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FIRST DIVISION, INNER HOUSE, COURT OF SESSION
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Lord President
Lord Kingarth
Lord Penrose
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[2008] CSIH49
OPINION OF THE COURT
delivered by LORD PENROSE
in
APPEAL UNDER SECTION 11 OF
THE TRIBUNAL AND INQUIRIES ACT 1992
by
THE COMMISSIONERS FOR HER
MAJESTY'S REVENUE & CUSTOMS
Appellants
against
A DECISION OF THE EDINBURGH VAT AND DUTIES TRIBUNAL DATED
19 JANUARY 2007 AND COMMUNICATED TO THE
APPELLANTS ON 22 JANUARY 2007
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Act: Currie, Q.C.; Shepherd & Wedderburn, W.S.
Alt: Tyre, Q.C.;
bto
21 August 2008
[1] The
appellants are the Commissioners for Her Majesty's Revenue & Customs
("HMRC"). HMRC appeal against a decision
of the Edinburgh VAT and Duties Tribunal dated 19 January 2007 in which the
Tribunal allowed an appeal by The Royal Bank of Scotland plc ("RBS") against
the refusal of HMRC to approve a special method for the allocation of input tax
on overhead expenditure incurred by companies within the Lombard Finance Group
("Lombard") as between their taxable and VAT exempt instalment credit
businesses. Lombard is part of the RBS VAT Group.
[2] So far as is
material for present purposes, the relevant part of Lombard's business is the
provision of asset finance, a form of hire purchase finance available for the
acquisition of business plant and machinery and motor vehicles. Typically, Lombard enters into a contract for the
purchase of a specified item of plant, identified by Lombard's customer, often after discussion
with the company's technical staff, and hires the item to the customer on
instalment terms that provide an option to purchase at the end of the contract
hire period. It is agreed between the
parties that, for the purposes of VAT, each transaction at the outset involves
the purchase and hire of corporeal moveable property, and the provision of
instalment credit finance. In due course the asset may be purchased by the
customer, or traded in for another asset or otherwise disposed of by Lombard as its property. The purchase and hire of the asset and other
transactions relating to its disposal are standard rated for VAT purposes. The provision of instalment credit finance is
exempt from VAT in terms of Group 6, item 3, of Schedule 6 to the Value Added
Tax Act 1994 ("the VATA").
[3] In the
conduct of its business Lombard incurs expenditure in the purchase of goods and services. Across the range of its activities particular
services may relate exclusively to one class of Lombard's business or another. But inevitably there is indirect expenditure
on the purchase of goods and services that relate to the business, or class of
business, as a whole. In so far as such
expenditure relates to mixed transactions, involving standard rated business
and exempt business in combination, VAT input tax charged on the supply of the
services to Lombard must be apportioned, since VAT input tax may be recovered
only in respect of outputs subject to VAT. The issue before the Tribunal was whether the
method of apportionment of this "residual" input tax incurred on overhead
expenditure that was proposed by Lombard was appropriate, having regard to the
statutory and regulatory framework governing the issue.
[4] Regulation
101 of the Value Added Tax Regulations 1995 (SI 1995 No 2518) ("the
Regulations") provides a standard method of apportionment of input tax that
allocates the relevant tax in the first place according to whether it is
exclusively related to taxable or exempt supplies, and, so far as any residual
input tax is concerned, allocates it according to the value of the respective
outputs supplied. The application of the
standard method was not in issue before the Tribunal and is not in issue before
the court. Regulation 102 provides for
the adoption of "special" methods of computation of the allowable input tax and
applies in this case. In order to deal
with its requirements, it is necessary to have regard to the wider context in
European and domestic legislation, EC Council Directive 67/227 of 11 April
1967, the First Directive, EC Council Directive 77/388 of 17 May 1977, the
Sixth Directive, the Value Added Tax Act 1994 sections 24, 25 and 26, and
regulations 101 and 102 in particular of the Value Added Tax Regulations 1995,
SI 1995/2518.
[5] With one
limited exception, counsel were agreed that, so far as concerns expenditure in
general, the relevant provisions, and material judicial comments on them, were
analysed by Warren J in his judgment in St
Helen's School Northwood Ltd v Revenue
& Customs Commissioners [2007] STC 633 at paragraphs [3] to [22]. His analysis was accepted by both parties to
be accurate. We agree with it, and find
it unnecessary to repeat his citations in full. What emerges are conditions that must be met
if input tax is to be allowed as a deduction in accounting for output tax on
goods and services provided by a taxable person in the course of taxable
business.
[6] The
over-riding requirement is that the goods and services on which input tax has
been incurred in the course of the business have been "used" in "making taxable
supplies": paragraph [14] of Warren J's
judgment. At paragraphs [17] to [19] he says:
"[17] The
jurisprudence of the Court of Justice of the European Communities (ECJ)
establishes that there must be a 'direct and immediate link' between the goods
in question (ie those in respect of which input tax, or some of it, is sought
to be deducted) and the taxable outputs of the taxable person: see for instance
BLP Group plc v Customs & Excise Comrs (Case C-4/94) [1995] STC 424, [1996] 1 WLR 174, and Midland Bank plc v Customs & Excise Comrs (Case
C-98/98) 2000 STC 501, [2000] 1 WLR 2080. This aspect is also connected with the 'cost
component' concept articulated in art 2 of the First Directive. Thus in Midland
Bank, the ECJ said this:
'29. It
should be borne in mind that, according to the fundamental principle which
underlies the VAT system, and which follows from art 2 of the First and Sixth
Directives, VAT applies to each
transaction by way of production or distribution after deduction of the VAT
directly borne by the various cost components...
30.
It follows from that principle
as well as from the rule enshrined in the judgment of [BLP], para 19 according to which, in order to give rise to the
right to deduct, the goods or services acquired must have a direct and
immediate link with the taxable transactions, that the right to deduct the VAT
charges on such goods or services presupposes that the expenditure incurred in
obtaining them was part of the cost components of the taxable transactions.
Such expenditure must therefore be part of the cost of the output transactions
which utilise the goods and services acquired. That is why those cost
components must generally have arisen before the taxable person carried out the
taxable transactions to which they relate.'
[18] As
it is put by Jonathan Parker LJ in Dial-a-Phone
Ltd v Customs & Excise Comrs
[2004] EWCA Civ 603 at [28], [2004] STC
987 at [28]:
'... in applying the "used for"
test prescribed by art 17 (2) of the Sixth Directive the relevant inquiry is
whether there is a "direct and immediate link" between the input cost in
question and the supply or supplies in question; alternatively whether the
input cost is a "cost component" of that supply or those supplies. [Underline
emphasis supplied.] It is clear from the judgments of the ECJ in BLP and Midland Bank, as I read them, that there is no material difference
between these alternative ways of expressing the basic test.'
[19] Thus
there are two separate tests but each is reflective of the other and they come
to the same thing: the one seeks a direct and immediate link between the goods
or services acquired and the output transactions giving rise to the right to
deduct; the other seeks to identify the cost of acquiring those assets as a
cost component of the output transaction."
[7] These
observations make the general scope of the factual inquiry clear in the case of
direct costs. Direct costs of production and distribution of a product, such as
raw materials, must have been incurred, in general in advance, in the
acquisition of the goods used in the course of the taxpayer's business
activities so as to be regarded as elements of the product's cost. Overhead expenditure of the kind in question
in the present case may have, but does not necessarily have, such a direct and
immediate link with the output transaction in the sense of the jurisprudence of
the ECJ. Expenditure may be incurred in consequence of the transaction, and
will continue to be incurred during the contract hire period. And in general terms much of the overhead
costs are of their nature indirect expenditure in relation to the specific
output transactions of the taxpayer. The
Midland Bank case involved indirect
expenditure of that kind. At paragraph 31 of the judgment of the Court, it is
said, as a result of the approach set out in paragraphs 29 and 30 quoted above:
"31. It
follows that... there is in general no direct and immediate link in the sense
intended in the BLP Group judgment...
between an output transaction and services used by a taxable person as a
consequence of and following completion of the said transaction. Although the expenditure incurred in order to
obtain the aforementioned services is the consequence of the output
transaction, the fact remains that it is not generally part of the cost
components of the output transaction, which Article 2 of the First Directive
none the less requires. Such services do
not therefore have any direct and immediate link with the output transaction. On the other hand, the costs of those services
are part of the taxable person's general costs and are, as such, components of
the price of an undertaking's products. Such
services therefore do have a direct and immediate link with the taxable
person's business as a whole, so that the right to deduct VAT falls within
Article 17 (5) of the Sixth Directive and the VAT is, according to that
provision, deductible only in part."
[8] Article 17
(5) of the Sixth Directive provides:
"5. As
regards goods and services to be used by a taxable person both for transactions
covered by paragraphs 2 and 3, taxable transactions in respect of which value
added tax is deductible, and for transactions in respect of which value added
tax is not deductible, only such proportion of the value added tax shall be
deductible as is attributable to the former transactions."
Section 26 (3) of the 1994 Act provides for regulations to be
made by the Commissioners "for securing a fair and reasonable attribution of
input tax" to mixed supplies and in particular supplies which have elements
that are taxable and elements that are exempt.
[9] It was not
disputed that in order to secure the fair and reasonable attribution of input
tax on overhead expenditure there has to be identified an acceptable proxy for
the concept of the "use" of the goods and services in the supply of taxable
services. It was also agreed that in
proposing a special method of attribution, it is for the taxpayer to
demonstrate that the method proposed secures a fair and reasonable attribution
of input tax.
[10] Prior to the
dispute focused in this appeal, the proportion of any unattributable or
residual input tax recoverable was computed in accordance with a method of
calculation agreed between the Finance Houses Association (now the Finance and
Leasing Association) and HMCE the predecessor of HMRC. The first step in the calculation required the
allocation of Lombard's total unattributable input tax as
between instalment credit business and total receipts:
Input
tax for apportionment x Instalment Credit Receipts
Total
receipts
That step identified the amount that thereafter had to be
allocated as to standard rated business on the one hand and as to exempt
business on the other. A fixed
percentage of the resulting sum, 15%, was allowed to be recovered against the
standard rated output tax in accordance with the agreement negotiated between
the Association and HMCE. The 15% was a
compromise, reached following negotiations, for general application across the
industry.
[11] The first step
remains applicable. The unattributable
overhead expenditure incurred by Lombard covers a very large range of items of expenditure of varying
classes and types. These are aggregated,
according to the group's current accounting practices, in a single control
account that covers the whole range of the group's activities of which
instalment credit finance falling within item 3 of Group 6 is one only. The first stage is an apportionment by value,
similar to the third stage in the standard method, and is not controversial so
far as the present appeal is concerned. However, Lombard, in common with other suppliers of
asset finance, became concerned that the fixed rate apportionment of the
resulting balance of unattributed input tax was inappropriate. According to the Tribunal, doubt was cast on
that approach by the decision in Sovereign
Finance plc v C&E Commissioners (1998)
Decision No 16237. It will be necessary
to return to that case, which raises the only controversial issue between
parties on the authorities. But at this
stage it is necessary only to note that the negotiated special method was not
in issue before the Tribunal and is not in issue before the court. It was one of a number of potential issues
summarised in the case statement prepared by HMRC that in the event were not
pursued before the Tribunal (notwithstanding that the Tribunal purports to have
arrived at a decision on the fairness and reasonableness of the method). If the appeal succeeds, the method will
continue to operate unless superseded by a new special method. The sole issue for the Tribunal was whether Lombard had demonstrated that the special
method proposed by it secured a fair and reasonable attribution of input tax to
the taxable supplies.
[12] The method
proposed by Lombard, to have effect from 1
January 2005,
was that the unattributed input tax on instalment credit business should be
allocated as to 50% to the business of dealing in plant and machinery and motor
vehicles and as to 50% to the provision of instalment credit finance.
[13] The basis on
which that was proposed was set out in a letter to the Commissioners dated 12
September 2005 and in the outline submissions for Lombard presented to the Tribunal. The
letter sets out the proposal succinctly as follows:
"It is our opinion that there are two
main transactions involved in an HP agreement one taxable and one exempt. The input tax we incur is mainly attributable
to the collection of the instalments. The
instalments relate to the repayment of the VAT inclusive principal sum and to
the payment of interest. Therefore, we would advise that with effect from 01
July 2002 we
wish to treat 50% of overhead input tax allocated to instalment credit activity
as attributable to the taxable supplies made under the agreement and thus make
full recovery of the related input tax. The
other 50% of the overhead input tax allocated to instalment credit activity
will be treated as attributable to exempt supply made under the agreement and
we will therefore make no recovery of the related input tax. Expressed as a
formula -
Recovery
% = No of taxable HP transactions
No of
taxable and exempt HP transactions
Irrespective of the number of
transactions the % will always be 50%.
This method would seem to accord with
the decision of the VAT Tribunal in the case of Sovereign Finance (VTD 16237)
where the Tribunal accepted the taxpayers contention that it was entitled to
treat a hire purchase transaction as two deals one taxable and one exempt."
The proposed starting date was departed from following
objection that it would operate retrospectively.
[14] The outline
submission set out the following contentions, among others:
"12. The
overhead costs with which this appeal is concerned... are all of the overheads of
Lombard. No attempt is made - or could be
made - to identify overheads attributable solely or principally to instalment
credit (hire purchase) business: hence step (i) of the calculation... It will be
seen that the expenditure is of the most general nature, including items such
as professional fees, staff advertising, telephone calls, cleaning, and repairs
and maintenance. The difficulty which
gives rise to the present dispute is identification of an appropriate proxy for
"use" of such goods and services.
...
14.
The nature of Lombard's business is asset finance. So far
as instalment credit (hire purchase) is concerned, this consists of the
purchase by Lombard of an asset from a supplier and the
hiring of that asset to Lombard's customer, on terms which provide for transfer of title to
the asset to the customer when all payments under the hire purchase agreement
have been made. Looked at from a non-VAT
perspective, Lombard is supplying the customer with an asset, at a price which
(i) is paid in instalments; (ii) includes the cost to the customer of obtaining
credit for the purchase; and (iii) recognises the assumption by Lombard of the
cost of hiring the goods and ultimately selling them to the customer or, in the
event of repossession, to a third party. This analysis is clearly demonstrated by the
terms of the hire purchase agreement. The activities undertaken by Lombard, in connection with which the
overheads are incurred, are directed towards this single objective: namely, the
provision of an asset at a price which includes the cost of delayed payment.
15.
For VAT purposes, and only for
VAT purposes, it is necessary to characterise the supply by Lombard to its customer as consisting, on
the one hand, of a supply of the goods hired and, on the other, of a supply of
credit. The approach taken by the Respondents is to attempt to classify the
various activities of Lombard's staff as attributable to either the goods or the credit.
Most of the activities are, the Respondents contend, more closely related to
the supply of credit. The Appellant submits
that this approach is misconceived. There is, in reality, no separate supply of
credit by Lombard. Such a 'supply' is merely an
artificial construct for VAT purposes. It
follows that there is no separable objective to which particular activities
ought to be regarded as referable. A
method of attribution of input tax which is founded upon the artificial VAT
distinction will not therefore produce a fair and reasonable result.
16.
In these circumstances, the Appellant
has proposed that if, as is the case, the supply of the goods must be regarded
for VAT purposes as consisting of two supplies, it is appropriate to treat each
of these supplies as a transaction and to attribute input tax on overhead costs
on the basis of a transaction count. In Sovereign
Finance plc v C&E Commrs (Decision
No 16,327), the Tribunal, when construing the expression 'taxable deal' in a
special method, reached its decision on the basis that a hire purchase 'deal'
should be regarded as consisting of a taxable transaction and an exempt
transaction. The method proposed by the Appellant is consistent with this
decision.
...
18.
The method proposed by the
Appellant acknowledges that Lombard's overheads, in so far as allocated to instalment credit
business, are used in an undifferentiated and indistinguishable way for its
business activity of the hiring of assets to customers at a price which takes
account of the provision of credit and of the ultimate transfer of title. There is a direct and immediate link between
the overhead expenditure and that activity. Since the activity falls to be regarded as two
transactions for VAT purposes, it is appropriate when attributing input tax for
VAT purposes to do so on the basis of a transaction count. The method proposed
is fair and reasonable. The Respondents' refusal to allow its use is
unreasonable..."
[15] The Tribunal
found that the special method proposed did achieve a fair and reasonable
result, and it is against that decision that HMRC now appeal. For the Commissioners, Mr Currie made three
broad submissions. First he argued that
the Tribunal had made no relevant findings in fact, or alternatively no
sufficiently detailed findings in fact, to support the characterisation of the
method as fair and reasonable. On the
evidence led for the taxpayer, findings in fact were made from which it could
be inferred that overhead expenditure was incurred in procuring goods and
services that were used in the provision of taxable services. But there were no findings in fact at all that
supported the proposition that a fifty:fifty allocation was fair and
reasonable. The decision had to be, and
bore to be, based on fact, but the decision did not disclose what the facts
were. None were set out.
[16] Secondly, Mr
Currie argued that there was no explanation provided of the Tribunal's
decision. In the context of the
decision, one was left with an impression that the Tribunal elected to support
the taxpayer's method because there was no other contender. But that was not the issue: the taxpayer had
to show that the method proposed secured a fair and reasonable result.
[17] Thirdly, the
Tribunal appeared to think that it had the support of Sovereign Finance, and, to that extent, it misdirected itself.
[18] Mr Tyre
submitted on behalf of Lombard that the appeal should be refused. He argued that it was in the nature of
overhead expenditure that, because it was not attributable to particular
supplies, something by way of a proxy for use had to be found. Lombard had shown the wide ranging nature of the overhead expenditure
in question, thereby demonstrating the nature of the problem. The method proposed was a proxy for actual
use.
[19] The parties,
he submitted, started with very different concepts in attempting to
characterise the business. HMRC
contended that the business was the provision of credit, or very largely the
provision of credit. Therefore the
recoverable percentage was low. Lombard disputed that proposition, and it was
not accepted by the Tribunal. Its characterisation was very different, namely the
provision of a sound asset at a price which included the cost of delayed
payment. By implication, the tribunal
found that the business was simply the purchase and sale of the assets. Lombard were not money lenders.
[20] The required
split into two transactions was necessary only for the purposes of VAT. It had
no reality otherwise. Just as in Sovereign Finance, one could say that
there were two transactions, based on transaction number. Because the exercise was an artificial
construct for VAT purposes, one had an artificial result. Mr Melville [the Commissioners' witness] identified
a number of "processes". But it had to
be recalled that the question before the Tribunal was not the fairness and
reasonableness of Mr Melville's method. That method had not been directed by HMRC. Cross examination was directed at showing that
Mr Melville's method nevertheless demonstrated the artificiality at the core of
any method of attribution by reference to what was done: it could be done so
many ways. Mr Melville's method was
unworkable.
[21] It was not a
matter of evidence before the Tribunal whether as a matter of professional
expertise a fifty:fifty split was fair and reasonable. So far as reasons for the Tribunal's decision
were concerned, it could be assumed that the Tribunal had accepted the
reasoning which the taxpayer had advanced. It was a fair reading of what the Tribunal had
said that it had accepted the characterisation put forward by Lombard. The Tribunal had clearly accepted that the
transaction was a sale at a price including the cost of credit. There was an artificial split for purposes of
VAT that otherwise did not have to be made.
[22] Dealing with
Mr Currie's submissions, Mr Tyre argued in the first place there was only one
material fact: the nature of the
business, and it had been held there was only one transaction. Secondly, so far as explanations were
concerned, if one made the assumption that the taxpayer's submissions were
accepted, that provided a sufficient explanation. Thirdly, so far as Sovereign Finance was concerned, neither he nor the Tribunal placed
weight on the decision. But it provided
some support for giving equal weight to the two components of the transaction.
[23] It is
appropriate to deal with the case of Sovereign
Finance plc against the background of the letter and the submissions. Apart from narrating the likely significance
of the decision in explaining the departure of the industry representative body
from the agreed special method, the Tribunal does not deal with the case, and
places no reliance on it. In our view
the decision is not relevant to the question that arises in the present case. The decision was not concerned with whether
the special method in question was fair and reasonable, but with the very different
question whether in construing the formulae contained in the agreement a hire
purchase transaction was comprised of two "deals" or only one. Once it was concluded that hire purchase
comprised two transactions, one taxable and one exempt, and that each was a "deal"
for the purposes of the application of the special method in question, the
formula set out in the parties' agreement had to be applied on that basis. That is not an issue in the present case: there is no equivalent term for interpretation
in any special method, and in any event the parties agree that for VAT purposes
a hire purchase contract is comprised of two transactions, one of which is
taxable and one exempt.
[24] Despite Mr
Tyre's arguments based on the artificiality of any attempt to split the hire
purchase transaction into two components, it is fundamental to a proper
approach to this case to note that the contract does in fact have two
components that fall to be characterised differently for VAT purposes. It is because of that fact that any
attribution of input tax to the taxable component falls to be made. It is really nothing to the point that Lombard may not analyse the transactions in
that way for general business purposes. In the context of VAT, the necessary
hypothesis is that there are two transactions, each of which may cause Lombard to incur specific expenditure, and
both of which may cause the group to incur expenditure for mixed purposes. In evidence, Lombard appear to have adopted the extreme
position that none of the overhead expenditure allocated to instalment finance
could be related directly to either activity. There are no findings in fact that deal with
the point, but one must assume for present purposes that, on the accounting
system in force, that is so. However, it
requires little imagination to envisage a situation in which indirect
expenditure on, for example, the inspection of assets, their insurance, and the
monitoring of maintenance and repair during the contract period could be
attributed to an asset hire function, and on credit checking, for example,
attributed to the provision of finance. There
may be practical accounting problems when the taxpayer aggregates the whole
overhead expenditure of the group into a single control account and proceeds to
allocate the aggregate on a value basis as in step (i) of the method in this
case. But that tells one little about
the essential reality of an approach to attribution by reference to activity:
it tells one only that Lombard's accounting system, as described in evidence, is not
designed to produce a relevant result automatically.
[25] Given the
requirements of the statutory scheme, any special method of allocating input
tax as between the taxable and exempt transactions comprised in hire purchase
contracts must attempt to relate the goods and services consumed in the course
of administering the contracts to the two functions that require to be
performed: the purchase, hiring and disposal of the physical asset and the
provision of finance. Neither party
relied on the value of the supplies in this case. The Tribunal noted that a method based on
value would produce a high attribution to the taxable supply because "the goods
will almost invariably cost substantially more than the credit facility". That appears to confuse the cost of the input
supplies with the value of the output supplies which has to be the relevant
basis. The credit supplied by Lombard may exceed or be less than the purchase
price of the goods. Lombard obtain discounts from suppliers of assets that are not necessarily
passed on to its customers. In many cases customers are required to pay
deposits. The relative values of the
goods and of the finance provided are likely to be affected by the casual
features of individual transactions that might be difficult to accommodate in a
simple generally applicable formula. It
is unnecessary to form any view on the applicability of value-based methods,
however. Given the Tribunal's expressed view about such a method, it is plain
that a value-based approach formed no part of the decision in favour of Lombard's fifty percent attribution of input
tax to each of the supplies.
[26] The Tribunal's
decision states:
"In the first place the Tribunal had
no hesitation in deciding as a matter of fact that the 15% figure operated at
present did not produce a fair and reasonable attribution and was not of itself
either fair or reasonable. That was
clearly confirmed by the analysis conducted, whether misconceived or otherwise,
by Mr Melville when viewed after cross-examination. In the light of that the Tribunal considered
the Appellant's proposal, which since it had no competitor, fell to be judged
as whether it of itself could be regarded as a fair and reasonable result..."
[27] Thereafter,
having set out the approach to the exercise of its powers as set out in St Helen's School, the Tribunal states:
"Following that approach and
considering the facts in the present case we have decided that the proposed
special method on a transaction based approach is fair and reasonable and that
it is more fair and reasonable than the method in operation. No other method was suggested to replace the
unfair and unreasonable method currently operated. The Tribunal must not substitute its own
views. Accordingly we allow the appeal."
[28] It is
impossible to discern any basis for this decision other than the view that a
hire purchase transaction comprises, for VAT purposes, one taxable supply and
one exempt supply. In that respect the
analysis is not particular to Lombard: it would appear to be common to all hire purchase business
irrespective of the business practices of the taxpayer, so far as the reasoning
of the Tribunal discloses.
[29] Lombard's contentions included a number of
statements of fact. The first, reflected
in step (i) of the calculation, was that Lombard's total overhead expenditure
was not analysed out and could not be analysed out so as to identify overheads "attributable
principally or solely" to instalment credit business. Part of that expenditure was allocated to instalment
credit business on the basis of value, and that approach was not controversial.
Allocation by value is consistent with
the third element of the standard method. Since it must be capable of producing
a fair and reasonable result in any case in which the standard method is
applicable, it is a candidate for application generally.
[30] However, it is
impossible to say what the Tribunal made of the statement. It is not referred to in the decision. It is of the nature of the overheads in
question that they cannot be attributed "principally or solely" to a particular
activity: if they could the standard method would be applicable at least to
those solely attributable and one would have a basis in the assessment that
others were principally attributable to one activity or another for
proportionate attribution. It does not
follow that there cannot be a basis for the fair and reasonable attribution of
overheads to different activities. The fair and reasonable allocation of
overhead expenditure across the several activities of any commercial company
would appear to be an essential element of financial control. To fail to institute and maintain a system for
allocating general overheads in pricing products, or in accounting for
distribution and sale, might in some circumstances call in question the
management of the business.
[31] In the outline
submission, a similar point is reflected in paragraph 18: the overheads are said to be used in "an
undifferentiated and indistinguishable way".
The Tribunal has not made any finding in fact in relation to that
proposition. However, in narrating the
evidence of Mr Dagg, the Tribunal sets out a range of activities in a way that
shows that Lombard does carry out activities that relate directly to purchase
and disposal of the asset, and the condition of the asset and its maintenance
and repair throughout the contract period.
[32] Paragraph 14 of
that outline contains statements about the nature of the contracts used by Lombard, under reference to the examples
produced. On any view the analysis is
incomplete. The decision does not
discuss the contract forms. In
describing the business of Lombard, the Tribunal describes it as asset finance. The decision proceeds (pp.7-8) to describe the
transaction as "the purchase of an asset...by Lombard from a supplier and the hiring of
that asset to Lombard's customer on terms which provide
for the transfer of the title of the asset from Lombard when all payments on the hire
purchase agreement have been made." The
contract form provides for hire with an option to purchase at termination of
the contract period. Until the option is exercised, Lombard remains the owner of the asset. It is that element of the reality of the
transaction that explains the emphasis in the evidence of Mr Dagg (Lombard's witness) on Lombard's interest in the health of the
asset as such. It also underlines the
factor of time in the relationship between overhead expenditure and the hire
element of the contract.
[33] It is not
clear on what basis in fact the Tribunal concludes in relation to the business
that "In order to achieve a satisfactory transaction various activities are
undertaken by Lombard but ultimately the object is the provision of a sound
asset at a price which includes the cost of delayed payment" (p.8). On any view of the hire purchase contract
forms, Lombard has a commercial interest in obtaining a return on the funds
laid out to purchase and hire out the asset. The "Triple Choice Agreement" form allows the
customer three interest basis options: a
day to day compound interest basis; a balanced payment basis, also computed on
a day to day basis compound; and a fixed rate basis, each capable of producing
different total amounts of interest over the contract period. Again, Mr Dagg's evidence disclosed activities
relating to the financial aspects of the transaction. The evidence shows that Lombard, unsurprisingly, investigates the
credit worthiness of customers. There
are no findings in fact relating to this evidence or to how it might be reconciled
with the general statements in the submissions.
[34] For HMRC an
attempt was made to analyse the activities related to the operation of the
asset finance operations of Lombard. The decision tells
us (pp.10-11):
"In an attempt by the Respondents to
sub-divide the above transaction into 'processes' a document was produced and
spoken to my Mr Melville. While the
narration therein of what could be done was accepted as broadly correct, its
relevance and the attribution of various items as a 'process' were disputed.
Cross-examination of Mr Melville by Mr Tyre was destructive of virtually all Mr
Melville's conclusions and attributions.
Mr Tyre was able in his final
submissions virtually to reject the whole attribution by Mr Melville, although
Mr Tyre stressed that he was not to be taken as agreeing that the consideration
of 'processes' was relevant or the correct way to proceed."
The Tribunal does not
disclose what items in Mr Melville's analysis were not destroyed by cross
examination. Nor does it disclose what
the evidence was, nor, perhaps more crucially, does it disclose the basis on
which cross-examination was conducted. Attribution
of overhead expenses cannot in the nature of things be a matter of precise
science. What one is concerned with is
the fair and reasonable allocation of an undifferentiated sum. There are no findings in fact that relate to
that issue.
[35] There was a
clear requirement in the present case for the Tribunal to examine Lombard's overhead expenditure in some
detail and to set out and to explain its findings in fact on the basis of
whatever of that evidence was acceptable. As already mentioned, Mr Dagg's evidence
demonstrated that there was overhead expenditure that was closely, if not
directly, referable to the transactions relating to the asset. Similarly there
was expenditure that was closely, if not directly, referable to the
transactions relating to the provision of credit. In the nature of things there is likely to
have been expenditure that was not so related to either aspect of the
transaction. Without appropriate findings it is not possible to say how the
Tribunal approached these issues.
[36] The Tribunal
appears to have thought that it was following St Helen's School. However, there are aspects of that decision that
are not dealt with at all. At paragraph
[17] Warren J cites the Midland Bank
case, and the statement there that the cost components must generally have
arisen before the taxable transaction to which they relate. There may be difficulties in applying that
approach to overhead expenditure generally. But it draws attention to the need to relate
costs incurred to supplies over a period of time. The transaction basis on which Lombard relied arises at the point the
initial transaction is entered into. It
is established finally at that point, and is not affected by experience during
the currency of the hire contract or by any event that occurs. It does not vary during the contract period,
and it subsists irrespective of the actual experience of the parties relating
to that contract, and the costs incurred by Lombard in the performance of its
obligations under the contract or in the administrative steps required to
protect its interests as owner during the contract period. Without a clear explanation it is impossible
to understand how the analysis of the transaction into two elements for VAT
purposes, which Lombard insisted is a wholly artificial construct for tax
purposes only, could in any real sense be an appropriate proxy for the use of
the group's overhead expenditure. In the
end of the day the Tribunal provides no explanation of the basis of its
decision
[37] It is apparent
that there are methods of allocating the input tax incurred by Lombard. Mr Tyre produced an analysis based
on examination of "processes" which differed in its result from that produced
by Mr Melville. An analysis of
activities might have been a better way of expressing the exercise. "Process" accounting might best be left to
manufacturing industry. But there is
nothing unreal or artificial in posing the question whether particular input
tax arises in respect of an activity that has a connection with the
administration of the asset hired or with the administration of credit. If such an approach is to be rejected it must
be for reasons particular to the case that require to be explained so that they
can be tested. As an alternative, value
might have been considered as a possible basis for a result approximating to
that sought by Lombard. This is not a case in which one
is driven to a wholly artificial result on the simple premise that the exercise
is founded on a wholly artificial construct required for VAT purposes. The scheme of the statute requires one to make
an allocation. The fairness and
reasonableness of the method adopted must depend on facts found on the basis of
the evidence.
[38] In the
circumstances it is clear that the Tribunal's decision cannot stand and must be
quashed. The first two arguments
advanced by Mr Currie are sound: there
are no relevant findings in fact sufficient to support the decision of the
Tribunal and its decision is, in substance, unexplained. A question arose whether in the event of such
a view being taken the case should be sent back to the Tribunal. However, there is no basis on which the case
could be sent back other than for re-hearing. It is open to either party to give notice to
the other in terms of regulation 102A or C contending that the current special
method does not fairly and reasonably represent the extent of use of goods and
services used in making taxable supplies. That is the approach that Lombard must take to re-open the issue.
