As the COVID-19 pandemic recedes many medical testing services businesses have been diversifying and bringing to market new products aimed at the growing health and wellbeing market. For example, blood and DNA testing and screening services. The VAT status of these new offerings is not always clear and recent VAT case-law, and commentary issued by HMRC, leaves some grey areas for interpretation, with risks for tax compliance.
One of the considerations when innovating and developing new products is the question of whether or not the contemplated supplies fall under the VAT exemption for medical care. As with all exceptions to standard rating, the medical care exemption is applied narrowly and has a series of conditions that all have to be met. There is also a ‘cliff-edge’ in the impact between having to account for VAT (at the standard rate of 20% in the UK) and exempt treatment; the possible addition of 20% VAT either makes products more expensive or reduces the supplier’s profit margin. Similarly, getting the VAT treatment wrong can cause unexpected costs at a later date given there is a four-year look-back period in VAT law.
Businesses should also be aware that the government offers corporate tax credits for qualifying R&D expenditures. This can provide valuable tax rebates to help incentivize and fund further research activity. In addition, if the product is patentable, the company may be able to claim tax benefits within the patent box.
VAT considerations
The COVID-19 pandemic has raised awareness and interest among consumers and employers for healthcare products. There also seems to be a greater acceptance of self-administering tests to obtain a rapid diagnosis. Some medical testing businesses may look to capitalize on this heightened interest in wellness. There is plenty of evidence of the introduction of new testing products for a range of illnesses or conditions. A key question is whether or not that product meets the conditions for VAT exemption as a medical care service. If it is a product for consumers or one being provided to organizations who cannot reclaim their VAT, such as private healthcare providers, then the addition of VAT will most likely increase the cost of the product as the VAT charged would be irrecoverable.
Unfortunately, what may be regarded as a medical service to a layman doesn’t automatically qualify for exemption under the VAT rules. HMRC’s policy on the VAT treatment of COVID-19 PCR testing services had to evolve rapidly in response to the fast-moving nature of the testing rollout, and some of the significant changes to the regulatory framework applying in the sector. That policy evolution has led to inconsistent VAT treatments being applied by some healthcare suppliers and testing laboratories. This has heightened the risk of HMRC challenging the approach which some suppliers have taken to the application of the VAT exemption and recovery of VAT on their purchases.
While the rule of thumb is that a medical service intended to protect, restore or maintain human health, can benefit from VAT exemption, there are conditions regarding how the service is delivered. For care or treatment outside a hospital, for instance, it’s important to establish whether this is wholly performed or directly supervised by a medical professional on one of the UK’s recognized professional registers. This is not always clear cut and the commercial aims of managing costs can be a factor, for example where outsourcing to lower-cost providers overseas is a factor. The fact that UK law refers to UK professional registers is not a surprise but does also raise a question of the consequences of testing being outsourced to laboratories based overseas whose employees may not meet this requirement. Does this preclude the UK VAT exemption from applying to such outsourced activities?
One of the VAT learnings from the COVID-19 PCR testing experience is that details such as whether the obtaining of a sample is self-administered and the medical qualification held by the individual carrying out the test (there are also different VAT rules for pharmacists as compared to medical doctors) could impact on the VAT treatment. Both of these have been areas of known dispute with HMRC and future developments may be expected that could have a retrospective as well as prospective impact on COVID-19 PCR testing services. These may be relevant to the way new medical testing products adopting similar methodologies are treated.
Another area of potential future revenue growth is the testing of employees for employers, this could be all domestically but could also include multinational groups where a UK parent company agrees a global contract to test or screen the group’s employees for certain conditions regularly. Given the contractual recipient of the service is the employer, does the service still benefit from the VAT exemption for medical testing services concerned with the protection, restoration, or maintenance of human health? One of the points reinforced by VAT case law is that the medical care exemption is applied based on a primary purpose test.
Where a business is involved in procuring medical care for individual recipients that can raise a question as to what is the business’s main purpose in involving a health professional to undertake a test or examination of an employee. The health of the patient or some other commercial aim?
In the case of CIG Pannónia Életbiztosító the Court of Justice of the European Union Court recently decided that, despite qualified health professionals being involved in the provision of the services, the services did not qualify for an exemption. The Court concluded that the purpose of one of the services was to provide a report relating to an insurance claim, rather than to benefit an individual’s health and a second service provided concerning the arrangements for the individual’s treatment was predominantly administrative. The decision highlights the need to assess whether the service is about the protection, maintenance, or restoration of human health and that this remains a subjective area.
Another example of where the VAT treatment of supply could be in doubt is where providers of medical care outsource logistics and testing activities i.e they effectively stand between the customer/ patient and the laboratory by providing a coordination or facilitation role. This kind of scenario raises important questions. First to what extent must the supplier employ its own appropriately qualified medical staff to directly supervise the provision of medical care services? Second, will the regulatory framework to which the supplier has to adhere be such as to qualify it as a state-regulated institution, which, like a hospital, is entitled to benefit from the VAT exemption? Case law has shown that where the service is essentially one of administration of care by third parties, this is unlikely to be exempt. As in all instances, the specific facts of each supplier need to be considered.
R&D and Patent Box
R&D tax credits are really valuable to companies. Based on current rules they can offer savings of up to 25% of the qualifying R&D expenditure. Loss-making SMEs and larger companies can also claim a repayment of tax. From 1 April 2023, changes are being made to UK R&D tax credits, including the rates. This partially reflects an increase in the main rate of UK corporation tax, but also improves the benefit of the R&D Tax Credit (RDEC) scheme while reducing that of the SME scheme. HMRC is consulting on introducing a single R&D tax credit scheme – bringing to an end the existing two schemes.
Medical testing companies will have had certain products for other purposes, but to meet the immediate need and impact of COVID-19 they will have had to innovate. As COVID-19 developed and changed these companies had to respond and adapt to changes in advice and demands from senior medical specialists; they had to adapt their processes and products to ensure that the results were increasingly accurate and produced in a shorter timeframe.
Where these changes constituted an advance in science or technology, resolving uncertainties that a competent engineer in the field could not do easily, this is likely to be an R&D activity that qualifies for the tax credits.
Medical testing companies should be seeking specialist tax advice to determine whether they should claim R&D tax credits. These provide valuable tax savings and refunds for qualifying companies.
Several medical testing companies will have applied for one or more patents for their testing products. Those companies should explore whether they qualify for and would benefit from the patent box. The effect is that profits relating to products containing one or more qualifying patents attract a corporation rate of 10%. A claim cannot be made until the patent has been granted although the benefit can accrue while the patent is ‘pending’ providing the company has made the required elections.
Taking this forward
The development of new innovative products and customer offerings highlights the need to consider the tax treatment. The impact on margins between having to account for VAT at the standard rate or not will be considerable and there are often ‘quirks’ in the VAT law which need to be understood. In some cases, we have seen that these can be acted upon in the design phase to optimize the preferred VAT treatment. These challenges are increased when considering VAT on cross-border activities as it then means that more than one national VAT system has to be considered and the VAT rules are often not fully aligned.
Recent experiences of HMRC’s policy of the UK VAT treatment of COVID-19 PCR testing services demonstrates that there is often more complexity than suppliers might expect and further developments on this are expected which may then have a consequent impact on other medical testing services delivered using a similar process.
Finally, R&D tax credits and the patent box can be valuable sources of finance for innovative companies. The board of any company should ask two simple questions to a specialist tax adviser – “does the company qualify?” and “how do we make a claim?”.