© 2025 by Michael Firth KC, Gray's Inn Tax Chambers
Contact: michael.firth@taxbar.com
A13. Economic reality
GENERAL
A fundamental criterion
- Economic and commercial realities are a fundamental criterion for the application of VAT
"[48] To answer that question, it must be borne in mind, first of all, that, under the Court’s settled case-law, consideration of economic and commercial realities is a fundamental criterion for the application of the common system of VAT (judgment of 22 November 2018, MEO – Serviços de Comunicações e Multimédia, C‑295/17, EU:C:2018:942, paragraph 43 and the case-law cited)." (ITH Comercial C-734/19)
"[42] As regards in particular the importance of contractual terms in categorising a transaction as a taxable transaction, it is necessary to bear in mind the case-law of the Court according to which consideration of economic and commercial realities is a fundamental criterion for the application of the common system of VAT (see, to that effect, Joined Cases C-53/09 and C-55/09 Loyalty Management UK and Baxi Group [2010] ECR I-9187, paragraphs 39 and 40 and the case-law cited)." (Newey C-653/11)
- Substance and reality of the matter
"[66] I would at the same time stress that the speeches in Redrow should not be interpreted in a manner which would conflict with the principle, stated by the Court of Justice in the present case, that consideration of economic realities is a fundamental criterion for the application of VAT. Previous House of Lords authority had emphasised the importance of recognising the substance and reality of the matter (Customs and Excise Commissioners v Professional Footballers' Association (Enterprises) Ltd [1993] 1 WLR 153, 157; [1993] STC 86, 90), and the judgments in Redrow cannot have been intended to suggest otherwise. On the contrary, the emphasis placed upon the fact that the estate agents were instructed and paid by Redrow, and had no authority to go beyond Redrow's instructions, and upon the fact that the object of the scheme was to promote Redrow's sales, indicates that the House had the economic reality of the scheme clearly in mind. When, therefore, Lord Hope posed the question, "Was something being done for him for which, in the course or furtherance of a business carried on by him, he has had to pay a consideration …?", and Lord Millett asked, "Did he obtain anything – anything at all – used or to be used for the purposes of his business in return for that payment?", those questions should be understood as being concerned with a realistic appreciation of the transactions in question."(HMRC v. Aimia Coalition Loyalty UK Limited [2013] UKSC 15)
- Small differences in facts may lead to very different outcomes
"[59] Finally, it is also said that the fact that PwC did not contract with Airtours to provide the Services to the Institutions is a very small point on which the present decision should turn. The answer to that was provided by Lord Reed in WHA Ltd, para 26, where he said that “decisions about the application of the VAT system are highly dependent upon the factual situations involved. A small modification of the facts can render the legal solution in one case inapplicable to another.”" (Airtours Holidays Transport Limited v. HMRC [2016] UKSC 21)
"[68] It is also important to bear in mind that decisions about the application of the VAT system are highly dependent upon the factual situations involved. A small modification of the facts can render the legal solution in one case inapplicable to another. I would therefore hesitate to treat the judgments in Redrow as laying down a universal rule which will necessarily determine the identity of the recipient of the supply in all cases. Given the diversity of commercial operations, it may not be possible to give exhaustive guidance on how to approach the problem correctly in all cases." (HMRC v. Aimia Coalition Loyalty UK Limited [2013] UKSC 15)
Transactions being economically equivalent does not mean they are treated the same
Determining economic reality
- Paying a person to accept assignment of lease not treated the same as sub-letting to that person at reduced rent
"[7] In 1993 Wako and CFI, with the landlord's consent, entered into an agreement for assignment of the lease to CFI. Under the agreement, CFI, which became the new tenant, undertook to perform Wako's obligations under the lease and to indemnify Wako for any losses or liabilities incurred by reason of the lease. In consideration of CFI taking over the lease, Wako undertook to pay CFI a sum of £1.5 million.
...
[31] It is true that Wako could have remained a tenant and sub-let the property to CFI for a lower rent than that which it had to pay the landlord or that it could have paid compensation to the landlord so that the latter would accept early termination of the lease. In both cases, the economic impact would have been comparable to that of the transaction at issue in the main proceedings, without the parties concerned having to pay VAT.
[32] However, that does not justify interpreting Article 13B(b) of the Sixth Directive so as to mean that it also applies to a supply of services that does not include the assignment of a right to occupy property.
[33] An approach of that kind would be contrary to the VAT system's objectives of ensuring legal certainty and a correct and coherent application of the exemptions provided for in Article 13 of the Sixth Directive. The Court observes in that connection that, to facilitate the application of VAT, it is necessary to have regard, save in exceptional cases, to the objective character of the transaction in question (see Case C-4/94 BLP Group [1995] ECR I-983, paragraph 24). A taxable person who, for the purposes of achieving a particular economic goal, has a choice between exempt transactions and taxable transactions must therefore, in his own interest, duly take his decision while bearing in mind the neutral system of VAT (see, to that effect, BLP Group, cited above, paragraphs 25 and 26). The principle of the neutrality of VAT does not mean that a taxable person with a choice between two transactions may choose one of them and avail himself of the effects of the other." (Cantor Fitzgerald C-108/99)
- Labels applied by parties not conclusive, often of little weight
"[31] Where parties have entered into a written agreement which appears on its face to be intended to govern the relationship between them, then, in order to determine the legal and commercial nature of that relationship, it is necessary to interpret the agreement in order to identify the parties' respective rights and obligations, unless it is established that it constitutes a sham.
[32] When interpreting an agreement, the court must have regard to the words used, to the provisions of the agreement as whole, to the surrounding circumstances in so far as they were known to both parties, and to commercial common sense. When deciding on the categorisation of a relationship governed by a written agreement, the label or labels which the parties have used to describe their relationship cannot be conclusive, and may often be of little weight..." (HMRC v. Secret Hotels2 Limited [2014] UKSC 16)
"[62] In both Kuwait and Church of England Children Society there was reliance by the court on how the ‘benefit’ was described in the contract. The Q8 vouchers (or at least the redemption goods) were described as ‘free’. The payment in Church of England Children’s Society was described as a gift. But there no suggestion the description determines matter. It could not determine the matter as the description the parties apply, deliberately or inadvertently, may not be an accurate one." (The Serpentine Trust Ltd v. HMRC [2014] UKFTT 876 (TC), Judge Mosedale)
- Subsequent behaviour may indicate that original contract does not represent true/full arrangement
"[33] In English law it is not permissible to take into account the subsequent behaviour or statements of the parties as an aid to interpreting their written agreement – see FL Schuler AG v Wickman Machine Tool Sales Ltd [1974] AC 235. The subsequent behaviour or statements of the parties can, however, be relevant, for a number of other reasons. First, they may be invoked to support the contention that the written agreement was a sham – ie that it was not in fact intended to govern the parties' relationship at all. Secondly, they may be invoked in support of a claim for rectification of the written agreement. Thirdly, they may be relied on to support a claim that the written agreement was subsequently varied, or rescinded and replaced by a subsequent contract (agreed by words or conduct). Fourthly, they may be relied on to establish that the written agreement represented only part of the totality of the parties' contractual relationship.
[34] In the present proceedings, it has never been suggested that the written agreements between Med and hoteliers, namely the Accommodation Agreements, were a sham or liable to rectification. Nor has it been suggested that the terms contained on the website ("the website terms"), which governed the relationship between Med and the customers, namely the Terms of Use and the Booking Conditions, were a sham or liable to rectification. In these circumstances, it appears to me that (i) the right starting point is to characterise the nature of the relationship between Med, the customer, and the hotel, in the light of the Accommodation Agreement and the website terms ("the contractual documentation"), (ii) one must next consider whether that characterisation can be said to represent the economic reality of the relationship in the light of any relevant facts, and (iii) if so, the final issue is the result of this characterisation so far as article 306 is concerned." (HMRC v. Secret Hotels2 Limited [2014] UKSC 16)
- Invoicing cannot change nature of arrangement
"[48]...As to factor (7), if Med was an agent as it contends, one would have expected the hotelier's invoices to have been for the gross sums with a deduction for Med's commission, and the fact that they were for the net sums is consistent with the Commissioners' analysis. However, the invoices are not financially inconsistent with the contractual arrangements contended for by Med, as the hotelier would expect Med to pay the net sum, not the gross sum. In any event, at least on their own, such invoices cannot change the nature of the contractual arrangements between Med, the customer and the hotelier, given that (i) they post-date not merely the contracts but their performance, and (ii) the customer was not aware of the invoices, so it is hard to see how they could affect her contractual rights or obligations." (HMRC v. Secret Hotels2 Limited [2014] UKSC 16)
- Look at the intended end result of transaction (e.g. supply of building + demolition services)
"[39] In a situation such as that at issue in the case in the main proceedings, it must be held that, for VAT purposes, the actions undertaken by the vendor are closely linked. The demolition work and the supply of the plot of land as such actually overlapped. The economic purpose of those actions was to supply land ready for construction. In this respect, it is not possible, without undue contrivance, to take the view that Don Bosco acquired from the same person first an old building and the ground it stood on which, as it happened, was of no economic use to him, and, only subsequently, the supplies in connection with the demolition of the buildings, which alone could render the land economically useful (see, by analogy, Aktiebolaget NN, paragraph 25).
[40] Consequently, the supply of land on which a dilapidated building still stands, which must be demolished so that a new building can be constructed in its place and demolition of which had already begun before that supply took place, and also the demolition of that building must, in circumstances such as those described by the referring court, be considered to form a single transaction for VAT purposes, having, taken as a whole, the aim of supplying not the existing building but land that had not been built on.
[41] Therefore, such a transaction, viewed as a whole, does not fall within the exemption from VAT provided for by Article 13B(g) of the Sixth Directive, regardless of how far demolition of the old building had progressed at the moment the land was actually ‘supplied’." (Don Bosco C-461/08)
CONTRACTS
- Contract starting point for economic reality
"[43] As regards the importance of contractual terms in categorising a transaction as a taxable transaction, it is necessary to bear in mind the case-law of the Court according to which consideration of economic and commercial realities is a fundamental criterion for the application of the common system of VAT (see, to that effect, judgment of 20 June 2013, Newey, C‑653/11, EU:C:2013:409, paragraph 42 and the case-law cited)." (MEO C-295/17)
- Contract normally reflects the economic reality
"[43] Given that the contractual position normally reflects the economic and commercial reality of the transactions and in order to satisfy the requirements of legal certainty, the relevant contractual terms constitute a factor to be taken into consideration when the supplier and the recipient in a ‘supply of services’ transaction within the meaning of Articles 2(1) and 6(1) of the Sixth Directive have to be identified." (Newey C-653/11)
- Contract is the most useful starting point, test against reality
"[47] This approach appears to me to reflect the approach of the Supreme Court in the subsequent case of WHA Ltd v Revenue and Customs Comrs [2013] UKSC 24; [2013] STC 943 where at para 27, Lord Reed said that “[t]he contractual position is not conclusive of the taxable supplies being made as between the various participants in these arrangements, but it is the most useful starting point”. He then went on in paras 30 to 38 to analyse the series of transactions, and in para 39, he explained that the tribunal had concluded that “the reality is quite different” from that which the contractual documentation suggested. Effectively, Lord Reed agreed with this, and assessed the VAT consequences by reference to the reality. In other words, as I said in Secret Hotels2 Ltd v Revenue and Customs Comrs [2014] STC 937, para 35, when assessing the VAT consequences of a particular contractual arrangement, the court should, at least normally, characterise the relationships by reference to the contracts and then consider whether that characterisation is vitiated by [any relevant] facts." (Airtours Holidays Transport Limited v. HMRC [2016] UKSC 21)
- Only go behind contract if it does not reflect true agreement
"[37] I accept that, when determining the nature of a transaction for VAT purposes, the court must look at the economic purpose of the transaction. However, the starting point is to determine what the parties have agreed. In my judgment, the correct reading of Newey and Secret Hotels2 is that the court only goes behind the contract if the contract does not reflect the true agreement between the parties." (ING Intermediate Holdings Limited v. HMRC [2017] EWC Civ 2111, Arden, Kitchin, Floyd LJJ)
- Where scheme operates though a number of contracts, look at matter as a whole to determine economic reality
"[26]...As was also noted in the Aimia case at para 38, the case-law of the Court of Justice indicates that, when determining the relevant supply in which a taxable person engages, regard must be had to all the circumstances in which the transaction in question takes place. Furthermore, as Lord Walker explained in Aimia at paras 114-115, in cases where a scheme operates through a construct of contractual relationships, as in the present case, it is necessary to look at the matter as a whole in order to determine its economic reality. Accordingly, although the transaction of particular importance is that between the garage and WHA, it has to be understood in the wider context of the arrangements between the insured, NIG, Crystal, Viscount, WHA and the garage." (WHA Limited v. HMRC [2013] UKSC 24)
- Termination of contract by customer does not affect economic reality
"[44] Inasmuch as MEO has a right under the agreements at issue in the main proceedings, in the event of failure to observe the minimum commitment period, to payment of the same amount as it would have received as payment for services which it undertook to supply in the event that the customer had not terminated his contract, a matter which it is for the referring court to ascertain if necessary, the early termination of the contract by the customer, or its termination for a reason attributable to that customer, does not alter the economic reality of the relationship between MEO and its customer." (MEO C-295/17)
- Economic reality confirming that assignment of right to 50% of horse's future winnings was consideration
"[53] As the referring court also observes, with regard to the value of contractual stipulations for the purposes of classifying a transaction as taxable, consideration of the economic and commercial reality is a fundamental criterion for the application of the common VAT system (judgment of 22 November 2018, MEO – Serviços de Comunicações e Multimédia, C-295/17, EU:C:2018:942, paragraph 43 and the case-law cited therein). In this light, the economics of the contracts concluded between the applicant in the main proceedings and the horse owners, as described in the order for reference, corroborates the conclusion that the assignment of receivables at issue in the main proceedings has a direct link with all the services comprising the single supply provided by the applicant in the main proceedings." (HAS C-713/21)
- Ineffective contractual term re passing of title to goods through insurers
"[34] The agreements between NIG and Crystal, Crystal and Viscount, and Viscount and WHA also contained provisions designed to secure that the title to vehicle parts appropriated for use in a repair under a valid claim under an NIG policy would be transferred in turn to Viscount, then Crystal, then NIG, prior to the parts being fitted in the insured's vehicle. It is common ground that these provisions were ineffective: there is no indication that they were notified to either the insured or the garages; they conflicted with retention of title clauses used by some of the garages; they did not address the situation where the policy covered only part of the cost of the repair; and they could not in any event prevent title from passing to the owner of the vehicle once a part was fitted." (WHA Limited v. HMRC [2013] UKSC 24)
May become apparent that contract does not reflect economic reality
- Insertion of additional contractual parties between insured and insurer not affecting who received supply of repair services
"[56] As I have explained, under the contract of insurance NIG undertakes to the insured that it will meet the cost of the repair. It does not undertake to repair the vehicle. If NIG were to perform the contract by itself paying the garage, that would be an example of third party consideration within the meaning of article 11A(1)(a) of the Sixth Directive: that is to say, consideration for a supply which the person providing the consideration does not himself receive, but which he pays for, in this example, in order to discharge an obligation owed to the recipient of the supply. On this hypothesis, the garage supplies a service to the insured by repairing his or her vehicle, and NIG meets the cost of that supply because it has undertaken to the insured that it will do so, and has received premiums from the insured as the consideration for its giving that undertaking. In that situation, the breakdown is a risk: an event insured against. The cost of the repair is the cover: it is not the consideration for a service provided to the insurer.
[57] The interposition of reinsurers does not alter that position. Neither, on the facts found by the tribunal, does the interposition of WHA. In economic reality, when WHA pays for the repairs it is merely discharging on behalf of the insurer (via the chain of contracts connecting it to NIG, through Viscount and Crystal) the latter's obligation to the insured to pay for the repair. WHA's role, in relation to the aspect of its business concerned with the payment of the garages, is to act as the paymaster of costs falling within the cover provided by the policies. The interposition of WHA does not, by some alchemy, transmute the discharge of the insurer's obligation to the insured into the consideration for a service provided to the reinsurer's agent." (WHA Limited v. HMRC [2013] UKSC 24)
- Where terms constitute a purely artificial arrangement
"[44] It may, however, become apparent that, sometimes, certain contractual terms do not wholly reflect the economic and commercial reality of the transactions.
[45] That is the case in particular if it becomes apparent that those contractual terms constitute a purely artificial arrangement which does not correspond with the economic and commercial reality of the transactions." (Newey C-653/11)
- Contractual terms may not reflect the true identity of the recipient of the supply
"[47] In the main proceedings, it is not disputed that, formally, in accordance with the contractual terms, Alabaster provided the lenders with the supplies of loan broking services and that it was the recipient of the supplies of advertising services provided by Wallace Barnaby.
[48] However, taking into account the economic reality of the business relationships between, on the one hand, Mr Newey, Alabaster and the lenders and, on the other hand, Mr Newey, Alabaster and Wallace Barnaby, as apparent from the order for reference and, in particular, the matters of fact mentioned by the Upper Tribunal (Tax and Chancery Chamber) in the third question, it is conceivable that the effective use and enjoyment of the services at issue in the main proceedings took place in the United Kingdom and that Mr Newey profited therefrom." (Newey C-653/11)
- If abusive, redefine the contractual terms
"[49] It is for the referring court, by means of an analysis of all the circumstances of the dispute in the main proceedings, to ascertain whether the contractual terms do not genuinely reflect economic reality and whether it is Mr Newey, and not Alabaster, who was actually the supplier of the loan broking services at issue and the recipient of the supplies of advertising services provided by Wallace Barnaby.
[50] If that were the case, those contractual terms would have to be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice (see, to that effect, Halifax and Others , paragraph 98).
[51] In the present case, the re-establishment of the situation that would have prevailed in the absence of the transactions at issue, if the referring court were to consider them to constitute an abusive practice, would, in particular, mean that the services agreement and the advertising arrangements concluded between Alabaster and Wallace Barnaby could not be relied upon against the Commissioners, who could legitimately regard Mr Newey as actually being the supplier of the loan broking services and the recipient of the supplies of advertising services at issue in the main proceedings." (Newey C-653/11)
- Careful before stigmatising contracts as artificial
"[57] For the reasons set out in paras 36-44 above, I consider that the contractual documentation supports the notion that Med was an intermediary, and, in the light of the discussion in paras 45-50 above, it seems to me that "economic reality" does not assist a contrary view. Further, one aspect of economic reality is that it is the hotelier, not Med, who owns the accommodation and it is the customer, not Med, to whom it is ultimately supplied: that does not, of course, prevent the hotelier supplying the accommodation to Med for supply on to the customer, but it makes it hard to argue that Med's analysis that it is no more than an agent is contrary to economic reality. Further, one must be careful before stigmatising the contractual documentation as being "artificial", bearing in mind that EU law, like English law, treats parties as free to arrange or structure their relationship so as to maximise its commercial attraction, including the incidence of taxation – see RBS Deutschland, cited in para 24 above." (HMRC v. Secret Hotels2 Limited [2014] UKSC 16)
"[61] For the reasons given above, I would dismiss this appeal. IDUK's deposit-taking business constituted the exempt business of banking services. I echo Lord Neuberger's caution near the end of his judgment in Secret Hotels2:
[O]ne must be careful before stigmatising the contractual documentation as being 'artificial', bearing in mind that EU law, like English law, treats parties as free to arrange or structure their relationship so as to maximise its commercial attraction, including the incidence of taxation--see RBS Deutschland, cited in para [24], above. ([57])
[62] IDUK was similarly free to structure the deposits in the way it thought fit and so it is in principle appropriate for the courts to determine whether there was a supply for VAT purposes by reference to the documentation it chose to use." (ING Intermediate Holdings Limited v. HMRC [2017] EWC Civ 2111, Arden, Kitchin, Floyd LJJ)
- Economic reality overriding contract: maintenance supplies received by trucker hirer
"[63] It follows from the above that we prefer the Respondents' contractual analysis to the contractual analysis proposed by the Appellant. On this contractual analysis, when the Appellant entered into the AS24 Contract and the contracts with the repairs and maintenance providers, even though each of those contracts was entered into by the Appellant and the relevant provider of goods or services on a bilateral basis and ROBO was not a party to the relevant contract, the terms of the relevant contract were such that the Appellant was contracting with the provider in question not to provide goods or services to the Appellant itself but instead to provide goods or services to ROBO on terms that the Appellant would meet the cost of those goods or services.
...
[67] However, in our view, taking into account all of the facts in this case, that was not the economic and commercial reality of the arrangement at all. On the contrary, that economic and commercial reality was that ROBO made its trucks available to the Appellant in return for the fixed payments and on the basis that the Appellant would continue to use the trucks in the course of its business in exactly the same way as it was doing before the arrangement with ROBO began (and would have continued to do if it had continued to own the trucks and have its own goods vehicle operator's licence.)" (D Nuttall UK Limited v. HMRC [2025] UKFTT 1600 (TC), Judge Beare)
- Bank contract claiming banking services were free would have been at odds with actual agreement
"[47] Judge Mosedale further held that, even if the contract had purported to say that there was no consideration whatsoever, that term would be so clearly at odds with the actual agreement between the parties, that under Newey and Secret Hotels2, she would have to disregard it. I agree." (ING Intermediate Holdings Limited v. HMRC [2017] EWC Civ 2111, Arden, Kitchin, Floyd LJJ)