Our VAT registered client A runs a pub that doesn’t currently offer food. To increase the number of people in the pub, A is ‘renting’ the kitchen to B who will run the food/kitchen themselves.
B will not be VAT registered and A will charge them a monthly amount of £100 plus 10% ‘commission’ on all food sales. All the food sales will go through the pub till as people will want to pay for food and drinks, etc. altogether on one bill, but the till ‘Z’ reading will identify the food sales. However, as the food takings are not the pub’s takings (and bearing in mind that A’s business is VAT registered, but B’s is not) how will HMRC view the fact that they are all going through one till?
Could readers advise on the above and whether there is any way round charging VAT on the ‘commission’ the pub will get from the food takings?
Query 17,819 – Red Lion.
Reply by Alex Millar, Millar Taxation Ltd
Red Lion’s client wants to attract more customers to their pub, which does not currently offer food. New customers may even include a hungry HMRC officer who remembers the pre-1997 days when it was occasionally possible to enjoy a VAT-free pie in a family-run pub. A common theme on such occasions was that the VAT-free pie was provided by a member of the family who was not VAT registered and who operated a sole trader catering business on the pub premises. After the 1997 Budget, such arrangements became less common as a result of VATA 1994, Sch 1 para 1A.
Paragraph 1A provides HMRC with statutory authority to consider the extent to which the different persons carrying on (business activities which have been artificially separated for the avoidance of VAT) are closely bound to one another by financial, economic and organisational links. When HMRC can establish that there has been an artificial separation of business activities for the avoidance of VAT and that the persons involved are closely bound to one another by financial, economic and organisational links, they can issue a direction under para 2.
A direction under para 2 has the effect of treating the persons involved as a single taxable person for VAT purposes in relation to the activities which have been artificially separated for the avoidance of VAT.
Turning back to Red Lion’s query, the method of separating the food and drink sales appears to be artificial and the motive appears to be an attempt to make the pub more attractive to customers by avoiding VAT on food sales.
Red Lion indicates that all the food sales will go through the pub till as people will want to pay for their food and drink together on one bill. This would suggest that the operation of the two businesses will be so closely bound to one another that most customers will not be aware that they are ordering the food and drink from different traders. However, which trader will issue the invoice and what information will be included on it if an off-duty HMRC officer orders a pie and a pint and requests a VAT invoice? When the HMRC officer is back on duty he can be expected to consider the extent to which the caterer and the publican are bound to one another by financial, economic and organisational links.
I note that it is intended that the caterer will run the kitchen himself. However, there is no mention of a separate restaurant area with separate waiting staff, so it would appear that the sale of food will be dealt with by bar staff in the bar area. This point, together with the issue of combined bills covering both food and drink and the use of one till would suggest that the caterer and the publican are closely bound to one another by financial, economic and organisational links. HMRC are unlikely to consider that these links are broken by the publican charging the caterer an amount of £100 a month plus 10% commission on all food sales.
I would suggest that HMRC will view the arrangement as an artificial separation of business activities for the purpose of avoiding VAT. A direction under para 2 is then likely to be issued, the effect of which will be that VAT will become due on the food sales as well as the drink sales.
Reply by Gardener
It is 99% certain that HMRC will start from the position that all the takings are subject to VAT. The issue is whether they can sustain that view on technical grounds. If the businesses are in fact carried on in partnership by A and B, or as a single operation by A with B acting as a subcontractor, the takings will all be taxable from the outset. If the two businesses are genuinely distinct but could be regarded as ‘closely linked by economic, financial and organisational factors’ and the two activities are artificially separated parts of a single business, then HMRC could issue a business splitting direction under VATA 1994, Sch 1 para 1A and 2, and regard A and B as a partnership.
The arrangements described appear to be a genuine separation of two businesses. If A and B deal with each other at arm’s length, it will be hard for HMRC to argue that there is in fact a single business or a partnership. The fact that all the money goes into one till is suggestive (particularly to a suspicious mind) of a single business, but it is not conclusive. As the takings of the food business are clearly identifiable by the operation of the till, it can be properly regarded as entitled to its own turnover, which would never belong to A. B should bank the share of the takings in a separate bank account and prepare proper accounts for income tax purposes.
If A and B do not deal at arm’s length, there are more likely to be problems on this issue. Traditionally it has been common for A to be the husband and B to be the wife: HMRC would routinely argue that there is either a single business which employs the wife, or else a partnership between them. If the relationship between A and B is purely business, it will be much harder for HMRC to sustain an argument that the facts are other than as Red Lion represents them.
On the other hand, it is hard to imagine how the £100 and 10% commission could be excluded from VAT (which B will not be able to recover, being unregistered). Charging the commission is part of the arm’s length dealing. It is consideration for a supply of services (in effect, the opportunity to sell food to A’s customers) which is received in the course of A’s business. It might be possible to charge an exempt rent for a licence to occupy the kitchen, but that is likely to fall foul of the arguments that HMRC use against hairdressers who try a similar arrangement – the supply is in reality ‘facilities’ rather than mere space.
HMRC may argue that the customer will regard the supply as a single composite of ‘food and drink’. However, if separate entities make the supplies, it is still good law that HMRC cannot compound them into one (see the Court of Appeal’s decision in Telewest Communications plc and another v CCE [2005] STC 481, reaffirmed recently by the Upper Tax Tribunal in Lower Mill Estate Ltd v CRC [2011] STC 636).
On the business splitting direction, HMRC may argue that there are close financial and economic links (which include the ‘view of the customer’ and passing all the receipts through a single till). If A and B run their businesses separately, it would be harder to show that there are close organisational links, although HMRC regard ‘common premises’ as satisfying this condition. The strongest argument against a direction is that this is not a single activity that has been artificially separated: the food operation is a new activity that has never previously been carried on by A, and B has run it independently from the outset. The terms of paras 1A and 2 are therefore not satisfied.
It will be helpful for both arguments if customers are made aware that there are two businesses. One of my locals has a similar arrangement: we all know that Jason is the publican, but a different business sells the food, and it also runs a cafe from a different location. I don’t know if they have set it up this way on VAT advice, but if they have, I think it ought to be effective.
