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Cite as: [2013] EWCA Civ 112

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		Neutral Citation Number: [2013] EWCA Civ 112
		Case No: A3/2011/2237

IN THE COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE UPPER TRIBUNAL
(TAX AND CHANCERY CHAMBER)
THE HON MRS JUSTICE PROUDMAN and MR JULIAN GHOSH QC

Royal Courts of Justice
Strand, London, WC2A 2LL

21/02/2013

B e f o r e :

LORD JUSTICE MUMMERY
LORD JUSTICE PATTEN
and
MR JUSTICE KENNETH PARKER
____________________

Between:

	BAA LIMITED	Appellant
	- and -
	THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS	Respondent

____________________

(Transcript of the Handed Down Judgment of
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____________________

MR RODERICK CORDARA QC, MR DAVID SOUTHERN and MS REBECCA MURRAY (instructed by Herbert Smith LLP) for the Appellant
MR OWAIN THOMAS and MR EDWARD BROWN (instructed by HM Revenue & Customs Solicitor's Office) for the Respondents
Hearing dates: 17th, 18th & 19th July 2012
____________________

HTML VERSION OF JUDGMENT
____________________

Lord Justice Mummery:

Brief introduction to appeal

In this three day VAT appeal the case against the Commissioners for Her Majesty's Revenue and Customs (HMRC) is that they should have allowed an input tax reclaim for VAT charged on supplies of professional and advisory services received by a company then known as Airport Development and Investments Limited (referred to as ADIL in the judgments below and in this judgment). The supplies were in connection with a take-over bid by ADIL. At the time when it incurred liability to pay VAT on the fees for those supplies ADIL was not registered for VAT. It was not a taxable person.

ADIL is a UK holding and management company incorporated on 27 March 2006. It was used as a special purpose vehicle for a take-over completed on 26 June 2006. It is responsible for the airports business of an investment consortium. A Spanish company, Ferrovial SA, is the majority shareholder in the consortium. Bankers and legal advisers made taxable supplies of services to ADIL in the course of a successful bid to acquire the entire issued share capital of the UK airport operator, BAA plc. In August 2006 BAA plc became BAA Airports Limited (BAA). Further name changes have occurred since. They are irrelevant to this appeal.

On 22 September 2006 ADIL joined the BAA VAT Group, which makes taxable supplies. ADIL thus became a taxable person with a VAT registration. BAA, as the representative member of the group, then claimed recovery, as input tax, of the VAT incurred and paid by ADIL on the supplies to it prior to the acquisition of the target company and prior to joining the BAA VAT Group.

The basis of the input tax reclaim is that the supplies were made to ADIL in the course of an "economic activity" carried on by it at the relevant time; that ADIL's economic activity was preparatory to the acquisition of the target company; that the BAA VAT Group's subsequent tax outputs should be attributed to ADIL's prior tax inputs; that the VAT incurred by ADIL was part of the "general overheads" of the BAA VAT Group; and that there was a "direct and immediate" link between the taxable supplies made to ADIL in connection with the take-over of BAA and the taxable supplies made by the BAA VAT Group.

The two main questions are:-

(1) Economic activity

Was ADIL carrying on an "economic activity" at the relevant time? i.e. when it incurred liability to pay the input tax to its professional advisers on the supplies connected with the take-over bid. If it was not, that is the end of the matter: there would be no right to recover input tax. If, however, it was carrying on an economic activity, there is a second question.

(2) Direct and immediate link

Was there a "direct and immediate" link between (a) the supplies of services to ADIL, on which ADIL incurred input tax at the relevant time, and (b) the outward taxable supplies (outputs as distinct from inputs) of the BAA VAT Group, of which ADIL had subsequently become a member, and which outputs might be attributed to ADIL?

The tribunals below reached different conclusions on the correctness of the decision by HMRC when, in issuing on 21 February 2007 their VAT assessment of BAA to £6.7m VAT, they disallowed, as part of the BAA Group's general overheads, the claim to recovery of the input tax incurred by ADIL on the take-over of BAA.

A second appeal

It is very tempting to de-clutter VAT "second appeals" in this court by making a bee-line for the legal issues and not spending very much time on the judgments below. In my opinion, that is not a good idea here. The careful judgments leading to different outcomes in the specialist tribunals need to be considered in some detail in order to understand the legal submissions, which, in large part, address the findings of fact and the legal reasoning in applying the law to those facts.

On 28 January 2010 the First-tier Tribunal (Tax Chamber) (the FtT) allowed BAA's appeal from HMRC's assessment on two grounds: first, ADIL was carrying on an economic activity at the relevant time, and, secondly, BAA was entitled to claim the input VAT incurred by ADIL as part of BAA's general overheads, there being a "direct and immediate" link between the supplies on which ADIL incurred input tax and the supplies on which BAA charged output tax.

On 22 June 2011 the Upper Tribunal (Tax and Chancery Chamber) (the UT) agreed with the FtT that ADIL was carrying on an economic activity at the relevant time, but allowed the appeal by HMRC on the ground that, at the relevant date, there was no direct and immediate link between the supplies of professional services on which ADIL incurred liability to VAT and the taxable output supplies on which BAA charged VAT. The FtT had found as a fact that ADIL had no intention, prior to the relevant time, of making taxable supplies or of joining BAA's VAT Group and that between 26 June 2006 and 22 September 2006 it made no charges for actual taxable outward supplies in its own right.

The UT dismissed a cross appeal by ADIL on the point that the FtT had erred in finding that there was no evidence that, prior to completion of the take over, ADIL intended to join BAA's VAT Group. The UT refused permission to appeal on that point, for which permission was granted by Patten LJ on 30 October 2011.

The UT granted permission to appeal against its decision on the question of "direct and immediate" link.

In this court ADIL argued that, on the facts found, there was no error of law in the FtT's decision. The UT was therefore wrong to allow the appeal by HMRC.

HMRC argued that the FtT erred in law in concluding (a) that there was a direct and immediate link between the inward supplies to ADIL and the outward supplies by the BAA VAT Group and (b) that, at the relevant time, ADIL was carrying on an economic activity for VAT purposes. The decision of the UT was right on (a), but wrong on (b). HMRC's challenge to the decisions below on the economic activity point is raised in the respondents' notice served by HMRC. They emphasise the importance of the FtT's finding that, prior to the relevant time, ADIL had neither made, nor had it any intention of making, any taxable supplies which could count as an economic activity by it. ADIL had simply achieved its target, which was to acquire all the shares in BAA.

Some key facts

The relevant services supplied to ADIL were mainly professional and advisory services by Macquarie Bank Limited, as financial advisers, and by Freshfields Bruckhaus Deringer, as legal advisers, in the course of the take-over of BAA. ADIL incurred liability to pay and in fact paid the fees plus VAT.

The consequential benefits produced by the take-over continued beyond completion on 26 June 2006. The completion of the takeover put ADIL in charge of the strategic and financial direction of the BAA's group business of running airports in the UK and overseas. The acquisition formed part of a continuum of onward investment.

The acquisition involved management. However, in the period between acquiring the shares in BAA and becoming a member of the BAA VAT Group, ADIL did not levy any intra-group charges on BAA's subsidiaries as fees for the supply of services in the form of management of the airport business or corporate governance.

ADIL said that it had been preparing for, or was otherwise engaged in, activities which were fully taxable for VAT purposes and that the services on which VAT was charged were in connection with the take-over and subsequent direction and management of the airport business. It argued that, in principle, it ought to be able to recover all that input tax once registered in its own right, or as a member of the BAA VAT Group. As for ADIL's real and relevant intentions, however, there was no evidence that there was any intention on its part, prior to the take-over, to charge for its intra-group services. Although ADIL did have such an intention as from completion of the take-over, no charges were ever made by it. Further, as already mentioned, there was no evidence of ADIL having an intention, prior to the completion of the takeover, to join the BAA VAT Group. The finding of absence of such an intention was the subject of an unsuccessful cross appeal by BAA to the UT.

Some basic legal principles

This appeal is about the correct application of the EU and UK legislation and the interpretive case law to the particular facts found by the FtT. There is no major dispute of interpretation nor is there any point in repeating for a third time all of the detailed legislative provisions, which are conveniently set out in the FtT and UT judgments.

All that is needed at this stage, in order to follow the rival arguments on the two questions of "economic activity" and "direct and immediate link", is a summary of the legal basis of the judgments below, the rival submissions and the conclusions in this judgment. The UT judgment contains at [29] a useful summary of some basic legal propositions accepted by the parties as correct. At a later stage a selection of the most relevant authorities cited on the deductibility of input tax will be discussed.

The law in force at the relevant time was in the Sixth VAT Directive (77/388/EEC). Since 1 January 2007 that has been replaced by the Principal VAT Directive (2006/112/EC), the provisions of which are identical on the matters in issue. Particular reference was made to Article 4 (defining who is a "taxable person") and Article 17 (on the right to deduct) of the Sixth Directive.

(1) Deduction of input tax

On a taxable supply VAT is chargeable after deduction of the amount of VAT borne directly by the various cost components of the supply. The right to deduct arises at the date when the deductible tax became chargeable i.e when liability for it was incurred. Deductions are meant to relieve the taxable trader entirely of the burden of VAT payable or paid in the course of the trader's economic activities.

(2) Economic activity

To be able to recover the input tax on the professional and advisory services supplied it is common ground that ADIL must have incurred the VAT in the course of an "economic activity" and it must be a taxable person i.e a person registered, or required to be registered, for VAT purposes.

Merely acquiring and holding shares is not regarded as an economic activity for VAT purposes. The economic activity position is different where the acquisition and holding of shares is also accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired. Such involvement may include acts preparatory to carrying on an economic activity.

(3) Direct and immediate link

The relevant services, on which input tax was incurred by ADIL, must be attributable to onward taxable supplies that are made by, or attributed to, ADIL. To be deductible the supplies on which the input tax was incurred by ADIL must have a "direct and immediate" link to onward taxable supplies by the BAA VAT Group on which the output tax is charged and which are made by, or attributed to, ADIL.

(4) VAT grouping

The VAT grouping provisions enable a group of associated companies to be treated as a notional single taxable entity by treating a representative member as if it were carrying on all the businesses of the other members, as well as its own business. In that way, it may be possible for the VAT charges made on supplies by the group's representative member to be treated as being made by ADIL, as the member of the group which had incurred the liability to input VAT.

(5) Faxworld

It is agreed that supplies by one person may, in some circumstances, be attributed to another person. The particular example relied on by ADIL, by way of analogy, is Finanzamt v Faxworld [2005] STC 1192 (Faxworld).The context of the case was that of supplies made in connection with preliminary work preparatory to establishing a business. The judgments of the FtT and the UT discuss Faxworld in detail.

The dispute in Faxworld arose with the German fiscal authorities under the German continuity of business provisions. A taxable partnership entity (Faxworld GbR) was formed solely in order to establish a corporate entity (Faxworld AG), to which the business and assets of the partnership would be transferred. The partnership did not intend itself to effect taxable transactions in its own right. It sole object was to undertake preliminary transactions resulting in assets that would be transferred, and were in fact transferred, to a corporate entity to be set up as its successor.

The input tax incurred by the partnership was held by the Luxembourg Court to be reclaimable by the partnership, because there was a direct and immediate link between the services supplied to the partnership, which incurred the liability to VAT on those services, and the taxable supplies made by the corporate body, which were attributed to the partnership. It was held that the input services procured by the partnership were "for the purposes of the recipient's taxable operations."

The parties' submissions on the judgment of the Court of Justice in Faxworld and the analysis of it by the FtT and the UT are examined in more detail later in this judgment.

The decision of the FtT

The FtT allowed ADIL's appeal from HMRC's assessment to VAT. It concluded that ADIL's input tax incurred on professional fees payable by it at the relevant date on the take-over of BAA was recoverable : [2010] UKFTT 43 (TC).

A. Findings of fact

The FtT is a fact finding body. In my judgment there are no grounds for interfering with its key findings of fact in [80] to [86] which are, in summary, as follows:-

(1) Purpose of ADIL.

ADIL was a new company formed by the consortium as a bid vehicle for the take-over of BAA plc and for the purpose of holding and overseeing the BAA group. It engaged the services of Macquarie Bank and Freshfields in connection with the acquisition of BAA. It incurred liability to them to pay fees plus VAT. Its purpose was not only to acquire the BAA shares, but also to provide "high level strategic governance of the ongoing group." It saw the take-over not as an end in itself: it was a "first, necessary step towards long term, large investment in UK airport infrastructure." Its role was to acquire, manage and operate the BAA airports. Its strategic input was evidenced by re-financing and post-transaction internal re-organisation. After acquisition ADIL assumed direction and leadership of the ongoing BAA group as a whole and took over its strategic governance as a long term business undertaking without a break. It was an active management company. There was a single overall transaction as a means to an end and the business plan covered both the acquisition and subsequent management developments. The financing and re-financing arrangements spanned acquisition.

(2) Intention and conduct re taxable supplies.

From the completion of the take-over in late June 2006 it was expected that ADIL would charge the BAA subsidiaries fees for its services, but no such charges were ever levied for services. Further, there was no evidence that an intention was formed, prior to the completion of the take-over, to make intra-group charges. The FtT stated that there was no evidence of ADIL having an intention to make taxable supplies as at the time when it received the supplies of professional services.

(3) Intention and conduct re BAA VAT group.

From the completion of the take-over in late June 2006 it was intended that ADIL should become a member of the BAA group, but there was no evidence that such an intention was formed prior to the completion of the take-over. ADIL became a member of the BAA group on 22 September 2006 following an initial refusal by HMRC.

(4) Continuing benefit of services supplied to ADIL.

The services supplied by Macquarie to ADIL were concerned mainly with the take-over "but the resulting work product did have continuing benefit beyond the take-over." The transaction costs were not written off, but were capitalised and that pointed to perceived continuing benefit of that expenditure.

B. Decision of FtT

(1) Economic activity

The FtT concluded that ADIL carried out an economic activity from its inception, with the "very important caveat" that it "never made an actual taxable output supply in its own right" [151]. That conclusion was based on the findings that there were continuing benefits beyond the take-over, that the shares in BAA were not acquired as an end in itself and that the acquisition was a necessary step in ADIL's larger involvement and long term investment in UK airport infra-structure.

(2) Intention to make taxable supplies

The FtT agreed that there could be no economic activity without taxable supplies. It noted that direct or indirect involvement in the management of subsidiaries must be regarded as an economic activity, adding, however, that it was common ground that ADIL never made an actual taxable output supply in its own right.

The FtT also agreed that an intention to make taxable supplies was sufficient, though there was no evidence of ADIL having an intention to make taxable supplies as at the time when it received the supplies of taxable services or of ADIL having an intention prior to completion of the take-over to join the BAA VAT group.

(3) Faxworld

The FtT received submissions from ADIL pursuing an analogy with Faxworld. The FtT stated that Faxworld "allows consideration of the intention to make taxable supplies by reference not just to the person incurring the VAT but also, in certain circumstances, another person."[156]. It was necessary for there to have been an intention to make such taxable supplies, but it was possible to attribute that intention also to another person, in that case to the partnership and its preparatory activities preceding the corporate body to which the business was transferred and which did not have an intention to make such supplies itself. The reasoning in Faxworld was that the partnership was entitled to take advantage of the taxable transactions of the incorporated transferee and was regarded as a taxable person carrying on an economic activity within the meaning of the Sixth Directive.

The FtT accepted the arguments by way of analogy with Faxworld and concluded that:-

"158. In the current appeal there was VAT incurred by ADIL in connection with an economic activity it expected to carry on and (bar actually making a taxable supply in its own right) it did carry on. Performing that economic activity (involvement in the management of the BAA companies) in the context of the BAA VAT group was a non-event for VAT purposes, being ignored under the UK domestic rules for grouping….ADIL and the BAA companies were treated as part of a single entity for VAT purposes. Accordingly our conclusion is that it follows that ADIL is entitled to take advantage of the taxable transactions of the BAA VAT group, and thus be regarded as a taxable person within the meaning of the Sixth Directive.

159. While sharing the reservations expressed by the Advocate General in Faxworld, the Tribunal considers that the fundamental principle of neutrality of taxation (Rompelman) requires, by the same process as adopted by the ECJ in Faxworld, that the taxable supplies of the BAA VAT group should be imputed to ADIL, so that the caveat referred to above is removed. To quote again Lord Hope in Svenska (already cited) on the grouping provisions: 'This conclusion is not easy to grasp if regard is had to what was happening in the real world. But the statutory scheme does not always follow the real world. The guiding principle as to relief for input tax as against output tax is that of fiscal neutrality (see Rompelman..) It is satisfactory to find that the various statutory rules which must be applied in this case have produced a result which is consistent with that principle.' "

(4) Link of input tax to output supplies

The FtT concluded that:-

"160. Following Faxworld there should be a direct and immediate link to the output supplies taken into consideration in determining the existence of an economic activity (see paragraph 51 of the Advocate General's opinion). Given that ADIL is a member of the BAA VAT group the direct and immediate link is to the outputs of the representative member of that group …"

Outcome

The FtT concluded that the appeal from the HMRC assessment should be allowed :-

"162.Absent a group situation the direct and immediate link is with general overheads…We consider that the same result should follow in a VAT group, so that the direct and immediate link is with the general overheads of the representative member of the group…. "

The decision of the UT

The UT decided that the input tax in dispute was not recoverable and allowed the appeal of HMRC on the basis that, although ADIL was carrying on an economic activity at the time it incurred the liability to VAT on supplies of professional services to it, there was no direct and immediate link between ADIL's VAT inputs and the taxable outputs of the BAA VAT Group. It rejected the Faxworld analogy.

(1) Economic activity

The UT did not disturb the decision of the FtT that ADIL had an economic activity at the time it incurred the liability to VAT. It referred to the findings of the FtT that the acquisition of the shares in BAA was not an end in itself, but was a step in an onwards investment, which involved the provision of management services by ADIL to the BAA group.

The UT said that :-

" 71. If ADIL, at the time at which ADIL incurred the relevant VAT, did not have an economic activity, the appeal succeeds. But it did. As we have observed above, the purpose of ADIL's acquisition of BAA was not an end in itself (contrary to the Commissioners' submissions) but was expressly recorded by the Tribunal as being the first step on an onwards investment, which involved management. That management included the provision of services by ADIL to the BAA group. Those were findings of fact made by the First-tier Tribunal and we see no basis to disturb those findings of fact. The Tribunal found that that was an economic activity and again we find no basis to disturb that."

(2) Direct and immediate link

The UT allowed the appeal by HMRC on the ground that there was no direct and immediate link between (a) the professional supplies made to ADIL, on which the VAT was incurred at the relevant date by ADIL, and (b) any onward taxable supplies, either made by, or attributed to, ADIL.

The supplies to ADIL were mainly concerned with the take-over. They were not for services to be provided by ADIL to BAA or to any company within the BAA group, although they had a continuing beneficial effect on the group after the takeover. The continuing indirect benefit was too remote to provide the necessary link, even if it were established that those management services had been intended taxable supplies before the take-over.

The FtT had also found that there was no intention on the part of ADIL prior to the time of completion of the BAA take-over to provide taxable services. The UT could not attribute any of the fees or the VAT incurred by ADIL to any post-completion activity or supply made by ADIL at all. None of the costs incurred by ADIL could be considered to be costs components of a taxable supply by ADIL itself, or attributed to ADIL by reason of the VAT grouping provisions. That meant that there was no direct and immediate link between ADIL's VAT and any onward taxable supply by the BAA VAT Group.

Further, it was clear that the time to test the recoverability of VAT was that at which the relevant VAT is incurred. What mattered was the intention to make the supplies at that time. Recovery was precluded by the absence of such an intention at the time of the taxable supplies on which the input tax was incurred. The problem was not solved by relying on the supplies as preparatory acts, because of the absence of a direct and immediate link to an onward taxable supply.

The UT went on to conclude that BAA's taxable supplies could not be attributed to ADIL by reason of the VAT grouping provisions or by an application of the Faxworld analogy.

(3) Grouping provisions

The grouping provisions only operated from the time at which all of the relevant companies are members of a single VAT group. At the time at which ADIL incurred the relevant VAT, ADIL was not a member of the BAA VAT Group and was found to have had no intention, prior to the completion of the BAA take-over, of joining the BAA VAT group. The VAT grouping provisions were not retrospective. ADIL's takeover of BAA could not be viewed as a preparatory act to make supplies to be attributed to ADIL.

(4) Faxworld

As for Faxworld the UT commented that:-

"79. …the essence of the ECJ's decision is that where a Member State's domestic provisions which are analogous to the United Kingdom's transfer of a going concern regime treats a transferor and a transferee of a business as a single fiscal entity, it makes sense to attribute the taxable supplies of the latter to the former, so as to secure a direct and immediate link between VAT incurred by the transferor and the taxable supplies of the transferee."

The UT said that the FtT was wrong to hold that the implication of Faxworld was that onward supplies by BAA could be attributed to ADIL. The UT explained that:-

" 80. While the partnership entity, Faxworld GbR, in Faxworld apparently expended the relevant VAT before the establishment of Faxworld AG, to which the business and assets were transferred (see paragraphs 11 and 13 of the ECJ's judgment) the ECJ was careful to point out that Faxworld GbR was established solely to establish, in turn, Faxworld AG (see paragraph 11) and importantly that Faxworld GbR incurred VAT "paid on input services which have been procured for the purposes of Faxworld AG's taxable operations" (paragraph 42, emphasis added). And that in circumstances in which the German provisions analogous to the United Kingdom transfer of a business as a going concern were engaged, so that the transferor and the transferee were, for VAT purposes, conflated (paragraph 42).

81. Thus it is easy to see why the ECJ considered that the principle of VAT neutrality would be offended unless the taxable supplies of Faxworld AG were attributed to Faxworld GbR. Faxworld GbR incurred the relevant VAT at a time when it was found to have the express intention of establishing Faxworld AG, which would make taxable supplies precisely because Faxworld GbR had paid for the services bearing VAT. Faxworld GbR was to transfer to Faxworld AG the business which was to generate those taxable supplies under provisions which made the transfer a non-event for VAT. The input services were "procured for the purposes of the recipient's taxable operations" (paragraph 42)

82.There is in those circumstances ("those precise circumstances": paragraph 42) a self-evident direct and immediate link between VAT on services incurred by Faxworld GbR and Faxworld AG's taxable supplies when the former acquired the relevant services and incurred VAT for the very purpose of enabling Faxworld AG to undertake taxable supplies."

The UT held that in this case the nature of the fees incurred by ADIL in connection with the take-over could not be described as "fees incurred to allow BAA to undertake taxable supplies, which BAA was already making, both prior to and after the take-over."

(5) Regulation 111

Regulation 111 was cited, but does not apply to this case, because, at the time at which ADIL incurred VAT, it was not attributable to onward taxable supplies.

BAA's submissions

BAA's submissions in support of the appeal are set out at length in two skeleton arguments to which has been added a cross referenced speaking note summarising the legal principles relied on by it. The submissions are bolstered by 3 lever arch files of legislation and authorities. The arguments on the appeal spread over three days. No ingratitude or disrespect for all the labour and ingenuity, which BAA's team, headed by Mr Roderick Cordara QC, have lavished on their multi-layered presentation, is intended by the following concise summary of BAA's main points.

(1) Economic Activity

In the first place, the concept of "economic activity" in VAT law is a very wide one. It has been translated into UK legislation as being "engaged in a business." It is the very opposite of being a final consumer. A person carrying on an economic activity is a taxable person, who has a right to recover input VAT incurred on taxable supplies in the course of that activity and, in so far as he is obliged, to charge output VAT.

ADIL carried on an economic activity at all relevant times. That activity was continuous and unbroken. The UT was wrong to divide the activity into two distinct parts of pre-acquisition and the post-acquisition activities. There was a single overall transaction, so that ADIL was carrying on an economic activity from the date of incorporation on 27 March 2006. There was no need to show a specific link of the input VAT to specific output supplies. What mattered was the carrying on of an economic activity, which carried with it the status of a taxable person acting in a business capacity.

Mr Cordara QC highlighted the factual point in the FtT judgment that ADIL was not just a vehicle for acquiring shares in BAA: its wider purpose was the provision of strategic governance to the BAA group.

(2) Direct and immediate link

Secondly, there was a direct and immediate link between the supplies on which ADIL incurred input tax and the outward supplies on which BAA charged VAT. ADIL was intending to make supplies.

The focus of Mr Cordara's criticisms of the decision of the UT was on [75] of its judgment which he described as the key passage-

"However we should say that we also agree with the Commissioners that the time to test the recoverability of VAT is at the time at which the relevant VAT is incurred…That preparatory acts of a taxable person may attract VAT recoverability does not affect that conclusion, since those preparatory acts must, at the time at which they attract the payment of VAT, have a direct and immediate link, of sufficient strength, to an onward taxable supply."

Mr Cordara submitted that the UT made four cardinal errors.

The first was that ADIL carried on one continuous unbroken economic activity from inception to the post take-over phase when the inputs were used to manage and re-finance the BAA Group. The UT wrongly divided the activity into a pre-acquisition phase and a post-acquisition phase and then concluded that there was no direct and immediate link with the overheads of the group as a whole. The continuum furnished the direct and immediate link.

Secondly, the UT applied the direct and immediate link test incorrectly. This was a case of "overheads VAT" in which all that needs to be established is a direct and immediate link with the taxable person's continuous and unbroken economic activity as a whole rather than with any particular or specific supplies.

Thirdly, the UT introduced, without authority from the legislation or from case law, the requirement that the direct and immediate link be "of a sufficient strength." It was, in any event, a "highly problematical" concept. There is either a link or there is not. On the facts as found a generalised intention to make taxable supplies provided sufficient linkage to enable the right to recovery to be exercised.

Fourthly, in construing the VAT grouping rules in s. 43 of the VAT Act 1994, the UT failed to give effect to the fiscal identity between the notional taxable person and the group companies and between the group companies and the notional taxable person.

Other criticisms of the UT were that the denial of recoverability of VAT lacked legitimacy, as it was contrary to the fundamental principle that fully taxable traders should be entitled to recover the input tax incurred by them in their business. That was an integral part of the VAT system. ADIL did not incur VAT for a non-business purpose. It incurred it in order to acquire and manage a fully taxable business of which it would form part.

The UT's conclusion was also inconsistent with the finding of fact that there was one continuum of single economic activity with no break between the period prior to the acquisition of the BAA shares and the period following the acquisition, so that the supplies are necessarily directly and immediately linked to such activity. It was wrong to treat ADIL as, in effect, a final consumer. The supplies related to the ongoing post acquisition airport business of the BAA Group relating to advice relevant to BAA's re-financing, working capital needs and strategic direction. The supplies to ADIL formed overheads of the BAA VAT Group and formed cost components of the BAA VAT Group's taxable supplies. Links to specific taxable supplies were not required to establish direct and immediate links.

ADIL was carrying on an economic activity from its inception and was entitled to repayment of VAT when the services acquired were used, or intended to be used, for the purposes of taxable transactions. The intention to make taxable supplies through the acquisition and management of a taxable group was a sufficient basis for the recovery of the input VAT. The making of the taxable supplies is evidence of a prior intention to make such supplies.

Further, the statutory legal fiction of a single person in s.43 of the 1994 Act meant that, if the VAT Group of which ADIL was a member made taxable supplies, ADIL made taxable supplies. The fiscal personality of the individual group members and the notional group were one and the same. The analysis in Faxworld (see above and below) applied where the taxpayer joins a VAT group whose members are treated as a single taxable person by virtue of Article 4(4) of the Sixth Directive.

On joining the BAA VAT Group ADIL became part of and was succeeded by the single taxable person in the form of the representative member. ADIL's unused inputs came into the BAA VAT Group and their recoverability takes colour from the outputs of the group. All the members of the group were carrying on a notional single business. ADIL continued to carry on that business through the medium of the group.

It was pointed out that the dates of the invoices were post-acquisition and after the date that ADIL intended to join the BAA VAT Group.

(3) Faxworld

Of the many cases cited by Mr Cordara QC in his written and oral submissions, Faxworld seemed to be the favourite for its confirmation of the vigour of the principle of VAT recovery by businesses. It was held that a person who does acts preparatory to the making of taxable supplies, not by himself but by another person, who continues the activities as his successor, is a taxable person entitled, under Article 17, to deduct VAT charged on supplies of goods or services intended to be used for the purpose of the successor's taxable supplies.

The principle of fiscal neutrality required the partnership in that case to be treated as a taxable person and to be entitled to deduct VAT charged on supplies of goods and services which the partnership intended that the company should use for the purposes of the company's taxable supplies.

That and other cases showed that "direct and immediate link" means "attributable to" and that there is always such a link to the business as a generalised activity viewed as a whole i.e "overheads VAT", as opposed to specifically attributable VAT. That approach enables the court to give effect to the policy of fiscal neutrality that a trader should be able to recover his input tax.

Intentions

As for intentions it was submitted that the purpose of ADIL, by acquiring the shares, was to take over the running of the BAA business which made wholly taxable supplies. That was an intention on the part of ADIL to make taxable supplies in the course of the group's business. It was sufficient to give rise to a right to recover VAT incurred on the takeover costs and to attribute those inputs to the group's outputs. The UT applied the wrong test of intention in determining whether the input tax could be recovered.

On the finding of fact that there was no evidence that, prior to the share acquisition, ADIL intended to join the BAA VAT Group, ADIL sought permission to appeal on the ground that the tribunals should have considered that it was a fair inference on balance that the intention to join the VAT Group existed before the take-over.

HMRC submissions

The essence of HMRC's submissions may be summarised as follows.

(1) Economic activity

The question whether a person's activities consist of "economic" activity for VAT purposes is a question of law and it is fundamental to entitlement to reclaim VAT: Lennartz v. Finanzamt Munchen III (Case C-97/90) [1995] STC 514 at [25] of the Advocate General's Opinion and [8], [9] and [14] of the judgment; Waterschap Zeeuws Vlaaderen v. Staatssecretaris van Financien (Case C-378/02) [2005] STC 1298 at [41].

The FtT and the UT ought to have held that, as a matter of law, ADIL was not carrying out an economic activity at the time the disputed supplies of services were received. It simply intended to purchase shares in another company. Neither that intention nor a subsequent intention to join the BAA VAT Group after acquisition were sufficient to count as an economic activity.

The general principle is that VAT is a tax on consumption: it bites on output transactions made for consideration and is levied by reference to the price of those output transactions after deduction of various costs components. In this case ADIL did not, at the time when it received the services, carry out, or even intend to carry out, any output transactions, which were the subject of the tax. It was not carrying out any taxable activities, or making any taxable supplies for a consideration, or even intending to do so, and was not entitled to be registered as a taxable person. It was acting as a corporate vehicle for the purposes of the takeover of BAA plc by the acquisition of shares. The supplies to it were made for that purpose.

BAA itself was not the recipient of any of the services supplied for the purposes of the take-over, which was against its wishes. The position of ADIL at the relevant time was that it was carrying out and intending to carry out investment activities for profit, not making taxable output transactions. It was not creating outputs against which any inputs might be deducted.

(2) Direct and immediate link

At the relevant time (i.e. when it received the supplies and incurred the liability to pay the input VAT) ADIL had no intention to make, nor did it in fact subsequently make, any onward taxable supplies. The professional services supplied to ADIL had no direct and immediate link to any onward supplies made by ADIL.

The intention of ADIL to take over BAA was insufficient to create the necessary link between the input tax incurred by ADIL and the VAT charged on output supplies by BAA. There was no-one in the BAA VAT Group at the relevant time that was entitled to deduct the input tax incurred by ADIL. There was no relation back to the input tax incurred on the takeover by a company that became a member of the representative group.

(3) Faxworld

The UT rightly rejected the FtT's analysis of Faxworld as meaning that taxable supplies made by BAA could be attributed to ADIL and correctly analysed in [80] –[82] the true effect of the ECJ decision in Faxworld. In this case BAA was making taxable supplies before the acquisition by ADIL.

Discussion and conclusions

As may be gathered from the differences in expert legal opinion in the FtT and the UT, the application of the law in this specialised area is somewhat unpredictable. It may take years to achieve finality in some cases.

Fortunately, in this case, the findings of fact by the FtT are clear and the basic propositions of law, as set out in the judgment of the UT, are agreed. Some of the more relevant authorities cited are a useful introduction to the discussion.

Authorities

On the "economic activity" question it was held in Polysar Investments Netherlands BV v. Inspecteur der Invoerrechten em Accijnzen, Arnhem [1993] STC 222 that an international holding company, the sole function of which was to hold shares in other companies in a world wide group, without any direct or indirect involvement in the management of those other companies, was not a taxable person. The mere holding and acquisition of shares did not amount to the exploitation of property and was not economic activity within the meaning of the Sixth Directive.

As the Court of Justice explained-

"11. It follows from Article 2 of the Sixth Directive which defines the scope of VAT, that within the territory of a member state only activities of an economic nature are subject to VAT. By virtue of Article 4(1), "taxable person" means any person who independently carries on such an economic activity. The expression "economic activity" is defined in Article 4(2) as comprising all activities of producers, traders and persons supplying services, and in particular the exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis….

"13. … The mere acquisition of financial holdings in other undertakings does not amount to the exploitation of property for the purposes of obtaining income therefrom on a continuing basis because any dividend yielded by that holding is merely the result of ownership of the property.

14. It is otherwise where the holding is accompanied by direct or indirect involvement in the management of the companies in which the holding has been acquired, without prejudice to the rights held by the holding company as shareholder.

15. ….it should be pointed out that a holding company does not lose its status as a non-taxable person by reason of the fact that it belongs to a worldwide group where the company confines its activities to the mere acquisition of financial holdings…" [See also the Opinion of the Advocate General at [1]-[7] ]

The opinion of the Advocate General also contains a helpful summary of the effect of Article 4(4) in relation to a VAT group, such as the BAA VAT Group of which ADIL subsequently became a member:-

"9. That provision allows two or more persons, though legally independent and thus capable of being regarded as separate taxable persons, to be treated as a single taxable person for the purposes of the application of the common system of VAT where they are closely bound to one another by financial, economic and organisational links. The question which arises is whether that option enables a member state to treat two persons who are closely bound to one another as a single taxable person where it is established that one of those persons does not engage in any 'economic activity' within the meaning of art 4 of the directive. In my view, that question must be answered in the negative. I share the Commission's view that, in order to establish whether there is liability to tax, it is necessary to focus on the activities of each legal person separately, and not on the activities of the concern as a whole. The second subparagraph of art 4(4) of the Sixth Directive does not derogate from that principle; it is a rule designed to simplify matters which enables the tax authorities to treat as a single person for the purposes of the application of VAT two or more legally independent persons who engage in economic activities on their own account as a result of the close financial, economic and organisational links between them, with the result that transactions between the two do not give rise to the charging and payment of turnover tax."

On the question of "direct and immediate link" the case of Abbey National plc v. Customs and Excise Commissioners [2001] STC 297 (Abbey National) is pertinent. It related to the deductibility of input tax on professional fees incurred to effect the transfer of the totality of assets or part thereof. The Court of Justice followed the principle that VAT applied to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components and the rule that, in order to give rise to the right to deduct, the goods or services acquired had to have a direct and immediate link with the taxable transactions.

In that case Abbey National submitted that, as the transferee of the assets was the successor of the transferor, the transferor may take into account the taxable supplies of the transferee so as to be able to deduct all the VAT on the expenditure incurred for the services acquired in order to effect the transfer. The Court of Justice said:-

"32. That argument cannot be accepted. First, it is clear from art 17(2) of the Sixth Directive that a taxable person may deduct only the VAT on the goods and services used for the purpose of his own taxable transactions. Secondly, in any event, the amount of VAT paid by the transferor on the costs incurred for the services acquired in order to carry out a transfer of a totality of assets or part thereof does not directly burden the various costs components of the transferee's taxable transactions, as required by art 2 of the First Directive. Those costs do not form part of the costs of the output transactions which use the goods and services acquired."

The court said that the various services acquired by the transferor in order to effect the transfer of assets did not have a direct and immediate link with one or more output transactions giving rise to the right to deduct. However, the court went on to conclude that the costs of those services formed part of the taxable person's overheads and had in principle a direct and immediate link with the whole economic activity of the taxable person.

Cibo Participations SA v. Directeur regional des impot du Nord-Pas-de Calais [2002] STC 460 was a case on the deductibility of input tax where a holding company incurred expenditure for services supplied to it in connection with the acquisition of shareholdings in subsidiary companies. The Court of Justice followed its earlier rulings that a holding company, whose sole purpose is to acquire holdings in other undertakings and which does not involve itself directly or indirectly in the management of those undertakings, is not a taxable person and has no right to deduct input tax. The court went on to rule that:-

"22. …the involvement of a holding company in the management of companies in which it has acquired a shareholding constitutes an economic activity within the meaning of art 4(2) of the Sixth Directive where it entails carrying out transactions which are subject to VAT by virtue of art 2 of that directive, such as the supply by a holding company to its subsidiaries of administrative, financial, commercial and technical services."

On the question whether a holding company may deduct VAT charged on expenditure incurred in respect of various services obtained by it in connection with the acquisition of a shareholding in a subsidiary, the Court of Justice ruled as follows on the requirement of a direct and immediate link for deduction of input tax on services purchased by a holding company and output transactions in respect of which VAT is deductible:-

"32. Clearly, there is no direct and immediate link between the various services purchased by a holding company in connection with its acquisition of a shareholding in a subsidiary and any output transaction or transactions in respect of which VAT is deductible. The amount of VAT paid by the holding company on the expenditure incurred for those services does not directly burden the various cost components of its output transactions in respect of which VAT is deductible. That expenditure does not form part of the costs of the output transactions which use the services.

33. On the other hand, the costs of those services are part of the taxable person's general costs and are, as such, cost components of an undertaking's products. Such services therefore do, in principle, have a direct and immediate link with the taxable person's business as a whole".

If the holding company is a taxable person carrying out both transactions in respect of which VAT is deductible and transactions in respect of which it is not, it may deduct only that proportion of the VAT which is attributable to the former.

In Kopalnia Odkrywkowa Polski v. Dyrektor Izby [2012] STC 1085 the question of the deductibility of input tax arose in the context of partners incurring expenditure prior to the creation and registration of a partnership with a view to economic activity. The invoices were issued before registration of the partnership. The national legislation prevented the partners who effected the expenditure from exercising the right to deduct VAT incurred on pre-registration investment expenditure. The court noted that the economic activities "may consist in several consecutive transactions and that preparatory acts, such as the acquisition of business assets and therefore the purchase of immovable property, must themselves be treated as constituting economic activity [28]. so that the partners may be considered to be taxable persons for the purposes of VAT and in principle entitled to exercise the right to deduct input tax.

The court also noted that in certain circumstances, as in Faxworld, a taxable person may exercise a right to deduct in relation to taxable transactions carried out by another taxable person:-

" 33. …it should be noted that the court has held that, in applying the principle of neutrality of VAT, a taxable person whose sole object is to prepare the economic activity of another taxable person and who has not effected any taxable transaction may exercise a right to deduct in relation to taxable transactions carried out by the other taxable person (see [Faxworld]….) That interpretation of the Sixth Directive concerned a situation where the VAT which the first taxable person wished to deduct related to supplies acquired by it for the purpose of carrying out taxable transactions planned by the second taxable person.

34. It is true, as the Advocate General observed at points 46 to 49 of his opinion, that the factual and legislative context of the dispute which led to the reference for a preliminary ruling giving rise to the judgment in Faxworld was different to that forming the basis for the present reference for a preliminary ruling. However, the grounds underlying the court's interpretation in that judgment remain valid in circumstances such as those which characterise the main proceedings.

35. It must therefore be held that, in so far as, under national legislation, the partners, even though they may be considered taxable persons for the purposes of VAT, are unable to rely on the taxable transactions effected by Polski Trawetyn in order to relieve the cost of the VAT on investment transactions effected for the purposes of and with a view to the activity of that partnership, the latter must, in order to ensure the neutrality of taxation, be entitled to take account of those investment transactions when deducting VAT …"