TOMS Revisited

Tour operators come under the microscope as the European Commission publishes its proposals for revising Article 26 of the Sixth Directive. MICHAEL LAMBOURNE ATII reports.

THE TOUR OPERATORS Margin Scheme has operated in the United Kingdom since 1987, and is based on European Union legislation (Article 26 of the Sixth Directive). Its primary purpose is to simplify VAT accounting obligations for United Kingdom based tour operators who buy in and re-sell travel services in their own name. Without it, tour operators would be required to register and account for VAT in all European Union countries where their services are consumed. Under the scheme, VAT is collected in two stages: firstly, in the country of consumption by blocking input tax credits on supplies such as hotel accommodation, that are bought in and supplied on to the traveller, and secondly, the tour operator pays United Kingdom VAT on his margin.

The European Commission has just published its proposals to revise Article 26, supported by an Explanatory Memorandum. This article looks at the proposals and considers what they could mean for the United Kingdom industry, if implemented.

Why are changes needed?

Since Article 26 was originally introduced in 1977, there have been substantial changes in the travel industry: it is much bigger, more specialised and, with greater market concentration and vertical integration, more competitive. The underlying message is that the market is now more sensitive to the impact of VAT and to any distortions of competition resulting from differences of VAT treatment within the European Union.

A key point is that not all European Union Member States are required to implement Article 26, because of approved derogations. This means that in some countries, tour operators' margins are VAT exempt. Moreover, those that have implemented it, operate different rules and varying degrees of flexibility in key areas such as the definition of a tour operator, the scope of the special arrangements, and how VAT liabilities are computed.

According to the Commission, this inconsistency has given rise to 'a number of complaints' from operators of distortion of competition. The evidence cited in the Explanatory Memorandum is hardly compelling but, presumably, consultations with industry representative bodies produced evidence of the need for remedial action.

The Commission addresses what it terms the crucial question 'whether the special margin scheme for travel agents and tour operators can also apply if the package of services is supplied to another travel agent and not to the traveller'. Differences of approach here are said to lead to distortion of competition and, potentially, to double taxation.

Supplies to business consumers are addressed. Under Article 26, customers are invoiced on a VAT-inclusive basis. Business customers therefore suffer a hidden and irrecoverable VAT charge, conflicting with the principle of fiscal neutrality.

The Commission also refers to an alleged loophole enabling non-European Union operators to escape European Union VAT, a position made worse by e-commerce and the Internet.

It is important to note from the outset that this is merely a review of Article 26 and related exemptions. The Commission does not examine the travel industry as a whole, or the interaction between Article 26 and other aspects of VAT. Tour operators' margins will therefore continue to be taxed at different rates, according to the country of establishment. Moreover, reduced or zero VAT rates that currently apply to certain travel services such as passenger transport and, in some countries, hotel and holiday accommodation, in circumstances where Article 26 does not apply, e.g. direct sales from hotelier to traveller, are not affected.

Definition of a tour operator

The European Court of Justice in T P Madgett and R M Baldwin (trading as Howden Court Hotel) v Commissioners of Customs and Excise (Cases C-308/96 and C-94/97) [1998] STC 1189 confirmed that Article 26 applies not just to conventional or licensed tour operators, but also to hoteliers and others who habitually buy in travel services from third parties and sell them in their own name to travellers.

United Kingdom law and practice has always been consistent with this, and so the Commission's proposal to amend the definition to include expressly 'tour operators and any other taxable person who supplies travel services in the same way' will have no practical effect here. Greater impact is likely to be felt in other countries that continued to confine their special schemes to licensed operators, even after the European Court ruling.

Wholesale supplies

The Commission's proposals for that 'crucial question' of wholesale operators could increase significantly VAT payable by the United Kingdom travel industry. There could be a saviour in the form of an opt-out clause elsewhere in the proposals, but until the position is clarified, the industry has every right to be nervous for the following reason.

Originally in the United Kingdom, Customs ruled that wholesale supplies, i.e. from one tour operator to another, were covered by the Tour Operators Margin Scheme. However, this was successfully challenged twice in the VAT Tribunal in Independent Coach Travel (Wholesaling) Ltd (11037) and Norman Allen Group Travel Ltd (14158), after which the scheme became compulsory only for sales made directly to the traveller.

The Commission evidently considers that those cases were correctly decided. However, the point has never been fully tested in the European Court, and some European Union countries have maintained, so far without legal challenge, a policy of including wholesale supplies within Article 26.

The effect is that wholesalers excluded from the scheme do not pay VAT in the country of establishment, but supposedly account for VAT in other countries in accordance with normal place of supply rules. On the other hand, wholesalers who are included within the special schemes enjoy the benefit of simplification, but could face a risk of double taxation.

Take a United Kingdom wholesaler buying and re-selling hotel accommodation in Spain. There is no United Kingdom VAT, implying that he registers and accounts for Spanish VAT. A wholesaler in another Member State may however be taxed under Article 26. He would therefore suffer blocked input VAT, and must account for domestic VAT on his margin. But assuming that the Spanish authorities treat all wholesalers the same, the end result could be either non-taxation of the United Kingdom company's sales or double taxation for his European Union counterpart.

The Commission's answer is that, in principle, Article 26 should be significantly broadened to include wholesale supplies. While this may bring about consistency, and may ease accounting burdens, many United Kingdom tour operators could be hit very hard indeed.

As stated above, some travel services falling outside Article 26 qualify for zero and reduced VAT rates. Thus, under normal VAT rules, intra-European Union passenger transport by air or sea is zero rated across the Community. Under Article 26, although the bought in service from the transport operator is zero rated, when that service is re-sold by the tour operator, he must account for domestic standard rate VAT on his margin.

If adopted, this change could increase the amount of VAT payable in the United Kingdom. Currently, many tour operators purchase flights or other forms of zero-rated passenger transport from an associated transport company. Because these transport companies come under the normal VAT rules, they can apply the zero rate. Moreover, because prices are set so that the tour operator makes no margin on the transport element of the package, there is no VAT to pay. So, is this about to be dealt a fatal blow?

Possibly not, as elsewhere in the proposals, the Commission recognises that some consumers of travel services will be taxable businesses. These may be discouraged from buying services from tour operators on a VAT-inclusive basis as they would be denied recovery of any input tax. As this offends the neutrality principle, the Commission proposes that tour operators may opt to apply the normal VAT rules to 'any supply covered by the special arrangements for taxing the margin'.

As drafted, the opportunities to exercise the option appear unlimited and unconditional, although tour operators' accounts must differentiate clearly between margin scheme supplies and opted supplies in accordance with national rules. But common sense suggests that the Commission did not intend the option to be applied purely at the discretion of the tour operator. Otherwise, Article 26 could become a totally voluntary scheme leading to increased inconsistency, not less.

I conclude that the scope of any option to apply the normal rules will be the subject of much further discussion and redrafting. For the sake of United Kingdom tour operators, we must hope that wholesalers will be permitted to exercise the option. Indeed, it would be illogical to respect the neutrality principle only at the final consumption stage, while disregarding problems of sticking VAT earlier in the supply chain.

Non-European Union operators

Where a non-European Union operator sells packages to be enjoyed in the European Union, it is alleged that such packages are not subject to tax, leading to avoidance, unfairness and distortion between European Union and non-European Union operators. But is this true?

The non-European Union operator without any form of establishment in the European Union cannot account for VAT under Article 26. But this does not mean that he falls outside the VAT net altogether. Rather, the normal VAT rules should apply. Supplies of hotel accommodation are thus taxable, under Article 9.2(a) of the Sixth Directive, in the country where the hotel is situated, and passenger transport will be taxed where it takes place, under Article 9.2(b), having regard to the distances travelled. When the tour operator acts in his own name, he has a liability to register and account for VAT in each country where such services are supplied.

Local VAT will in any event be charged to the non-European Union operator, where appropriate, with no opportunity for him to reclaim it under the 13th VAT Directive. He can only recover this VAT through a local VAT registration, in which case he would have to account for output tax. To that extent, consumption of travel services within the European Union will inevitably be taxed in the appropriate country.

The Commission implies that there is a loophole under existing legislation enabling a non-European Union tour operator's margin to go untaxed. This would be correct if the margin represents consideration for the organisation of the package, and that this is a separate service in its own right, subject to the basic place of supply rule, where the supplier is established. The package of travel services is not a single supply, as Article 26 would otherwise be otiose. Thus, each travel service retains its own separate identity, and is taxed accordingly. Moreover, the service of co-ordinating the individual components of the package should be seen as ancillary to those services, and not a (VAT-free) supply in its own right (see T P Madgett and R M Baldwin and Card Protection Plan Ltd v Commissioners of Customs and Excise (Case C-349/96) [1999] STC 270.

If my analysis is correct, any non-taxation arises through non-compliance, not defective place of supply rules. However, the Commission appears to take the opposite view, proposing new place of supply rules confirming that travel services supplied by a non-European Union operator that are used and enjoyed within the European Union are to be taxed in the customer's country of residence, on a similar principle to Article 9.2(e).

Such provisions could have some quite remarkable effects. Firstly, they do not appear to be confined to European Union customers. Thus, in the case of a United States tour operator selling European Union package tours to United States residents, the result would be a VAT-free sale, giving him an immediate competitive advantage over European Union companies. This was not intended.

If the same United States company sells holidays in Austria to German residents, its inputs are likely to be subject to Austrian VAT, while its outputs are liable to German VAT. Moreover, if customers are scattered throughout the European Union, multiple VAT registrations will be required, in stark contrast to the single registration requirement for European Union operators.

Having registered for VAT in Germany and other Member States on this basis, it is assumed that the non-European Union operator would then be required to comply with the remaining Article 26 provisions. This would require him to calculate the margin on a per country basis.

The Internet has clearly accounted for increased penetration of the European Union travel marketplace by non-European Union operators. However, the Commission's reaction is quite different in this context to its response to the challenge posed by digitised products and other services supplied by electronic means. In the latter case, it has recognised the need to encourage voluntary compliance by introducing a ground-breaking simplification measure: the concept of a single point of European Union VAT registration. The aim is to relieve non-European Union suppliers of the onerous burdens associated with multiple VAT registrations.

Yet, for online travel companies based outside the European Union, the proposals will create the need for multiple registrations, providing no incentive for companies, unfamiliar with European Union VAT rules, to comply.

Global accounting

The proposals recognise that it may be difficult to identify a profit margin on a per transaction basis, and therefore Member States are to be given the express option of permitting tour operators to calculate this margin over time. As this in effect already happens under the Tour Operators Margin Scheme, this is unlikely to have any real impact in the United Kingdom. However, the VAT Advisory Committee has to be consulted prior to implementation.

Although the proposals also define profit margin for the purposes of the scheme, they do not address the more awkward scenario of a package containing a mixture of bought-in supplies and in-house supplies. Presumably, they consider that the European Court in Madgett and Baldwin has already provided adequate clarification of this issue.

Removal of derogations

The United Kingdom does not take advantage of any existing derogations from Article 26, and therefore the Commission's proposals for more uniformity through the abolition of these derogations will have no effect on the Tour Operators Margin Scheme. Countries that will be affected include Ireland, Denmark, and Belgium.

Not settled yet

Many of the Commission's proposals are already reflected in the Tour Operators Margin Scheme, and so in many respects the United Kingdom will be affected less than other Member States. However, the proposals for wholesale supplies could have far reaching implications particularly in relation to domestic and intra-European Union passenger transport services. If United Kingdom tour operators are to avoid hefty increases in United Kingdom VAT liabilities, either this proposal will need to be reversed, or agreement to apply the opt out provisions should be secured. The position for non-European Union operators also requires careful reconsideration.

M J Lambourne is a senior consultant at Ernst & Young.

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