FIRST DIVISION, INNER HOUSE, COURT OF SESSION |
|
Lord PresidentLord KingarthLord Penrose |
[2008] CSIH49OPINION 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 _______ |
Act: Currie, Q.C.; Shepherd & Wedderburn, W.S.
Alt:
[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.
[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,
[3] In the
conduct of its business
[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.
"[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.'
[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
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
[12] The method
proposed by
[13] The basis on
which that was proposed was set out in a letter to the Commissioners dated
"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
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
...
14.
The nature of
15.
For VAT purposes, and only for
VAT purposes, it is necessary to characterise the supply by
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
[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
[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.
[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
[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
[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.
[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
[29]
[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
[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
[34] For HMRC an
attempt was made to analyse the activities related to the operation of the
asset finance operations of
"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
[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
[37] It is apparent
that there are methods of allocating the input tax incurred by
[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