baxi reads as if the CJEU applied back-to-front reasoning” – meaning that the court appeared to say at that because @1 transferred property from itself to Baxi’s customers it was therefore making a supply to Baxi’s customers and that therefore because the supply was by @1 to Baxi’s customers, then @1’s receipt of money from Baxi had to be third party consideration for that supply. The Tribunal observed that the CJEU did not even consider the possibility that @1 made a supply to Baxi of the services of giving the free gifts to Baxi’s customers in return for the fee paid to it by Baxi – they did not consider, in other words, a Redrow analysis.
The Tribunal took the view that LMUK and Baxi are, and must be seen as, consistent decisions. The Supreme Court recognised in LMUK that Redrow did not always provide the answer in a tripartite situation to the question of to whom the supply was made: economic reality must always be considered. Baxi must be seen an example of a case where economic reality trumped the basic ‘follow the liability to pay’ rule set out in Redrow
WHA – Supreme Court (my analysis of the decision at the time can be accessed here)
The Tribunal observed that in this case an insurance company (NIG) offered breakdown insurance to purchasers of second hand cars. It arranged its affairs, as part of a complicated scheme to avoid VAT, so that the garages who carried out the repairs when the cars broke down invoiced a UK based claims handling company. The question addressed by the Supreme Court was whether the garages made a supply of their repair services to that claims handling company (WHA) or to the owner of the car.
The Supreme Court’s conclusion was that on the particular facts of the case the supply of the garage was made to the car’s owner so that WHA’s payment of the cost of that supply was no more than third party consideration, discharging NIG’s obligation to indemnify the car owner against the cost of the repair.
The Tribunal considered that WHA was a case where the court’s answer resulted in the VAT supply not correlating with the contract. In WHA the contract was between WHA and the garage; but the supply was found to be between the garage and the owner of the car. Yet the owner of the car had no obligation to pay the garage for the repair in so far as it was covered by the insurance policy – the Tribunal noted that the peculiarity of the parties to the supply not matching the parties to the contract underlying the supply was not discussed by the Supreme Court.
The Tribunal also considered that it was superficially difficult to distinguish Redrow from WHA on the facts: in both cases there was a tripartite contract under which the “non-owner” was liable to pay for the services, and the owners (in Redrow of the house, and in WHA of a car) were not liable to pay for the services from which they would benefit – yet the House of Lords/Supreme Court reached diametrically opposite conclusions without the Supreme Court overruling the earlier decision of the House of Lords. The quandary in which this left the Tribunal was described as follows (at ):
Both decicisons represent the law but there is no doubt therefore that the CJEU’s judgment in LMUK has qualified Redrow. But how does a tribunal know when to apply the ‘follow the liability to pay’ rule in Redrow/Tolsma/Aimia and when to apply the ‘economic reality’ rule in Baxi and WHA?
The Tribunal’s answer to that question was as follows (at ):
My analysis of the situation is therefore that the Tolsma/Redrow/Aimia ‘follow the liability to pay’ rule is the default rule under which the VAT supply will follow the contracts and that rule applies in tripartite situations unless the economic reality is inconsistent with the contractual position. And the economic reality is inconsistent with the contracts where final consumption takes place without a contract (or other legal relationship) supplying the thing to be consumed to the final consumer.
The Tribunal considered that this approach explained the decisions in Baxi and WHA:
- in Baxi the final consumer of the ‘free gift’ was Baxi’s customer but there was no contract under which the free gift was supplied to Baxi’s customer. So economic reality did not match the contracts, so the VAT supply route did not match the contracts either.
- in WHA, the final consumer of the repair work was the owner of the car, the insured party. But there was no contract with the insured under which the work of repair (for which the insured was indemnified) was carried out. So economic reality did not match the contracts, so the VAT supply route did not match the contracts either. It followed economic reality, so the supply was found to be to the insured party and not to WHA, who had the contractual liability to pay for it.
Airtours – Court of Appeal
The Tribunal observed that in this case, a company (in financial difficulties and owing banks large sums of money) entered into an arrangement under which a professional services firm (PWC) agreed to supply the service of reviewing the company’s restructuring plan and to provide a report on it to creditor banks. The company was liable to pay PwC’s contract fee.
The question the Court of Appeal considered was to whom did PwC’s supply their professional services? The decision of the majority was that as a matter of fact the company did not engage with PwC to provide a report to the banks; on the contrary the banks contracted with PwC to provide them with the report. The company acted as no more than provider of third party consideration. The dissenting judgment essentially disagreed with the legal analysis of the contract, finding that Airtours “had a contractual right to require” PWC to provide the services to the banks. And on that basis considered that that meant that there was a supply of services to the company by PwC: the agreement to provide something to someone else.
The Tribunal considered that that decision of the majority was consistent in outcome (if not reasoning) with Baxi, LMUK and WHA and stated as follows (at ):
While it was in the company’s best interests to contract with PwC to provide the report, it was in a comparable position to Baxi when it contracted for free gifts to be provided by another company to Baxi’s customers. It was in Baxi’s commercial interests for free gifts to be received by its customers because this promoted its business and was intended to generate customer loyalty and in that sense it ‘consumed’ @1’s service of agreeing to give away goods to Baxi’s customers; but the economic reality is that the free gifts themselves were consumed by the customers, in the same way that PwC’s report was directly consumed by the bank. And in such a case the CJEU has said the supply must be seen as made to the person who finally consumes the goods or services.
Conclusions on the legal principles to be applied
The Tribunal appeared to adopt the following principles, after considering the above cases:
- a VAT supply, ordinarily at least, requires a legal relationship between the supplier and recipient under which the supplier is obliged to make the supply and the recipient is liable to pay for it, whether or not that liability arises under an enforceable contract
- Nevertheless, where the economic reality of the legal relationship is such that it results in final consumption of goods or services by a consumer in circumstances where in effect there is no VAT charge on that consumption then this normal rule is overridden because the ultimate purpose of the Principle VAT Directive is to tax final consumption – e.g., Baxi and WHA
- in a situation where B agrees to pay A to provide goods and/or services to C, and C agrees with B to pay for the goods and/or services provided by A, then a Redrow ‘follow the liability to pay’ analysis applies to decide to whom A’s supply is made. This is because the legal relationships reflect the economic reality and the outcome is consistent with the Principle VAT directive because final consumption is taxed. In other words, A’s supply is to B, and B makes an on-supply to C.
- but where a Redrow ‘follow the liability to pay’ analysis does not lead to tax on final consumption, because although A makes a supply to B (of providing goods/services to C), B does not on-supply A’s services to C, then C’s consumption will be untaxed, and, applying Baxi/LMUK/WHA, economic reality requires the supply to be seen as made to the final consumer.
Application of the principles to the case
The Tribunal observed that Adecco saw the economic reality as being that the temps’ work was actually consumed by the client, as indeed it was. However, the Tribunal was of the view that Adecco missed the point – economic reality only ‘trumps’ the rule that supplies follow the same route as the legal liability to pay where that route differs from the economic reality. In Baxi, LMUK and Airtours, the person who had the liability to pay for the thing consumed was not the person who consumed the thing. So the legal liability to pay differed from the economic reality of consumption. Here, on the contrary, the client consumed the temps’ work, but also had the liability to pay for the temps work. It did not matter that that liability to pay was owed to Adecco and not to the temps: there was nothing inconsistent with the Principle VAT directive in the thing to be consumed being supplied to the ultimate consumer through a number of middlemen. That was a normal incident of business. Properly understood, Baxi, WHA and Airtours did not assist the appellant.
The Tribunal also observed that Adecco’s position seemed to be predicated on the basis that an agreement by A with B to provide goods or services to C as a matter of economic reality must be seen as a supply by A to C as the goods/services effectively move directly from A to C – but that was a wrong legal analysis. Where something is supplied by A to B, and then B to C, even though that thing moves directly from A to C, the contracts are consistent with economic reality as final consumption is taxed.
Similarly, it was wrong to say that the supply must be by A to C because the economic reality is that the goods/services in reality move directly from A to C – ‘economic reality’ means something else.
Ultimately, the Tribunal concluded that the economic reality did match the contractual position. At  the Tribunal concluded as follows:
The point is that the economic reality which matters for VAT purposes is the identity of the final consumer. If the final consumer is not the person with liability to pay for the thing consumed, whether goods or services, then economic reality does not match the contractual position. Here Adecco’s client is the final consumer of the work undertaken by the temps, for all the reasons give by the appellant: but under the contracts Adecco’s client does have liability to pay for the work it consumes. So economic reality is consistent with the contracts.
The Judge appreciated that the decision was an unfortunate outcome in the sense that two tribunals have reached diametrically opposed conclusions on the same issue, potentially giving one competitor in the same market a financial advantage over another, assuming Reed and Adecco are in competition. However, the Judge considered that she must apply the law as she sees it and was unable to follow the decision in Reed Employment.
No doubt the Upper Tax Tribunal (and potentially higher Courts) will have more to say about the subject.