Over a year on from VPAG: is there a VAT-shaped hole in the Government’s calculations?

HMRC has been granted permission to appeal the First-Tier Tribunal’s VAT decision in the case of Boehringer Ingelheim Ltd v HMRC. We summarise the First-Tier Tribunal decision and discuss the potential silver lining for suppliers of branded medicines in the dark cloud of increasing voluntary scheme repayment percentages.

Background to the voluntary schemes

The voluntary scheme for branded medicines pricing, access and growth (VPAG), introduced in 2024, is an agreement between the Department of Health and Social Care (DHSC), NHS England, the Association of the British Pharmaceutical Industry (ABPI) and manufacturers or suppliers of branded medicines who have signed up to the scheme.

Voluntary schemes that apply to branded medicines have been around in different forms for decades. The central part of these schemes is the UK-wide affordability mechanism, designed to keep the UK Government’s spending on branded medicines in check. Under this mechanism, voluntary scheme members make repayments to DHSC if sales of branded medicines to the NHS are above an agreed allowed growth rate.

Historically, such repayments were stable and predictable, with the yearly repayment percentages fluctuating between 5 to 10% (in line with comparable mechanisms operating in other countries). However, in recent years, there have been significant increases: the repayment percentages under VPAS, VPAG’s predecessor, jumped from 5.1% in 2021 to 15% in 2022 and to 26.5% in 2023. 

These increases generated significant consternation amongst suppliers of medicines in the UK, as margins for many products covered by the schemes are small, with some being supplied at cost to the NHS. In public protest at the increases in repayment rates, AbbVie and Lilly both left VPAS at the beginning of 2023. This symbolic decision was intended to put pressure on the UK Government ahead of the negotiations that resulted in VPAG. Following these negotiations, the headline repayment percentage under VPAG for 2024 was 15.1%; however, on 16 December 2024 DHSC announced an increase to 22.9% for 2025.

The consistent message from industry has been clear: the recent significant increases in repayment percentages have created an environment that does not support continued investment in the UK life sciences industry or the supply of certain medicinal products.

The 21 October 2024 decision of the First-tier Tribunal (Tax Chamber) (FTT) in Boehringer Ingelheim Ltd v HMRC offers a potential silver lining for suppliers that make repayments to DHSC under voluntary schemes, provided it survives the appeal process.

The facts of Boehringer Ingelheim Ltd v HMRC

Boehringer Ingelheim Limited (BIL) supplies branded pharmaceutical products (branded medicines) to the NHS, primarily through wholesale distributors in the UK. The supplies of branded medicines to such wholesalers are chargeable to VAT at the standard rate, with the amount of VAT calculated based on the “taxable amount”. The meaning of “taxable amount” is governed by Article 73 of the Directive 2006/112/EC (the VAT Directive) and includes all consideration obtained or to be obtained by the supplier from the customer or third party in return for the supply.¹ According to Article 90(1) of the VAT Directive, which is implemented in the UK by section 19 and paragraph 4 of Schedule 6 to the VAT Act 1994, “where the price is reduced after the supply takes place, the taxable amount shall be reduced accordingly”. 

Between 2014 and 2020, BIL made payments to DHSC under voluntary schemes. The payments were calculated as a percentage of net sales. The payments were made after the supplies of branded medicines had been made. 

In 2018, BIL took the view that the amounts paid to DHSC should have been treated as reducing the price of its supplies of branded medicines, and thus the VAT chargeable. As BIL had accounted for VAT on the full price of the medicines, BIL considered it had a claim for repayment of overpaid output tax and submitted five error correction notices claiming repayments of VAT exceeding £21 million. 

HMRC rejected BIL’s claim on the ground that payments under the voluntary schemes did not reduce the consideration obtained for the supply of the branded medicines because DHSC was not the final consumer of the health service medicines supplied by BIL. BIL appealed to the FTT.

VAT legislation and case law 

Under the VAT Directive, consideration for the purpose of calculating the taxable amount includes “taxes, duties, levies and charges” but not, among other things, “price discounts and rebates granted to the customer and obtained by him at the time of supply”. 

The FTT judge, Judge Greg Sinfield, referred to the case of Elida Gibbs Limited v Customs and Excise Commissioners, in which the European Court of Justice (ECJ) held that consideration is the “subjective value”, meaning the value actually received in each specific case. In that case, a taxable person who was the first link in a chain of transactions ending with a final consumer had granted that final consumer a reduction (through money-off coupons or cashback). The ECJ ruled that this reduction had to be accounted for when calculating the taxable amount; otherwise the tax authority would receive by way of VAT a sum calculated by reference to an amount greater than the amount actually paid by the final consumer, at the expense of the taxable person. 

The judge derived the following principles from European case law:

• VAT is charged on the actual consideration received for a supply, which must have a direct link to the supply itself. The taxable amount cannot exceed what the supplier receives from the final consumer.
• VAT is intended to tax the final consumer, and the taxable amount for VAT purposes must reflect the economic reality borne by the final consumer.
• The final consumer need not be a participant in the contractual chain of supply.
• After a transaction, if part or all of the consideration is not received, the taxable amount and VAT payable must be reduced. This includes voluntary price reductions and mandatory price reductions (e.g., by law), but excludes payments unrelated to the supply.

Did the voluntary scheme repayments reduce the price obtained by BIL in return for the supplies of branded medicines, and therefore the taxable amount of those supplies?

The judge held that the wording of Article 90(1) of the VAT Directive is clear: where the price of a supply is reduced after it has taken place, the taxable amount must be reduced. 

The question, therefore, was whether BIL’s payments under the voluntary schemes reduced the consideration received for its supplies of branded medicines. 

HMRC argued that there was no direct link between DHSC’s funding payments to the NHS and supplies of branded medicines by BIL and so DHSC could not be treated as a final consumer. The judge found HMRC’s interpretation to be “entirely artificial” and held that DHSC was a final consumer of the branded medicines supplied by BIL because, in economic reality, it bore the cost of purchasing them. (The majority of DHSC's budget was directly transferred to the NHS to fund the costs of (among other things) purchasing and providing health service medicines.)

HMRC also contended that, even if DHSC were a final consumer, there was not a sufficient link between the voluntary scheme payments and the supplies of the branded medicines. The judge held that a link could be established on the following facts:

• one purpose of the voluntary schemes was to limit prices for the supply of branded medicines by a manufacturer such as BIL;
• prices were limited by requiring BIL to pay DHSC amounts calculated by reference to the sales of the branded medicines by BIL - BIL submitted quarterly returns of its UK-wide sales and made payments to the DHSC in accordance with the returns; and
• the voluntary scheme payments were booked as a discount against the ‘sales’ line in BIL’s accounts.

There was no requirement that the rebate linked to specific items purchased by consumers, simply that the voluntary scheme payments reduced the consideration received by BIL for the supply of branded medicines.

The judge held that, because there was a direct link between the supply and the consideration received, it followed that there must also be a direct link between any price reduction and the consideration given for the supply. BIL’s payments under the voluntary schemes therefore did reduce the consideration received for its supplies of branded medicine and BIL’s appeal was allowed.

In finding in favour of BIL, the judge also rejected HMRC’s argument that BIL would be “unjustly enriched” if it received a repayment of part of the VAT originally accounted for.

What does the future hold?

Unsurprisingly, given the significant sums involved, HMRC sought permission to appeal the First-Tier Tribunal decision to the Upper Tribunal (UT). Permission was granted in February. Should the UT decide in BIL’s favour, critical questions will arise regarding how HMRC will fund the significant cost of repayments, particularly given the already strained financial position, with the "£22bn black hole" in the country's finances highlighted by Chancellor Rachel Reeves in the Autumn Budget 2024 announcement.

The hearing is scheduled to take place at the Rolls Building, with no date yet set. We await further updates and the eventual outcome of the UT appeal with keen interest.

If the UT decide in BIL’s favour, it will be interesting to see whether this triggers a flood of claims from suppliers of branded medicines, who have been accounting for VAT based on the headline (pre-voluntary scheme payment) price of their medicines, seeking to recover overpaid output VAT. 

Given the significant amounts of potentially overpaid VAT, sellers and purchasers of companies supplying branded medicines should be alive to this point when structuring deal terms and the extent to which a seller may wish to seek value for any unresolved and/or potential claims. 

It is also interesting to consider how closely or holistically DHSC work with HMRC and other parts of Government in relation to structuring the voluntary scheme, and the level of VAT payments, if any, DHSC has factored into its calculations for voluntary schemes over the years (particularly VPAG). This case indicates that there might be a VAT-shaped hole in these calculations. According to some sources, with approximately £14bn of branded medicine rebates paid to DHSC over the past five years, the total overpaid output VAT repayable by HMRC could be as high as £2.5bn. This figure could potentially be higher still if the same principles also apply to repayments made in respect of branded medicines under the Statutory Scheme², for companies that are not signed up to VPAG. 

Footnotes

[1] This definition is from Article 73 of the Directive 2006/112/EC

[2] As set out in The Branded Health Service Medicines (Costs) Regulations 2018.