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Channel Islands VAT loophole closed: LVCR explained

After VAT changes, Play.com becomes a pure marketplace

In early January 2013, the Japanese giant Rakuten, which bought Play.com in 2011, announced that the website would stop selling its own products and instead convert into a pure marketplace.  This means the existing website will remain, but only to provide a platform where businesses and individuals can offer their own stock for sale - much like eBay.

This is a remarkable change in business plan for a company that, at its peak in 2011, had a turnover of over £500m. Play.com was also recently rated as the second-biggest online retailer in the UK by Hitwise and was voted the UK’s second-favourite music and video retailer in a survey by Verdict Research.

In order to understand this spectacular rise in the CD / DVD / Blu-ray market followed by an incredibly quick exit, we need look no further than the changing fortunes of a piece of European tax legislation known as Low Value Consignment Relief (LVCR).

When goods are imported to the UK from a non-EU territory they are often subject to VAT, customs duty and excise duty.  LVCR is a relief that was designed to free up the circulation of low-value goods between member states when they had customs borders.  In other words, goods under a certain value arriving from non-EU states wouldn't be subject to tax.

One of the main reasons for the enviable success of Play.com was that it was based in Jersey, and run by Jersey natives. Despite having close ties with the UK and being within the EU customs area, Jersey is self-governing and not part of the European Union.  Play.com was therefore able to take advantage of LVCR by shipping low-value products (less than £18) VAT free by sending them on a round trip from the UK to Jersey, and then back again.

When it shipped its very first consignment back in 1998, Play.com had an immediate 17.5 percent advantage over competitors such as Virgin Megastores, Woolworths and HMV, all of which were based in the UK. In such a fiercely competitive environment, this 17.5 percent difference was often more than the actual margin added to the product by the physical retail stores.

This allowed Play.com to make a profit while selling for less than the cost price paid by many retailers. The aggressive pricing and VAT-avoiding business model led to the company achieving phenomenally quick year on year growth.

In August 2004, Tesco and Amazon met with HM Revenue & Customs to complain about the VAT-free status that Play.com was achieving in the UK market. The UK government make no indications that the situation would be changing, so both businesses also started shipping via Guernsey and Jersey in order to be able to continue competing with Play.com.

In July 2005 HMV also moved its operations from Birmingham to Guernsey stating, "We resisted the move that for as long as we could, but we realised that if we were to try to compete on the same, level playing field then we would have to try to get the benefit and the VAT advantage as well”.

HMRC seemed to be unconcerned about what appeared to be a mass exodus to the Channel Islands and so the next half decade saw a proliferation of companies selling everything from car parts to contact lenses VAT free by simply sending the goods to the Islands and back again.

In 2000, Play.com's turnover was £12 million but this had grown by a 2,300 percent to £250 million by 2005. It again doubled to £500 million by 2011. The company didn't know it was about to have its VAT-free business decimated almost overnight.

The Jersey Government sent 17 retailers including Amazon and Tesco letters in which they described the circular shipping of goods via the Islands as a ‘complete sham’.  Their licenses to trade on the Islands were removed in 2006 and both initially moved offshore. Amazon soon returned by shipping in partnership with a company called Indigo Starfish (who did still have a license) and Tesco returned along with Asda by shipping through a Guernsey based company called Thehut.com.

Play.com claimed that it was based in Jersey out of circumstance as the founders were indigenous to the Islands and that LVCR was just a happy coincidence. This point was perhaps valid, but consignments of multiple items costing more than £18 when combined were split in to separate packages and single items over the threshold were shipped from a UK warehouse. This suggests that the business model was very much geared towards avoiding VAT.

Guernsey attempted to introduce a ‘code of conduct’ for retailers on the Island but it was voluntary and didn’t include any sanctions against retailers that flouted the rules.

These limited measures weren't enough to deter a number of mainland UK based retailers from forming a pressure group in 2010 with the help of Richard Allen, a man who had already lost his business as a direct result of LVCR. RAVAS (Retailers Against VAT Avoidance Schemes) begin to put pressure on HMRC not only directly but also via the European Commission who had an obligation to ensure that market distortion didn’t occur as a result of the incorrect application of LVCR by a member state.

The commission observed that the process of 'round shipping' of goods is potentially abusive and is contra to the original intention of LVCR. The UK government was subsequently told it would face possible infraction proceedings if it did not seek to end this abuse.

In 2011 Play.com prepared for floatation on the stock market but failed when the long term prospects for LVCR from the Channel Islands seemed unclear after a sudden change in rhetoric from HMRC and high profile campaigning by RAVAS.

In the same year, budget Chancellor George Osborne stated that LVCR was being used for a purpose for which it was never intended and immediately announced that the threshold for packages that would qualify for Low Value Consignment Relief was being bought down to £15. Although it was a small move, this budget announcement was the first real indication that the government now considered LVCR to be a problem and many believed it would go further.

Also in 2011, Play.com sold out to the Japanese group Rakuten for a paltry £25m despite its £500m turnover. That's almost certainly down to the uncertainty of the future of LVCR.

Just eight days after the new threshold for LVCR came in to effect, the minister responsible for LVCR, David Gauke, announced the UK governments’ intention to withdraw the LVCR concession entirely in relation to mail-order goods coming from the Channel Islands.

A brief legal challenge by Jersey and Guernsey ensued on the basis that the Islands believed it to be discriminatory for the proposed legislation to single them out individually. The case ultimately made it to the High Court where it was declared that the UK is within its rights to withdraw LVCR for goods coming from a specific territory and as a result Channel Islands retailers would be obliged to pay VAT at the point of export. That change came into effect on 1st April 2012.

Fast forward to 2013. A few companies refused to admit defeat and have moved to other areas such as Switzerland. There, LVCR relief still applies as the UK government has only partially closed the loophole. Curiously, The Guardian claims that Thehut.com group is now routinely sending DVDs on a 7,000 mile round trip to Chicago and back in order to avoid having to charge the VAT.

Many analysts believe such an elaborate dodge will ultimately be futile as the UK government has now set a precedent to close the relief for any other area that might become problematic. Therefore investing in new warehousing, staff training and infrastructure may not make sound business sense.

The fallout from the closure of LVCR from the Channel Islands has resulted in Play.com losing a now 20 percent advantage over both online and offline retailers who are still based in on the UK mainland. Even worse, it doesn’t have the streamlined business model and economies of scale that Amazon enjoys.

Once all its stock has been cleared, the company will rejig its operations resulting in the closure of the Jersey warehouse and operate out of a Cambridge office where 200 staff are expected to work.

With eBay to contend with, and Amazon offering a massive combined retail business and online marketplace, only time will tell whether Play.com can get back in the game.

Guest author Chris Holgate works for Refresh Cartridges, an independent supplier of printer cartridges and consumables, based in the South West of England.

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