England and Wales High Court (Chancery Division) Decisions

IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL (Judgment handed down at Teesside Crown Court)
		15/12/2009

The Honourable Mr. Justice McCombe:

1. This is an appeal by Vision Express (UK) Limited ("VEUK") from a decision dated 14 November 2008 of the VAT and Duties Tribunal, sitting at Manchester, whereby the Tribunal dismissed appeals by VEUK: first, against a Notice of 22 March 2005 served on VEUK by the Commissioners of Revenue and Customs ("the Commissioners") under regulation 102A of the Value Added Tax Regulations 1995 ("the Regulations"); and secondly, against an assessment dated 1 February 2007 designed to recover input tax totalling £4,119,103 for which VEUK claimed credit, which the Commissioners say exceeded the amount properly recoverable.
2. VEUK operates a well-known chain of retail opticians' shops. For purposes of VAT, like many others in this business, it makes two types of "supply". It supplies to customers goods (in the form of spectacles and contact lenses) and services (in the form of eye-testing, optical advice and the like). Its supplies of goods are "standard rated" for VAT purposes; its supplies, in so far as properly described as "medical care" services, are exempt from VAT. VEUK is, therefore, (what is known in the jargon as) a "partially exempt trader" for VAT purposes. The issue raised by the appeal is as to the proportion of VAT paid by VEUK (known confusingly, but notoriously, as "input tax") in the course of its business that is deductible by it from the sums for which it must account to the Commissioners for tax paid by customers (known, equally confusingly, as "output tax").
3. The typical VEUK customer pays a single total price for the services and goods he or she receives, the end product being usually dispensed spectacles or contact lenses. The customer is, of course, only interested in the total price, not in the niceties of taxable and exempt supplies that he or she receives from VEUK. However, on part of that price the customer is paying VAT, on the other part he/she is not. VEUK pays VAT on goods and services that it purchases from suppliers in the course of its "partially exempt" trade. Some supplies to it are used exclusively for its exempt business, others exclusively for its taxable business and others for both. Its suppliers are, of course, indifferent as to the proportion in which VAT paid to them is deductible from VAT paid to VEUK which would otherwise be payable by VEUK to the Commissioners. However, VEUK is by law only entitled to deduct a part of the amount of VAT that it has paid to suppliers for those goods and services which are acquired in part for its exempt business and in part for its taxable business. The question on these appeals is to find, in principle, how that deductible "part" is to be ascertained. In 2001 VEUK agreed with the Commissioners a method of calculating the apportionment – a "partial exemption special method" or PESM.
4. The basic statutory scheme for solving the apportionment dilemma is helpfully summarised by the Tribunal in paragraph 2 of its Decision under appeal as follows:

"The general rule, prescribed by regulation 101(2), is that the input tax incurred by a trader in obtaining goods and services is to be attributed, as far as possible, to his taxable and exempt supplies by reference to the use made by him of the goods and services in making those supplies. So much of that input tax as is wholly attributable to the making of taxable supplies is recoverable, while so much as is wholly attributable to the making of exempt supplies is not. What remains, that is the input tax which cannot be fully attributed to taxable or exempt supplies, referred to as "residual input tax", is attributed to the trader's taxable and exempt supplies in the same proportions as the values of his taxable and exempt supplies bear to the total value of his supplies. In other words, where it is not possible to attribute by reference to use, values are used as a proxy, reflecting the requirements of article 19(1) of the Sixth VAT Directive (77/388/EEC), the European legislation in force at the relevant time-the corresponding provision in the current legislation is to be found at article 174(1) of the Common System Directive (2006/112/EEC). The general rule represents the "standard method"."

5. It will be seen that this scheme endeavours, so far as possible, to attribute directly the input tax appropriately between taxable and exempt supplies by reference to the use made of the acquired goods and services in making those different supplies. That which cannot be attributed in this way is called "residual input tax" and is attributed to the taxable and exempt parts of the business in a more or less rough and ready, "proxy" fashion. While precision is impossible in this exercise, the apportionment so achieved must be "fair and reasonable". As a matter of legislation, at the relevant times in this case, this was all achieved by a combination of Article 2 of the First Council Directive (67/227/EC), Articles 13.1 (c), 17.1, 17.2, 17.5 (especially subparagraph (c)), 18.1, 19.1 and 19.3 of the Sixth Directive (77/388/EEC), the Value Added Tax Act 1994 sections 24(1), 25(1) and (2), 26 (1) and (3) and regulations 101(1) and (2) of the Regulations. It is not necessary to set out those provisions in full.
6. The Commissioner's notice in this case (an "override notice") was served under r.102A of the Regulations. This provides as follows:

"…where a taxable person-

(a) is for the time being using a method approved or directed under regulation 102, [i.e. the PESM in this case] and

(b) that method does not fairly and reasonably represent the extent to which goods or services are used by him in making taxable supplies,

the Commissioners may serve on him a notice to that effect, setting out their reasons in support of that notification and stating the effect of the notice."

As a result, the short question for the Tribunal, on the appeal against the Commissioners' notice, was whether the PESM achieved a fair and reasonable attribution of inputs to taxable supplies. If it did not do so, then the Commissioners' override notice was valid and the appeal would fail; if it did so, the notice was invalid and the appeal would succeed.

7. The effect of the override notice was not to require another specified method of calculating a proper deduction, but (by reference to regulation 102B) to require VEUK to calculate its recoverable input tax in a manner which "represents the extent to which the goods or services are used by [it] or are to be used by [it] in making taxable supplies…". In other words, the regulations specify the end to be achieved but not the method by which it is to be achieved.
8. The way in which the PESM operated in this case is again helpfully summarised in paragraphs 22 to 26 of the Tribunal's decision as follows:

"22. The first step requires the identification of as much input tax as can be directly attributed to taxable and exempt supplies, and the segregation of the remainder, the residual input tax, into five categories of expenditure: rents and service charges, other expenses relating to retail stores; support office expenses and corporate overheads, expenses which cannot be directly related to any of those categories; and management charges. Why the fourth and fifth of those categories appear in that order was not explained.

23. The second step requires the identification of those areas of the stores, by reference to what was agreed between Miss Jutsum and Mr Beresford to be a representative example of six, which are used respectively for taxable, exempt and mixed purposes, and allocating a weighted value to each such area, the weighting being determined by the zoned rental value. We shall deal with the zoning of rental values in more detail shortly. The recoverable proportion of the residual input tax incurred on rents and service charges (the second of the categories identified at step one) is calculated by multiplying it by the zoned weighted area used for taxable purposes and then dividing it by the aggregate of the zoned weighted areas used for taxable and exempt purposes.

24. Step three is applied to the residual input tax incurred on other store expenditure, and is identical to step two save that zoning is left out of account.

25. Step four deals with the remaining three categories of expenditure identified at step one, and uses two calculations, one based on a staff head-count and the other on turnover. It is in this step that the apportionment of VEUK's charges to its customers to which we have referred is taken into account but, as this part of the PESM is not the subject of a specific challenge, we shall not describe the calculations further.

26. Step five draws the results of the preceding steps together in order to determine VEUK's overall percentage of recoverable residual input tax. Save that it uses data whose validity, or appropriateness, is challenged, that step, too, is not controversial."

The PESM concluded by providing that each year's recoverable residual input tax was to be calculated by reference to the preceding calendar year's figures.

9. In the annex to the override notice the Commissioners set out their reasons for wishing to override the PESM. First, the use of floor areas as a factor in the calculations was attacked. It was said that the areas of the stores identified as used for the making of taxable supplies were in fact used for making both taxable and exempt supplies. Further, it was said that even if VEUK's assessment of the use of floor areas was correct, as much as 46% was used for mixed supplies and there was no evidence that the application of step 3 of the PESM reflected the actual proportions. It was also contended that there was little relationship between some of the supplies whose costs were dealt with in step 3 and the floor areas. Secondly, the Commissioners challenged the use of the concept of "zoning" in attributing rental costs to the various store areas. Thirdly, and finally, the Commissioners objected to the use of the preceding year figures for the apportionment and required that the recovery be determined by contemporaneous figures.
10. The business of a retail optician was described by McCullough J in CEC v Leightons Ltd [1995] STC 458, 461 as follows:

"It is agreed that the stages in the sale of a pair of corrective spectacles can be summarised as follows. (i) The patient is first seen by a dispensing optician who examines the patient's existing spectacles (if any), prepares a record card and decides on the appropriate next step. (ii) Usually the patient has his eyes tested by an ophthalmologist (who is a registered medical practitioner) or an ophthalmic optician who writes out a prescription. (iii) The patient takes the prescription to the dispensing optician who then or later may discuss matters with the prescriber. (iv) The dispensing optician takes detailed measurements of the patient's eyes and other features and prepares detailed notes. (v) The dispensing optician advises the patient on the options available in respect of lenses and frames. (vi) The dispensing optician draws up a specification for the lenses and frames from the measurements which he has taken. (vii) The specification is sent to a laboratory which produces the lenses and frames to specification. (viii) When the spectacles are returned the dispensing optician will check whether they conform to the specifications sent. (ix) And finally the dispensing optician will fit the spectacles with patient and make any minor modifications required."

11. The treatment of opticians' supplies for VAT purposes has had a chequered history in this country. Eye-tests have always been regarded as constituting an exempt supply. There was, however, at one time a doubt as to the proper treatment of the supply of dispensed spectacles. Until 1988 the whole supply was treated as exempt. However, that position changed with the decision of the European Court in EC Commission v UK [1988] STC 251 where it was held that, while the provision of the "medical care" element of the supply was exempt, the supply of spectacles and contact lenses themselves was taxable. In the wake of that decision the Commissioners decided that the services of ophthalmic opticians undertaking eye-tests constituted exempt supplies. However, strangely, their view then was that dispensing opticians made a single taxable supply of spectacles and lenses to which the dispensing service was merely ancillary. Not surprisingly, it was then decided in Leightons' case (supra) that that was incorrect and that dispensing opticians, providing prescription spectacles, made separate supplies of goods and services, the former being taxable and the latter exempt. As the Tribunal noted in this case,

"…the decision [in Leightons] merely reflected the observation by the Court of Justice in EC Commission v UK , at paragraph 33 of its judgment, that , "the supply of medicines and other goods, such as corrective spectacles supplied by a doctor or by other authorised persons, is physically and economically dissociable from the provision of the service…" ".

12. The principal deductions in issue in the present case are the rents and service charges and the other expenses relating to VEUK's retail stores. As indicated above, steps 2 and 3 of the PESM allocated different uses to various parts of the retail stores. The Tribunal heard oral evidence on the store layouts, studied plans and other documentary materials bearing on that subject and visited one of these stores which was at the Trafford Centre in Manchester. On that visit they saw the layout there and were provided with information, as required by the Tribunal members, by VEUK's store staff. It made the following findings as to the physical layout of the stores:

"35. Internally, each store has five basic sections, in some occupying a single unbroken expanse of floor space, in others occupying two or more areas separated by other sections. The first and, as the plans indicated, the largest single area, accessed immediately from the entrance and (since we understand the doors are usually left open during trading hours) readily visible from the exterior, is the area in which spectacle frames and other goods are displayed and around which customers may walk freely. The second contains the desks and chairs from which the dispensing process-measuring customers' facial features, discussing the suitability of frames for a customer's prescribed lenses and the fitting of the finished spectacles- is undertaken. Third are the rooms in which eye tests are carried out; these include not only the ophthalmic opticians' rooms but also those in which equipment for checking the condition of the customers' eyes is located. In most stores contact lenses are dispensed from a specially designated room in this area. Customers are instructed in the room, away from public view, in the insertion and removal of their lenses. Chairs are also provided near the examination rooms, but in an open part of the store, for customers who are waiting for an eye test. The fourth area, usually a prominent feature of the store, is the laboratory in which the lenses are manufactured and inserted into the customers' chosen frames: for most prescriptions VEUK offers a one-hour manufacturing service, and in many stores, including that at the Trafford Centre, customers may look into (though they may not enter) the laboratory and watch the process. The fifth section contains those areas which are not accessible by the public, consisting of staff and storage rooms.

36. The display areas are laid out with generous space, to allow customers to circulate freely, though they may be intercepted by sales staff as they do so. At the Trafford Centre, which we take to be typical, the area is well lit and laid out attractively. The dispensing desks, quite small and typically with a chair for the dispensing optician on one side and two chairs for a customer and a companion on the other, are in most cases set within the display areas. The eye test rooms are usually at the rear of the store, as are the staff and storage rooms, though some of those rooms may be on an upper floor or in a basement. The position of the manufacturing section varies; in the Trafford Centre store it is set in the centre of the display area, is rectangular in shape and has a row of dispensing desks along one of its longer sides, and various display cabinets along the other. In that store the display area completely encircles the laboratory and the dispensing desks, but the plans show that in other stores, the laboratory or the dispensing desks are at one side of the store. Each store has a reception desk near the entrance, and some have another near the rear where customers seeking eye tests are greeted."

13. VEUK's position throughout, both in the operation of the PESM and in argument on the appeals, has been that the "display area" of each store is used exclusively for taxable purposes, save for a small notional part of that area (at the entrance), known in the case as the "doormat adjustment", designed to reflect the fact that customers walk through the display area to get a sight test or to have spectacles fitted or dispensed at a dispensing desk. This adjustment area is treated as being used for "mixed" supplies, i.e. used for both exempt and taxable purposes. The laboratory areas are treated as being used wholly for taxable supplies. The examination rooms are treated as areas involving exclusively exempt supplies. The contact lens instruction rooms are treated as being of "mixed" use, since the "exempt" element of advice and instruction is provided there and the taxable sales of lenses also occur in this area. The dispensing desk areas are treated as mixed, as are the waiting areas, near the eye-test rooms and the contact lens instruction rooms. The storage and staff areas are treated as involving mixed use, although the Tribunal found that the storage rooms were principally used to store taxable goods.
14. The Tribunal found that some of VEUK's store staff (particularly ophthalmic opticians) made predominantly or exclusively exempt supplies, while others (mainly lab staff) made predominantly or exclusively taxable supplies. The remaining staff made mixed supplies, by dispensing prescriptions and selling frames and lenses. No staff members undertook dispensing only.
15. The essential stance of VEUK before the Tribunal was that the allocation of the various areas of the stores to exempt, taxable and mixed use correctly reflects the way in which the stores are used in practice, and was a suitable "proxy" for the attribution of the use of residual input tax. On the other hand, the Commissioners' position was that the allocation of the display area to taxable purposes was inappropriate because, although the frames displayed within that area form the subject of a taxable supply, the area is not used exclusively for selling frames, but also for the dispensing process as a whole. The Commissioners further contended that a very high proportion of the store was said by VEUK to be devoted to mixed use and that a floor area allocation can only satisfactorily be used to meet the statutory test when a high proportion of aggregate floor area can be directly attributed to exempt or table supplies. In other cases, such as this one, the high proportion of mixed areas distorts any proper evaluation of the use of the premises in question.
16. The parties were further divided about the manner in which VEUK calculated the costs of renting its stores, by use of the valuation tool known as "zoning". It is well known that for the purposes of calculating the rent of a shop, surveyors value first the front portion of the shop, usually in England the front 20 feet, which is known as "Zone A". The rental value for the portions further to the rear, Zones B, C and D etc., are then calculated by dividing the rental of the preceding zone by 2. Once the rental value of zone A is determined the rest of the shop then falls into place. As the Tribunal noted, the consequence of the system is that the rent of a broad fronted shallow shop will be greater than that of a narrow fronted, deep shop.
17. VEUK's position was that such zoning was not merely a convenient valuation tool but a reflection of the reality that the front part of a retail store, used for taxable supplies, is more costly to it than the rear portions of the same store. In this case, therefore, the prominent area which VEUK contends is devoted to taxable supply costs more than the other parts of the shops, leading to a higher recovery of input tax in respect of rent.
18. The Tribunal's principal findings on this issue can be found in paragraphs 51 and 53 of its decision^[1] in the following terms:

"51. What can be said with certainty is that it is not possible to identify the areas of the stores which are used for exempt, taxable and mixed purposes with the precision adopted by the PESM. It is apparent from what we have already said that a member of VEUK's staff engaged in selling a frame into which dispensed lenses are to be fitted is, throughout the process, simultaneously selling taxable goods and making an exempt supply of dispensing services. The two are inextricably mixed in that the one is of no value without the other. We find it impossible to conclude that, when one customer is in the display area but not at a dispensing desk, the dispenser is making a wholly taxable supply of a frame, but when a customer sits at the dispensing desk the dispenser is making a mixed supply. The emphasis may be on the sale or the dispensing respectively, but the abrupt switch from one activity to the other which the PESM assumes is not present. It is unrealistic to conclude, as the PESM implies, that when the customer is standing in one spot he is receiving an exclusively taxable supply, but if he sits down two feet to the side he is receiving a mixed supply, even though he is continuing the same conversation with the same salesperson. …

… 53. It may be that a floor area-based PESM is suitable for some retail opticians' businesses, and even that one could be devised which is suitable in VEUK's case, Though we are doubtful since in our view VEUK's chosen method of doing business, in open-plan stores, has by its nature the result that only a modest part of each store can properly be regarded as used for exclusively taxable or exclusively exempt supplies. It is certainly clear to us that the PESM we must consider is unsuitable. A number of criticisms of detail were made – the occasional seeking of advice ophthalmic opticians on matters which might properly be regarded as relevant to the sale of a frame, and the placing in some stores of focimeters (devices which check the characteristics of a lens, and which are used for that purpose by dispensers before spectacles are handed to the customer) within the laboratories, which we think might be considered de minimis. Much more important is the treatment of the display area, in its attribution to taxable use when, as we have indicated, the area is in reality used almost entirely for mixed purposes. It is, of course, possible to sell a frame without dispensed lenses, though it was clear that VEUK seldom does so. In those few instances, and in cases when a customer requires non-prescription sunglasses or accessories, the display area is used for the making of a wholly taxable supply. In every other case it is used for the purpose of making both exempt and taxable supplies. If the display area were attributed, as it should be, to mixed uses the only remaining area of exclusively taxable use would be the laboratory."

19. Subject to one point taken by Mr Cordara QC (who appeared with Mr King) for VEUK, relating to the precise scope of the "medical care" exemption, it seems to me that these paragraphs of the Tribunal's decision include clear findings of fact as the use or uses to which the various areas of the store are actually put. Such findings are not open to challenge in this court, where appeals are confined to matters of law. The conclusion drawn from those findings of fact was that the PESM does not represent a fair and reasonable attribution of the residual input tax to taxable supplies. I agree with Mr Thomas that that is a value judgment of a primary decision maker with which an appeal court has to be slow to interfere. The appeal court must apply the principles set out by Jacobs LJ in the Court of Appeal in Procter & Gamble UK v Revenue and Customs Commissioners [2009] STC 1990 at p.1993j – 1994h, paragraphs 9 – 11.
20. On the subject of zoning and its appropriateness or otherwise in determining costs of the various store areas in this context, the Tribunal's decision was as follows:

"The use of a zoning factor in a retail optician's PESM was considered in Optika Limited v Customs and Excise Commissioners (2004, Decision 18627). The tribunal concluded (at paragraph 143) that it was inappropriate since, as the Commissioners argued before us, zoning was no more than a method of calculating the rent, which was expressed as a single amount for the whole premises; it could not be concluded that there were separate rents for separate zones. The same reasoning was adopted by the tribunal in Banbury Visionplus, but it added the observation that, while zoning was a tool for valuing the rent of comparable premises with different frontages, other factors, particularly location, also affected the rent of shop premises. That finding was not challenged on appeal to the High Court (see [2006] STC 1568).

In our view those tribunals came to the right conclusion, and for the right reason. We think, however, that the introduction into a retailer's PESM of an adjustment by reference to zoning is inappropriate on another, additional, ground. A trader such as VEUK, though it carries on different activities in different parts of the store, is nevertheless carrying on a single business, each part of which is dependent on every other. The core of the business is the sale of dispensed spectacle and contact lenses. While it is true that parts of the process are carried out at the front, and other parts at the rear, of the store, the reality is that virtually all of the store is used, in one way or another, for the core business. If VEUK were able to segregate its core business and undertake those parts which give rise to exempt supplies in less expensive premises, while undertaking those which result in taxable supplies in other, dearer, premises there might be merit in its argument. The fact is, however, that it does not, and in practical terms cannot, segregate its business in that way. It requires the whole of the store in order to carry on every part of its chosen business, and it follows that the rent cannot be said to weigh more heavily in one aspect of the business than another."

Again, it seems to me that those are findings of fact that there were not separate rents for separate zones and that rent could not be said to weigh more heavily on one aspect of the business than another.

21. As a result of the findings summarised above, the Tribunal decided that the PESM did not produce a fair and reasonable result and that the combination of the method itself and the manner in which it had been implemented, by the allocation of floor areas to various supposed uses, would inevitably result in over-recovery by VEUK of input tax. The Tribunal noted that overall VEUK's output tax calculation assumes that about 35% of its supplies from its stores are taxable, yet it has recovered 88% of the input tax attributable to stores expenditure by use of the PESM.
22. On the present appeal, VEUK takes three principal points against the tribunal's decision. In each respect, it argues that the Tribunal was wrong in law. First, it is submitted that the Tribunal erred in its determination of the scope of the exempt services provided in the stores. Secondly, it is said that the Tribunal erred in its consideration of the accuracy, fairness and reasonableness of the PESM. This point raises, in essence, the suitability of a "floor-space + zoning" calculation in making an attribution of the residual input tax – in my view, a value judgment of the type to which Jacobs LJ's comments in Procter & Gamble (supra) apply. Thirdly, it is argued that the tribunal was wrong in its acceptance of the override notice and the assessment as leading to a fair and reasonable outcome.
23. Mr Cordara's first point was that the Tribunal had erred in its approach to the PESM because it misunderstood or misapplied the ambit of the "medical care" exemption provided for by Article 13 A.1 of the Sixth Directive. That Article is in the following terms:

"1. Without prejudice to other Community provisions, member States shall exempt the following under conditions which they shall lay down for the purpose of ensuring the correct and straightforward application of such exemptions and of preventing any possible evasion, avoidance or abuse: …

… (c) the provision of medical care in the exercise of the medical and paramedical professions as defined by the Member State concerned."

The Directive's provision is implemented in this country, for present purposes, by s. 31 of, and Schedule 9 to, the Value Added Tax Act 1994, schedule 9 Group 7 item 1 providing as follows:

"The supply of services consisting in the provision of medical care by a person registered or enrolled in any of the following -… (b) either of the registers of ophthalmic opticians or the register of dispensing opticians kept under the Opticians Act 1989 or either of the lists kept under section 9 of that Act of bodies corporate carrying on business as ophthalmic opticians or as dispensing opticians… "

Note 2 to the Group further provides:

"Paragraphs (a) to (d) of item 1…include supplies of services made by a person who is not registered or enrolled in any of the registers or rolls specified in those paragraphs where the services are wholly performed or directly supervised by a person who is so registered or enrolled… ".

It is common ground that VEUK's staff members operate under these provisions. The argument is about where in the stores the relevant services are supplied.

24. Mr Cordara argued that the Tribunal did not properly appreciate the narrowness of this exemption and, therefore, it misassessed the areas of the stores in which true "medical care" was being provided. In his submission, the display area of the shop was simply devoted to the supply of goods and no relevant "medical care" was provided away from the dispensing desks. It is said that once the optician strays with his customer away from the dispensing desk he embarks upon the supply of goods and "medical care" ceases.
25. In my judgment, that is not correct. I agree with Mr. Thomas, who appeared for the Commissioners, that the supply of the services of a dispensing optician, aside from the physical sale of the spectacles or the contact lenses themselves, have been found by this court to be exempt. That is the effect of the decision in Leightons (supra). The dispensing optician's function is to convert the prescription drawn up by the ophthalmic optician into an order for the manufacture of a suitable optical instrument, spectacles or lenses, which will correct the customer's vision. As it was put by the Tribunal in Southport Visionplus Ltd v CCE (2001) Decision No.17502,

"…The customer who purchases dispensed spectacles wants the services of a dispensing optician to ensure that the optical appliance that he ultimately purchases is entirely appropriate to his individual needs…".

26. It is not necessary to accompany the Commissioners' witness, Professor Jalie, so far as to find that the provision of cosmetic advice by a dispensing optician, as to the aesthetic appearance of a set of frames, by a dispensing optician may in some senses be regarded as part of a psychological (and ergo, a "medical") service to the customer. However, in my judgment, the service function, looked at as a whole, of the dispensing optician, as described for example in Leightons' case, seems to me to be a therapeutic one directed to the correction of the customer's vision. The optician does not stop the exercise of that function when he strays away from the dispensing desk and into the display area, even if he does assist the customer in choosing a frame from the display racks, among other reasons, because of the frame's aesthetic appeal. It is to be recalled that Article 2 of the Sixth Directive provides that,

"The following shall be subject to value added tax:

1 the supply of goods or services effected for consideration within the territory of the country by a taxable person acting as such…"

By Article 5, for these purposes,

" "supply of goods" shall mean the transfer of the right to dispose of tangible property as owner…".

There seems to be little in the dispensing optician's activity even in the display area of VEUK's stores, apart from (at the very end of the transaction) the handing over of the dispensed product against payment, which has anything to do with "the transfer of the right to dispose of tangible property as owner".

27. The function of the dispensing optician, as found by the Tribunal here, is obviously different from the services considered by the European Court in the three cases to which Mr Cordara referred: D v W Case C-384/98, Ambulanter Pflegedienst Kuegler GmbH v Finanzamt fuer Koerperschaften Case C-141/00, and Diagnostico & Therapeftiko Kentro etc. v Ipourgos Ikonomikon [2006] STC 1349. Those cases concerned respectively the taking and analysis of medical samples for paternity proceedings, the provision of general domestic services to patients and the provision of accommodation and board to the relatives of hospital in-patients. Clearly, none of those services amounted to "therapeutic" treatment of a patient. The principle emerges in a short passage in D v W (supra), at paragraphs 18 and 19 of the judgment of the court in these terms:

"Clearly, therefore, the concept of 'provision of medical care' does not lend itself to the intereptation which includes medical interventions carried out for a purpose other than that of diagnosing, treating and, in so far as possible, curing diseases or health disorders.

So, services not having such a therapeutic aim must, having regard to the principle that any provision establishing an exemption from VAT is to be interpreted strictly, be excluded from the scope of Article 13A(1) (C) of the Sixth Directive and are therefore subject to VAT."

28. I also agree with Mr Thomas that the finding of the Tribunal in this respect does not fall foul of the decision of the European Court in EC Commission v UK [1988] STC 251. That case simply indicated that a line had to be drawn for VAT purposes between the distinct supplies of goods and the supply of medical care services. In the infraction proceedings brought by the Commission in that case, the court simply held that it was not permissible to extend the exemption to a supply of goods by seeking to subsume it in the related supply of medical care services: see paragraph 34 of the judgment of the court. It was not attempting to lay down the precise boundaries between the two supplies.
29. I turn now to VEUK's second point. This raises the question whether a floor-area attribution of residual costs (with or without "zoning") produces a fair and reasonable result in this case. I remind myself that I am assessing the Tribunal's value judgment, made after hearing extensive evidence.
30. The Commissioners made a number of criticisms of the PESM to some of which I shall return. However, I think it is useful to mention at the outset two points. First, this case is not dealing with input costs which have a direct and immediate link with only taxable or only exempt outputs. It is concerned with costs that are agreed to be residual, i.e. they relate to some extent to both taxable and exempt supplies. Secondly, as already mentioned, VEUK treats the income from each sale of dispensed spectacles as consisting of 35.63% taxable and 64.37% exempt. With regard to contact lenses, the comparable split is 49% to 51%. The sale of spectacles is the substantially larger portion of the business. Notwithstanding these percentages, the PESM attributed 88% of the store related input tax to taxable supplies. Those stark figures must raise a very serious question, at the outset, as to whether the PESM represented a fair and reasonable attribution of the costs in question, even before one begins to examine the detail of the operation of the PESM. In short, the immediate impression from these simple figures is that something has gone wrong somewhere.
31. The first major criticism of the PESM was that the attribution that it made of floor space within the stores was simply wrong. The most significant deficiency was said to be the treatment of the "retail" or "display" area at the front of the stores as relating wholly to taxable supplies. I have already considered the question of the boundary between the supply of medical care and the supply of frames and lenses. That question also bears on this issue.
32. In my judgment, it is impossible for VEUK to overcome the factual findings of the Tribunal on this aspect of the case. Those findings were to the effect that these stores as a whole were used for the supply and sale of dispensed spectacles and contact lenses and that it was unrealistic to divide them into retail areas and medical care areas. The short findings are encapsulated in two passages of the decision in paragraphs 43 and 51. First, the Tribunal found that,

"…the core of the business is the sale of dispensed spectacles and contact lenses. While it is true that parts of the process are carried out at the front, and other parts at the rear, of the store, the reality is that virtually all of the store is used in one way or another for the core business…"

Further, the Tribunal decided,

"…it is not possible to identify the areas of the stores which are used for exempt, taxable or mixed purposes with the precision adopted by the PESM…".

33. The other findings in paragraphs 46, 47 and 50 to 53 all support that view of VEUK's business activities at the stores. I find it impossible, consistently with the test laid down by Jacobs LJ in Procter & Gamble (supra), to impugn those findings as a whole or the "value judgment" as to the fairness and reasonableness of the PESM in this case. In any event, given the evidence before the Tribunal, I consider that those findings were clearly right.
34. In those circumstances and in the light of those findings, the economic use of the inputs in question here could not be fairly and reasonably attributed between taxable and exempt supplies by the rigid categorisation of floor areas that the PESM presupposes.
35. In my judgment, the Tribunal's findings also accorded with the approach adopted by Warren J in St Helen's School Norhtwood Ltd. v Revenue & Customs Commrs. [2007] STC 633. In that case a suggested alternative method of apportionment of input tax, based upon temporal use of the school's sports complex between exempt educational user and taxable use by fee payers under licence of the facilities, was rejected. The learned judge concentrated upon the economic use to which the relevant inputs themselves had been directed, namely the school's business of making exempt supplies of education services. The licence to the fee-paying users simply put to productive use that which had been acquired for a different main purpose, namely education. In my view, the Tribunal here similarly directed its attention to finding the economic use to which the relevant inputs were directed and found that they could not be attributed by means of a physical floor space allocation.
36. I also consider that some of the Commissioners' other criticisms of the PESM go to support the main conclusion of the Tribunal to which I have alluded above. These points are summarised in paragraphs 54 to 59, 65 and 66 of Mr. Thomas's skeleton argument and need not be set out extensively here. There were five points: first, the "doormat adjustment" made so little difference to recovery of input tax as to be a merely cosmetic attempt to adjust for the mixed use characteristics of the front of the store; secondly, the floor space calculation assumes that 46% of mixed use floor space is used in the same ratio as "taxable" floor space bears to "taxable" plus "exempt" areas, whereas only 54% is allocated specifically to one or other category; thirdly, costs other than rent and service charges are also apportioned according to a floor space method; fourthly, it is not demonstrated that the sample stores are representative of the estate as a whole.
37. It seems to me that each of these criticisms of the floor space assumptions added weight to the overall conclusion that the Tribunal reached in this case. I shall look at each briefly in turn. I shall return separately to the question of "zoning".
38. First, there is the "doormat adjustment". Here it was shown that if the adjustment was removed from the calculation recovery of input tax in respect of rent and service charges and other store related inputs would increase by less than 1 per cent. This is such a minimal effect on the recovery rate that it appears to give no real force to the factors that the adjustment was supposed to represent.
39. Secondly, the Commissioners raised objection to the apportionment of mixed-use areas according to the ratio between taxable-use areas and taxable-use areas plus exempt-use areas. Their point was that there was no reason to suppose that these mixed areas, amounting to as much as 46% of the whole floor area, were in truth used for taxable and exempt activities in these proportions. The thinking behind this argument is that the less that can be said to be properly and clearly attributable to either taxable or exempt supplies, the less merit there is in calculating the recovery of other costs by reference to the use of relatively small parts of the store. A similar argument found favour with the Tribunal in Banbury Visionplus v CCE [2005] Decision 19266: see paragraph 125. The present Tribunal made findings in this case which support this argument: see paragraphs 52 and 53.
40. Thirdly, calculations produced to me indicated that some 73% of store related costs, other than rent and service charges, were not related to floor areas at all. Yet those costs too are attributable in terms of input tax by reference to the same floor areas.
41. Fourthly, the point was raised that the sample stores were not shown to be representative of VEUK's stores as a whole. This submission was supported by references to the evidence before the Tribunal which indicated that no witness was able to throw light upon how the stores were selected for the sample and how others were omitted. In addition, there was no objective evidence available to support the selection of the stores in question. The point is made that one aspect of fairness of a PESM is the ability to verify and audit it. In this respect, it was argued, the present PESM failed to be fair and reasonable. In my view, this too is a valid point militating against the fairness and reasonableness of the PESM.
42. I turn now to the issue of "zoning" in calculating rental costs of the allocated store areas. I have explained above how this concept operated in the context of the PESM. I have also summarised the Tribunal's findings on the issue. Those are to be found in paragraphs 42 and 43 of the Decision. In my judgment, the Tribunal was right for the reasons it gave. The result of the application of "zoning" into the PESM was that it was legitimate to view the rent as being overwhelmingly attributable to the taxable stream of VEUK's business in supplying frames and lenses and only marginally used in providing exempt services. This is patently absurd in the light of the nature of VEUK's business as it was found to be by the Tribunal on the basis of ample evidence available to it. In my view, the Tribunal was entirely correct in finding that rent does not weigh more heavily on any one part of the business more than on any other. Similar uses of zoning were also rejected by other Tribunals in Optika at paragraph 143 and in Banbury at paragraphs 135-138. The reasoning was similar and, in my respectful judgment, equally correct.
43. In my judgment also the reasoning which compelled the Tribunal's conclusion in the light of its findings with regard to VEUK's business is well supported by analogy with the findings of the Tribunal with regard to the very different business of the gaming premises in Aspinall's Club Ltd. (2002) Decision 17797. That case concerned a floor area attribution of input tax in relation to a casino which provided exempt gaming supplies and taxable catering supplies. Only a very small physical area was in fact devoted to gaming, whereas the rest of the premises was used to provide catering and other common recreational areas, creating an aura of "luxury and opulence" for the club as a whole: see paragraph 1 of the decision. The trader was seeking to promote a "floor based" special method of input tax attribution. In finding that this did not produce a "fair and reasonable" result, the Tribunal said this at paragraph 49:

"We would accept the way the matter is put by Mr Cannon, if not all, the floor areas of the Club are of mixed use; they are used to make the supplies of the business, both taxable supplies and exempt supplies. Furthermore, in running the business costs are primarily incurred to facilitate exempt gaming. This does not mean that exempt supplies are physically made from areas such as the bar and restaurant or, on the other hand, that taxable supplies are physically made from the gaming rooms. Nor, we would add, does it mean that there is for VAT purposes a single supply of gaming to which the catering is merely ancillary. But those factors do not rule out costs incurred in one area being incurred to make supplies in another area. This applies even more so in relation to costs incurred in respect of the common areas from which no supplies are directly made. Such costs are incurred and are truly 'cost components' of the exempt supplies which physically take place in the small gaming area. Those costs are funded by the gaming. That in itself does not make them cost components of those exempt supplies. But in this case it is additional proof, if any is needed, that gaming is the foundation of the business and it is the furtherance of that gaming which causes and is seen as justifying commercially the decisions to incur the expenditure. Here there is capital expenditure and ongoing expenditure incurred specifically to create and maintain the opulence and luxury, especially in the creation of spacious surroundings and general ambiance, which is seen as commercially necessary to promote the highly profitable gaming business. For these reasons, in our judgment, the Commissioners in considering the methods proposed have not confused use with purpose and have not acted unreasonably in deciding to reject them. Indeed for our part, if it is open to us to decide whether the floor area methods put forward by the Appellants are capable of achieving a fair and reasonable attribution of input tax, we have not been satisfied that they do."

I find that reasoning compelling.

44. Before leaving this aspect of the appeal, it is necessary to say something about the Tribunal's decision in DCM (Optical Holdings) Ltd. v Commrs of Revenue & Customs (2009) Appeal No, EDN/02/182. In that case, it is clear that a final decision remains to be delivered, but the approach in the published decision does favour VEUK's submission here that a floor area is capable of producing a fair and reasonable result in the case of that optician's business, at least if "zoning" is removed from the calculation.
45. It is clear that in that case also the submissions about the true ambit of the medical care exemption were advanced more fully than they had been in this case before this Tribunal – this was described as a "fresh legal issue" set out in the taxpayer's "Supplementary Heads of Submission" (see paragraph 14 of the Decision). On the facts in DCM the floor plans had also been drawn to specify only an area of 1.8 metres in front of the frame display stands as a "taxable" area, rather than the whole "display area" identified here as "taxable". Further, there was, as here, a factual dispute between expert witnesses as to the ambit of "dispensing" services.

These features led to two important findings by the Tribunal, one of fact and the other of law. The factual finding was this, which one finds in paragraphs 9 to 12 of the Decision:

"Professor Taylor considered that dispensing in the Appellant's manner of operating took place only at the dispensing desks, not starting until measurements of face and spectacle frame were taken at these desks.

In addition to his academic experience and teaching Professor Taylor works part-time as an optometrist. He visited one of the Appellant's outlets in Brighton to view the manner in which they conducted their activities and served their customers.

Professor Jalie differed, taking a wider interpretation of "dispensing" and including the selection of frames on aesthetic grounds. He is, of course, a dispensing optician, qualified and experienced only in that particular stage of the provision of a pair of spectacles or contact lenses. (In fact he de-registered as a dispensing optician in 2008 and ceased full time practice in 1986). He is, we understand, an expert in the design of optical lenses.

This differing interpretation is significant in determining whether the choosing of a frame, conducted in the 1.8 metres "taxable" area in front of the frame stands, involves "dispensing". We preferred on the basis of his broader professional experience and our own assessment of the evidence of the course of providing customers' spectacles in the Appellant's establishments, Professor Taylor's more limited definition of "dispensing", i.e. confining it to the dispensing desks and not (unless exceptionally) extending to the "taxable" area in front of the display stands. In any event this issue may be resolved on legal principle. Whatever the sense of "dispensing" is, it is not as such the exempt activity for VAT purposes. The exemption is in respect of "medical services", infra. "

The legal finding, in paragraphs 15 and 16, was:

"The essence of an exempt medical service seems to be a therapeutic aim. Fashion advice and aesthetic considerations fall outside that definition in our view.

This suggests to us that as a matter not simply of fact but also of law the dispensing of spectacles (i.e. the exempt activity) in the Appellant's premises takes place substantially if not entirely at the dispensing desks and only exceptionally, if at all, does an aspect of the medical service take place within the 1.8 metres taxable area in front of the frame display stands."

46. Mr Cordara submitted that I should be guided by the reasoning of the Tribunal in DCM to find that a floor area method could be applied in a fair and reasonable manner, even if adaptations of detail were required. I should not feel compelled to "throw out" the PESM, if capable of fair operation, just because certain details might be thought to operate unsatisfactorily. Clearly, he also commended to me the Tribunal's approach in that case to his submissions upon the ambit of the "medical care" exemption.
47. Mr Cordara is obviously right to submit that the approach of the Tribunal in DCM is supportive of his argument to me. However, it must be noted that the findings of fact in that case differed from those made by the Tribunal here and they were made on the basis of a different floor space approach. Those factual findings were clearly more restrictive of the nature of the "medical supply" element in that case: see the lengthy "Revisals to Findings-in-Fact", especially in paragraph 17(ii), which were extremely restrictive in this sense. Further, the decision in law was also firmly based upon the factual findings made: see again paragraph 16 of the Decision in that case. I do not see, however, that the DCM decision, even if correct in law, would compel a finding that the Tribunal in this case erred in law in its decision on the facts as it found them to be.
48. In the result, I find that the Tribunal made no error of law in dismissing VEUK's appeal against the override notice. In my judgment, this follows from the conclusion that the statutory criteria for the service of that notice were satisfied: see regulation 102A. Once it was found that the PESM did "not fairly and reasonably represent the extent to which goods or services are used by [a taxable person] in making taxable supplies", it followed that the notice was valid and the appeal had to be dismissed.
49. I cannot agree with Mr Cordara in his submission that it is necessary, at this stage of the process, to examine the methodology adopted by the Commissioners in raising their assessment in order to find whether the "cure is worse than the disease" as Mr Cordara put it. The sole issue on the appeal against the notice is whether regulation 102A is satisfied. If it is satisfied, that is the end of the matter and the notice is good. It is, as a matter of statutory construction of the regulations, unnecessary for these purposes to decide whether the Commissioners, in calculating their later assessment, have come up with an alternative which does satisfy the overall statutory objective of a fair and reasonable attribution.
50. The final step in the PESM which was criticised in the Commissioners' override notice was the use of the preceding calendar year's figures in calculating each year's recoverable residual input tax. The Tribunal's finding on this point can be shortly stated by reference to two sentences in paragraph 55 of the Decision. The Tribunal said this:

"[The Commissioners] are right to argue that, as a matter of principle, the proportion of the input tax which is recovered should be the amount incurred on supplies which have been used in making taxable supplies. The use of figures removed by a year or, in this case 15 months, without any provision for adjustment in the light of differences from year to year, or changes in the business, is inconsistent with that principle".

51. The argument on both sides on this point was, with respect, sketchy at the end of a demanding case: see paragraphs 76 and 77 of VEUK's written submissions and paragraph 77 of the Commissioners' skeleton argument. In the light of what I have said previously, the point could not in any way be decisive of the competing arguments. It is not necessary to say more than that I can find no ground on which to fault the Tribunal's finding as a matter of law.
52. I turn now to the appeal against the assessment.
53. The parties are agreed that the matter which the Tribunal had to decide was the validity of the assessment "in principle". The Tribunal understood that this was the issue: see paragraphs 1 and 64 of the Decision. However, it now appears that the parties and the Tribunal itself may have been at odds to some extent as to what a decision "in principle" meant. Mr Thomas argued before me that once it was decided that the override notice was valid, in the sense that the PESM failed to achieve a "fair and reasonable" result for the reasons contended for by the Commissioners, it was inevitable that the recovery of input tax had been excessive and, in the absence of a further "use based" account by the taxpayer under regulation 102B, an assessment necessarily followed. Matters of quantum were to be decided later. Accordingly, the appeal against the assessment was bound to fail on this ground alone. The Tribunal's understanding of its task may have been the same as that of the Commissioners'. Its finding was fairly short (in paragraph 64) as follows:

"We must also dismiss the appeal against the assessment, in principle, since it is implicit in our earlier conclusions and in our rejection of the appeal against the override notice that there was some difference between the input tax for which VEUK claimed credit, and the credit to which it was entitled…".

The Tribunal went on to observe that it had heard little about the detail of the assessment and gave the parties liberty to apply for a further hearing for the amount of the assessment to be determined. The Tribunal did, however, go on to say this,

"Lastly, as the parties requested, we express our views about what might be a suitable method, in the light of the evidence we heard. That evidence extended only to the use of the retail stores; we are aware that VEUK makes other supplies of which the PESM must take into account but we heard insufficient about them to express any view which does so.

We have already indicated that we think it unlikely that a floor area-based method could ever be suitable. We heard some evidence about the calculations, referred to as a "full cost apportionment", VEUK makes in order to determine the taxable and exempt proportions of the charge it makes for dispensed spectacles and the slightly different calculation it makes in respect of contact lenses. We are aware that the Commissioners have misgivings about the calculations, but as we understood the matter, their misgivings relate to the details of the calculation, rather than to the principle. The more we heard evidence on the matter, the more it seemed to us clear that a method which satisfactorily calculates VEUK's output tax liabilities is as likely, perhaps with adjustment for special factors, to represent a suitable method for calculating the input tax for which it is entitled to credit. We did not understand how an expense which is a cost component of a mixed supply must be treated in one way when calculating the output tax liability, and in another when calculating the input tax credit. In short, it appeared to us that the Commissioners were right to conclude that, in relation to the retail business taken alone, the standard method, perhaps with some small adjustment, was appropriate."

54. It does not appear to me, therefore, that the Tribunal made any decision as to the suitability of the rival method of calculation that underlay the Commissioner's assessment. It simply gave informal views. However, both parties addressed argument to the Tribunal on the point: see paragraphs 145 to 158 of the VEUK's written heads of argument below and paragraphs 71 and following of the Commissioners' skeleton argument. Equally, it is apparent that the Commissioners' assessing officer was cross-examined about it. As the Commissioners said, they heard "some evidence" about the calculations referred to as a "full cost apportionment". I too have heard argument about those calculations. In the light of these features of the case I have considered whether it is either open or desirable for me to express views on the underlying calculations. I have concluded that it is neither. It is clear to me that the Tribunal made no findings on the subject against which any appeal would lie; it seems that their view was that, if the parties could not agree upon a method of calculation, the matter would have to be determined at the further hearing for which they gave permission to the parties to apply.
55. In so far as the present appeal goes to the Tribunal's brief finding in paragraph 64 of the Decision (quoted above), it must be dismissed for the reasons there given, as amplified by Mr. Thomas in his argument before me.
56. In the result, both appeals to this court must be dismissed.
57. In conclusion, I would like to express my thanks to counsel for their extremely helpful arguments.

Note 1   There is an additional subsidiary finding in paragraph 52 to which I shall return.    [Back]