The European Commission has referred the UK to the European Court of Justice (ECJ) over concessions offered by the EU to the UK in 1977, which allowed the UK to apply a zero-rate of VAT to transactions on specific commodity markets.

The Commission now argues that the UK has overstepped its mark and that VAT on “terminal markets orders” should be subject to VAT to keep the playing field level with other countries within the European Union.

The consequences of this could prove complex and costly to the LME, as well as to other exchanges based in the City of London, the ancient heart of the capital city that is now home to its financial district. These other exchanges include ICE Futures Europe and the London Platinum & Palladium Market (LPPM).

The UK, however, is counter-claiming that the disagreement could blunt its competitive edge after the country completes its proposed departure from the EU, known as “Brexit”, while the LME’s 142-year history as the center of the metals industry could also be at stake.

The discrepancies claimed by the Commission are that the UK has extended the scope of the derogation, specifying that the UK has made at least eight amendments to the terminal markets order and has failed to align its legislation with EU VAT law.

“Since this derogation was notified to the Commission in 1977, the UK has extended the scope of the measure considerably, meaning that it is no longer limited to trading in the commodities originally covered,” the European Commission, the executive arm of the EU, said in a press release published on January 24.

In its role as Guardian of the Treaties under which it was established and is now governed, the EU claims that the derogation contributes to major distortions of competition which act to the detriment of other financial markets within the EU, the Commission said.

The UK joined the common market, known at the time as the European Economic Community, on January 1, 1973.

LME business could reroute
In light of the litigation now before the ECJ, the LME’s business could suffer because of the UK’s continuing discussions with the EU over a trade deal to come into effect once the UK leaves the union. If the UK fails to agree such a deal with the administration in Brussels, the court case could face dismissal because the country would no longer be subject to the EU authorities.

“The problem the Commission has is that the UK has not advised various contract changes affecting tax. If you make any such changes, you are supposed to notify Brussels,” a source close to the matter told Fastmarkets. “On paper, the terminal markets order is a derogation given to the UK. There is nothing to stop other markets in the EU from creating the same thing.”

Central to the case is the LME’s use of bonded warehouses for physical delivery, which are exempt from VAT. The LME’s physical delivery network of warehouses is built around the concept of tax-free trade.

More specifically, while physical, cash-settled contracts and over-the-counter (OTC) transactions remain subject to value-added tax, questions remain about how Britain could conduct tax-free business after it leaves the EU.

Once the UK is no longer part of the EU, the LME’s market will be open to competition from the likes of the US and Asia. LME business could in theory be rerouted, and metal stored elsewhere, which would negatively affect LME revenues and volumes.

“The LME notes the continuing infraction proceedings against the UK in respect of the VAT treatment of certain commodity derivatives, trading under the TMO [terminal markets order],” the bourse said in a press statement on February 1. “The LME continues to work with its stakeholders to ensure effective trading on the LME’s market.”

Conditional market consequences
Because the court case is broadly contingent on the conditions of the UK’s exit from the EU, market participants have expressed mixed sentiments toward the consequences the case might have for the metals industry.

“If the VAT law is changed, there’s a big debate [that must be had] about financial transaction reporting. If it becomes necessary to add VAT to LME transactions, it would require parties to declare the VAT on both sides. This would involve various accounting processes, and invites more risk,” according to an LME broker who declined to be named.

“Given the turnovers on the LME, if you start sticking VAT on all or some transactions, it would be to the detriment to the current business model,” the broker told Fastmarkets.

This would be because the UK would, after Brexit, be considered a third-country counter-party (CCP) – meaning, a non-EU party to trading.

For warehouses, the onus lies with the UK. With a large portion of the LME’s volumes circulating through continental Europe, UK customers would suffer the most.

Additionally, fiscal representation agreements with LME members would change, which could further complicate business transactions with the UK if the Commission wins its case.

“There are only a few LME warehouses left in the UK, and any decision Britain takes [regarding VAT] could have a bearing on EU warehousing – but I think this is going to affect UK business the most,” a senior LME warehousing source told Fastmarkets.

“Currently, UK entities are stockpiling commodities prior to Brexit, largely to avoid any potential change to import tariffs,” the source added. “Our status remains unchanged, but if the UK is considered to be a third country, and then has to pay VAT on top of that, it could really damage LME business.”

Archie Hunter and Perrine Faye in London contributed to this story.