No ‘legitimate expectation’ for leading mobile phone company

Judicial review is a hot topic amongst taxpayers and their advisers at present, particularly in the light of a number of challenges that have been made to the fairness of the APN system. A recent ruling of the Upper Tribunal (“UT”), R (on the application of Telefonica Europe plc) v R & C Commrs [2016] BVC 512, sheds some light on this difficult area.

The facts

Paragraph 8 of Schedule 4A to the VAT Act 1994 (‘VATA94’) provides that, where a supply of telecommunications services would otherwise be regarded as made in the UK but the services are “effectively used and enjoyed” in a non-EU country, then the supply is treated as made in the non-EU country and thus not chargeable to UK VAT. The Claimants challenged a decision of the ‘HMRC’ issued on 26 November 2014 that Telefonica must change the way it calculated the proportion of the monthly charge to customers for the supply of access to the mobile telephone network that related to such access used and enjoyed by customers outside the EU.

Between 2008 and 2014, Telefonica, with the agreement of HMRC, calculated the value of the non-EU access by reference to the charges made for voice calls, messaging and data services not included in the customers’ fixed monthly charge (‘additional services’). In summary, Telefonica first determined what proportion of the charges paid by the customer for additional services in a month related to additional services used in non-EU countries as compared with total charges paid by that customer in that month for the time spent and number of texts sent, since charges for additional services are calculated on the basis of time spent and texts used. Telefonica then applied that proportion to the network access charge and treated the amount so determined as not subject to VAT. Telefonica referred to that method of calculation as the ‘Revenue Methodology’.

In November 2014, HMRC formed the view that the Revenue Methodology was distortive because customers on the relevant tariffs pay more for non-EU additional services than for additional services in the UK and EU.

Telefonica challenged HMRC’s change of heart, by way of judicial review, on three grounds, namely that:

(1) the Usage Methodology that HMRC required Telefonica to use was unlawful because it is contrary to EU and domestic VAT legislation;

(2) the Decision constituted a breach of Telefonica’s substantive legitimate expectation, based on a clear assurance given by HMRC in 2008, that it could continue using the Revenue Methodology until there was a material change in the law or in Telefonica’s business, which there has not been; and

(3) it was taken without adequate consultation to enable Telefonica to explain to HMRC the fundamental difficulties inherent in the adoption of the Usage Methodology which was a breach of Telefonica’s procedural legitimate expectation.

 The business of Telefonica

Telefonica, trading as O2, provides mobile telecommunications services to business and private customers in the UK. Monthly pay customers pay a fixed charge that includes three elements, namely:

(1) a tariff or call bundle charge which is consideration for an agreed number of voice call minutes, messages and data that the customer can use each month without incurring any additional charges;

(2) an amount in consideration of the supply of the mobile phone handset, if provided, by Telefonica to the customer;

(3) the network access charge which is consideration for the supply of access to a mobile telecommunications network in the UK and elsewhere;

(4) a variable amount for any additional services e.g. ‘roaming’ services when UK customers travel outside the EU.

HMRC’s representation and change of approach

In a letter to HMRC dated 27 March 2008, Telefonica explained that it had used the Revenue Methodology “to calculate the effective non EU use and enjoyment of the line rental services provided” – i.e. the non-EU network access charge. The letter then summarised that methodology as follows:

The methodology adopted has been to apportion between EU and non EU use and enjoyment of this service by reference to revenues. This has been done by calculating the percentage non EU call, SMS and MMS revenues represents as a proportion of total call, SMS and MMS revenues. The percentage generated from this calculation is then applied to the line rental revenues and the proportion of VAT over-declared on those revenues is then calculated.”

Further details of the Revenue Methodology, including the relevant figures, were contained in appendices to Telefonica’s letter of 27 March 2008.

In an email dated 29 May 2008  and a letter of 4 August 2008 HMRC confirmed their acceptance of Telefonica’s use of the Revenue Methodology used by the company.

In May 2013, HMRC hosted a meeting with representatives of the telecommunications industry to discuss the new place of supply rules for intra-EU supplies that were to come into force on 1 January 2015 and, at the same time, HMRC raised the issue of how the non-EU use and enjoyment measure, i.e. the calculation of the non-EU network access charge, could be improved by reference to actual rather than estimated data.

On 3 July 2013, HMRC wrote to Telefonica referring to the meeting with the representatives of the telecommunications sector in May and stating:

As part of the discussion HMRC outlined our position on the use of estimation in calculating use and enjoyment of broadband and line rental [ie network access] charges. We believe that since HMRC agreed a methodology with you for calculating these charges, the technological advances in data systems have improved the capability for both capturing and storing customer data. Consequently, we consider that sufficient data is now held within customer accounting systems to allow for direct measurement of services used by customers outside the EU.’

HMRC then moved, as part of its change of approach, to a ‘usage’ basis, that is minutes spent, number of texts, data consumed/access occasions outside the EU as a portion of total consumption of each feature.

The UT’s decision – the Usage Methodology

The UT did not agree with the taxpayer.

The UT set out the relevant legislation and pointed out that, under Article 58 of Council Directive 2006/112/EC on the Common System of Value Added Tax (‘the Principal VAT Directive’ or ‘PVD’), the place of supply of telecommunications services to a non-taxable person “shall be the place where that person is established, has his permanent address or usually resides.” However, this general rule is subject to a discretion granted to Member States in Article 59a which provides:

In order to prevent double taxation, non-taxation or distortion of competition, Member States may, with regard to services the place of supply of which is governed by Articles 44, 45, 56, 58 and 59:

 (a) consider the place of supply of any or all of those services, if situated within their territory, as being situated outside the Community if the effective use and enjoyment of the services takes place outside the Community …”

 Based on the facts as found and the relevant legislation, the Tribunal then addressed the above three issues.

In terms of the lawfulness of the usage methodology, the UT said:

‘In our view, the starting point is to identify the supply. In this case, there is no dispute that the service supplied by Telefonica to its customers is the ability to access a telecommunications network, where available, in the UK and elsewhere ….Having identified the supply, the next step is to decide what is meant by ‘effective use and enjoyment’ of the ability to access a telecommunications network for the purpose of determining the place of supply…

The final step is to determine how the monthly network access charge is to be apportioned between EU and non-EU locations where a service is used and enjoyed in more than one place. Both the Revenue Methodology and the Usage Methodology rely on the customer’s actual chargeable use of networks as a proxy for the benefit he enjoys from the availability of networks to him. Both methods rely on comparing the proportion of actual access to the overseas networks to the total actual access to all networks over the month for which the access charge is imposed. The difference is whether the proportion is calculated by using, e.g. the minutes used by the customer when accessing the overseas networks compared to all minutes used (in the Usage Methodology) or the charges made for the minutes used by the customer when accessing the overseas networks compared to total charges for minutes used (in the Revenue Methodology)……

  there is nothing in the wording or purpose of the legislation that precludes an approach to determining use and enjoyment based on actual usage.’

The UT’s decision – legitimate expectation grounds

 The UT was unimpressed with the taxpayer’s arguments.

‘The second ground of Telefonica’s claim asserts that Telefonica has a substantive legitimate expectation that it would be able to continue to use the Revenue Methodology until such time as the law or its business changed in a relevant way, that is, in a way which undermined the appropriateness of the methodology. This expectation is said to arise from the wording of the 4 August letter accepting that the Revenue Methodology should continue to be used unless it becomes necessary to make changes to the methodology due to changes in law or in Telefonica’s business……. Further, Telefonica contends that ‘[t]his expectation was reinforced by HMRC’s continued acceptance’ of Telefonica’s calculations based on the Revenue Methodology.’

The doctrine of substantive legitimate expectation is well established in public law. The leading case on the application of these principles in the context of the relationship between HMRC and a taxpayer is R v Inland Revenue Commissioners ex parte MFK Underwriting Agencies Ltd [1989] STC 873 (‘MFK’).

The Tribunal set out the key grounds for a finding of legitimate expectation.

  • The claimant has an expectation of being treated in a particular way favourable to the claimant by the defendant public authority;
  • The authority has caused the claimant to have that expectation by words or conduct;
  • The claimant’s expectation is legitimate;
  • It would be an unjust exercise of power for the authority to frustrate the claimant’s expectation.

In the Tribunal’s analysis, the key factors for a taxpayer to rely on legitimate expectation are;

  1. First, it is necessary that the taxpayer should have put all his cards face upwards on the table. This means that he must give full details of the specific transaction on which he seeks the Revenue’s ruling;
  2. Secondly, it is necessary that the ruling or statement relied on should be clear, unambiguous and devoid of relevant qualification.”

The UT then said:

‘The 27 March 2008 letter did not include any request for a ruling on future treatment of the VAT adjustment for the line rental. It simply claimed the refund of past VAT paid, setting out the reasons why Telefonica argued that such a refund was justified and explaining the Revenue Methodology. There was nothing in that letter that would have alerted HMRC to the suggestion that Telefonica was seeking an assurance that it would be entitled to apply the Revenue Methodology for years into the future. The 16 June letter was also largely concerned with explaining what Telefonica had done for the previous VAT period…..

In particular we consider it is important that Telefonica did not put forward at any stage any reason why it needed any such assurance. On the contrary, Telefonica had expressly told HMRC in the 2 May 2008 letter that it would not be changing its tariffs in reliance on the acceptance of the Revenue Methodology but would be absorbing the VAT saving as additional income.   So there was nothing in the previous correspondence to indicate to HMRC that Telefonica wanted or needed an indication from HMRC as to continued acceptance of the Revenue Methodology.

We also reject Telefonica’s assertion that the subsequent practice of HMRC in accepting their VAT returns based on the Revenue Methodology between 2008 and2013   ‘reinforced’ a   legitimate expectation that   the   practice would   continue indefinitely….. We therefore hold that there was no legitimate explanation generated either by the 4 August letter or by the acceptance of the Revenue Methodology over a number of years. There is no unfairness or abuse of power in HMRC now changing the way that the VAT adjustment is calculated.’

The UT’s decision – was there a breach of Telefonica’s procedural legitimate expectations?

The UT once again found in favour of HMRC.

The UT said:

‘Telefonica’s case is that the agreement that it could use the Revenue Methodology had been in place since 2008 and that gave rise to a duty on HMRC properly to consult Telefonica before requiring it to change to the Usage Methodology.’

….in R (on the application of Bhatt Murphy (a firm) and others) v Independent Assessor; R (on the application of Niazi and others) v Secretary of State [2008] EWCA Civ 755 (‘Bhatt Murphy’).   Laws LJ gave a broad summary of the place of legitimate expectations in public law with particular reference to when the duty to consult arises [50] as follows……

 “The power of public authorities to change policy is constrained by the legal duty to be fair (and other constraints which the law imposes).   A change of policy which would otherwise be legally unexceptionable may be held unfair by reason of prior action, or inaction, by the authority. If it has distinctly promised to consult those affected or potentially affected, then ordinarily it must consult (the paradigm case of procedural expectation).   If it has distinctly promised to preserve existing policy for a specific person or group who would be substantially affected by the change, then ordinarily it must keep its promise (substantive expectation). If, without any promise, it has established a policy distinctly and substantially affecting a specific person or group who in the circumstances was in reason entitled to rely on its continuance and did so, then ordinarily it must consult before effecting any change (the secondary case of procedural expectation).   To do otherwise, in any of these instances, would be to act so unfairly as to perpetrate an abuse of power.”

 ….we consider that HMRC had a duty to consult Telefonica about the proposed change to the agreed methodology for calculating the effective use and enjoyment of the telecommunications services outside the EU…… In our view, HMRC did consult properly in that they provided Telefonica with an adequate opportunity to make representations and explain why they could not implement the Usage Methodology.


The decision of the UT will come as a disappointment to taxpayers who seek to hold HMRC to clear assurances, in circumstances where those assurances have been relied upon by the taxpayer concerned.

The case demonstrate that, unless the representation is embodied in a public statement of practice or is absolutely clear and unequivocal, the taxpayer may have an uphill struggle to succeed in cases where legitimate expectation is being invoked.


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