England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		29 July 2005

Mr Justice Blackburne:

Introduction

1. This is an appeal, with a cross-appeal, against the decision of the VAT and Duties Tribunal (Dr Nuala Brice, chairman, and Mr L G Wilkinson FCIB) ("the Tribunal") released on 8 June 2004 allowing in part an appeal by The Church of England Children's Society ("the Society") against a decision of the Commissioners of Customs and Excise dated 14 October 2002. By that decision the Commissioners refused to allow input tax credit in the sum of £253,500.56 claimed by the Society in its June 2002 return. The sum was taxed on the supply to the Society of fundraising services and of goods and services relating to the production and distribution of a newsletter. The newsletter was provided by the Society to committed donors to the Society who agreed to make regular donations of money to it.

2. The input tax was disallowed because the Commissioners were of the view that the provision of the newsletter by the Society to the committed donors was not a supply because it was not made for a consideration. The Society appealed contending that the provision of the newsletter was made for a consideration and so was a supply. Alternatively, it argued that, even if there was no consideration, the provision of the newsletter was to be treated as a supply because it was a transfer or disposal of assets of the business.

The Tribunal's findings of fact

3. So far as material to this appeal, I can recite the Tribunal findings of fact fairly shortly.

4. The Society, which is a company limited by guarantee, is registered for VAT and is a charity. It has among its objects "to care for and support children and young persons in need, whether material, physical, mental, emotional or spiritual, and to promote their physical, mental, emotional and spiritual development (whether through their families, community or otherwise howsoever) in accordance with the principles of the Church of England". In furtherance of those objects the Society has power to provide residential and day care establishments and social work support for children and young persons, to place children and young persons with adopters or in suitable homes with foster parents, and to establish and maintain schools and institutions for the education and training of children and young persons. Children and young persons are defined as persons up to the age of twenty-five years.

5. In the year to March 2002, the Society's income was £35,892,000 of which £26,701,000 derived from fundraising. Most of the fundraising income came from legacies and donations with some from fundraising events such as fun runs, treks and pilgrimages, some from other activities, and with some from shops. Of the total income which was not from fundraising, most came from fees and grants from local authorities and central government of which about £9 million was paid to the Society by local authorities and central government under contracts to provide welfare services. In the Society's financial statements for 2001/2002, income was listed under two heads: (1) "voluntary income sources" comprising, among others, legacies, donations (including donations from so-called committed givers), collecting boxes and parish giving; and (2) "incoming resources from operating activities" comprising, among others, income from welfare services provided to local authorities and central government, fundraising events and shops.

6. In paragraph 19 of the decision the Tribunal stated that for the purposes of value added tax the Society carried on business activities and made both standard-rated supplies (for example, the sale of donated goods in charity shops) and exempt supplies (for example, the provision of welfare services under contract to local authorities and central government, and fundraising events). The Tribunal noted that before the establishment of the committed givers club (see below) the Society treated the value added tax it paid on supplies connected with its newsletters as residual input tax.

7. In June 2001 the Society reviewed the progress of its direct giving campaign and was advised that there would be benefits in offering a membership scheme with a minimum monthly subscription. The intention was that scheme members would receive a regular publication produced specifically for them as a direct benefit of their subscription. This was seen as enabling the Society to recover the input tax on the costs of acquiring the new members. The proposal was that a membership scheme should be introduced with the membership fee set at £5 per month, to be paid by direct debit.

8. The Society employed professional fundraisers to canvas members of the public in the street and to encourage them to make donations. The fundraisers were told that, when canvassing, they should make reference wherever possible to the fact that committed supporters who pledged £5 per month or more by direct debit would be entitled to receive exclusive regular newsletters about the Society's work and would automatically join the Society's so-called committed givers club.

9. The professional fundraisers, who supplied the fundraising services, were paid a single fee by the Society for each donation of £5 or more. The fee was repayable to the Society in whole or in part if the donation ceased within the first three months.

10. The newsletters, which were only sent to committed givers who had not cancelled or missed their payments, were published by the Society which paid for the provision of supplies to it in connection with its publication. Examples include supplies from the photographer of photographs used in it, from an illustrator who provided illustrations for an article in it, from a printer for the provision of proofs and for polywrapping the newsletter, from an envelope supplier for supplying envelopes and from another supplier for the design, typesetting and artwork involved in producing the newsletter. The edition of the newsletter which appeared closest to the date of the assessment in issue had 16 pages and contained a full-page advertisement for a sponsored trek, a contents and editorial page, a news review about the work of the Society, an article on Youth Justice and another on Young Carers, some fundraising news about sponsored events and a letters page.

11. Relying upon correspondence passing between representatives of the Commissioners and the Society in the course of October 2001, the Society included in its return for the accounting period ending on 30 June 2002 a claim for input tax credit in respect of the tax paid to the suppliers of the fundraising services relating to the committed givers, and also of goods and services relating to the production and distribution of the newsletters. The Society treated the amounts received from the committed givers who paid less than £5 per month as being made by way of donation and so outside the scope of value added tax. It treated the amounts received from committed givers who paid £5 per month as being made by way of consideration for the taxable supply of the newsletter. It treated the amounts received from committed givers who paid more than £5 per month as being made partly (to the value of £5) by way of consideration for the taxable supply of the newsletter and as to the balance by way of donation.

12. By letter to the Society dated 14 October 2002, the Commissioners expressed the view that the whole substance of the relationship between the Society and a committed giver was that of the giver making a donation to the Society and did not involve the sale by the Society to the giver of a subscription to the newsletter. Accordingly the claim for input tax credit was refused. In subsequent correspondence the Commissioners at first accepted that the costs of producing the newsletter could be treated as residual input tax, not because the provision of it was a taxable supply but because the costs of producing it were overhead costs of the "truly taxable supplies" that the newsletter supported, but later withdrew that view of matters and stated that "VAT on the costs of producing the newsletter is not properly 'residual' and is therefore not recoverable to any extent".

The Tribunal's conclusions

13. The Tribunal concluded that the provision by the Society of the newsletter to the committed givers was not done for consideration and so was not a supply within the meaning of section 5(2)(a) of the Value Added Tax Act 1994 ("the 1994 Act"). It went on to conclude, however, that, because it was agreed that the provision by the Society of the newsletter to the committed givers was a deemed supply under paragraph 5(1) of Schedule 4 to the 1994 Act, the Society could recover all the tax on the supply to it of the goods and services used exclusively in the production and distribution of the newsletter but could not recover the tax on the supply of the fundraising services. In the result the Tribunal held that the input tax relating to the production and distribution of the newsletter was recoverable in full but that the input tax relating to the fundraising services was not recoverable at all. The Society's appeal

14. In reaching its conclusion that the input tax on the costs of the fundraising services was not recoverable, the Tribunal said this (in paragraph 62):

"However, in our view the supplies of fundraising services are not supplies relating to the production and distribution of the newsletter. If anything, the supplies of the fundraising services were supplies relating to the soliciting of donations and that is not a taxable supply by the Appellant (nor indeed a supply at all). Accordingly, in our view the input tax on the fundraising services is not recoverable."

15. The Society does not appeal against the decision insofar as the Tribunal held that no part of a committed giver's monthly donation is consideration (in the VAT sense) for the supply to the giver by the Society of the newsletter which is provided, and is expressed to be provided, to the giver free of charge. In other words, the Society accepts that the provision of the newsletter is not an actual taxable supply (as opposed to a "deemed" taxable output supply under paragraph 5 of Schedule 4) made in return for a consideration in the form of donations. Instead, accepting, as the Tribunal held (in paragraph 62 of the decision), that the supply to the Society of the fundraising services was not a supply which related to the production and distribution of the newsletter and, accepting, as the Tribunal further held in that paragraph, that the soliciting of donations was not a taxable supply by the Society or indeed a supply at all, the Society now appeals on the basis that the supply of those services related to the raising of monies (by means of the donations) for the general purposes of the Society. It therefore contends that the input tax on that supply falls to be dealt with in the same way as the input tax on the supplies to the Society of its overheads in general, namely as so-called residual input tax.

16. In thus pursuing the Society's appeal, Mr David Milne QC frankly accepted that this approach was different from the basis upon which the Society had brought its appeal. (Mr Kenneth Parker QC, appearing with Mr Paul Harris for the Commissioners, characterised the change of approach as a "jettisoning" of the earlier approach.) The Society's previous approach had been to argue (as appears in Mr Milne's skeleton argument in support of the appeal) that the fundraising supplies "clearly relate to the distribution of the newsletter (a deemed taxable supply)" in that the soliciting of donations (for which the Society had engaged the services of the professional fundraisers) and the soliciting of deemed taxable supplies of newsletters were "indissociable: the activities of the recruiters inevitably relate to both". From that premise, Mr Milne QC had submitted (in his skeleton argument) that the input tax on the fundraiser's fee "must be apportioned in accordance with section 24(5)" of the 1994 Act and that "that part apportioned to the supply of the newsletters is recoverable". His revised stance on behalf of the Society no longer depended upon any direct link between the fundraisers' services and the delivery of the newsletter and abandoned any reliance on an apportionment under section 24(5).

17. This change of stance had been prompted by the release on 26 May 2005 of the decision of the European Court of Justice in Kretztechnik AG v Finanzamt Linz, Case C-465/03 (The Times, 21 June 2005) ("Kretztechnik").

(1) The legislative background

18. Before coming to the decision in Kretztechnik, it is appropriate to set out the relevant legislative background.

19. Article 4 of the Sixth Directive provides, so far as material, that:

"1. 'Taxable person' shall mean a person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.

2. The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services …"

20. Article 17 of the Sixth Directive provides, so far as material, that:

"1. The right to deduct shall arise at the time when the deductible tax becomes chargeable.

2. 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 within the territory of the country 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 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."

21. The 1994 Act provides, so far as material, as follows:

"4(1) VAT shall be charged on any supply of goods or services made in the United Kingdom where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him.

(2) A taxable supply is a supply of goods or services made in the United Kingdom other than an exempt supply.

5(1) Schedule 4 shall apply for determining what is, or is to be treated as, a supply of goods or a supply of services.

(2) Subject to any provision made by the Schedule and to Treasury orders…

(a) "supply" in this Act includes all forms of supply, but not anything done otherwise that for a consideration;

…

24(1) Subject to the following provisions of this section, "input tax", in relation to a taxable person means the following tax, that is to say –

(a) VAT on the supply to him of any goods or services …

being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him.

(2) Subject to the following provisions of this section, "output tax", in relation to a taxable person means VAT on supplies which he makes …

…

(5) Where goods or services supplied to a taxable person …are used or to be used partly for the purposes of a business carried on or to be carried on by him and partly for other purposes, VAT on supplies … shall be apportioned so that only so much as is referable to his business purposes is counted as his input tax.

25(1) A taxable person shall –

(a) in respect of supplies made by him…

account for and pay VAT by reference to such periods (in this Act referred to as "prescribed accounting periods") at such time and in such manner as may be determined by or under regulations and regulations may make different provision for different circumstances.

(2) Subject to the provisions of this section, he 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.

(3) If either no output tax is due at the end of the period, or the amount of the credit exceeds that of the output tax then … the amount of the credit or, as the case may be, the amount of the excess shall be paid to the taxable person by the Commissioners; and an amount which is due under this subsection is referred to in this Act as a "VAT credit".

26(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 …

(3) The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above …"

22. The Value Added Tax Regulations 1995 ("the Regulations") which were made under, among others, sections 25(1) and 26(1) and (3) of the 1994 Act provide, so far as material, that:

"100 Nothing in this Part shall be construed as allowing a taxable person to deduct the whole or any part of VAT on the … acquisition by him of goods or the supply to him of goods or services where those goods or services are not used or to be used by him in making supplies in the course or furtherance of a business carried on by him.

101(1) Subject to regulation 102, the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.

(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."

Regulation 101(3) then provides for certain exclusions in the calculation of the proportion referred to under paragraph 2(d) and regulation 101(4) provides for the ratio calculated for the purpose of paragraph 2(d) to be expressed as a whole number percentage.

(2) Kretztechnik

23. Kretztechnik's objects were the development and sale of electro-medical appliances. Sales of its products were subject to VAT with the result that it was entitled to deduct input tax on supplies of goods or services acquired by it for the purpose of making those sales. In order to increase its share capital, it obtained a listing on the Frankfurt stock exchange. To do so it had to purchase certain services. VAT was charged on the cost of those services. Kretztechnik wished to deduct that tax (input VAT). The following three questions arose for the decision of the Court of Justice. (1) In becoming listed on a stock market and in issuing shares in that connection to new shareholders in return for the issue price, does a company make a supply for consideration? (2) If it does, are all the services obtained in connection with the listing to be attributed to an exempt supply (with the result that there would be no right to deduct input tax)? (3) If it does not, is there a right to deduct input tax on the ground that the services in respect of which the right of deduction is claimed are used for the purposes of the undertaking's taxable transactions?

24. The context for those questions was as follows. First, for input VAT to be deductible at all, the relevant input transaction must have a direct and immediate link to taxable output transactions. Second, a taxable person's general overheads are in principle cost components of and thus have a direct and immediate link to the whole of that person's economic activity and may therefore be deducted to the extent that the output supplies are taxed. Third, if the share issue was an exempt supply, there could be no right to deduct the VAT paid on services directly and immediately attributable to that supply. Fourth, the costs to Kretztechnik of the disputed services were (as the referring court had found) attributable exclusively to its admission to the stock market for the purpose of the share issue. Fifth, Kretztechnik made only taxable output supplies.

25. The answer to the first question was that a company makes no supply for consideration when it obtains a stock market listing and issues shares in return for the issue price. It followed therefore that the second question did not arise.

26. As regards the third question, Advocate General Jacobs stated in his opinion to court, delivered on 24 February 2005, as follows:

"70. If the share issue cannot be regarded as a supply by Kretztechnik, capable of taxation or exemption within the VAT system, then it is necessary to view in that light the referring court's finding that the costs of the disputed services are attributable exclusively to the admission to the stock market for the purpose of that issue.

71. Determination of the right to deduct governed by Article 17 of the Sixth Directive is based on an attribution of input costs to output transactions.

72. Any link which those costs may have with other events, such as outputs, transactions purely internal to the taxable person's business, or events, other than supplies, entirely outside the scope of VAT, is simply irrelevant in that regard.

73. For example, if a trader uses the services of a broker or valuator when acquiring a commodity, the cost of those services may be said to be directly, immediately and exclusively linked to the acquisition. That does not however determine whether the VAT on the services is deductible. The right to deduct must be determined by the output transactions for the purposes of which the services are used. The transactions in question will usually be the onward supply of the commodity or of the goods or services for which it is used or in which it is incorporated. The right to deduct will depend on whether that supply is taxed or not.

74. Thus, if the transaction with which the input is most closely linked is one which falls entirely outside the scope of VAT because it is in any event not a supply of goods or services, it is irrelevant for the purpose of determining deductibility. What matters is the link, if any, with such output supplies, and whether they are taxed or exempt.

75. The question to be asked in Kretztechnik's case is therefore whether the capital raised by the share issue was used for the purposes of one or more taxed output transactions.

76. It seems likely that the use of the capital - and the services connected with the raising of that capital - cannot be linked to any specific output transactions, but must rather be attributed to the company's economic activity as a whole. There can be no reasonable doubt that a commercial company which raises capital does so for the purposes of its economic activity.

77. It appears to be common ground that Kretztechnik makes only taxed output supplies, so that it raised the capital in its capacity as a taxable person acting as such. In such cases, VAT on inputs attributable as overheads to its whole economic activity will be wholly deductible … If however it were also to make other supplies, only a proportion would be deductible, determined in accordance with Article 17(5) of the Sixth Directive."

27. The Court of Justice (First Chamber) followed the Advocate-General's opinion on all three questions. The paragraphs of the judgment relevant to the third question were as follows:

"36. In this case, in view of the fact that, first, a share issue is an operation not falling within the scope of the Sixth Directive and, second, that operation was carried out by Kretztechnik in order to increase its capital for the benefit of its economic activity in general, it must be considered that the costs of the supplies acquired by the company in connection with the operation concerned formed part of its overheads and are therefore, as such, component parts of the price of its products. Those supplies have a direct and immediate link with the whole economic activity of the taxable person …

37. It follows that, under Article 17(1) and (2) of the Sixth Directive, Kretztechnik is entitled to deduct all the VAT charged on the expenses incurred by that company for the various supplies which it acquired in the context of the share issue carried out by it, provided, however, that all the transactions carried out by that company in the context of its economic activity constitute taxed transactions. A taxable person who effects both transactions in respect of which VAT is deductible and transactions in respect of which it is not may, under the first subparagraph of Article 17(5) of the Sixth Directive, deduct only that portion of the VAT which is attributable to the former transactions …"

(3) The Society's submissions

28. Mr Milne submitted that, in the light of Kretztechnik, the last sentence of paragraph 62 of the Tribunal's decision was incorrect as a matter of law. It does not follow, he said, that because the soliciting of donations to which, in the Tribunal's view, the fundraising services related (ie to which they were linked) was not a supply at all (let alone a taxable supply) input tax on the cost of those services was not recoverable. As Kretztechnik makes clear, he said, once it is established that the transaction with which the fundraising services are most directly and immediately linked is not a supply at all, that link is irrelevant for the purpose of determining deductibility. What matters, he said, is the link, if any, which the output supplies made by the Society have with the fundraising services and, if there is such a link, whether that supply is taxable or exempt. In other words, were the funds that were raised, ie the donations, used to any extent for the purposes of any taxable output transactions by the Society? If and to the extent that they were, the input tax on those services is deductible.

29. I agree. I would only add, since there seemed (at any rate at one stage in the course of argument) to be some difference about this, that in determining the extent to which the input tax is deductible, it is first necessary, as Mr Parker submitted, to assess the extent to which the donations (and therefore the input tax on the fundraising services supplied in soliciting those donations) were used for the purposes of the Society's business at all. That, as he pointed out, is an application of section 24(5) (enacting in UK law Article 4 of the Sixth Directive where the reference is to "economic activity") and, having identified what that purpose is, then to establish how much of what is left was used in the making of taxable supplies and how much in making exempt supplies. That involves or may involve an apportionment in accordance with regulation 101(2)(d) with a view to securing a fair and reasonable attribution of the input tax, so far as apportioned to the Society's business as distinct from its non-business activities, as between the Society's taxable and exempt supplies. This overall approach is, I consider, implicit in regulation 100 which makes clear that nothing in that part of the Regulations is to be construed as allowing a taxable person to deduct any part of the VAT on the supply to him of goods or services which are not used by him "in making supplies in the course or furtherance of a business carried out by him" and also in regulation 101(2), in particular the wording of paragraph (2)(c) which requires that, in attributing input tax to taxable supplies, no part of the input tax on the goods or services in question shall be so attributed which have been used, or are to be used, "exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies" (emphasis added).

(4) The Commissioner's submissions

30. The difficulty which Mr Milne faced in advancing this challenge to the Tribunal's decision is that, as I have mentioned, the Society's case as now advanced is different from the case as advanced by it before the Tribunal. Before the Tribunal the only basis advanced by the Society for recovering the input tax paid on the cost of the fundraising services was that, insofar as they related to donations of £5 or more, they were costs which related to an actual supply - that of the newsletter, ie as consideration for the taxable supply of the newsletter - and therefore that the input tax on such services, insofar as they so related, was recoverable. (The Society had treated amounts received from committed givers who gave less than £5 per month and donations to the extent that they exceeded £5 per month as being made by way of donation only and therefore as wholly outside the scope of value added tax and accepted that, to that extent, an apportionment under section 24(5) of VATA 1994 fell to be made.) It was never the Society's position that the fundraising activities were attributable to any extent to the Society's general business activities, so as to open the way to an argument of the kind that, in Kretztechnik, found favour with the Court of Justice.

31. Mr Parker submitted that this revised approach was not open to the Society since the Tribunal had found that the fundraising services were not attributable to any of the Society's economic activities and thus that they were wholly attributable to activities outside the scope of value added tax. But even if the Tribunal did not go quite so far in its findings, the fact is, he said, that the Society wholly failed to provide the evidence for contending that there was a direct and immediate link between the fundraising services and the Society's economic activities.

(5) Conclusions

32. Although I do not read the Tribunal's decision - paragraph 62 being the only relevant passage - as going quite as far as a finding that no part of the fundraising services was attributable to the Society's business activities, the fact is that, as Mr Parker submitted, the Tribunal did not come to any conclusion as to the extent to which those services (and therefore the input tax paid on the cost of acquiring them) were attributable to the Society's business activities generally. It did not do so because that issue was simply not raised. On the other hand it was common ground, or if it was not common ground the Tribunal found (see paragraph 19 of the decision recited at paragraph 6 above), that for the purposes of value added tax the Society carried on business activities and made (standard-rated) taxable supplies. What the Tribunal did not decide, because it was not asked to do so, was (a) whether, as the Society now contends, the donations received through the activities of the fundraising services, are unrestricted and could be used for any purpose of the Society and (b) assuming that they were, the extent to which the monies so raised were in fact used, by funding the Society's general overheads, towards the Society's taxable supplies.

33. This point is bound to arise, if only in connection with future VAT returns by the Society. The correct and sensible course, in my judgment, is, failing agreement between the Commissioners and the Society, to remit the matter to the Tribunal to determine the extent to which the monies raised as a result of the use of the fundraising services, were applied by the Society, as part of its general overheads or otherwise, in the making of taxable supplies. For this purpose it will be necessary to determine what proportion of the Society's activities are not for the purpose of its business at all (and as such outside the scope of value added tax) and what proportion of what remains is properly attributable to taxable supplies.

34. It follows that, on the Society's revised approach, its appeal succeeds.

The Commissioners' appeal

35. The Commissioners (since 18 April 2005 the Commissioners for Her Majesty's Revenue and Customs) cross-appeal.

36. Their appeal arises out of the alternative argument of the Society advanced before the Tribunal that if (as the Tribunal held) the provision of the newsletter to the committed givers was done otherwise than for a consideration, then it came within paragraph 5(1) of Schedule 4. That paragraph treats as a supply goods which form part of the assets of a person carrying on business but which that person transfers or disposes of (whether or not for a consideration) so as no longer to form part of those assets.

37. It was common ground between the parties - at any rate by the time the matter came to be argued before the Tribunal - that, on the basis that the provision of the newsletter was done otherwise than for a consideration, paragraph 5(1) applied. It was also common ground that, if there was a deemed supply of the newsletter, that supply would be a taxable, albeit zero-rated, supply with the result that no output tax had to be accounted for on the supply.

38. The argument before the Tribunal was over the extent to which, on that deemed supply, the Society would be entitled under sections 25 and 26 to input tax credit in respect of the supplies to it of the goods and services which went into the production and distribution of the newsletter. The Society contended that it was entitled to credit in full of all of the input tax on those goods and services. The Commissioners contended that the Society was only entitled to credit on such supplies as residual input tax, meaning that there should be an apportionment of the supplies to taxable uses so as to give rise to a partial right to deduct the input tax in question. Effectively this meant apportionment on the basis on which, prior to the establishment of the committed givers club, the Society had treated the VAT it had paid on the supplies to it connected with its newsletter.

39. The appeal raises the correct interpretation of paragraph 5 of Schedule 4 and whether I should follow the decision in Customs and Excise Commissioners v West Herts College [2001] STC 1245 ("West Herts College"). The Tribunal held that it was bound by West Herts College and, accordingly, that the Society could recover all of the input tax on the supplies to it of goods and services used exclusively in the production and distribution of the newsletter.

(1) The relevant provisions

40. So far as material, paragraph 5 of Schedule 4 provides as follows:

"(1) As subject to sub-paragraph (2) below, where goods forming part of the assets of a business are transferred or disposed of by or under the directions of the person carrying on the business so as no longer to form part of those assets, whether or not for a consideration, that is a supply by him of goods.

…

(5) Neither sub-paragraph (1) nor sub-paragraph (4) above shall require anything which a person carrying on a business does otherwise than for a consideration in relation to any goods to be treated as a supply except in a case where that person … has or will come entitled –

(a) under sections 25 and 26, to credits for the whole or any part of the VAT on the supply … of those goods or of anything comprised in them …"

41. I should also mention Section 19(1). That section, which gives effect to Article 11A.1 of the Sixth Directive, states that for the purposes of the 1994 Act the value of any supply of goods or services is to be determined, except as otherwise provided for by the Act, in accordance, inter alia, with Schedule 6. So far as relevant Schedule 6 provides, by paragraph 6, that:

"(1) Where there is a supply of goods by virtue of –

…

(b) paragraph 5(1) … of Schedule 4 (but otherwise than for a consideration); …

then … the value of the supply shall be determined as follows.

(2) The value of the supply shall be taken to be –

(a) such consideration in money as would be payable by the person making the supply if he were, at the time of the supply, to purchase goods identical in every respect (including age and condition) to the goods concerned; or

(b) where the value cannot be ascertained in accordance with paragraph (a) above, such consideration in money as would be payable by that person if he were, at that time, to purchase goods similar to, and of the same age and condition as, the goods concerned; or

(c) where the value can be ascertained in accordance with neither paragraph (a) nor paragraph (b) above, the cost of producing the goods concerned if they were produced at that time."

42. It is also material to set out Article 5(6) of the Sixth Directive (which is enacted domestically as paragraph 5 of Schedule 4):

"The application by a taxable person of goods forming part of his business assets for his private use or that of his staff, or the disposal thereof free of charge or generally their application for purposes other than those of his business, where the value added tax on the goods in question or the component part thereof was wholly or partly deductible, shall be treated as supplies made for consideration. However, applications for the giving of samples or the making of gifts of small value for the purposes of the taxable person's business shall not be so treated."

(2) The Commissioners' submissions

43. Mr Parker submitted that Article 5(6) - and therefore paragraph 5 of Schedule 4 - is an anti-avoidance provision. It is designed, he said, to ensure that a trader who has deducted input tax on the supply to him of goods used, or to be used, wholly or partly for making what would be taxable supplies but who makes a free disposal of the goods is put in the same position as an ordinary consumer would be. It achieves this by treating the disposal as if it were a supply and, as such, as attracting a corresponding charge to output tax. Mr Parker gave the simple example of a trader who purchases a computer for £1000, the VAT on which is £175. The computer is used exclusively to make taxable supplies. The input tax of £175 is recoverable in full because the computer is so used. But if the trader then gives the computer away for free (or he decides to use it exclusively for his own private, non-business purposes) he must account for £175 on the deemed supply (assuming, to keep the numbers simple, that the deemed supply is for a consideration of £1000).

44. That this is the rationale for the "deeming" provision is apparent, he submitted, from Kuwait Petroleum (GB) Ltd v Customs and Excise Commissioners (Case C-48/97) [1999] STC 488, ("Kuwait"). That case concerned the correct treatment of free vouchers offered to customers buying fuel at service stations. In the course of his opinion to the court, Advocate General Fennelly discussed the origins of Article 5(6) - it had replaced Article 5(3)(a) of the Second Directive - and stated (at paragraph 26):

"It is, thus, clear that the authors of the Second Directive were concerned that goods obtained by taxable persons in circumstances giving rise to a right to claim a deduction should not be capable of being supplied free of charge without the imposition of a corresponding charge to VAT. This objective was maintained in the Commission's proposal for the Sixth Directive."

This was carried into the wording of Article 5(6). At paragraph 21 of its judgment in that case, the Court of Justice said this:

"21. … It should be noted that the purpose of art 5(6) of the Sixth Directive is to ensure equal treatment as between a taxable person who applies business assets for private purposes and an ordinary consumer who purchases goods of the same type …

22. … it is clear from the very wording of the first sentence of art 5(6) of the Sixth Directive that this provision treats as a supply made for consideration, and therefore subject to VAT, a taxable person's disposal free of charge of goods forming part of his business assets, where input VAT was deductible on those goods…"

45. Against that background, Mr Parker submitted that, in order to negate the advantage which the trader has enjoyed and to ensure equal treatment with the ordinary consumer, the disposal falls to be treated as a taxable supply only to the extent that the input tax was deducted on the initial attribution, ie, on the supply to the trader of the goods in question. If therefore in the case of a supply of the goods to the trader the cost of the supply was apportioned because the goods in question were to be used by the trader for a combination of two or more of (1) non-business purposes, (2) exempt supplies and (3) taxable supplies so that only the tax paid on that part of the supply as was attributable to the taxable supplies was recoverable as an input tax credit, there can be no basis, when the goods are given away free, for treating the disposal as a taxable supply other than to the extent that the input tax was deducted on the initial attribution. The fundamental principle in VAT law, he submitted, is that the taxpayer should recover input tax only to the extent to which taxable supplies are made. The true position, therefore, is that the deemed disposal is treated as a taxable supply only to the extent necessary to correct the input tax deduction. Consistently with this, he submitted, is that if the trader has only claimed by way of input tax on the initial attribution, say, 10% of the cost to him of the supply (the remaining 90% not being recoverable because the goods in question were to that extent to be used for nonbusiness purposes or in making exempt supplies), it would be to put the taxpayer in a worse position than the private consumer if on the deemed supply when he disposes of the goods free of charge, he were to be treated as making a taxable supply to the extent of 100% of the cost of the goods rather than just 10%.

46. But the principle, he said, cuts both ways. So that if the deemed supply is zero-rated, it is not open to the taxpayer to be treated as if he were making a taxable (albeit zerorated) supply to the extent of 100% of the cost of the deemed supply if on the initial attribution (when the goods in question were supplied to the trader) input tax on only, say, 10% of the cost of the goods was deducted. To allow such a result would be absurd because the costs of the supply to the trader have not in fact been used as to 100% in respect of taxable output transactions. Indeed, said Mr Parker, it would be all the more absurd because the taxpayer would be relying on an anti-avoidance provision (paragraph 5(1) of Schedule 4), designed to ensure that the trader gains no advantage over an ordinary consumer, to secure for himself the tax advantage of deducting input tax as if, contrary to the fact, the costs giving rise to the input tax had been used exclusively to make taxable supplies.

47. Coming to the wording of paragraph 5(1) of Schedule 4, Mr Parker submitted that that provision does not state the extent to which the disposal is to be treated as a supply of goods. In order to give effect to the rationale of Article 5(6), it is necessary therefore to treat the disposal as a supply of goods only to the extent necessary to negate the advantage which the trader would otherwise have over the ordinary consumer. That this is the correct approach is reinforced, he submitted, by paragraph 5(5) of Schedule 4 which recognises that a deemed supply under paragraph 5(1) only arises (a) where the disposal by the person carrying on the business does something in relation to the goods "otherwise than for a consideration" and (b) where that person "has or will become entitled under sections 25 and 26 to credits for the whole or any part of the VAT on the supply…". Relevantly to the instant case, he said, paragraph 5(1) is only triggered if there is a right of deduction of some part of the input tax in relation to a relevant supply to the trader in question.

48. Summarising, Mr Parker submitted that Article 5(6) is a deeming provision to deal with a mischief. It assumes, contrary to the fact, that a supply has been made. To that extent it is a fiction. Like any fiction it should only be applied to the extent necessary to address the mischief. The mischief is to prevent the trader seeking to put himself in a better position than the ordinary consumer. That is addressed by looking simply at the input tax position. The examples provided show that the mischief is eliminated by calculating the output tax on the basis that there is a supply only to the extent that the input tax has been allowed. Paragraph 5(1) of Schedule 4 (and, if necessary, paragraph 6 of Schedule 6) should be construed so as to give effect to that aim.

(3) The Society's submissions

49. Mr Milne submitted that there was no scope for deeming a supply only to the extent necessary to deal with some imagined advantage which the taxpayer has had. By paragraph 6 of Schedule 6 the taxpayer is deemed to supply the goods at the cost to him of the goods or at the cost which he would have incurred if he had produced the goods at the time of their deemed supply. There is no conceivable basis for suggesting that there is only a partial application of that provision.

50. The position, he said, was straightforward. Input transactions are attributed to the output transaction to which they have a direct and immediate link. It is irrelevant what the wider purpose of the output transaction may be. That was well illustrated in BLP Group plc v Customs and Excise Commissioners, Case C-4/94, [1995] STC 424 where the input tax incurred on the legal expenses connected with a sale of shares in the taxpayer's subsidiary (an exempt supply) was attributed to that exempt supply (and was thus irrecoverable) irrespective of the fact that the sale of the shares was undertaken to raise funds to enable the taxpayer to discharge debts which had arisen from its taxable transactions.

51. Mr Milne submitted that if the newsletter had been sold in the ordinary way (a taxable, albeit zero-rated supply), there could be no question but that the input tax incurred on the costs of its production and distribution would have been wholly deductible (just as it is for any other newspaper which is sold) regardless of newspaper content and regardless therefore of whether, for example, the newspaper contained articles designed to encourage readers to make charitable donations. Being a zero-rated transaction all of the input tax on the supplies relating to the production and distribution of the newspaper will be recoverable. Because, however, the newspaper is given away it is deemed to be a supply. If, contrary to the actual position in law, newspapers had been standard-rated, the result would be that the output tax on the deemed supply (effectively, applying paragraph 6 of Schedule 6, on the cost of producing and distributing the paper) would cancel the input tax: the one would be the same or more or less the same as the other. Absent Article 5(6) (and absent, therefore, paragraph 5(1) of Schedule 4) input tax on the costs of producing and delivering the newsletter given away would fall to be recovered as residual input tax in accordance with the Society's partial exemption method since, ex hypothesi, there would be no taxable supply. The effect therefore of paragraph 5(1) is to give rise in such a case to a need to account for VAT on the deemed supply of the newsletter so that (assuming that newspapers had been standard-rated) instead of enjoying the advantage of a partial recovery of input tax under the partial exemption method, the Society would have been entitled to set against the input tax (on the cost of producing and distributing the newsletter) all of the output tax on the deemed supply. The one would cancel out the other. There would cease to be any recovery. The advantage otherwise enjoyed is removed by the deemed supply.

52. The only difference here, and it is what has prompted the cross appeal said Mr Milne, is that newspapers are zero-rated with the result that the deemed supply when the newsletter is given away free is likewise zero-rated. There is therefore no charge to output tax. On the other side of the equation is the cost of producing and distributing the newsletter, ie, costs which are directly attributable to the deemed taxable supply. The input tax on this cost is fully recoverable just as it would have been if the newsletter had been sold. That is the inescapable consequence of deeming the gift of the newsletter to be a supply. There is nothing odd about this: in the case of any zero-rated supply the person who produces the supply recovers the input tax but does` not have to account for any output tax.

(4) West Herts College

53. Mr Milne went on to submit that not only was this how paragraph 5 of Schedule 4 was intended to operate, it is how in West Herts College it was found to operate.

54. In that case, West Herts College produced, printed and distributed numerous free prospectuses detailing its courses and facilities. The prospectuses were issued free of charge to students and others. The college's expenditure on the production of the prospectuses had been treated by the Commissioners as expenditure in making both taxable and exempt supplies on the basis that a proportion of input tax on the goods and services used by the college in making both taxable and exempt supplies was attributable by operation of regulation 101 of the Regulations to the college's taxable supply. The college then sought in reliance on paragraph 5(1) of Schedule 4 to reclaim all of the input tax on the cost of producing the prospectuses. It succeeded in so doing before the VAT and Duties Tribunal. The Commissioners' appeal against that decision was dismissed by Hart J.

55. The college contended (1) that the prospectuses were "goods forming part of the assets of [the college's] business", (2) that those goods had been "transferred or disposed of" by the college so as no longer to form part of those assets and (3) that paragraph 5(1) was not disapplied by paragraph 5(5) in that the college was entitled, disregarding paragraph 5, to credit for part of the input tax on the supplies to it in connection with the production of the prospectuses because of the operation of regulation 101 and the treatment in the past of the college's expenditure on producing the prospectuses as expenditure in making both taxable and exempt supplies. As Hart J observed (at 1248):

"Given therefore [that] what one was now looking at was a supply under paragraph 5(1), the only question is whether that is a taxable supply. If it is a taxable supply, the consequence follows that the whole of the input tax of the relevant goods and services has to be attributed under reg 101(2)(b) of the 1995 regulations to the making of that taxable supply. It plainly is a taxable supply, albeit zero-rated, since it is not an exempt supply. None of the exemptions in Sch 9 cover the issue of the prospectuses in question."

56. The Commissioners raised two points. They challenged the proposition that paragraph 5(5) had no application. They did so on the basis that for a credit to exist, to which paragraph 5(5) refers (and without which paragraph 5(1) will not apply), the credit must be for the purposes of the person's taxable and not exempt supplies whereas the college's prospectuses had been produced exclusively for the purpose of making the college's exempt supplies of education. Hart J held, however, that, having regard to the fact that the Commissioners had historically accepted that the expenditure in question was for both taxable and exempt supplies, it was not open to them to contend otherwise. He therefore proceeded on the footing that the college was entitled to deduct part of the input tax on the supplies made to it with the result that paragraph 5(5) did not apply so as to prevent paragraph 5(1) from operating. The Commissioners' other point was to contend that the prospectuses were not goods forming part of the assets of the college's business. In short the Commissioners disputed the very existence of a separate supply. Hart J rejected that submission. Towards the end of his judgment he said this (at 1251):

"I have therefore come to the conclusion that neither of the arguments presented attractively by [counsel for the Commissioners] succeeds. I do, however, agree with him that the result is an odd one. Paragraph 5 is, in broad terms, an antiavoidance provision, deeming something to be a supply (and therefore taxable if not exempt) which would not otherwise be a supply. It is odd that in the circumstance where a taxable person is partially exempt, it should have the effect of entitling that person to claim full input tax credit in respect of that supply without generating a corresponding and neutralising liability for output tax. The oddity however is mainly the result of the fact that the rate of output tax on the notional supply is zero, coupled with the fact that the commissioners had not established that the goods or services in respect of which the input tax is claimed as deductible, are used exclusively by the college for making its exempt supplies."

57. Mr Parker submitted that, in that last passage, the judge rightly recognised that the result was odd but, in the light of the two arguments presented to him, was not able to see the principles upon which Article 5(6) and therefore paragraph 5(1) of Schedule 4 operate so as to avoid that odd conclusion. In particular, the judge did not have the benefit of the arguments which the Commissioners have addressed to me. By contrast, Mr Milne pointed out that Hart J was fully aware of the observations of the Court of Justice in Kuwait outlining the rationale for Article 5(6) and mentioned the very passage in the court's judgment in that case to which Mr Parker referred me. The fact that Hart J felt that the outcome was or appeared to be odd was, as the judge recognised, the result or largely the result of the fact that the deemed supply of the prospectuses was zero-rated. Likewise here in the case of the newsletter. Mr Milne submitted that there is no reason why I should not follow the decision in West Herts College, indeed that I ought to follow it unless confident that it was wrong.

(5) Conclusions

58. The provisions of paragraph 5 of Schedule 4 and paragraph 6 of Schedule 6 are clear. I am not persuaded, forcefully although the contrary was argued by Mr Parker, that it is correct to give them the qualified application that he advanced. Nor am I persuaded that there is anything in Article 5(6) (or, for that matter, Article 11A.1(b)) from which the domestic provisions derive which make it appropriate that I should. In particular, I am not persuaded that paragraph 6 of Schedule 6 is directed to the case where the original input has been wholly deductible and is not directed to how the matter is to be approached where the input tax deduction has been restricted either because the trader has made exempt supplies or because he has carried out activities which are altogether outside the scope of value added tax.

59. I see nothing odd in treating as a supply, to its fullest extent, a disposal of goods, made otherwise than for a consideration, even where the original input tax has been restricted. It will only have been restricted because it has not been possible to attribute the input costs to an output transaction. But once an output transaction is identified, as paragraph 5(1) of Schedule 4 requires in the circumstances set out in that provision, it is merely a question of identifying the input costs relating to the deemed supply and all else follows.

60. I am not therefore persuaded that the decision in West Herts College would have been different if Hart J had had the benefit of Mr Parker's submissions to this court. On the contrary, I am of the respectful view that he reached the correct decision for the correct reasons.

61. It follows therefore that on this point the Tribunal reached the right conclusion and that the Commissioners' appeal should be dismissed.