10 May 2016

Telefonica had previously agreed with HMRC that it could calculate VAT on phone charges using a method based on revenue.  When HMRC challenged this method, Telefonica appealed HMRC's direction and the Tribunal found that Telefonica had not been given a clear assurance from HMRC that it could use the VAT calculation indefinitely.  Therefore, Telefonica’s appeal for judicial review failed.

Of wider interest, the case suggests that HMRC may well be under a non-statutory duty to consult taxpayers in some circumstances.

This case was an appeal by Telefonica for a judicial review of HMRC’s decision to disallow its use of the following method for calculating the VAT payable on call charges.

Schedule 4A, para. 8 VAT Act 1994 provides that where telecommunications services are ‘effectively used and enjoyed’ in a non-EU country, the supply is treated as being made in that country and is therefore not a subject to UK VAT.

On this basis, Telefonica used what it called a 'revenue method' to calculate VAT payable by customers.  This revenue method used the proportion of the charges paid by the customer for additional non-EU calls in any month as compared with the total charges payable by the customer in that month and used this proportion to apply an amount of VAT payable or not payable under that contract.  HMRC challenged the revenue method because it found that customers paid more for non-EU services than for those within the UK and EU.  This difference meant that the charges for the non-EU services were a much higher proportion of the total than was reflected in the actual usage.

HMRC stated that Telefonica should calculate the proportion of the monthly network charges that related to non-EU services by reference to the actual usage such as time spent on calls, number of text message, volume of data etc.  This method was referred to as the 'usage method' which would result in a significantly smaller proportion of the monthly network access charges being treated as non-EU services and therefore not subject to UK VAT.  Telefonica brought judicial review proceedings against this direction.

Telefonica's case was based on three principle grounds of appeal:

  • the usage method was unlawful because it was contrary to EU VAT legislation
  • the decision constituted a breach of Telefonica's legitimate expectation that HMRC had given in recent communication that Telefonica could continue to use the usage method 'for future years subject to any adjustment that may be necessitated by changes in law or business practice'.
  • HMRC had failed to undertake adequate consultation with Telefonica prior to the direction because the agreement between it and HMRC in relation to the revenue method had been in place since 2008, HMRC had a duty to consult Telefonica before it required it to change to the usage method.

Regarding the first ground of appeal, the Upper Tribunal found that in order to determine the place of use of the supply of mobile network that incurred mobile network charges, there had to be some actual use of the network.  This meant that for VAT purposes, the use of the network meant that the usage method was therefore within the scope of VAT legislation.

When considering the second ground of appeal, the Upper Tribunal found that HMRC's communications with Telefonica had not contained any indefinite or formal assurance that the revenue method could be used by Telefonica forever.  Additionally, certain adjustments by Telefonica made to the revenue method demonstrated to the Tribunal that neither Telefonica nor HMRC considered the method to be fixed and unchanging.  This susceptibility to change raised the issue that had Telefonica obtained clear advanced assurances from HMRC in relation to the revenue method, its appeal may have succeeded.

Finally, on the third ground of appeal, the Upper Tribunal considered that HMRC did have a duty to consult Telefonica.  On the facts, the Tribunal found that HMRC did consult properly with Telefonica in that HMRC provided Telefonica adequate opportunities to make representations and explain why they could not implement the usage method.  This consultation process was deemed to have started when HMRC first raised concerns about Telefonica's revenue method and identified at an early stage by HMRC.


The Telefonica case represents a significant VAT change for telecoms businesses (and may well be appealed).

Outside that narrow field, however, the case raises an interest point of wider interest.

The case suggests that where HMRC has established a policy effecting a specific person who was entitled to rely on its continuance and did so, then ordinarily it must consult before effecting any change.  This is the case even though there is no statutory obligation to consult.  However, the case sets the bar for the requirement of consultation on HMRC quite low because if a taxpayer is asked or given the opportunity to make representations, that is sufficient to constitute a consultation by HMRC.

This case highlights the importance of obtaining a formal advance assurance from HMRC when relying on any leniency or procedural statements made by HMRC to a taxpayer.  This case also highlights that there is a difference between a legitimate expectation in procedure and a legitimate expectation in substance and it is important for any taxpayer to clarify which side of the line its case falls.    

Key contact

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John Barnett Partner

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