First-tier Tribunal (Tax)

[2010] UKFTT 332 (TC)

TC00617

Appeal number: TC/2009/09916

PARTIAL EXEMPTION – ECJ decision after special method approved – whether special method continues in spite of the decision – yes – appeal dismissed

FIRST-TIER TRIBUNAL

TAX

MERCEDES-BENZ FINANCIAL SERVICES LIMITED                                                       Appellant

                                                                      - and -

                                 THE COMMISSIONERS FOR HER MAJESTY’S

                                                   REVENUE AND CUSTOMS               Respondents

                        TRIBUNAL: JOHN F AVERY JONES CBE (TRIBUNAL JUDGE)                                                                                                     

Sitting in public at 45 Bedford Square, London WC1 on 1 July 2010

Geoffrey Tack, DLA Piper UK LLP, for the Appellant

Philippa Whipple QC, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.       Mercedes-Benz Financial Services Limited appeals against a decision dated 23 March 2009, and against the rejection of a voluntary disclosure dated 24 June 2009 in respect of periods 08/05 and 02/06.  The Appellant was represented by Mr Geoffrey Tack, and the Respondents (“HMRC,” which I shall use to include its predecessor HM Customs and Excise Commissioners) by Miss Philippa Whipple QC.

2.       The issue in this appeal concerns the effect of an ECJ decision, Nordania Case C-98/07, on an existing partial exemption special method.

3.       The facts are not in dispute.  I find the following facts:

(1)        The Appellant operates a financial business which includes the finance leasing of motor cars, which are sold after the end of the lease.  It is partly exempt.

(2)        On 12 June 2002 the Appellant and HMRC agreed a partial exemption special method that determined the recoverable input tax by the ratio of taxable supplies to total supplies subject to various conditions but expressly provided for the exclusion from the ratio of “Supplies arising from the disposal of goods, which have been used for the purposes of making supplies of leasing services.”  This was in addition to the exclusion of supplies of capital goods in accordance with reg 101(3) of the VAT Regulations 1995.

(3)        Following Nordania the Appellant seeks to include supplies from the disposal of leased goods (“leased goods supplies”) in the calculation.

4.       Article 17(5) of the Sixth Directive (now 173(2)(c) of the Principal VAT Directive) provides:

“5.     As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which value added tax 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.

This proportion shall be determined, in accordance with Article 19, for all the transactions carried out by the taxable person.

However, Member States may:

 (a)     authorise the taxable person to determine a proportion for each sector of his business, provided that separate accounts are kept for each sector;

 (b)     compel the taxable person to determine a proportion for each sector of his business and to keep separate accounts for each sector;

 (c)     authorise or compel the taxable person to make the deduction on the basis of the use of all or part of the goods and services;

 (d)     authorise or compel the taxable person to make the deduction in accordance with the rule laid down in the first sub-paragraph, in respect of all goods and services used for all transactions referred to therein;

 (e)     provide that where the value added tax which is not deductible by the taxable person is insignificant it shall be treated as nil.”

5.       Mr Tack, for the Appellant, contends that:

(1)        Nordania requires the inclusion of leased goods supplies and accordingly HMRC is unlawfully retaining such sums.

(2)        The overpayment can be corrected as an error made by the Appellant in accounting for VAT (reg 35 of the VAT Regulations 1995) or as overpaid VAT (reg 37).

6.       Miss Whipple, for HMRC, contends:

(1)        Nornania concerns Danish legislation giving effect to art 19 of the Sixth Directive and has no direct application to the UK where the legislation is a reasonable use method following art 17(5), even though the result is similar in outline to art 19.

(2)        The special method continues until it is varied or replaced by agreement.

7.       I start by considering Nordania.  The taxpayer in that case carried on a similar business to the Appellant.  As mentioned, Danish law follows art 19 of the Sixth Directive, and art 19(2) excludes supplies of capital goods from the calculation.  The taxpayer took the view that disposals of leased vehicles on termination of the lease were not capital goods and included leased goods supplies in the calculation.  The tax authority contended that these should be excluded as supplies of capital goods.  The ECJ decided that the leased goods supplies were not of capital goods.  The purpose of the exclusion of capital goods was to prevent distortion of the calculation caused by sales of an unusual nature outside the normal activities of the taxpayer.  Here the leased goods supplies that took place at the termination of the vehicle leases were part of the normal taxable activities of the taxpayer:

22      The objective of Article 19(2) is apparent from the Explanatory Memorandum to the proposal for the Sixth Directive, which was submitted by the Commission of the European Communities to the Council of the European Communities on 29 June 1973 (see Bulletin of the European Communities, supplement 11/73, p. 19), according to which ‘[t]he factors mentioned in this paragraph must be excluded from the calculation of the proportion lest, being unrepresentative of the taxable person’s business activity, they should deprive the amount of any real significance. Such is the case with sales of capital items and real estate and financial transactions which are only ancillary operations, that is to say are only of secondary importance in relation to the total turnover of the business. These factors are only excluded if they are not part of the usual business activity of the taxable person’.

23      In that regard, the Court has already held that the purpose of excluding incidental financial transactions from the denominator of the fraction used to calculate the deductible proportion in accordance with Article 19 of the Sixth Directive is to comply with the objective of complete neutrality guaranteed by the common system of VAT. If all receipts from a taxable person’s financial transactions linked to a taxable activity were to be included in that denominator, even where the creation of such receipts did not entail the use of goods or services subject to VAT or, at least, entailed only their very limited use, calculation of the deduction would be distorted (Case C-306/94 Régie dauphinoise [1996] ECR I-3695, paragraph 21).

24      By adopting the provisions of Article 19(2) of the Sixth Directive, the Community legislature thus intended to exclude from the calculation of the proportion the turnover attributable to a sale of goods where that sale is of an unusual nature in relation to the normal activities of the taxable person concerned and does not therefore require the use of goods or services for mixed use in a way that is proportionate to the turnover which it generates. As the Advocate General stated in point 68 of his Opinion, the inclusion of that turnover in the calculation of the deductible proportion would distort the resultant figure in the sense that it would no longer reflect the division of use of goods or services for mixed use as between taxable and exempt activities respectively.

25      In those circumstances, the notion of ‘capital goods used by the taxable person for the purposes of his business’ within the meaning of Article 19(2) of the Sixth Directive cannot include capital goods the sale of which is, for the taxable person concerned, in the nature of a normal business activity. For the party concerned, the purchase and subsequent sale of such goods means that it has to use goods and services for mixed use on an everyday basis. Since that sale is part of the normal taxable activities of the taxable person, the turnover attributable to it must be taken into account in the calculation of the deductible proportion in order for that proportion to reflect as accurately as possible the division of use, in respect of those activities, of the goods and services put to mixed use, since otherwise there would be a failure to have regard to the objective of the neutrality of the common system of VAT.

26      Therefore, if, as in the case in the main proceedings, the sale, on termination of the leasing contracts, of the vehicles covered by those contracts is in the nature of a normal activity for the taxable person concerned, who carries out that activity by way of business and as a matter of course, it would be contrary to that objective of neutrality if that taxable person were not actually relieved of the portion of VAT imposed on the overall costs incurred to effect that sale and thus to carry on its usual taxable business activity. It follows that the turnover attributable to such a sale cannot be considered to relate to ‘capital goods used by the taxable person for the purposes of his business’ within the meaning of Article 19(2) of the Sixth Directive.

8.       If therefore the UK had adopted art 19 it is clear that the Appellant’s leased goods supplies are not capital goods and cannot be excluded from the partial exemption calculation on that ground.  But I agree with Miss Whipple that the UK does not adopt art 19 as such but, as authorised by art 17(5), makes Regulations “for securing a fair and reasonable attribution of input tax” (s 26(3) VATA 1992), namely reg 101, which is similar, but not identical, to art 19.   However, by reg 102(1)

“the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101”

which they have done by approving the Appellant’s special method.  By reg 102(3):

“A taxable person using a method as approved or directed by the Commissioners…shall continue to use that method unless the Commissioners approve or direct the termination of its use.”

No such approval or direction has been made by HMRC.

9.       It follows that while leased goods supplies are not supplies of capital goods and cannot be excluded on that ground, there is nothing to prevent them from being excluded for some other reason in a special method, and such special method will continue to govern the deduction of input tax until it is varied or terminated.  Miss Whipple points to a similar situation in Oxfam v HMRC [2010] STC 686, where the basis of a special method was changed by a subsequent domestic decision.  Sales J said at [43]:

“Oxfam and HMRC specifically agreed the approved method formula on the basis that the denominator of the approved method formula should include the value of unrestricted fundraising (see paras 67(3) and 88 of the decision), so giving a recovery rate for input tax of about 75 per cent which each party regarded as reasonable. There was no agreement that the approved method formula should be capable of operating in any different way, if the general understanding of the law might happen to change in some respect (as occurred with the judgment in the Church of England Children's Society case [2005] STC 1644). That might undermine the intended effect of the agreement, to produce a reasonable relationship between recoverable input tax and the proportion of Oxfam's activities which involved the making of taxable supplies (as would indeed be the case if the operation of the approved method formula were changed in the light of the judgment in the Church of England Children's Society case, since a reasonable rate of recovery of 75 per cent of input tax would be increased to an unreasonable rate of 85–90 per cent).”

10.    The Appellant is not without remedies.  If it does not now like the special method that HMRC has approved it must seek their agreement to bring it to an end, including the possibility of doing so retrospectively (reg 102(4), providing that a direction for a special method applies from the date the Commissioners give the direction, applies only to the “direction” not the “approval” of a special method).  Alternatively, it can serve a notice under reg 102C:

“(1)     Subject to regulation 102A, where a taxable person—

(a)     is for the time being using a method approved or directed under regulation 102, and

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

the taxable person may serve on the Commissioners a notice to that effect, setting out his reasons in support of that notification.

(2)     Where the Commissioners approve a notice served under this regulation, the effect is that regulation 102B shall apply to the person serving the notice in relation to—

(a)     prescribed accounting periods commencing on or after the date of the notice or such later date as may be specified in the notice, and

(b)     longer periods to the extent of that part of the longer period falling on or after the date of the notice or such later date as may be specified in the notice.”

11.    Accordingly, I dismiss the appeal.

12.    This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

JOHN F AVERY JONES

TRIBUNAL JUDGE

RELEASE DATE: 14 July 2010