Trade-volume pro rata method confirmed by Supreme Court
Trade-volume pro rata method confirmed by Supreme Court
In a recent case, the Dutch Supreme Court provided important guidance on the use of a trade volume-based pro rata method for VAT purposes by market makers earning income through bid-ask spreads. The Court confirmed that, under certain circumstances, such a method may offer a fair and accurate basis for determining input VAT recovery and clarified how other forms of remuneration should be treated within this framework.
Under all market conditions, the taxpayer continuously quotes bid prices (the highest price the taxpayer would pay for the security) and ask prices (the lowest price for which it would sell the security). These prices reflect the amounts at which the taxpayer is willing to purchase or sell securities. The difference between the bid and ask price constitutes the income generated (the “spread”).
In addition, the taxpayer received income from its non-EU subsidiaries through transfer pricing agreements (TNMM compensation) and profit split agreements (RPSM payments).
Due to difficulties in establishing the location of customers (EU/non-EU), the taxpayer reached an agreement with the Dutch Tax Authorities on the use of a pro rata method based on trade volume.
However, in 2016 the taxpayer sought to include the TNMM compensation and RPSM payments in the non-EU proportion of the trade volume calculation. This request was rejected by the Dutch Tax Authorities.
The Supreme Court confirmed that where revenue is generated through a spread between bid and ask prices, a trade volume-based method should be applied wherever possible, in line with the CJEU case in First National Bank of Chicago.
The Court further determined that, for the purpose of the pro rata calculation, the taxpayer may use any information at its disposal to establish the place of establishment of its customers. The VAT Directive does not impose requirements on the nature of the evidence, nor does Dutch VAT law contain specific evidentiary rules in this respect.
Finally, the Supreme Court held that other taxable remuneration (in this case, TNMM compensation and RPSM payments) must be included in the pro rata calculation. However, the case was referred back to the Court of Appeal to assess whether the RPSM payments qualify as consideration for supplies made by the subsidiaries and therefore should indeed be included in the pro rata calculation.
The case also confirms that any evidence can be used to substantiate the place of supply of customers within the method, so long as the data used is precise, reliable and up-to-date.
Further clarification from the Court of Appeal is required on how other income should be incorporated into a trade volume-based method. Given the significant trade volumes processed by many market makers, this is likely to have a material impact only where recovery rates are very low or where profit splits are non-EU and substantial.
Background – case summary
A market maker in financial instruments active on securities exchanges (hereinafter referred to as the taxpayer) receives income from effecting trades on electronic platforms. It ensures that continuous trading in securities is available to investors on (electronic) trading platforms such as Euronext.Under all market conditions, the taxpayer continuously quotes bid prices (the highest price the taxpayer would pay for the security) and ask prices (the lowest price for which it would sell the security). These prices reflect the amounts at which the taxpayer is willing to purchase or sell securities. The difference between the bid and ask price constitutes the income generated (the “spread”).
In addition, the taxpayer received income from its non-EU subsidiaries through transfer pricing agreements (TNMM compensation) and profit split agreements (RPSM payments).
Due to difficulties in establishing the location of customers (EU/non-EU), the taxpayer reached an agreement with the Dutch Tax Authorities on the use of a pro rata method based on trade volume.
However, in 2016 the taxpayer sought to include the TNMM compensation and RPSM payments in the non-EU proportion of the trade volume calculation. This request was rejected by the Dutch Tax Authorities.
Findings of the Supreme Court
The Supreme Court overruled a number of positions taken by the Court of Appeal, which were based on an incorrect interpretation of the law.The Supreme Court confirmed that where revenue is generated through a spread between bid and ask prices, a trade volume-based method should be applied wherever possible, in line with the CJEU case in First National Bank of Chicago.
The Court further determined that, for the purpose of the pro rata calculation, the taxpayer may use any information at its disposal to establish the place of establishment of its customers. The VAT Directive does not impose requirements on the nature of the evidence, nor does Dutch VAT law contain specific evidentiary rules in this respect.
Finally, the Supreme Court held that other taxable remuneration (in this case, TNMM compensation and RPSM payments) must be included in the pro rata calculation. However, the case was referred back to the Court of Appeal to assess whether the RPSM payments qualify as consideration for supplies made by the subsidiaries and therefore should indeed be included in the pro rata calculation.
Practical consequences
Where taxpayers earn their income via a spread between bid and ask prices, we see this case as a confirmation that a volume-based method can be applicable, as it would give a more fair and accurate method of apportioning input tax.The case also confirms that any evidence can be used to substantiate the place of supply of customers within the method, so long as the data used is precise, reliable and up-to-date.
Further clarification from the Court of Appeal is required on how other income should be incorporated into a trade volume-based method. Given the significant trade volumes processed by many market makers, this is likely to have a material impact only where recovery rates are very low or where profit splits are non-EU and substantial.
