Private hire vehicle (PHV) operators remain in the spotlight, as I wrote in A lightning bolt for the VAT Tour Operators Margin Scheme. In 2021, the Supreme Court decided that Uber drivers were ‘workers’ not self-employed, which had a knock-on effect on the VAT treatment of Uber’s services. If the drivers have rights as a worker, this implies that Uber must be making supplies of ride-hailing services as principal and not acting as an agent. The Supreme Court went on to note that, in London, the only contractual arrangement compatible with the licensing regime is one where the PHV operator acts as principal.

A separate Uber case in 2023 (Uber v Sefton Borough Council) confirmed that in order to operate lawfully outside of London, any PHV operator licensed in England (except Plymouth) or Wales is required to enter into a contract with the passenger as principal. These cases taken together mean that the PHV market as a whole is moving towards a model where the operator acts as principal, but what does this mean for VAT purposes?

The VAT implications

In a model where PHV operators are considered to be acting as principal, the operator is making a supply of transport services to the passenger. Passenger transport is only zero-rated in the UK in a vehicle with seating to carry 10 or more people, including the driver and crew, and in this article I’ve assumed that the PHV carries 9 people or fewer. Therefore, assuming the operator turns over £90,000 or more in a 12-month period, and is thus required to be VAT-registered, the consequence is that VAT is required to be charged, at the standard rate, on the full value of the services provided by the operator to the passenger. In this case, the full value of services equates to the full fare paid by the passenger.

Previously, Uber believed it was acting as agent, and most other operators acted in the same way. In an agency arrangement, although the passenger is making a booking through the operator, they are receiving the services directly from the driver. PHV drivers are unlikely to have an annual turnover over £90,000 so are unlikely to be VAT-registered. As a result, the driver does not have to charge and account for VAT on their services. Furthermore, the operator only has to charge and account for VAT on the services it is supplying to the driver, ie, the commission it receives.

It’s clear that requiring PHV operators to account for VAT on the full fare and not just the commission they receive will push up prices, and government analysis supports this. Since these cases were decided, two-thirds of PHV operators in England have already made the change to acting as principal. The government estimates that the impact of the other third, currently acting as agents, switching to acting as principal could push up fares across the whole market by up to 2.5%. For the average passenger, this could equate to an increase in fares of up to £5.60 per year. However, the government notes that 7% of people, likely to include vulnerable consumers without access to their own vehicle or public transport, use PHVs at least weekly and the financial impact on these passengers could be significantly higher. 

The government has concerns about this potential increase in fares, which it notes could have a negative impact on PHV operators, drivers and passengers; it estimates that a 2.5% increase in fares could lead to a 2.5% decrease in demand. As a result, it has launched a consultation to consider potential alternatives. 

Government intervention

The government aims to address the negative impacts of the cases mentioned above on the PHV sector. The proposals are designed to:

• support vulnerable customers who rely on PHV services;
• maintain passenger safety and consumer protection;
• promote fair competition in the PHV sector; and
• ensure value for taxpayers.

The government has also tried to ensure that the possible interventions minimise any non-compliance risk and are easy to administer for both taxpayers and HMRC.

With this in mind, the government has identified options that broadly fall into two categories:

• changing the legislation that currently requires the standard rate of VAT to be applied to all passenger fares; and
• targeted interventions to mitigate the impacts of the judgments on consumers.

Changing legislation

To avoid VAT having to be charged at the standard rate on PHV fares, the government could amend the transport legislation that requires PHV operators to act as principal. Alternatively, it could amend the VAT legislation to allow operators to act as agents for VAT purposes, even if, legally, they are acting as principal. Both options raise potential complications.

Amending transport legislation

The government has already committed to improve the regulation of the PHV and taxi sector in England. As part of this reform, the government could amend the legislation for PHVs in England so that PHV contracts are between the driver and the passenger.

However, government legal analysis suggests that the only way to ensure that a PHV driver can contract directly with a passenger would be to remove the role of licensed PHV operators entirely, effectively merging PHV and taxi licensing structures.

The government has two main concerns about this approach:

• the current system offers more consumer choice, which would be lost in a merged system; and
• allowing drivers to act as principal for all services would reduce government revenue by around £750m a year.

Given these concerns, it seems that the government may already have discounted this approach as a genuine option.

Amending VAT legislation

The alternative option is for the government to amend VAT legislation to allow PHV operators to account for VAT as though they were agents, while remaining as principal for legal purposes.

This approach has several obvious benefits. First, VAT legislation applies uniformly throughout the UK. Furthermore, this approach doesn’t undermine passenger safety or fair competition in the PHV sector.

However, this approach would allow PHV operators to account for VAT in the same way on all of their bookings, effectively creating a new VAT relief on supplies that are currently unaffected by the court judgments.

Perhaps most importantly though, this approach would undermine the core VAT principle that tax treatment should reflect the economic reality and contractual position of a transaction. While such ‘legal fictions’ have precedent, they’re typically reserved for severe compliance issues (eg, overseas businesses evading UK VAT). This isn’t the case in the PHV sector.

The government generally avoids such exceptions as they can create uncertainty for businesses. Therefore, despite potential benefits, this option also seems unlikely to be adopted by the government.

Mitigation options

The government has proposed alternative mitigation options, some of which also involve amending VAT legislation. However, these options focus on changing the VAT treatment of specific services rather than creating an agency relationship as described above.

Lower rate of VAT

The first option being considered is a change to the VAT rate that applies to PHV services. Currently standard-rated, the government has suggested that the services could be reduced-rated or zero-rated. These changes would cost, respectively, an estimated £1bn (reduced-rated) or £1.5bn per annum.

The consultation notes that a VAT rate change could lead to a surge in VAT registrations by currently unregistered PHV drivers seeking to reclaim VAT on expenses. With an estimated 300k PHV drivers in England, this could strain HMRC resources. 

Furthermore, there is no guarantee that introducing a lower rate of VAT would lead to lower prices for passengers. We have seen time and time again that new or extended zero rates have very rarely led to the same proportionate decrease in prices for consumers as the VAT saving is not 100% passed through.

As a variant on this idea, the government has also considered legislating to zero rate demand-responsive transport services. This would only cost a few million pounds per year and would be a more targeted relief, aimed at those living in rural areas with fewer public transport options. This would not solve the perceived problem in the PHV sector, but may meet the government’s objectives more effectively.

Margin scheme

Alternatively, the government could introduce a new margin scheme, specifically for the PHV sector. This is an interesting option, not least because Uber’s competitor, Bolt, accepted that it acted as principal but took a case to the First-Tier Tribunal in 2023, arguing that the ride-hailing services it provides should fall within the Tour Operators Margin Scheme (TOMS). It won the case and, as a result, is (currently) only required to account for VAT on the margin between what it charges to passengers and what it is charged by drivers. However, HMRC is appealing the Bolt case and the government’s position remains that the TOMS does not apply to the PHV sector. 

It therefore seems strange to offer an alternative margin scheme to the PHV sector, but the government states that such a scheme would be simpler than TOMS and would allow TOMS to remain targeted at tour operators. The government notes, however, that a new margin scheme could result in an increased administrative burden for PHV operators, with this disproportionately impacting smaller operators. 

Introducing such a scheme would probably negate any rise in fares for passengers but, as a result, it would cost the government an estimated £750m per annum.

Non-VAT options

Finally, the government has considered whether it can best meet its objectives without changing legislation by broadening existing transport schemes designed to support vulnerable customers. For example, it could:

• extend the disabled person’s bus pass;
• increase the bus service operators grant; or
• fund community transport provision.

Conclusion

The government’s decision to consult on this issue is welcomed. Although it seems the first two options are unlikely to be adopted, their inclusion in the consultation at least shows a willingness to consider them. That being said, I’m inclined to agree with the government’s analysis of these options. When I worked in practice, we had a saying: “the VAT tail shouldn’t wag the commercial dog”, and I think the same principle applies here. Changing legislation, because the VAT treatment that follows the economic reality leads to slightly higher prices, is a risky approach, not least because we don’t know how business models might further change in the future.

ICAEW’s Tax Faculty advocates for a tax system that is simple, constant and easy to collect and calculate. This means not making unnecessary changes to underlying rules, and not introducing new margin schemes for supplies where standard VAT accounting works. We know from experience that introducing lower rates of VAT generally does not lead to proportionately lower prices for consumers and, as the consultation rightly highlights, there are generally better ways to target support to vulnerable customers than changes to VAT.

The consultation closes on 8 August 2024. ICAEW’s Tax Faculty will be responding to the consultation and is keen to hear members’ thoughts. Please email Ed Saltmarsh by 12 July if you’d like to provide input.

Ed Saltmarsh, Technical Manager, VAT and Customs, ICAEW