Supply of services presents one of the greatest challenges to the value-added tax. They are now rapidly growing in economic performance, and yet they are defined for the VAT proposes in a residual way: under the proposed law, any transaction that is not a supply of goods, but is a supply of services.
On the one hand, it gives supply of services a deceptively simple definition, and on the other, it leaves supply of services at the centre of many of the important difficulties raised by the VAT. Under Section 3 of the proposed provincial law, taxable supply of services is anything that is not a supply of goods, money, or immovable property shall be a supply of services, including the following:
-- Any supply of goods other than a sale, including but not limited to a lease, hire, or other right to use goods.
-- The grant, assignment, termination, or surrender of a right.
-- The making available of a facility, opportunity, or advantage.
-- Refraining from or tolerating an activity, a situation, or the committal of an act; or handling of documents, other than by a government.
-- A supply of services, ie ancillary or incidental to an import of goods, shall be treated as part of the import of goods. For the supplies to be taxable, the proposed law sets out three additional requirements: the supplies must be, (i) "effected for consideration" (ii) "within the territory of the country" (iii) "by a taxable person acting as such". Together with the definition of supply of services, there are thus four elements for something to be deemed supply of services.
Each of these elements, in turn, is critical in different situations. In some cases, taxability will turn on the existence of consideration; in others the question will be whether the supplier is acting as a taxable person. The residual nature of the definition and the reference to "any transaction" indicate that the definition is a broad one. Can we get an intuitive sense of how broad it is? Even without any legislative definition, we can easily appreciate the meaning of supplies and imports of goods.
The definitions in the proposed law clarify the meaning and make some important adjustment to the scope of the concepts, but even without the definitions, the terms do not obviously raise serious conceptual difficulties. Moreover, there are categories that generally have long been the subject of taxation. Further, the physical nature implicit in the term "goods" indicates something that is in principle easy to identify, and thus typically easy to locate and tax. This is not to say that we anticipate no problems in using these terms, but we expect that they will be only the usual problems of drawing lines, problems that are inevitable whenever we try to determine the scope of any taxing provision.
The same cannot be said of supply of services. There is no complete meaning that jumps to mind. Initially, we will think of services performed by individuals - work done (although we know that work done as an employee is excluded since employees are not acting as taxable persons). This includes the work of professionals, consultants, artisans and artists: from lawyers to lobbyists to plumbers to sculptors. Other things described as services will come to mind, such as financial services.
Then we must also consider other things that do not sound like a supply of goods, such as supply of intangibles (eg copyright) or of the use of physical things (hirings and lettings). The link between these terms that would justify calling all of them supply of services is starting to look tenuous. But the residual nature of the definition makes it inevitable that it will be something of a mixed bag. On the other hand, the residual definition indicates that all of these things (and any other items that may fall within it) arc proper and indeed necessary subjects of a fully-hedged VAT.
A deceptively simple definition
An interesting example of how deceptive the simplicity of the definition of supply of services can be is that of the decision of the House of Lords in Customs and Excise Commissioners v. Redrow Group plc. Redrow built houses that it sold to private purchasers. The purchasers often had old houses of their own which they had to sell before they could buy houses from Redrow. In order to facilitate its sales, Redrow would offer to pay the cost of the estate agent's fees on the sale of the purchaser's old house.
The purchaser would have to use an estate agent chosen by Redrow and whom he would supervise. Moreover, the fee would only be paid if the purchase of the Redrow house went through. Otherwise, subject to a suitable agreement between the agent and Redrow's prospective purchaser, the fee would be payable by the prospective purchaser.
The agent's fee paid by Redrow included an amount of VAT. Redrow sought to deduct that the VAT as input tax. The arrangement was designed to make purchasing a Redrow house attractive, but Redrow might well have passed the cost of the agent's fees on to its purchasers as part of the price of its house. If Redrow could not deduct the VAT, the purchaser would effectively pay the VAT on the fees twice; first the VAT charged by the agent, and then the VAT charged by Redrow on the portion of the-house price that represented the cost of the fee.
The problem for Redrow's position was that the provisions of British law define a taxable person's input tax as "value added tax due or paid in respect of goods or services supplied or to be supplied to him." In other words, the right of deduction is given to the person to whom the supply is made, rather than to the person who pays for the supply. The solution affirmed in the House of Lords was to treat the payment to the agent by Redrow as being for the supply of another (ill-defined) service. This gave Redrow a clear right to a deduction.
The problem with the Lords' decision comes from the striking simplicity of the central proposition on which the result is based. Lord Millett expressed it in two parts.
-- "The first is that anything done for a consideration, which is not a supply of goods constitutes a supply of services. This makes it unnecessary to define the services in question. The second is that unless the services are rendered for a consideration, they cannot constitute the subject matter of a supply." The core of Lord Millett's argument is based on what is now section 5(2) of the British Value Added Tax Act 1994:
-- "(2) (a) 'Supply in this Act included all forms of supply, but not anything done otherwise than for a consideration; (b) anything, which is not a supply of goods but is done for a consideration (including, if so done, the granting, assignment or surrender of any right) is a supply of services."
There are, however, two problems with this. The first arises from a difference of structure between the Value Added Tax Act and the European Union's sixth directive. It is a small difference, and its significance is not normally evident. The sixth directive does not include the requirement of consideration within the definition of "supply." It is instead an additional requirement for a charge to the VAT. The provisions of the sixth directive corresponding to those of British Value Added Tax Act 1994 quoted above arc contained in articles 2 and 6(1):
Article 2
The following shall be subject to value-added tax:
"The supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such;"...
Article 6 supply of services
Supply of services shall mean any transaction which does not constitute a supply of goods within the meaning of Article 5. Such transactions may include inter alia:
-- assignments of intangible property,
-- obligations to refrain from an act or to tolerate an act or situation."
In the meaning of the sixth directive, it is only a part of the truth to say with Lord Millett that "anything done for a consideration, which is not a supply of goods, constitutes a supply of services." More important, this proposition cannot be used, as he uses it, as a way of defining what "supply of services" means. On his approach, once you have identified a payment, if it constitutes consideration, then it is payment for a supply. It is not necessary to identify what it might be consideration for : as long as it is not consideration for a supply of goods, it is ipso facto consideration for a supply of services. The only constraint seems to be that the payment must not be gratuitous.
Even if this is not the correct approach, the meaning of "supply of services" is clearly still very broad. Indeed the wording of Section 3 of the proposed law suggests that it can extend to "any transaction", a phrase that appears to have the broadest of meanings. The European Court of Justice has, however, said otherwise in Mohr v, Finanzamt Bad Segebeg and in Landboden - Agrardienste GmbH & Co KG v. Finanzamt Calau. It interpreted "any transaction" in the light of its role within the broader scheme of the VAT and the intended nature of the tax. These cases concerned payments made to farmers as compensation for being required not to grow crops (set-aside payments). The court concluded that the farmers did not "provide services to an identifiable consumer or any benefit capable of being regarded as a cost component of the activity of another person in the commercial chain." This is required because as stated in the first directive, "the principle of value-added tax involved the application to goods and services of a general tax on consumption. In other words, a supply of services is really any transaction for (or in the commercial chain leading to) consumption, other than a supply of goods."
Lord Millet says that, having found a payment by a taxpayer claiming a credit, the question is: "did he obtain anything - anything at all - used ... for the purposes of his business, in return, for that payment." The court in Landboden says that in determining whether there was a supply of services what matters is what was done or undertaken by the purported supplier. The use made of it by the recipient payer is irrelevant.
The purported supplier must provide a benefit to identifiable persons and this benefit must be of such a nature that those persons can be considered to be consumers (either directly or as in the sense that an intermediate producer consumers inputs that contribute to his or her supplies). In other words the question is not: Did the recipient obtain a benefit? but: Did the supplier provide a benefit to an identifiable recipient? Whether the recipient, in fact, benefited is irrelevant. What matters is whether the nature of what the supplier did (or, as in Landboden) undertook not to do, was such as to provide a benefit in an identifiable direction that would ultimately lead to consumption.
These are very subtle distinctions. It is not even clear that they would have had much effect on the result in Redrow, particularly or-r" the facts of- that case. The estate agents acted according to Redrow's instructions in order to facilitate the sale of houses by Redrow. While it is clear that the definition of a supply of services in Redrow, is incorrect in light of Mohr and Landboden, what is troubling about Redrow is not that the House of Lords held that the estate agents made supply of services to both the prospective house purchaser and to Redrow.
The concern is that the single set of fee payable to the estate agents could constitute consideration for either supply, depending only on who paid the fee, which, in turn, depended on whether Redrow's sale went through. In each case, the agent does the same thing for the sale price. The implication of the finding that there were two supplies is that the agreement between the parties was that the agent's world receive consideration for one service in one case and for the second service in the other case. If the agent supplied a distinct service to Redrew as well as to the prospective purchaser, could the entire amount of the fees really constitute consideration for that supply?
Of course, if the fees were not consideration for a service supplied to Redrow, then Redrow could not deduct the VAT on the fee as input tax, and the prospective purchasers could not deduct the fee since they were not acting as taxable persons. Thus the solution to the puzzle posed by Redrow lies in the element of consideration rather than in the definition of supplies of services.
Nevertheless, the error of the House of Lords in its interpretation of the definition is significant. If any payment in consideration for something was in consideration for a supply of (unspecified) services, then in principle a taxable person could always obtain a deduction subject to provisions of section 27 of the Value Added Tax Act for a payment in consideration, even if the payment was economically for a supply to a third person, because Redrow, would recharacterize it as a payment for a right to have a supply made to the third person, 'this matters where the payer is a taxable person making taxable supplies, but the recipient of the underlying service is in a different position. The underlying recipient may not be a taxable person, or may be making exempt supplies or supplies taxable at a higher rate.
Even if the House of Lords' subtle error in defining a supply of services affected the result in that ease, it not clear that the ECJ's more sophisticated approach in Mohr and Landboden yielded a correct result in those cases. It is not obvious why these compensation payments should be singled out as not resulting in supply of services, even though it is clear that undertakings not to act can be supply of services. Why should compensation for not farming not be subject to the VAT? If the government had compensated Mohr for not producing any more milk by compulsorily buying up his cattle herd and, destroying it, there would have been a supply of goods subject to VAT. Leaving aside the differences between supply of goods and supply of services discussed by the court in those cases, it is not clear why, as a matter of the policy of the VAT system, the result should be so different. The lines drawn in these cases are of numbing legal subtlety. It is worth seeing what light policy can throw on the matter.
(The writer is a graduate of University of Southern California and an Advocate and is currently working as Managing Partner of M/s Azim ud Din Law Associates Karachi.)
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