ON APPEAL FROM UPPER TRIBUNAL
Mrs Justice Proudman
Tax and Chancery Chamber
Strand, London, WC2A 2LL
B e f o r e :
LORD JUSTICE ETHERTON
LORD JUSTICE PITCHFORD
| The Commissioners for Her Majesty's Revenue & Customs
|- and -
|London Clubs Management Limited
WordWave International Limited
A Merrill Communications Company
165 Fleet Street, London EC4A 2DY
Tel No: 020 7404 1400, Fax No: 020 7404 1424
Official Shorthand Writers to the Court)
Mr Andrew Hitchmough and Jonathan Bremner (instructed by BDO Stoy Hayward) for the Respondents
Hearing dates : 4th October 2011
Crown Copyright ©
Lord Justice Etherton:
The factual background
The legal principles
"On each transaction, value added tax … shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components."
"In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:
(a) value added tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person;"
"5. As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions.
This proportion shall be determined, in accordance with Article 19, for all the transactions carried out by the taxable person."
(a) A is the total amount exclusive of VAT of turnover per year attributable to transactions in respect of which VAT is deductible under Article 17(2) and (3) [(3) not being relevant here], and
(b) B is the total amount exclusive of VAT of turnover per year attributable to transactions included in A and to transactions in respect of which VAT is not deductible (ie. exempt transactions).
"(2) In respect of each prescribed accounting period –
(a) goods imported or acquired by and goods or services supplied to, the taxable person in the period shall be identified,
(b) there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies,
(c) no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies, and
(d) there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period."
"(1) … the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 …
(1A) A method approved or directed under paragraph (1) above –
(a) shall be in writing …
(9) With effect from 1st April 2007 the Commissioners shall not approve the use of a method under this regulation unless the taxable person has made a declaration to the effect that to the best of his knowledge and belief the method fairly and reasonably represents the extent to which goods or services are used by or are to be used by him in making taxable supplies.
" I agree with Mr Thomas [counsel for the school] that the search in the present case is for a fair and reasonable proxy for the 'use' of the sports complex in making the exempt and taxable supplies made by the School. However, I also agree with Miss Simor that the physical use of the complex is not necessarily a fair and reasonable proxy for that use. I consider that her use of the phrase 'economic use' is a helpful approach to establishing what the search is for.
 In that context, it is instructive, I consider, to look at the position had the School not granted the licence at all and had not allowed any out-of-hours use. In those circumstances, there would have been no taxable supply at all. In consequence, none of the input tax would fall to be attributed to taxable supplies as a result of regs 101(2)(b) and (c), reg 101(2)(d) not applying. However, the sports complex is used for the purposes of the School's (exempt) business. It is so used not because there is a supply to parents of the physical use (by their daughters) of the sports complex to their children, but because the availability of the complex is part of the package of benefits which is acquired by parents for the fees they pay and which constitutes the exempt supply by the School. The use made by the School, for VAT purposes, of the sports complex is its use in providing that package of services, a single supply. There is, of course, no need to identify a proxy for use when there is only an exempt supply since questions of allocation under reg 101(2)(d) do not then arise. Nonetheless, one can see that the 'use' referred in reg 101 (as elsewhere) is not physical use but some special VAT use. It is, I think, the same as what Miss Simor terms 'economic use'.
 On the facts of the present case, it seems to me that the overwhelming economic use of the sports complex by the School is in relation to the provision of educational services. In that context, I agree with Miss Simor that the source of funds and the purpose of constructing the sports complex are relevant considerations. To regard those factors as relevant is not, in my judgment, to fall into the error, as Mr Thomas would say it is, of categorising the nature of a supply by reference to the purpose or motive in making it. There is no doubt that in the present case, the supplies are distinct and readily identifiable, that is to say the taxable supply of the licence to [the company] and the exempt supply of education. Nor, in my judgment, is there any question, in taking those factors into account of treating a taxable supply as an exempt supply or vice versa. The question is what 'use' is being made of the inputs in producing the outputs. It seems to me that the purpose of the School, objectively ascertained, in constructing the sports complex is a highly relevant factor in attributing cost components between the relevant outputs and is an entirely different issue from identifying the nature of the output by reference to purpose or motive (which is inadmissible), the issue addressed by Patten J in Customs and Excise Comrs v Yarburgh Childrens Trust  STC 207"
"It must also be recalled that consideration of economic realities is a fundamental criterion for the application of the common system of VAT."
"48.What is very apparent to us is that the catering activities by themselves are not conducted with a view to profit. No board of directors could have permitted the catering business to continue for its own sake. It could only be justified in conjunction with other activities, i.e. gaming. Consequently we do not find it credible that the board could have regarded the refurbishment expenditure as a profitable project for the catering business, since clearly there would be a negative return on such an investment. Yet Aspinall's would claim that, nevertheless, up to 55% or more of the VAT on that expenditure is recoverable.
49. … Most, if not all, the floor areas of the Club are of mixed use; they are used to make all the supplies of the business, both taxable supplies and exempt supplies. Furthermore, in running the business costs are primarily incurred to facilitate exempt gaming. This does not mean that exempt supplies are physically made from areas such as the bar and restaurant or, on the other hand, that taxable supplies are physically made from the gaming rooms. Nor, we would add, does it mean that there is for VAT purposes a single supply of gaming to which the catering is merely ancillary. But those factors do not rule out costs incurred in one area being incurred to make supplies in another area. This applies even more so in relation to costs incurred in respect of the common areas from which no supplies are directly made. Such costs are incurred and are truly 'cost components' of the exempt supplies which physically take place in the small gaming area. Those costs are funded by the gaming. That in itself does not make them cost components of those exempt supplies. But in this case it is additional proof, if any is needed, that gaming is the foundation of the business and it is the furtherance of that gaming which causes and is seen as justifying commercially the decisions to incur the expenditure. Here there is capital expenditure and ongoing expenditure incurred specifically to create and maintain the opulence and luxury, especially in the creation of spacious surroundings and general ambiance, which is seen as commercially necessary to promote the highly profitable gaming business. For these reasons, in our judgment, the Commissioners in considering the methods proposed have not confused use with purpose and have not acted unreasonably in deciding to reject them. Indeed for our part, if it is open to us to decide whether the floor area methods put forward by the Appellants are capable of achieving a fair and reasonable attribution of input tax, we have not been satisfied that they do."
"Those costs are funded by the gaming. That in itself does not make them cost components of those exempt supplies. But in this case it is additional proof, if any is needed, that gaming is the foundation of the business and it is the furtherance of that gaming which causes and is seen as justifying commercially the decisions to incur the expenditure."
The Decision of the FTT
"Accordingly, we must consider first if the proposed special method is fair and reasonable. If we decide that it is, we must compare it with the existing method, and only if the new method is in our judgment more fair and reasonable than the existing method should we allow the appeal. Otherwise the appeal should be dismissed, even if we consider that both methods are unfair or unreasonable, but the new method is less unfair or unreasonable. What we cannot do is substitute our own version of a more reasonable method …"
"The residual costs with which we are here concerned are not one-off costs of the nature considered in St Helen's School, but are ongoing costs, such as rent, in running the business as a whole. Taking premises costs, such costs are incurred in order to provide premises for the carrying on of the whole of the Appellant's business. We have found that the food and beverage supplies made by the Appellant are made from defined and measurable parts of the Appellant's premises and accordingly we find that part of the purpose of the Appellant in incurring that expenditure is to provide space for the provision of those supplies. Although it is accepted that gaming is able to generate a higher turnover and profit for each square foot of the premises that it occupies as compared with the restaurants and bars, that does not, in our view, lead to the conclusion that gaming is the principal user or consumer of the premises costs incurred and that, as a result, a partial exemption method must reflect that in assuming greater use by the gaming part of the business. It seems to us that the proposed floor space method does provide a fair and reasonable allocation of such costs, as it reflects directly the use of those costs."
"43.We have found that a substantial proportion of the residual costs of the Appellant's business are property-related. Although this proportion may fluctuate from quarter to quarter, we accept that the figures presented to us, which showed property-related costs at 71 % of total residual costs, are a fair representation of the position. A floor space method is, in our view, appropriate for providing a reasonable proxy for such costs. It assumes that costs that cannot be directly-attributed are used or consumed by the separate parts of the business by reference to the amount of floor space those separate parts occupy. The greater the space so occupied, the more consumption of those inward supplies is assumed.
44.For costs that are not property-related, the floor space method does not provide such a close approximation to use. The consumption of such costs is likely to depend on a number of factors, of which the area of the floor space occupied by a particular part of the business is only one. We had no evidence that in this case the use of a floor space method for non-property related costs would be so distortive as to render the proposed method, as it would operate in relation to costs in the aggregate, unfair or unreasonable. A substantial proportion of the costs in this case are property-related, for which we consider the proposed method to be fair and reasonable, and it is not prevented from being fair and reasonable by the fact that it also operates in respect of the minority of non-property related costs."
"In one of the Appellant's premises, Rendezvous London, in the nine months to 31 December 2006, 97% of food and drink supplied was given away. At other premises the percentage was lower; the average was 35%. We are considering a proposed method for the whole of the Appellant's business. Taking the average for the whole business, the Appellant's case is different from that of Aspinall's Club. In that case the Tribunal found that the catering activities were not conducted for profit. By contrast, in the Appellant's case, although the catering activities are not currently profitable, we are satisfied that they are businesses in their own right and are not merely ancillary to the gaming business. Unlike Aspinall's Club, we have found that the business costs are not primarily incurred to facilitate gaming, but to facilitate all parts of the Appellant's business. Furthermore, in this case, as we have described, the proposed method does provide fairly and reasonably for the fact that some elements of the catering supplies are made free of charge."
" … What we regard as the essential question is: which of the methods, the existing or the proposed method, is the more fair and reasonable approximation for the use of costs? We accept Mr Hitchmough's [counsel for the respondent] analysis of the assumption that effectively underlies the existing method. In our view, in the case of a business whose residual costs are predominantly property-related, the existing method does not, in our view, provide as coherent a proxy for the use of those costs as does the floor space method proposed by the Appellant. That method, as we have found, takes account of the economic use of the floor space (including the effect of the non-chargeable catering supplies) and thus the use and consumption of property-related costs, in a way that the existing method fails to do. The treatment of non-property related costs we regard as neutral as between the two methods. Accordingly, we conclude that the proposed method is more fair and reasonable than the existing method."
The UT – Proudman J
The appeal to the Court of Appeal
"1. Having accepted that an essential part of its [viz the UT's] approach was to assess the economic use made by the taxpayer of its residual costs, it failed to make a proper assessment of economic use and misunderstood the required approach.
2. It made general errors in its assessment of the decision of the First-Tier Tribunal's decision which vitiated its holding that the proposed Partial Exemption Special Method resulted in a fair and reasonable attribution of residual input tax and/or that the result of the proposed method was more fair and reasonable than the existing method."
"For costs that are not property-related, the floor space method does not provide such a close approximation to use. The consumption of such costs is likely to depend on a number of factors, of which the area of the floor space occupied by a particular part of the business is only one. We had no evidence that in this case the use of a floor space method for non-property related costs would be so distortive as to render the proposed method, as it would operate in relation to costs in the aggregate, unfair or unreasonable. A substantial proportion of the costs in this case are property-related, for which we consider the proposed method to be fair and reasonable, and it is not prevented from being fair and reasonable by the fact that it also operates in respect of the minority of non-property related costs."
Lord Justice Pitchford
Lord Justice Ward