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Agent or principal? - The importance of contracts

A recent Supreme Court ruling in the case of HM Revenue and Customs v Secret Hotels2 Ltd has provided a timely reminder of some important issues that should be considered where a supplier believes that they are acting in the capacity of an agent rather than a principal.

The difference is important as it determines the value of your supply for VAT purposes (i.e. do you account for VAT on the full value or just on your commission or profit?).

The Secret Hotels2 case concerned a company which operated a website to market supplies of hotel accommodation and the issue before the court was whether it was acting as a principal in the supply of hotel accommodation to customers or whether it was acting as an agent or intermediary for the overseas hoteliers. The court concluded that Secret Hotels2 was acting as an agent and that the supplies it made to the overseas hoteliers were therefore not liable to UK VAT under a special scheme for travel agents. This overturned the earlier decision of the Court of Appeal. 

Although this case concerned a travel operator, the findings are equally applicable to any other situations that rely on identifying whether a supplier is acting as principal or agent (e.g. the supply of staff). 

An example of where this makes a difference is where a supply of temporary staff (subject to VAT) is made to an entity that is unable to recover this VAT as input tax. If staff are supplied by a supplier acting as an agent then VAT will only be due on their commission whereas where the staff are supplied by a supplier acting as a principal, VAT will be due on the wages element as well. This makes a significant difference if the customer is unable to recover the VAT it is charged.    

It is important to mention that a key point regarding contractual terms was also highlighted by this case. The Judge commented that under English Law, where a written agreement is not a sham, it is not permissible to take into account the subsequent behaviour or statements of the parties as an aid to interpreting that agreement. However, it was pointed out that in order to interpret an agreement a court must have regard to the surrounding circumstances and to commercial common sense.

HMRC often challenge contractual arrangements using the argument of "substance over form" yet this case reinforces the principle that although the overall economic and commercial reality of an arrangement between parties is important, the written agreement between parties is often crucial in determining the relationship between the parties. We are increasingly seeing HMRC ask to see documentary evidence, in the form of contracts with suppliers and customers, to support assertions made by clients. Because of this, great care should be taken in ensuring that written agreements are drafted appropriately.

The case highlights the importance of the contractual terms between suppliers and their customers when considering whether you are acting in the capacity of principal or agent. For clients operating in the not for profit sector or in financial services the distinction is particularly important if you are relying on your supplier to get it right in order to reduce your irrecoverable VAT.

If you are not sure that you are applying the appropriate VAT treatment or would just like to review whether your arrangements are structured efficiently for VAT purposes then please contact us and we would be happy to assist.

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