Introduction to VAT terminal markets

The VAT treatment of transactions carried out on commodity exchanges can often appear unusual when compared with normal VAT principles. One of the most distinctive areas is the treatment of supplies made on so-called "terminal markets", where certain transactions are eligible for zero-rating under special VAT rules. The application of the zero-rate can be highly beneficial and lead to VAT savings for those who have incorrectly treated their sales differently.

Although the Terminal Markets Order (TMO) has existed for over fifty years, it remains highly relevant to commodity traders, brokers, financial institutions and market participants involved in the trading of commodities, futures and options. Understanding how the regime operates is important, particularly given the significant values and volumes of transactions that occur in these markets. While it can result in VAT savings, incorrectly applying zero-rating when it is not available can also lead to unexpected VAT costs, so determining the correct VAT treatment of the transactions remains vital.

A terminal market is a recognised commodity market on which commodities or commodity-based contracts are traded. Historically, the regime applied to specified commodity exchanges and market associations involved in trading commodities such as metals, coffee, cocoa, sugar, grain, and other internationally traded raw materials.

HMRC describes terminal markets as commodity markets operating in trading centres such as London, where contracts relating to commodities are bought and sold. The objective of these markets is often to allow businesses to manage price volatility through hedging arrangements, while also enabling speculative trading by investors.

The legal framework is contained within Section 50 of the Value Added Tax Act 1994 and the TMO 1973 SI 1973/173. These provisions identify certain recognised commodity exchanges and provide a special VAT treatment for qualifying transactions carried out by market members.

The markets covered by the TMO include exchanges involved in the trading of commodities such as:

• base metals (for example, copper, aluminium and zinc)
• precious metals, including gold and silver
• agricultural commodities such as coffee, cocoa, sugar and grain
• and energy products such as crude oil.

Importantly, the TMO applies to transactions carried out on recognised exchanges and market associations specified within the legislative framework.

Although the core framework has remained largely unchanged since its introduction, the Government has recently consulted on reforming and modernising the legislation to better reflect current market structures.

The TMO provides for a VAT zero rate for certain transactions carried out by members of recognised terminal markets.

A key feature of the regime is that it applies to many transactions in which no physical delivery of the underlying commodity occurs. In commodity markets, contracts are frequently settled through offsetting trades before delivery, particularly when futures, forwards, and options are involved. The legislation recognises this commercial reality and extends zero-rating to qualifying transactions even where ownership of physical goods never changes hands.

In practice, much of the activity on terminal markets relates to commodity-based contracts such as:

• futures contracts
• forward contracts
• options contracts
• and other commodity derivative transactions.

The regime can also apply to certain brokerage and intermediary services supplied by market members in connection with qualifying transactions.

The TMO is important as ordinarily many financial derivative transactions fall to be considered under the VAT exemption for financial services. However, the TMO provides a separate statutory framework under which qualifying terminal market transactions may be zero-rated instead. This distinction can be particularly important because zero-rated supplies preserve entitlement to input tax recovery, whereas exempt supplies may restrict recovery. Businesses that wrongly assume that their sales are VAT exempt could therefore be missing out on significant amounts of input VAT recovery, which would add greater profitability to the business.

VAT law notes that commodity futures, options and other derivatives may constitute financial instruments and should be considered within the wider framework for financial services and financial derivatives.

However, the TMO creates a special statutory regime for certain transactions carried out on recognised terminal markets. Where the conditions of the TMO are satisfied, qualifying supplies made by market members can be zero-rated, even where the transactions involve commodity contracts, options or other derivative instruments linked to underlying commodities.

The distinction between zero-rating and exemption is significant.

• Exempt supplies do not carry VAT but generally restrict the supplier's ability to recover related input tax.
• Zero-rated supplies are taxable supplies subject to VAT at 0%, meaning the supplier remains entitled to recover input tax incurred on costs relating to those supplies, subject to the normal rules.

This reflects one of the key policy objectives behind the TMO. Commodity exchanges often involve substantial transaction volumes carried out between fully taxable businesses. A key effect of the TMO is that qualifying transactions remain taxable supplies for VAT purposes, preserving input tax recovery and supporting VAT neutrality within commodity markets.

Businesses operating within terminal markets should not assume that all commodity transactions automatically qualify for zero-rating. The application of the TMO depends on several factors, including:

• whether the transaction is carried out on a recognised terminal market
• whether the parties meet the relevant membership requirements
• whether the goods or rights being traded fall within the categories covered by the legislation
• whether the specific statutory conditions are satisfied.

Careful review of the contractual arrangements and the nature of the transaction is therefore essential.

Conclusion

The TMO represents a long-standing but highly specialised area of UK VAT law. By providing zero-rating for certain commodity market transactions, the regime reduces administrative burdens and supports the efficient operation of wholesale commodity markets.

Although the underlying policy is relatively straightforward, the detailed conditions can be complex. Businesses involved in commodity trading, brokerage activities or commodity-linked derivative transactions should carefully assess whether their activities fall within the scope of the TMO and whether the statutory conditions for zero-rating are satisfied.

If you would like support in reviewing your VAT position regarding commodity-related derivatives, please speak to your usual Crowe UK contact.