England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		9th November 2000

The Hon Mr Justice Patten:

1. Introduction and Overview

This is an appeal by RAP Group plc ("RAP") from a decision of the VAT and Duties Tribunal (Chairman: Mr. David Demack) released on 14^th April 2000. The issue for the Tribunal was whether RAP was entitled to deduct the input tax on the supplies of services by three professional advisers in relation to the acquisition by it of Welpac plc ("Welpac").

2. The input tax in question was charged to RAP in respect of three invoices which were described in the Agreed Statement of Facts as follows:

"1. An invoice from KPMG, chartered accounts, dated 20^th September 1995 in the sum of £15,741.55 (including £2,101.09 VAT) (against that invoice was a credit note for £1,948.17 (including VAT of £290.23) issued on 2^nd November 1995). The invoice was raised in respect of "placing and open offer" and "offer for Welpac plc";

2. An invoice from Messrs. Travers Smith Braithwaite, solicitors, dated 30^th October 1995 in the sum of £55,150.91 (including VAT of £8,985.53) in respect of "professional costs in connection with the recommended offer by you to acquire the whole of the issued share capital of Welpac plc and the placing and open offer to existing RAP shareholders.......";

3. That part of the invoice from Messrs. Williams de Broe, stockbrokers, dated 17^th August 1995 in the sum of £94,000 (including VAT of £14,000) for "corporate finance advice services in connection with the recommended offer for Welpac plc and the placing and open offer of new RAP shares"."

3. The Tribunal decided that all three invoices were attributable to an exempt supply, namely the issue of shares necessary to effect the acquisition of Welpac, and the Commissioners were therefore correct to treat the professional services as falling within Regulation 101 (2)(c) of the VAT Regulations 1995. The Tribunal therefore dismissed RAP's appeal against the assessment of £29,267 notified on 10^th June 1997.
4. I have reached the conclusion that there are no grounds upon which I can properly interfere with the Tribunal's decision in respect of the invoices rendered by KPMG and Williams de Broe. I am however satisfied that the Tribunal's decision in respect of the Travers Smith Braithwaite invoice cannot stand and that the services of that firm were demonstrably used in making both taxable and exempt supplies within the provisions of Regulation 101 (2)(d). The appeal to that extent will be allowed.
5. The Facts

The Tribunal was presented by the parties with an agreed Statement of Facts which is attached as an Appendix to this judgment. For the purposes of outlining the issues on this appeal those facts can be summarised very briefly without repeating unnecessary matters of pure detail:

(1) RAP is the parent company of a group and provides management and other services to its subsidiaries. Both RAP and each of the companies in the group are separately registered for VAT;

(2) on 13^th July 1995 RAP and Welpac announced the terms of a recommended offer to be made by RAP for the entire issued share capital of Welpac. RAP was to offer one new RAP share plus one RAP warrant for every 130 Welpac shares. The prospectus also contained details of a Placing and Open Offer involving the issue of up to 1,384,813 placing shares at l45p per new RAP share. This issue was underwritten by Williams de Broe and was designed to raise £1.65m for the reorganisation of Welpac and as additional working capital for the group;

(3) pursuant to the prospectus the shares were placed and openly offered and the share capital in Welpac was purchased;

(4) RAP received advisory services from a number of sources including KPMG, Williams de Broe and Travers Smith Braithwaite. A single price was agreed and RAP received a single supply of services from each supplier;

6. The relevant legislation

The scope of permissible deductions for VAT purposes is dealt with in Article 17 of

the Sixth Council Directive ("the Sixth Directive"). Paragraphs 2 and 5 of the Sixth

Directive provide that:

"2. Insofar 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 the 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.............""

7. The relevant domestic legislation is contained in Sections 25 and 26 of the Value Added Tax Act 1994 which (so far as material) provide as follows:

"Section 25(2) Subject to the provisions of this section, he [the taxable person] is entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under Section 26, and then to deduct that amount from any output tax that is due from him.

Section 26(1) and (2)

"(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below.

(2) The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business -

(a) taxable supplies;

(b) supplies outside the United Kingdom which would be taxable supplies if made in the United Kingdom;

(c) such other supplies outside the United Kingdom and such exempt supplies as the Treasury may by order specify for the purposes of this subsection.""

8. The ability of RAP as a taxable person to obtain credit by deduction in respect of input tax in any relevant period therefore depends upon it establishing that the input tax is treated under the regulations made under Section 26 as attributable to taxable supplies made or to be made by RAP in the course or furtherance of its business. The relevant regulation is Regulation 101(2) of the 1995 VAT Regulations which provides that:

"(2) In respect of each prescribed accounting period -

(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.""

9. An exempt supply is defined in Section 31 and Schedule 9 of the 1995 Act as follows:

"31(1) A supply of goods or services is an exempt supply if it is of a description for the time being specified in Schedule 9 and an acquisition of goods from another member State is an exempt acquisition if the goods are acquired in pursuance of an exempt supply.

Schedule 9 Group 5 Item 6.

The issue transfer or receipt of, or any dealing with, any security or secondary security being -

(a) shares, stocks, bonds, notes (other than promissory notes), debentures, debenture stock or shares in an oil royalty; or

(d) any letter of allotment or rights, any warrant conferring an option to acquire a security included in this item, any renounceable or scrip certificates, rights coupons, coupons representing dividends or interest on such a security,

bond mandates or other documents conferring or containing evidence of title to or rights in respect of such a security;""

It was common ground before me in the light of these provisions and of the judgment of Lightman J in Mirror Group Newspapers Limited v CEC [2000] STC 156 that an issue of shares constitutes an exempt supply for VAT purposes.

10. The issue on the appeal.

The choice between Regulation 101 (2)(c) and 101 (2)(d) depends on whether the services provided by the three sets of professional advisers (KPMG, Williams de Broe and Travers Smith Braithwaite) were used exclusively in making an exempt supply in the form of an issue of shares or were used in making both taxable and exempt supplies. Before the Tribunal it was contended by those representing RAP that the services of all three advisers were not confined to the issue of the RAP shares but were also attributable to the acquisition of Welpac whose shares were acquired in exchange for the RAP shares which were issued. Part at least of the cost of those services was therefore a general overhead and a cost component of RAP's taxable transactions in the form of the management services RAP would in time supply to Welpac as part of the RAP group because the professional services facilitated and were incurred in acquiring Welpac and therefore in preparation for the making of those taxable supplies to that company. The taxpayers argument is perhaps best summarised in two paragraphs from its skeleton argument before the Tribunal:

"The Appellant contends that in applying the above approach to the facts of the present appeal it is clear that there is a direct and immediate link between the supplies received from KPMG, Travers Smith Braithwaite, and Williams de Broe. All the invoices refer to work done in connection with the offer for and purchase of the entire shareholding in Welpac. It is agreed between the parties that the services supplied in each case comprised a single supply of services which cannot be broken down into their composite elements. The appellant therefore contends that services were received for the purposes of both the issue of shares and the purchase of Welpac.

Insofar as the services relate to the purchase of Welpac the costs were incurred in order that the appellant could proceed to make taxable supplies to Welpac and as such represent an overhead which forms a cost component of management services which were ultimately provided by the appellant to Welpac following acquisition. The appellant contends that it made no supply which can be considered to be an intervening supply to which the costs can be said to be exclusively directly and immediately linked. Despite the proximity of the issue of shares and the acquisition there remains a causal link between the advisory services received and the taxable supplies made as a consequence of the acquisition of Welpac. The issue of shares is not an intervening supply of the type envisaged in BLP.""

11. The reference in that extract to a "direct and immediate link" between the input tax and the relevant output transactions was taken from the decision of the European Court of Justice in Midland Bank plc v CCE [2000] STC 260. In that case the bank claimed to deduct as input tax the VAT paid in respect of legal fees to its solicitors. The solicitors had advised the bank in connection with a corporate take-over by Quadrex Limited, one of the bank's clients. The bank was subsequently sued for negligence in relation to the take-over and retained the same firm of solicitors to act for it. It sought to deduct the entire amount of VAT on the whole of the legal fees incurred on the grounds that they were attributable to its supply of financial services to Quadrex which was a taxable transaction. The Commissioners contended that the VAT incurred in respect of legal fees in connection with the claim for damages was also attributable to the bank's business generally and therefore fell to be apportioned in accordance with Article 17(5). The High Court referred the issue to the ECJ which ruled that in order to be able to deduct input tax under Article 17 paragraph 2 of the Sixth Directive, the goods or services acquired must have a direct and immediate link with the output transactions giving rise to the right to deduct. Given that the VAT on the litigation costs post dated the output transactions it was not possible to establish that link and to treat the expenditure as cost components of the taxable transactions. However the litigation costs were part of the bank's general costs and as such cost components of its general business. They therefore fell within Article 17(5).
12. In the case before me there is no question of the taxpayer seeking to attribute to a prior taxable supply the input tax levied in respect of a subsequent supply of services. The issue in this case is whether the professional services were used by RAP exclusively in making an exempt supply in the form of the issue of shares or to adopt the language of Article 17(2) whether the services were used for the purposes of RAP's taxable transactions (in this case the supply of management services to Welpac). The relevant professional services were rendered in advance both of the exempt and the taxable supplies. The question however is whether they had a direct and immediate link to anything but the exempt supply.
13. Before the Tribunal Mr. Mantle contended on behalf of the Commissioners that it was not permissible to look beyond the issue of shares and to take into account the purchase of Welpac. To do so was, he said, to have regard to the aim of the taxpayer in making the supply which was irrelevant to the right to deduct. The latter depended on the supply to which the input tax was directly and immediately related which was the issue of shares. The fact that the purpose of the issue of shares included the acquisition of Welpac made no difference. The chain of causation outlined in RAP's skeleton argument (quoted above) was broken by the exempt supply in the form of the issue of shares.
14. In support of this submission Mr. Mantle relied upon the decision of the ECJ in BLP Group plc v CCE [1995] STC 423. In that case the taxpayer company sought to deduct as input tax the VAT which it had paid on invoices for professional services from merchant bankers, solicitors and accountants in connection with the sale of shares in a subsidiary company. The sale was an exempt supply. BLP contended that the purpose of the sale was to raise funds to pay off debts arising on taxable transactions and that the professional services should therefore be treated as having been used "for the purposes of its taxable transactions" within Article 17. The High Court referred the following question to the Court for a preliminary ruling:

"Having regard to Article 2 of the First Directive and Article 17 of the Sixth Directive, where a taxable person (A) supplies services to another taxable person (B), and those services are used by B for an exempt transaction (sale of shares) which was treated as an "incidental financial transaction" and whose purpose and result was to raise money to discharge all of B's indebtedness, are those services supplied by A:

(a) services used for the purpose of an exempt transaction such that input tax thereon is not deductible;

(b) services used for the purpose of taxable transactions (namely B's core business of making taxable supplies) such that input tax thereon is deductible in whole;

(c) services used for both exempt and taxable transactions such that the input tax thereon is deductible in accordance with Article 17(5) of the Sixth Directive?""

The question was answered in these terms:

"25. It is true that an undertaking whose activity is subject to VAT is entitled to deduct tax on services supplied by accountants or legal advisers for the taxable person's taxable transactions and that if BLP had decided to take out a bank loan for the purpose of meeting the same requirements, it would have been entitled to deduct the VAT on the accountant's services required for that purpose. However, that is a consequence of the fact that those services, whose costs form part of the undertaking's overheads and hence of the cost components of the products, are used by the taxable person for taxable transactions.

26. In that respect it should be noted that a trader's choice between exempt transactions and taxable transactions may be based on a range of factors, including tax considerations relating to the VAT system. The principle of the neutrality of VAT, as defined in the case law of the Court, does not have the scale attributed to it by BLP. That the common system of VAT ensures that all economic activities, whatever their purpose or results are taxed in a wholly neutral way, presupposes that those activities are themselves subject to VAT.....

27. Finally, as to the argument that Article 19 of the Sixth Directive applies, that provision presupposes the goods or services have been used by the taxable person both for transactions in respect of which there is a right to deduct and for transactions where there is no such right. In the present case, however, the services in question were used for an exempt transaction.

28. The answer to question 1 must therefore be that Article 2 of the First Directive and Article 17 of the Sixth Directive are to be interpreted as meaning that, except in the cases expressly provided for by those Directives, where a taxable person supplies services to another taxable person who uses them for an exempt transaction, the latter person is not entitled to deduct the input VAT paid, even if the ultimate purpose of the transaction is the carrying out of a taxable transaction.""

15. The decision in BLP was considered by the English Court of Appeal in CCE v UBAF Bank Limited [1996] STC 371. In that case the bank sought to deduct input tax charged on professional fees which had been incurred in connection with the acquisition of three leasing companies. The bank contended that the tax was attributable to taxable outputs in the form of the bank's leasing business. In order to expand this business it had acquired the three companies. The Commissioners contended that only a proportion of the tax was recoverable because the businesses of the leasing companies were not, until after they were acquired, part of the bank's business and could not therefore be said to have been used in making taxable supplies by the bank. That argument was rejected on the basis of the finding by the Tribunal that the acquisition of the three companies and their businesses "were intended to, and did, enable the bank to add substantially to its own existing leasing business, and, in VAT terms, to make taxable supplies of leasing." There was therefore a finding of fact by the Tribunal that there was a direct link between the acquisitions and the making of the taxable supplies. This was in contrast to the BLP case where it is clear from the question referred to the ECJ that the professional services were used for an exempt transaction.
16. As the judgment in the Midland Bank case makes clear the question whether there is a direct and immediate link between the input tax and a particular output transaction is a question for the national tribunal in each case. Some further assistance is to be derived from the Opinion of the Advocate General in case C-408/98 [Abbey National v CCE]. The facts of that case are not, I think, of assistance in the context of the present dispute but in the course of his Opinion the Advocate General sets out his understanding of the judgment in BLP as follows:

"The reference to cost components in the BLP judgment is a reminder of the basic principles set out in Article 2 of the First Directive: "on each occasion, value added tax....... shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components." Thus what matters is whether the taxed input is a cost component of a taxable output, not whether the most closely-linked transaction is itself taxable. As the Commission submitted at the hearing, the conclusion to be drawn from the BLP judgment is that the question to be asked is not what is the transaction with which the cost component has the most direct and immediate link, but whether there is a sufficiently direct and immediate link with a taxable economic activity. Indeed it may be stressed that in that case the Court was concerned with supplies which were not objectively linked to taxable transactions. Nevertheless, it remains clear from BLP that the chain-breaking effect which is an inherent feature of an exempt transaction will always prevent VAT incurred on supplies used for such a transaction from being deductible from VAT to be paid on a subsequent output supply of which the exempt transaction forms a cost component. The need for a "direct and immediate link" thus does not refer exclusively to the very next link in the chain but serves to exclude situations where the chain has been broken by an exempt supply.""

17. The Advocate General was emphasising that an absence of temporal proximity between a taxed input and a taxable output does not prevent the former being treated as a cost component of the latter. The necessary direct and immediate link between the two can exist just as it did in the UBAF case. What matters is whether there is a sufficient link of that kind with the relevant taxable supply and for the purpose of answering this question one has to take into account any intervening exempt transaction for which the same taxable services have been used. If, as in BLP, the services were used for the purposes of an exempt supply it matters not that the same inputs might as a component part of that exempt supply also properly be treated as a cost component of the subsequent output supply. Their use for the purposes of the exempt supply breaks the causal link for VAT purposes.
18. In its skeleton argument filed in support of this appeal RAP said this:

"The issue of shares by RAP in the commercial context of the acquisition of Welpac is properly analysed for VAT purposes as a necessary but nevertheless preparatory economic activity enabling RAP to make taxable supplies following the acquisition of Welpac......

The Appellant contends that there is a "direct and immediate" link on the facts of this case:

The costs of acquisition of Welpac are clearly part of RAP's business overheads. RAP is a fully taxable business and so the costs in issue are components of RAP's taxable transactions (see judgment of the ECJ in BLP - paragraph 25 page 435)

In order to establish a "direct and immediate" link it is not necessary to show links between every input and particular output transactions. A link with the underlying business will suffice (see paragraph 24 Opinion of Advocate General Sagio in CCE v Midland Bank plc C-98/98)

The acquisition of Welpac enabled RAP to add to its existing business. Welpac was acquired to enable RAP to make taxable supplies (CCE v UBAF Bank Limited [1996] STC 371 per Neil LJ at page 380)""

None of these submissions properly recognises the effect of an intervening exempt supply as explained in the BLP case and the Advocate General's Opinion in the Abbey National case. The application of the principles derived from those decisions would in my judgment be fatal to a contention that the issue of shares can in effect be ignored because it is merely a preparatory economic activity to the making of taxable supplies following the acquisition of Welpac. The fact that but for the exempt supply the professional fees might also properly be treated as a cost component of the subsequent taxable supplies is irrelevant although I accept (as I think Mr. Mantle did in argument) that for the purposes of establishing a direct and immediate link between the input and the output transactions it is not necessary to relate each input to some particular output. The real question however in every case is whether the input supply was used exclusively for the purposes of the exempt transaction or partly for the exempt supply and partly for the taxable supply. If the answer to the first question is yes then it follows, I think, as a matter of law, that there cannot be the necessary direct and immediate link with the subsequent taxable supply.

19. Doubtless with this in mind Mr. Anderson on behalf of RAP put in a supplementary skeleton argument which addressed the real question in this case. He submitted that the invoices demonstrate on their face that the input supply was not restricted to the issue of the shares. The professional services were in fact supplied both in respect of the issue of shares and in respect of the acquisition of Welpac. The case was therefore distinguishable from BLP where the entirety of the services were used in respect of the exempt transactions. For the Commissioners Mr. Mantle accepted that if the professional services were supplied both in respect of the issue of shares and in respect of other matters which were apart from the exempt share issue transaction then apportionment under Regulation 101 (2)(d) was appropriate. However he did not accept that any of the three invoices did in fact relate to anything other than the issue of the shares. The appeal therefore turns on what is essentially a factual dispute.
20. The Tribunal's conclusions are set out in paragraph 34 of its decision:

"For the purposes of my decision, I find myself unable to distinguish Mrs. Brown's argument from that rejected by the ECJ in the BLP case (see paragraph 17 of the judgment). The ECJ went on to say in paragraph 19, that "to give the right to deduct under para 2 [of Article 17], the goods or services must have a direct and immediate link with the taxable transaction, and that the ultimate aim pursued by the taxable person is irrelevant in this respect". I am unable to accept that any of the services in point in the instant case had a "direct and immediate link" to RAP's general overheads. Had RAP not issued some shares in exchange for the Welpac shares and issued others generally, the services of the accountants, etc. would not have been required: the services were required for the share issue and for no other purpose.""

Mr. Anderson submitted that the last sentence of that paragraph was illogical. I would prefer to say that it poses the wrong question. Whether the services were required for the share issue is not in point. The question is whether the services were used for the exempt transaction or for that and some other taxable supply. That is a question of fact which cannot be answered by some process of logical deduction. But that said it is clear that the Tribunal applied the "direct and immediate link" test and answered it against the taxpayer. I can only interfere with that decision if I am satisfied that there was no proper material upon which the Tribunal, acting judicially and in accordance with the law, could conclude that the input supply was used exclusively for the purposes of the exempt transaction: see Edwards v Bairstow [1956] AC 14 at page 36. If, however, the primary facts justify alternative inferences of fact I cannot, as an appellate court, substitute my own preference for that adopted by the fact finding Tribunal. In such a case there has been no error of law: see Furniss v Dawson [1984] AC 474 at page 528.

21. Although given an opportunity to do so the taxpayer decided to call no oral evidence from the professional advisers to explain and amplify the invoices which they had rendered. Therefore the Tribunal was not able to look beyond the description of the work contained in those invoices. In paragraph 6 of the decision the Tribunal sets out what it regarded as the relevant parts of the three invoices. The invoice from KPMG refers only to "placing and open offer" and "offer for Welpac plc". The invoice from Williams de Broe is in similar terms. The offer for Welpac (as found by the Tribunal) was one new RAP share and warrant for every 130 Welpac shares. Full acceptance of the offer required the issue of 310,852 new RAP shares. The placing and open offer was 3 placing shares for every 23 RAP shares held on 6^th July 1993. This involved the issue of 1,384,813 placing shares at 145p per new RAP share. There is nothing in these facts (all of which are set out in paragraph 4 of the decision) which dis-entitled the Tribunal to find that the services of KPMG and Williams de Broe were used for the purpose of an exempt supply in the form of the issue of shares. Nothing in either of the invoices indicates that the services related to anything apart from the issue of shares and the Tribunal concluded (see paras. 34-38 of the Decision) that RAP had failed to show that the input tax in dispute was not directly attributable to its exempt supply of shares. I accept that the Tribunal might have inferred that the offer for Welpac would involve an assessment of the value of that company in order to fix the offer price but the Tribunal had no evidence before it as to whether and if so to what extent KPMG and Williams de Broe were involved in that process and they were entitled on the face of the invoices to infer (as they did) that the services in question related only to the issue of the shares. For the reasons already explained it is not enough for RAP to contend that through the medium of the share issue it was able to acquire Welpac. What it needed to demonstrate was that KPMG and Williams de Broe were actually involved in tasks which went beyond what could reasonably be described as the issue of shares. No attempt was made to do this.

22. In the case, however, of Travers Smith Braithwaite there was more information available. Although the invoice begins in similar terms to the other two it then proceeds to spell out in detail the work done by the firm. This included items such as advising on the financing of the transaction, preparing service contracts for the executive directors, preparing a due diligence report on Welpac, investigating title to its properties and preparing papers for the AGM of Welpac following its acquisition. It seems to me that the Tribunal was wrong to ignore the clear terms of this invoice and to treat all this work as limited to the issue of shares. Plainly it was not.

22. Conclusion

I therefore propose to allow the appeal so far as it relates to the input tax on the invoice of Travers Smith Braithwaite. In respect of the input tax on the invoices of KPMG and Williams de Broe the appeal will be dismissed.