DECISION
1. Volkswagen
Financial Services (UK) Limited (“VWFS”) appeals against an assessment to VAT
in the sum of £498,866 for periods 10/07 to 3/08 issued by HMRC on 16 June 2008
and a decision letter dated 30 September 2008 by which, upon reconsideration of
the assessment, HMRC upheld it.
2. The
dispute between the parties concerns what is a fair and reasonable
apportionment of residual input tax on costs incurred by VWFS in a particular
sector of its business, the Retail sector, which is one of a number of sectors
included in VWFS’s approved partial exemption special method (“PESM”).
Specifically, the dispute relates to the recovery of residual input tax in
respect of hire purchase transactions which, it is accepted, involve both a
taxable supply of the vehicle being financed, and an exempt supply of finance.
3. Whereas
in relation to sectors of VWFS’s business other than Retail the PESM operated in
respect of residual input tax according to a formula taking the value of
taxable transactions made by a particular sector in the relevant period as a
proportion of the value of total transactions, no agreement could be reached on
an appropriate formula for Retail. Instead, the issue was effectively
postponed, to be subject to resolution of the dispute, by providing in the PESM
that residual input tax was to be recoverable for the Retail sector:
“to the extent that it is incurred on goods or
services which are used to make taxable supplies, expressed as a proportion of
the whole use or intended use.”
4. This
formulation does not of course answer the question how the proportion of use is
to be ascertained. The parties put forward different methodologies for the
Retail sector, which each claims is fair and reasonable. VWFS’s preferred
methodology is to quantify the ratio of taxable transactions to total
transactions, counting every HP agreement as two transactions (one taxable, one
exempt), every leasing transaction as two transactions (both taxable) and every
fixed price service and maintenance contract as one (taxable) transaction. On
this basis, 50% of the residual input tax referable to HP transactions is
recoverable.
5. HMRC
take a different approach. Their preferred method is to allocate input tax
between HP transactions, leasing transactions and service and maintenance
contracts on a contracts count basis and then to apportion the tax using the
value of taxable and exempt outputs in each sub-sector. In relation to HP
transactions, however, no account is taken of the value of the vehicle. This
substantially eliminates the taxable value of the HP transactions, and results
in most of the residual input tax apportioned to those transactions being
irrecoverable.
6. Nicola
Shaw and Michael Jones appeared for VWFS. Owain Thomas represented HMRC.
The facts
7. We
had a helpful Agreed Statement of Facts, which we reproduce below. We also had
witness statements from seven witnesses for VWFS: Graham Wheeler, managing
director, David Maloney, business development director, Philip Wood, e-commerce
director, David Heathfield, head of customer services and Norma Doherty,
indirect tax accountant (all of whom also gave oral evidence and were subject
to cross examination) and John Thirlwell, in-house solicitor and Robert
Newbold, group finance director of the Vindis Group, a retailer of VW motor
cars. For HMRC we had two witness statements from Jonathan Cannan, an indirect
tax specialist with HMRC Large Business Service. We also had two bundles of
documents.
Agreed statement of facts
8. We
set out here the agreed statement of facts:
1. The Appellant is the representative member of the
VWFS VAT group. The Appellant is a wholly owned subsidiary of Volkswagen
Financial Services AG, which is ultimately owned by Volkswagen AG.
2. The Volkswagen AG Group owns a number of brands
or marques of vehicle (“Group Brands”): these include Volkswagen Cars,
Volkswagen Commercial Vehicles, Audi, SEAT and Skoda.
3. In the course of its business, the Appellant
makes a number of taxable and exempt supplies. The Appellant is, therefore, a
partially exempt trader.
4. The Appellant’s business comprises a number of
different sectors:
(1) Retail – (i) entering into hire purchase (“HP”)
agreements with customers in respect of Group Brand vehicles; (ii) entering
into leasing agreements with customers in respect of Group Brand vehicles; and
(iii) fixed price service and maintenance contracts on Group Brand vehicles;
(2) Wholesale – providing funding to dealers of
Group Brand vehicles for the purchase of demonstrator vehicles and stock (new
and used cars);
(3) Volkswagen Insurance Services (“VIS”) – the arrangement of insurance for owners of Group Brand vehicles and dealers of
Group Brand vehicles;
(4) Asset Backed Securitisation (“ABS”) – servicing
(and reporting on) securitised hire purchase contracts;
(5) Contract Disposals – the disposal of previously
leased and/or repossessed Group Brand vehicles; and
(6) Catch All – miscellaneous items, such as the
provisions of training programmes or the rental of signage to dealers of Group
Brand vehicles.
5. In the course of its business, the Appellant
incurs input tax, some of which is directly attributable to the making of either
taxable or exempt supplies and some of which is not directly attributable to
the making of taxable or exempt supplies (ie is residual input tax).
6. The residual input tax in question relates to
everyday overhead expenditure, such as: (i) temporary staff, staff training and
recruitment; (ii) hotel accommodation, staff meals and drinks; (iii) travel,
parking, road tolls and car hire, service and repairs; (iv) marketing and
corporate hospitality; (v) IT maintenance and enhancement; (vi) heating, lighting,
cleaning, security and other premises costs; (vii) furniture leasing; (viii)
couriers, stationary, printing, photocopying and archiving; and (ix) legal, tax
and accounting expenses.
7. On 11 September 1984 HMRC and the Finance Houses
Association (now known as the FLA) agreed a partial exemption special method
(“PESM”) to establish the proportion of recoverable residual input tax incurred
in relation to HP transactions. Pursuant to that agreement, the recoverable
input tax in respect of HP transactions was as follows:
(a) all of the input tax incurred on the goods; plus
(b) 15% of the residual input tax.
8. On 4 August 2000, the Appellant agreed a PESM
with HMRC in respect of its residual input tax. This PESM distinguished the HP
part of the Appellant’s business from the rest of its business. The recoverable
proportion of the residual input tax allocated to the HP part of the business
was restricted to 15% in accordance with an agreement between HMRC and the FLA and an additional 5.4% was allowed to reflect services provided to the Asset Backed
Securitisation sector. The recoverable proportion of the remainder of the
residual input tax was established by a values-based formula similar to the
standard method, namely by reference to the ratio of taxable income to total
income.
9. At some point in 2000, the FLA withdrew from the
agreement of 11 September 1984.
10. Following a number of meetings between the
parties to discuss updating the agreed PESM, on 2 February 2007, the Appellant
wrote to HMRC to suggest a new PESM (“the New PESM”) which apportions the
residual input tax between sectors (1)-(5) above in proportion to the turnover
of each sector and then applies the following methodologies to quantify the
recoverable input tax for each sector:
(i) for Retail, the proportion of recoverable input
tax is quantified by reference to the total number of taxable transactions to
total transactions; and
(ii) for Wholesale, VIS, ABS and Contract Disposal,
the proportion of recoverable residual input tax is quantified by reference to
the ratio of taxable income to total income in the sector;
11. HMRC approved the New PESM suggested by the
Appellant except in relation to the methodology proposed for Retail. In
addition, HMRC suggested a Catch All sector where the proportion of recoverable
residual input tax is quantified by reference to the extent to which it is
incurred on goods and services used to make taxable supplies, expressed as a
proportion of the whole use or intended use.
12. To enable the New PESM to operate pending the
resolution of the dispute as to the appropriate method for Retail, the parties
agreed to apply the same wording as for the Catch All sector, namely “input tax
allocated to this sector is deductible to the extent that it is incurred on goods
or services which are used or to be used to make taxable supplies, expressed as
a proportion of the whole use or intended use”.
13. The agreement of the New PESM is recorded in a
letter of HMRC dated 6 December 2007.
14. The New PESM has been applied with effect from 1
October 2007. For VAT periods 10/07 to 07/08 the Appellant applied its
preferred method to Retail and HMRC raised assessments based on its preferred
method. The Appellant appealed against those assessments.
15. From VAT period 10/08 onwards, the Appellant has
applied HMRC’s preferred method to Retail and has submitted voluntary
disclosures for under-claimed input tax. HMRC has rejected those voluntary
disclosures and the Appellant has appealed against those rejections.
16. HMRC’s preferred method for Retail is to
allocate input tax between HP transactions, leasing transactions and service
and maintenance on a contracts count basis and then to apportion the tax using
the value of taxable and exempt outputs in each sub-sector. In relation to HP
transactions, however, no account is taken of the value of the vehicle.
17. The Appellant’s preferred method for Retail is
to quantify the ratio of taxable transactions to total transactions, where
every HP agreement is counted as two transactions (one taxable, one exempt),
every leasing agreement is counted as two transactions (both taxable) and every
fixed price service and maintenance contract is counted as one transaction
(taxable).
Further findings of fact
9. From
the evidence and from the documents produced to us we find the following
further facts.
10. The retail
sector of VWFS’s business offers three types of what are termed “purchase
products” to both businesses and individuals. Although they have different
descriptions: hire purchase, “Solutions” and lease purchase, they all comprise
types of hire purchase contracts that are the subject of the disputed element
of the PESM.
11. In respect of
each of the purchase products VWFS purchases the vehicle from the retailer and
supplies it to the customer on deferred payment terms under an HP agreement.
Under the HP contracts title to the vehicle does not pass to the customer until
all payments due under the terms of the agreement have been paid. This
business is fully regulated, including under the Consumer Credit Act 1974. VWFS
is deemed to be the supplier of the vehicle under the HP agreement and as such
a number of terms are implied by law into the HP agreement for the protection
of the customer, including a condition that the vehicle is of satisfactory quality.
Although VWFS would nevertheless have its own recourse to the retailer in this
respect, this liability has the effect that the service provided by VWFS is not
limited to the provision of funding, but extends to the provision of support in
terms of the vehicle itself, such as dealing with complaints regarding quality.
12. The three types
of purchase product may be described as follows:
(1)
Hire purchase. This is essentially a conventional HP agreement
under which the customer pays a deposit and the balance is paid off by monthly
payments divided equally over the term of the contract. On payment of the
final instalment and an option to purchase fee, title passes to the customer.
(2)
Solutions. This is essentially a personal contract plan under
which a proportion of the cost of the vehicle is deferred until the end of the
contract. A small sum is initially paid up front and then low monthly payments
are made throughout the term of the contract, with a final “balloon” payment at
the end. This final payment represents a significant proportion (which could
be anything up to 90%) of the total value of the vehicle. When the contract
reaches maturity (that is, when the final balloon payment is due to be paid),
the customer has four options:
(a)
pay the balloon payment and a small “option to purchase” fee to take
title to the vehicle;
(b)
return the vehicle to Volkswagen without any further payment;
(c)
part-exchange the vehicle with Volkswagen and begin a new finance
agreement in respect of another vehicle; or
(d)
re-finance the balloon payment so that the customer can retain the car
but further spread the cost.
(3)
Lease purchase. This product was designed for business customers
who want the option of owning a fleet of vehicles at the end of the finance
term. The customer chooses the repayment schedule (which can be anything from
one to four years) and a part of the cost of the vehicles is delayed until a
balloon payment at the end of the agreement.
13. We were shown
copies of typical HP agreements regulated by the Consumer Credit Act 1974. Such
an agreement sets out the cash price of the vehicle, which is equal to the
price paid by VWFS to the retailer, with no mark up. From this there is
deducted any advance payment (such as a deposit), leaving an amount of credit
to be financed over the relevant period. The total amount payable (which
includes the advance payment) is specified, along with details of the monthly
and other payments to be made. The difference between the cash price and the
total amount payable is the total charge for credit, which is broken down in
the agreement between interest charges, and acceptance fee and an option to
purchase fee. The option to purchase fee and the acceptance fee are set at
market rates.
14. The market or
advertised rate of interest is determined by VWFS. It does this by applying a
margin for overheads, a profit margin and an allowance for bad debts to its own
cost of financing the vehicle. However, the VW brands use a range of
incentives to make their cars more attractive to consumers, including discounts
and free specification upgrades. The incentives also extend to the finance
options, including offers of low or zero rate finance and low deposit
requirements. If the VWFS market rate is higher than the VW brands wish to
offer to their customers, the brands can subsidise the difference by making
subvention payments to VWFS. The brands pay the difference to VWFS up front
out of their marketing budgets. The commercial risk of these incentives is
therefore borne by the VW brands.
15. From the
evidence we find that the overheads that are the subject of this appeal are
built into the interest rate, the option to purchase fee and the acceptance
fee. There is no separate fee charged to cover overheads. Overheads do not
form part of the cash price for the vehicle, as that merely reflects the price
paid by VWFS to the retailer.
16. We accept that
the primary purpose of VWFS’s finance packages is to aid the sale of Volkswagen
brand cars. VWFS is an in-house finance arm that does not provide any finance
other than in respect of VW brands. We also accept that the availability of
finance packages forms an integral element to the sales of cars to consumers,
by the VW brands and by the retailers. This is supported by VWFS in a number
of ways, including by training of retailers’ sales forces, and the use of an e-Learning
system that retailers can access as part of the marketing and sale of VW brand
vehicles. No separate charge is made by VWFS to VW brands or to the
dealerships for its involvement and support of marketing campaigns, although
some charges, principally for accommodation and out-of-pocket expenses, may be
made for participation in e-Learning. In general the cost is amortised across
VWFS’s whole operating budget.
17. We heard, and we
accept, that these systems, which VWFS has designed and implemented, are
designed for the following purposes:
(a)
to train, monitor and incentivise the retailer’s sales force;
(b)
to enable the retailer to configure a vehicle for his customer and to
provide a series of quotes based on the different purchase products offered by
VWFS (namely, hire purchase, Solutions and lease purchase); and
(c)
to allow the retailer to prepare and submit a proposal to VWFS once the
customer has selected a particular vehicle and finance package and, once the
proposal has been accepted, to print out the customer agreement in the showroom
18. However, we also
find that those sales activities, although supported by VWFS, are carried on by
separate businesses to that which is the subject of this appeal. The same
applies to the collection of data to encourage customer retention. Those
separate businesses, even within the VW group, are not part of the same VAT
registration as VWFS.
19. The involvement
of VWFS in the sale of vehicles is limited to those cases where VWFS provides
the finance. VWFS is not a car dealership, and does not sell cars for cash.
VWFS only acquires the vehicle as part of the financing arrangements, at a time
when a customer has agreed to buy the car on those terms from the dealer.
20. The VWFS
business is organised into eight departments. The following is a brief
description of the functions and processes undertaken by each of them;
(1)
Treasury department. VWFS’s own funding requirements (that is,
in respect of the funding of the vehicle from the dealer and the supply of
credit to the customer) are met by a combination of internal borrowings (that
is, from other VW group companies), external borrowings and from securitisation
activities. Securitisation activities relate solely to the funding of the
retail HP business.
(2)
Marketing and development department. This department works very
closely with the VW brands to develop joint marketing campaigns. VWFS’s own
external marketing budget is relatively low on account of the fact that the VW
brands bear most of the cost, and reliance is placed on the existing dealer
network. The external budget is reserved for the development of point-of-sale
marketing materials for dealers and for direct marketing campaigns to existing
customers. The hire purchase options are an integral part of the dealers’
sales processes. Because the “route to market” for VWFS is through the VW
brands dealership network, the marketing department focus is not primarily on
the end consumer, but is on the VW brands and the dealerships. However, direct
marketing to customers is also an important element: VWFS retains contact with
the customer after the sale of the vehicle (for example, by collecting monthly
payments or dealing with customer enquiries and complaints) and consequently
collects and retains an extensive amount of information on its customers.
(3)
Sales department. This department, through its business
development managers, works with the retailers. This includes provision of
training to the retailers’ staffs in the use of the VWFS purchase products.
The department is also responsible for defining the funding terms with a
retailer. The funding terms include the basic rate of interest that the
retailer can offer the customer and the level of retailer bonuses and
commissions. There is some degree of flexibility with respect to price and
funding structures that may be offered. The performance of the retailer is
monitored and the bonuses and commissions paid by VWFS are administered
accordingly.
(4)
New business department. This department sets up the new
contracts with customers. Once the retailer has agreed with the customer the
specifications of the vehicle and the terms of the finance, he uses VWFS’s
web-based system (Connect Online) to apply for a credit agreement on behalf of
the customer. Based on credit checks made through the system, an application
may be “auto approved”. If it is not so approved, VWFS staff will make the
underwriting decision whether to approve or decline the application. Following
signing of the agreement, VWFS checks, through an HPI registration check, that
no other person has an interest in the vehicle; this is to ensure that the
vehicle provides reasonable security for the financing. Following checking,
VWFS purchases the vehicle from the retailer and enters into the HP agreement
with the customer.
(5)
Customer services department. This department is responsible for
liaising with the customers and providing services to them during the currency
of the contract with VWFS. This includes dealing with customer complaints. The
department receives a significant number of telephone enquiries each month.
These relate primarily to (i) early settlement of the contract, (ii) voluntary
termination, (iii) processes, in particular balloon payments and part exchange
and other options on solutions and lease purchase contracts, relating to the
end of a contract, (iv) making payments, (v) clearance that VWFS no longer has
an interest in the vehicle, (vi) data changes, such as change of address, and
(vii) complaints about the service or the car.
Complaints about the quality
of the vehicle are also received in writing. As VWFS is the supplier under the
finance contract customers are entitled to make complaints about the quality of
the vehicle direct to VWFS. However, complaints are generally passed on to VW
brands or to the retailer, who typically bear the cost if a complaint is valid,
although we heard, and we accept, that in practice VWFS bears an equal
proportion of cost in certain cases.
(6)
Risk department. This deals with cases where a customer falls
into arrears, including, in appropriate cases, repossession of the vehicle. If
a vehicle is repossessed it is taken by an agent of VWFS to an auction house
for resale. The department is also responsible for setting the residual value
of the vehicle in order to protect VWFS’s asset, and for setting the amount of
the balloon payment on an applicable contract.
(7)
Finance department. This department comprises Tax, Shareholder
Reporting, Controls (responsible for forecasting and budgeting) and Finance
Operations. Its activities cover the traditional transaction processing
activities of sales and purchase ledger, financial accounting, cash processing
and controls. The work includes the processing of bank collection runs to
receive money from retail customers and cash from the sale of vehicle
disposals, the payment of suppliers and the payment of retailers for vehicles.
(8)
IT department. This department is responsible for building,
maintaining and developing all the IT systems used by VWFS across its business.
This includes the bespoke Contract Management Systems (incorporating Finance
Online and Connect Online), and other non-bespoke systems. It is also
responsible for the maintenance and development of the web-based browser
applications and the daily running of the desk top PCs within VWFS, working
closely with other departments. Retailers have direct contact with the IT
department if they have problems accessing or using the web-based platforms.
VWFS accounts
21. We were shown
the accounts of VWFS for the year ended 31 December 2007, which were
representative of accounting entries made for the relevant periods.
22. In the
directors’ report the principal activities of the company were described thus:
“The principal activity of the company is the
provision of retail, business user and fleet finance to the customers of the
Volkswagen Group United Kingdom Limited franchised dealer networks. In
addition to this the company provides various insurance and service and
maintenance products, along with business development activities to the
retailer networks.”
23. The same report
notes that in 2005 the company had undertaken a strategic review and had
subsequently chosen to strengthen its position as an automotive captive finance
supplier to the VW group brands. Closer relationships had been developed with
the VW group to achieve common goals.
24. The notes to the
accounts, in the description of principal accounting policies, describe the use
of lessor accounting for finance leased assets, including hire purchase and
lease purchase. Interest income is included in turnover. However, turnover
does not include that part of the payments under the hire purchase and lease
purchase contracts that relates to the purchase price of the vehicle. Only the
finance charge is included in turnover.
The agreed PESM
25. The PESM divides
the business into six sectors (Retail, Wholesale, Volkswagen Insurance
Services, Asset Backed Securitisation, Contract Disposal and “Catch All”). The
first stage for the attribution of input tax ignores the division into
sectors. It is to identify all supplies, acquisitions and imports used, or to
be used, exclusively in making taxable supplies; the input tax thereon is
recoverable. The same process is performed in relation to exempt supplies or
activities other than the making of taxable supplies; that input tax is not
recoverable. Input tax which cannot be directly attributed in this way is
dealt with as follows:
(a)
First, all supplies etc which are used, or to be used, exclusively
within a single sector are identified; the input tax thereon is allocated in
full to that sector.
(b)
For input tax which cannot be directly attributed or allocated in full
to a single sector, a proportion of the residual input tax is allocated to each
of the sectors and the corresponding recovery rate is then ascertained by
applying the appropriate methodology. This allocation is done on a value
basis: the input tax is allocated between the sectors in the same ratio as the
value of supplies made by each sector bears to the total value of supplies made
by all the sectors. However, in making these apportionments the value of vehicles
sold on under hire purchase agreements is excluded.
26. For each of the
sectors other than Retail and Catch All, the recoverable input tax is
ascertained by applying a formula to the residual input tax apportioned to that
sector. In each case the formula compares the value of taxable transactions in
the sector with the value of total transactions for the relevant period. For
each of Retail and Catch All, non-attributable input tax allocated to the
sector is deductible to the extent that it is incurred on goods and services
which are used or to be used to make taxable supplies, expressed as a
proportion of the whole use or intended use.
Retail sector: VWFS methodology
27. The starting
point for the methodology put forward by VWFS as fair and reasonable in
relation to the Retail sector is that within the Retail sector there are both
taxable and exempt supplies. The supplies in relation to contract hire and
service contracts are taxable. But in relation to hire purchase transactions
there is no single supply; the sale of the car is a taxable supply, and the
provision of finance is an exempt supply. The VWFS methodology accordingly
identifies these supplies and weights each transaction within the sector with
the aim of ensuring that the computation accurately reflects the extent to
which the various transactions use the overheads to which the residual input
tax relates.
28. On this basis
the VWFS methodology proposes that hire purchase transactions are treated as
two transactions (one taxable, one exempt). Contract hire transactions are
taxable transactions, but the method proposes that they be given an equal
weighting to hire purchase transactions on the basis that they consume the same
amount of overheads as those transactions; contract hire transactions are
accordingly also given a weighting of two (both taxable). Service contracts
are not regarded as using as much of the overhead cost, and so are counted as
one (taxable) transaction.
29. A simple
calculation is then made by applying to the residual input tax allocated to the
Retail sector the proportion which the number of taxable transactions
(calculated according to the weighting given) bears to the total number of
transactions (so calculated). The number of transactions is not related to the
number of contracts, but to the payments, usually monthly, made under those
contracts.
HMRC methodology
30. HMRC’s
methodology applies a transaction-count basis to apportion the residual input
tax attributable to the Retail sector between the three activities of contract
hire, hire purchase and service contracts. Each deal is treated as one
transaction, not weighted in the manner of the VWFS methodology, which has the
effect that an equal amount of input tax is allocated to each.
31. Each amount of
input tax so allocated is then apportioned between taxable and exempt supplies
based on the value of those supplies, but excluding the value of the initial
supply of the vehicle under a hire purchase contract. Despite the value of
this initial supply being excluded (with the result that the value of the hire
purchase transaction will largely be attributable to the exempt supply of
finance), some of the residual input tax allocated to hire purchase contracts
is recoverable because recovery is given against the other taxable supplies
made under such contracts, such as settlement charges and option to purchase
fees.
The law
32. Article 2 of the
First Council Directive of 11 April 1967 (67/227/EEC) (“the First Directive”)
provides as follows:
“The principle of the common system of value added
tax involves the application to goods and services of a general tax on
consumption exactly proportional to the price of the goods and services,
whatever the number of transactions which take place in the production and
distribution process before the stage at which tax is charged.
On each transaction, value added tax,
calculated on the price of the goods or services at the rate applicable to such
goods or services, shall be chargeable after deduction of the amount of value
added tax borne directly by the various cost components.
The common system of value added tax shall be
applied up to and including the retail trade stage.”
33. Articles 167 to
177 of EU Council Directive of 28 November 2006 (2006/112/EC) (“the Principal
VAT Directive”) provide for the deduction of input tax in so far as it is used
in the making of taxable supplies. Article 173 provides:
“In the case of goods and services used by a taxable
person both for [taxable and exempt transactions], only such proportion of the
value added tax as is attributable to [taxable] transactions shall be
deductible.”
34. Articles 173 to
175 establish the method by which the deductible proportion is to be
determined. The standard method (in Article 173(1)) is that the deductible
proportion is equivalent to the ratio of taxable turnover to total turnover.
However, Member States are permitted to derogate from the standard method and
can authorise alternative methods of establishing the deductible proportion
including on a sector by sector basis (Article 173(2)(a)) or a “use method”
basis (Article 173(2)(c)).
35. The right to
deduct input tax is implemented in UK law by s 26 VATA. That provides that the
amount of credit for input tax is that which is allowable under regulations as
attributable to, relevantly, taxable supplies made by a taxable person in the
course or furtherance of his business. Section 26(3) provides for HMRC to make
regulations for securing a fair and reasonable attribution of input tax to
taxable supplies.
36. The method for
establishing the fair and reasonable attribution of input tax to taxable
supplies and, in a case where goods and services are used for both taxable and
exempt supplies, a fair and reasonable proportion of input tax attributable to
taxable supplies, is prescribed by regulations 101 and 102 of the Value Added
Tax Regulations 1995 (SI 1995/2518) So far as material, regulation 101
provides:
“(1) … the amount of input
tax which a taxable person shall be entitled to deduct provisionally shall be
that amount which is attributable to taxable supplies in accordance with this
regulation.
(2) … in respect of each
prescribed accounting period—
…
(b) there shall be
attributed to taxable supplies the whole of the input tax on such of those
goods or services as are used or to be used by him exclusively in making
taxable supplies,
(c) no part of the input tax
on such of those goods or services as are used or to be used by him exclusively
in making exempt supplies, or in carrying on any activity other than the making
of taxable supplies, shall be attributed to taxable supplies,
(d) … there shall be
attributed to taxable supplies such proportion of the residual input tax as
bears the same ratio to the total of such input tax as the value of taxable
supplies made by him bears to the value of all supplies made by him in the
period,
(e) the attribution required
by subparagraph (d) above may be made on the basis of the extent to which the
goods or services are used or to be used by him in making taxable supplies, …”
37. Regulation 102
provides for the approval or direction by HMRC of a method other than that
specified in regulation 101. Approval was given to the special method of VWFS
that is the subject of this appeal.
Discussion
38. The dispute in
this case is on the methodology which VWFS has adopted, and wishes to adopt,
under its special method, in determining a fair and reasonable proportion of
the input tax it incurs on its overhead expenses which is attributable to the
taxable supplies it makes in the supplies of vehicles under HP agreements, and
should consequently be recoverable.
39. We have
described earlier the method which VWFS proposes to achieve such an
attribution. It does not look to the value of the respective taxable and exempt
supplies; it is common ground that such a values-based method would not give a
fair and reasonable result. Instead it adopts a transaction count method,
giving equal weight in an HP transaction to the taxable supply of the vehicle
and the exempt supply of the finance. Thus, VWFS’s method provides for 50% of
that part of the overheads input tax that is apportioned to HP transactions to
be recovered.
40. HMRC dispute
that this method is fair and reasonable. They do so on the basis that this is
contrary to their published policy (and, as argued before us, contrary to
fundamental principles of VAT law). HMRC’s policy – which is now expressed in
Revenue & Customs Brief 82/09 - allows recovery of input tax allocated to
HP transactions in respect of taxable supplies such as the option to purchase
fee, but not to allow recovery in respect of the supply of HP goods (the
vehicles in this case) that are resold at cost without any margin to cover
overhead costs. As Business Brief 82/09 describes it, as there is no margin on
the HP goods, the cost of the overheads will normally be built into the price
of the supply of credit. HMRC’s view is that the overheads in these
circumstances are purely cost components of the exempt supply. They point to
the fact that, if recovery is otherwise enjoyed, a business would continually
enjoy net VAT refunds despite charging a total consideration under the HP
agreement that fully recovers its costs and an element of profit. HMRC say
that their method reflects this policy.
41. That is the full
extent of the dispute. Other aspects of what amounts to a fair and reasonable
attribution, such as ease of audit and operation, are not at issue. Nor,
although the Tribunal itself asked for clarification, is the 50/50 weighting
that VWFS proposes as between the taxable supplies of the vehicle and the
exempt supplies of finance under the HP agreements. The evidence of Mr Cannan
for HMRC shows that the weighting is accepted as realistic; indeed he concedes
that it may be more realistic than that adopted by HMRC’s method. The dispute
is not on the weighting, but on whether any part of the residual input tax
should be attributed at all to the taxable supply of the vehicle.
42. At its essence
the dispute is on whether any part of the overhead costs with which this appeal
is concerned represent cost components of the supply of the vehicles under the
HP agreements. That must be considered against the background of the clear
fact, which we have found, that overhead costs are built into the price (namely
the interest charge) for the supply of credit, and fees, such as the acceptance
fees and the option to purchase fees, and are not factored into the cash price
of the sale by VWFS of the vehicles, for which there is no mark up on the price
paid by VWFS to the retailer.
43. It is convenient
at this stage for us to address, if only to dismiss as immaterial to our
decision, a dispute that arose between the parties as to the effect of the
Consumer Credit (Agreements) Regulations 1983 (“the Agreements Regulations”).
The difference arose in relation to the meaning of “cash price” in relation to
goods sold under HP agreements as defined by reg 1(2) of the Agreements
Regulations. It is that cash price that must be included in the agreement by
virtue of para 4, column (2) in Schedule 1 to the Agreements Regulations.
VWFS say that the cash price is the price at which its customer could buy the
vehicle for cash from the dealer, and accordingly the price at which VWFS
purchases the vehicle from the dealer. This, it is submitted, means that,
because the cash price must be stated on the face of the agreement, it is a
determined amount, and it is not open to VWFS to apply a mark-up and insert a
higher cash price into the agreement.
44. Furthermore, it
is said, any additional amount that VWFS might attempt to charge in excess of
the cash price would be treated as a charge for credit. This is the effect of
the Consumer Credit (Total Charge for Credit) Regulations 1980, which by virtue
of reg 4(b) includes in the total charge for credit (in addition to interest)
other charges (apart from excluded items) payable under the transaction by the
debtor or a relative of his, whether to the creditor or any other person.
45. Regulation 1(2)
of the Agreements Regulations provides:
“ ‘cash price’ in relation to any goods, services,
land or other things means the price or charge at which the goods, services,
land or other things may be purchased by, or supplied to, the debtor for cash”
46. Mr Thomas argued
that this definition of cash price did not have the effect that VWFS were
precluded from selling the vehicle under the HP agreement at a profit. He
submitted that VWFS was free to insert in the agreement the price at which VWFS
itself was prepared to sell the vehicle to the debtor, and that this could be a
price greater than that paid by VWFS to the dealer. He argued that this
followed from the fact that “debtor” was itself defined by s 189 of the
Consumer Credit Act 1974 as the individual receiving credit; the debtor was the
debtor of VWFS and not of the dealer.
47. As we have
indicated, we do not consider the resolution of this issue as material to our
decision. Whatever reason there might be for the fact that the vehicle is
supplied under the HP agreement at its cost to VWFS, whether that be due to
regulation or commercial decision, what we have to consider is the nature of
the actual supply, not the reason why it has its particular characteristics.
However, as the issue was raised, we ourselves consider VWFS’s analysis to be
the correct one. In our view the rationale for requiring the cash price to be
restricted is to ensure that the total cost for credit is properly identified.
If a mark-up from the dealer price were to be permitted, this would distort the
charge for credit, and render the regulations in that respect ineffective. We
do not consider that the fact that the customer is the debtor of VWFS is
relevant; that merely identifies the person whose position in relation to the
cash acquisition must be considered. Where a dealer arranges a sale to that
person through hire purchase arrangements which involve a sale of the vehicle
to the finance company, and the on-sale on finance terms to that person, we are
satisfied that the agreement cannot provide for any price other than that paid
by the finance company to the dealer. Any other amount charged in that respect
must be included in the total charge for credit.
48. We turn now to
the authorities on the question of input tax recovery. We start with common
ground. The right to deduct arises only in respect of goods and services which
have a direct and immediate link with taxable transactions. This follows from
the ECJ decision in BLP Group plc v Customs and Excise Commissioners
(Case C-4/94) [1995] STC 424. In that case BLP, a holding management company,
disposed of certain shares it held in a German subsidiary. It sought to deduct
input tax incurred on professional services in connection with the share sale.
BLP claimed a deduction on the basis that, although the share sale was an
exempt transaction, the purpose of the sale was to pay off debts that had
arisen directly from its taxable transactions. The Court of Justice held that there
was no entitlement to deduct input tax on services used for an exempt
transaction, even if the ultimate purpose of the transaction was the carrying
out of a taxable transaction.
49. BLP thus
makes clear that the intention of the taxable person is not material. The test
of linkage to taxable transactions is an objective one. Regard must be had to
the objective character of the transaction in question (BLP, para 24).
Whilst in BLP’s case the professional services could have represented cost
components of the underlying taxable transactions if finance had been raised
other than by means of an exempt transaction, that was simply a consequence of
the choice that a trader could exercise between exempt and taxable transactions
(paras 25-26).
50. What we must
consider therefore are the objective characteristics of the HP transactions in
issue in this appeal. We do not therefore consider that the purpose of VWFS in
increasing sales of VW brand cars can play any part in this analysis. Those
sales are not by VWFS, but by other traders, either connected to VWFS but not
part of its VAT registration, or unconnected. VWFS does, however, make its own
supplies of vehicles as part of the HP transactions, and it is those
transactions that we must objectively consider.
51. For the same
reason, and as we have already said, we do not consider that the reason why the
vehicles are sold at cost price under the HP agreements is material. Whether
there are regulatory constraints, or simply commercial reasons, those are only
examples of the range of factors to which the ECJ referred in BLP (at
para 26) as influencing the trader’s choice of taxable or exempt transactions.
What matters is the result of that choice, in terms of the transactions
actually carried out, not the reason for it.
52. The requirement for
a direct and immediate link with taxable transactions presupposes that the
expenditure incurred is part of the cost components of the taxable
transaction. But in cases where there is no direct and immediate link, but the
cost components of the services in question form part of the taxable person’s
overheads, those are as such cost components of the products of the business as
a whole. In Abbey National plc v Customs and Excise Commissioners (Case
C-408/98) [2001] STC 297, there was a sale of certain leasehold interests on
which the rent was chargeable to VAT. The sale itself was, however, not
subject to VAT as it constituted a transfer as a going concern. The company
sought to deduct the professional fees incurred in connection with the
transfer. Having found that the services did not have a direct and immediate
link with transactions giving rise to the right to deduct, the Court went on
(at para 35):
“However, the costs of those services form part of
the taxable person's overheads, and as such are cost components of the products
of a business. Even in the case of a transfer of a totality of assets, where
the taxable person no longer effects transactions after using those services,
their costs must be regarded as part of the economic activity of the business
as a whole before the transfer. Any other interpretation of art 17 of the Sixth
Directive would be contrary to the principle that the VAT system must be
completely neutral as regards the tax burden on all the economic activities of
a business provided that they are themselves subject to VAT, and would make the
economic operator liable to pay VAT in the context of his economic activity
without giving him the possibility of deducting it (see, to that effect, Gabalfrisa
SL and ors v Agencia Estatal de Administración Tributaria (AEAT)
(Joined Cases C-110/98 to C-147/98) [2000] ECR I-1577, para 45).”
53. There is thus a
distinction between the direct and immediate link with particular output
transactions in the sense of BLP, and costs which are part of general
costs and which accordingly have a direct and immediate link with the taxable
person’s business as a whole. In that case the right to deduct depends on the
nature of the supplies made in the business as a whole. In Midland Bank plc
v Customs and Excise Commissioners (Case C-98/98) [2000] STC 501, the bank
incurred legal fees in a dispute concerning a proposed takeover by one of the
bank’s clients. The bank claimed that the input tax was deductible as
attributable to its supply of taxable services to its client. The
commissioners took the view that the input tax was also attributable to the
bank’s business generally, and as the bank made both taxable and exempt
supplies, only a proportion of the input tax should be deductible. The Court
said (at paras 29 - 31):
“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 (see, to this effect, BP Supergas Anonimos
Etairia Geniki Emporiki-Viomichaniki kai Antiprossopeion v Greece (Case C-62/93) [1995] STC 805 at 821,
[1995] ECR I-1883 at 1913, para 16).
30. It follows from that principle as well as from
the rule enshrined in the judgment of BLP Group plc v Customs and Excise
Comrs (Case C-4/94) [1995] STC 424 at 437,
[1995] ECR I-983 at 1009, 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 charged 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 costs 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.
31. It follows that, contrary to what the Midland claims, there is in general no direct and immediate link in the sense intended in BLP
Group, 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 art 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 art
17(5) of the Sixth Directive and the VAT is, according to that provision,
deductible only in part.”
54. This link with
the whole economic activity of the taxable person, and the apparent exception
to the ordinary rule of a direct and immediate link to a particular transaction,
was considered by Carnwath LJ in Mayflower Theatre Trust Ltd v Revenue and
Customs Commissioners [2007] STC 880. He concluded that this was justified
by the need to ensure that the VAT system is completely neutral (see [28]).
Lord Justice Carnwath referred to BLP and Abbey, and then (at
[29]) to Kretztechnik AG v Finanzamt Linz (Case C-465/03) [2005] STC
118. He said:
“… In that case it was decided that a share issue
leading to a listing was not a 'supply' for VAT purposes. The question then
arose whether VAT paid on services received in connection with the issue was
deductible. It was argued for the company (supported by the UK Government) that
those inputs could be regarded as 'part of the overheads of the company' and
thus 'components of the price of the products marketed by it' (see para 32 of
the judgment). The Court of Justice accepted this argument:
'34. The deduction system is meant to relieve the
trader entirely of the burden of the VAT payable or paid in the course of all
his economic activities. The common system of VAT consequently ensures complete
neutrality of taxation of all economic activities, whatever their purpose or results,
provided that they are themselves subject in principle to VAT …
35. It is clear from the last-mentioned condition
that, for VAT to be deductible, the input transactions must have a direct and
immediate link with the output transactions giving rise to a right of
deduction. Thus, the right to deduct VAT charged on the acquisition of input
goods or services presupposes that the expenditure incurred in acquiring them
was a component of the cost of the output transactions that gave rise to the
right to deduct …
36. In this case, in view of the fact that, first, a
share issue is an operation not falling within the scope of the Sixth Directive
and, second, that operation was carried out by Kretztechnik in order to
increase its capital for the benefit of its economic activity in general, it
must be considered that the costs of the supplies acquired by that company in
connection with the operation concerned form part of its overheads and are therefore, as
such, component parts of the price of its products. Those supplies have a direct and immediate link with the
whole economic activity of the taxable person [emphasis added] …'
”
55. A similar
conclusion can be drawn from Cibo Participations SA v Directeur regional des
impost du Nord-Pas-de-Calais (C-16/00) [2002] STC 460, to which Carnwath LJ
also referred. There is a clear contrast between the normal BLP rule
and the special rule for overheads. The ECJ held there that expenditure on
services purchased by a holding company in connection with its acquisition of a
shareholding in a subsidiary did not have a direct and immediate link with any
output transaction in respect of which VAT was deductible. The amount of the
VAT paid on that expenditure did not directly burden the various cost
components of those output transactions. Nevertheless, the costs were part of
the taxable person’s general costs and were, as such, cost components of an
undertaking’s products (Cibo, judgment, paras 32-33; cited in Mayflower
Theatre, at [31]).
56. In Mayflower
Theatre itself, it was held that the case was not about overheads, but
about specific attribution of costs to particular supplies. The special
treatment of overheads (or, an alternative description, “general costs”) serves
only a particular and limited purpose in the VAT system, for those inputs which
would not otherwise be brought within the calculation, and should not be
extended beyond that purpose (see [33]).
57. The references
to cost components flow from article 2 of the First Directive, and are repeated
in the cases to which we have referred. We see also reference, in para 31 of Midland
Bank and para 36 of Kretztechnik, to the components of the price
of an undertaking’s products. Mr Thomas argued that in relation to the HP
transactions the overheads are used economically for the supply of credit and
not the supply of goods (the vehicles) since they do not form a component of
the price of the goods. He relied in particular on the fact that the overheads
are reflected solely in the charge for credit and in the fees (acceptance and
option to purchase), and not in the price at which VWFS supplies the vehicle.
58. Mr Thomas
referred us to Rompelman v Minister van Financiën [1985] ECR 655 where
at para 16 the ECJ said:
“ … a basic element of the VAT system is that VAT is
chargeable on each transaction only after deduction of the amount of VAT borne
directly by the cost of the various components of the price of the goods and
services …”
Mr Thomas also referred us to the French text:
“… qui a grevé directement le coût divers éléments
constitutifs du prix …”
59. Mr Thomas
likewise took us to the French text of paragraph 21 of Midland Bank
(which in the English version refers to Article 2 of the First Directive, and
to “cost components of a taxable transaction being capable of being deducted”)
and of paragraph 30, which likewise refers to cost components of the taxable
transactions. In each case the French version refers to “éléments constitutifs
du prix”.
60. Reliance on
foreign language texts of decisions of the Court of Justice poses evidential
problems for a UK tribunal. Even if the tribunal has knowledge of the language
in question, such knowledge is unlikely to be sufficient to appreciate the
nuances of language that are likely to be present. A straight word-by-word
translation is not adequate. Where reliance is placed on a foreign language
version in an attempt to elucidate, or even contradict, the ordinary meaning of
the English language text, the tribunal must be given expert evidence to
support any such submission. Absent such evidence, no reliance can be placed
on the foreign language text.
61. The use of the
phrase “éléments constitutifs du prix” does not in any event appear to shed any
light on the words used in the English language versions of the judgments
referred to. Those words are used in the French language version of article 2
of the First Directive, the English version of which refers simply to “various
cost components”. There is no argument that the English version of article 2
is wrong. Furthermore, the original language of Rompelman was Dutch,
and the original language of Midland Bank was Italian. We accordingly
place no reliance on the French texts.
62. Nonetheless, we
do find references to price in the English language texts. Mr Thomas referred
us also to Skatterverket v AB SKF (Case-29/08) [2010] STC 419. In that
case SKF proposed to dispose of all its shares in a wholly-owned subsidiary and
its minority shareholding in another company. The reason for the disposals was
to obtain funds to finance other activities of the group. The question
concerned the deductibility of VAT on services acquired to carry out the
disposals. The CJEU referred to the principle of equal treatment and the need
to avoid a taxable person being burdened with the cost of VAT in the course of
his economic activity without giving him the possibility of deducting it
(judgment, paras 69-70). Case law, including the ECJ judgments we have
referred to, was cited in support of the accepted principle that a taxable
person has a right to deduct even where there is no direct and immediate link
between a particular input transaction and an output transaction or
transactions giving rise to the right to deduct, where the costs of the
services in question are part of his general costs and are, as such, components
of the price of the goods and services which he supplies. Such costs do have a
direct and immediate link with the taxable person’s economic activity as a
whole (para 58).
63. The CJEU
continued (at paras 60-62):
“60. It follows that whether there is a right to
deduct is determined by the nature of the output transactions to which the
input transactions are assigned. Accordingly, there is a right to deduct when
the input transaction subject to VAT has a direct and immediate link with one
or more output transactions giving rise to the right to deduct. If that is not
the case, it is necessary to examine whether the costs incurred to acquire the
input goods or services are part of the general costs linked to the taxable
person's overall economic activity. In either case, whether there is a direct
and immediate link is based on the premise that the cost of the input services
is incorporated either in the cost of particular output transactions or in the
cost of goods or services supplied by the taxable person as part of his economic
activities.
61. In the present case, the referring court
describes the costs linked to the services acquired by SKF, first, as 'directly
attributable' to the disposal of shares and, second, as forming part of the
general costs associated with SKF's overall economic activities.
62. In that regard, it must be held that it is not
possible from the case file submitted to the court to determine whether those
costs have a direct and immediate link, within the meaning of the case law
cited in paras 57 and 58 of this judgment, with the envisaged share disposals
or with SKF's overall economic activity, given that, according to the referring
court, the purpose of those transactions was to secure funds to finance other
activities of the group. In order to establish whether there is such a direct
and immediate link, it is necessary to ascertain whether the costs incurred are
likely to be incorporated in the prices of the shares which SKF intends to sell
or whether they are only among the cost components of SKF's products.”
64. The reference to
price at para 62 of the CJEU’s judgment relates to the question of direct
attribution to the sales of shares. There is no such reference in the context
of the general costs which could be regarded as cost components of SKF’s products.
In our view, when one is looking at overhead costs, what the cases say is that
because these are overhead, or general, costs, they are, by virtue of that
fact, cost components of the price of the taxable person’s products. There is
no separate test or hurdle of incorporation into price that has to be met or
overcome. Those costs are then directly and immediately linked with the
taxable person’s economic activity as a whole.
65. Mr Thomas
submitted that the issue in this case is not whether the costs in question are
residual at all – it is common ground that they are – but whether the
methodology put forward by VWFS is fair and reasonable despite the fact that
the input tax on those costs is not a cost component of the price (or even the
intended price) of the taxable output represented by the sale of the car. He
argued that the input tax in making the HP transaction should either be passed
on to the consumer as part of the supply of the vehicle (in respect of which
value VWFS has a liability to account for output tax) or consumed by VWFS as
the final consumer in making the supply of exempt credit.
66. Mr Thomas
further submitted that the plain result of VWFS’s methodology is that there is
a third category of input tax which is incurred in making the supply of goods,
but is not passed on to the consumer as part of the value of the supply of
goods but is passed on as part of the value of the supply of exempt credit but
in respect of which it nonetheless enjoys a right to deduct. He argues that
such an outcome frustrates the normal operation of the tax. It is illogical,
he says, and artificial as it assumes that one element of a single transaction
(which has two component VAT supplies) cross-subsidises the remainder of the
same transaction.
67. Miss Shaw submitted
that HMRC’s argument in this respect proceeded on the fallacious basis that an
input must be a cost component of the price of an onward taxable transaction
before it can be recovered by the trader. She referred to Revenue and
Customs Commissioners v London Clubs Management Limited [2010] STC 2789
where (at [36] – [38]) Proudman J in the Upper Tribunal (Tax and Chancery) had
rejected HMRC’s submission that the supplies in question in that case were made
at a loss and could not support the costs attributed to them in the proposed
partial exemption special method. The learned judge held that this submission
conflated the issue of profitability with the costs of making it. As Etherton
J had observed in Banbury Visionplus Limited v Revenue and Customs Commissioners
[2006] STC 1568 (at [68]):
“… the issue of profitability or loss is of no
significance … The critical issue is the use of inputs in the provision of
outputs. There is no obvious or necessary correlation between that issue and
the issue of profitability or loss.”
68. We have
concluded that, in relation to overheads, there is no requirement that the
input tax referable to those expenses should be reflected in the price of the
products of the overall economic activity to which the expenses are related.
It is not necessary to trace the costs into the price of particular products.
What is needed is a fair and reasonable proxy for the use by VWFS of the
relevant costs in making both taxable and exempt supplies. Whilst it is clear
that the use in question is economic use, and not physical use (see St
Helen’s School Northwood Ltd v Revenue and Customs Commissioners [2007] STC 633, per Warren J at [75]), that is not directed at profitability, but at the
true nature and characterisation of the taxable person’s business.
69. There is no
direct attribution of any part of the input tax in question to either the
taxable or exempt supply components of the HP transactions. The costs are, to
the extent attributable to those transactions, cost components of that economic
activity as a whole. It is accepted that the input tax incurred by VWFS on its
acquisition of a vehicle from a dealer is directly and immediately linked to
the onward supply of that vehicle under the HP transaction, and is accordingly
recoverable. But overhead costs are, to the extent that they are apportioned
to the HP transactions, used for those transactions as a whole. It follows
therefore, in our view, that the overhead costs are cost components of each of
the supplies that make up those transactions. We agree therefore with Miss Shaw
that the individual supplies comprised in the HP transactions must be respected
so as to allow recovery to the extent that a cost component of the whole
transaction can be regarded as a cost component of a taxable supply.
70. Accordingly, in
our view, any method that has the effect of treating the overhead costs as solely
cost components of a particular element, or elements, of the transactions, to
the exclusion of another element, or other elements, cannot be fair and reasonable.
The relevant economic activity is the carrying out of the HP transactions.
This is simply a reflection of the way in which the business of VWFS is carried
on. We do not agree with Mr Thomas when he seeks to apply the label “finance
business” to VWFS, pointing to the way in which VWFS accounts for the HP
transactions, to argue that such a business ought not to recover the vast
majority of its input tax. The observable features of the HP transactions are
that they comprise not only exempt supplies of finance but also taxable
supplies of the vehicles.
71. What HMRC’s
argument amounts to, in essence, is that there is a limit to the amount of cost
that can be a cost component of a supply, and that because the supply of the
vehicle is at cost, and so reflects only the price paid by VWFS to the dealer,
and input tax on the acquisition of the vehicle by VWFS is directly
attributable to that supply, the cost component capacity of the vehicle supply
has been exhausted, with the result that no other costs can be cost components
of that supply. We consider that to be wrong in principle. The mere fact that
only particular costs are recovered by a supplier in the price he charges for
the making of a particular supply does not lead to the conclusion that no other
costs are cost components of that supply. Unrecovered costs not directly
attributable to a particular supply, or such costs recovered in other ways, for
example by marking up other supplies, are nonetheless cost components of
transactions of the business in general, and to the extent that those
transactions include taxable supplies, the input tax incurred on those costs is
deductible.
72. Mr Thomas argued
that the system for deduction of input tax reflected the principle of fiscal
neutrality which underpins the VAT system. As a general matter taxable
persons, unlike final consumers, do not themselves bear the burden of VAT.
Although VAT is charged on every supply made by a taxable person, it is
intended to be a neutral tax with the result that goods and services should
bear the same tax burden whatever the length of the production and/or
distribution chain. But where a person makes exempt supplies, that person is
not entitled to deduct VAT in respect of those transactions and is therefore
treated as a final consumer of such exempt goods or services. Mr Thomas argued
that the principle of fiscal neutrality is relevant to the determination of
what is a fair and reasonable attribution of input tax and that, because the
VWFS methodology operates regardless of where the burden of tax falls, it does
not reflect that principle.
73. We accept Mr
Thomas’ description of the basic way the VAT system operates, and that it is
underpinned by the principle of fiscal neutrality. However, that principle
does not mean that deductibility is dependent on the burden of input VAT
incurred having itself been passed on through incorporation into the price of
the relevant goods or services. It would not be consistent with fiscal
neutrality for a trader who has incurred costs in making taxable supplies not
to be able to deduct the referable input tax merely because the price charged
for those taxable supplies does not reflect, or does not wholly reflect, that
input tax, or because the trader has chosen to recover such costs through other
pricing means. As we have earlier noted, when considering Mayflower Theatre
(per Carnwath LJ at [28]), the conclusion that overhead costs are cost
components of the economic activity as a whole (which in this context means the
HP transactions, and thus both the taxable supply and exempt supply components
of those transactions) is itself an expression of the principle of fiscal
neutrality. It is not a breach of that principle for a methodology that
attributes residual input tax on those overhead costs to both the taxable
supply and exempt supply components of the HP transactions to which residual
input tax can be apportioned to be regarded as fair and reasonable.
74. Nor do we agree
with Mr Thomas’ submission that to allow a trader in the position of VWFS to
recover a substantial proportion of input tax attributable to the HP
transaction on the basis that the provision of security for the credit happened
to be in contractual form which entailed retention of title in VWFS and a
supply of goods as opposed to other forms of finance transaction for the
purchase of cars where overhead VAT is rightly irrecoverable does not respect
the principle of equal treatment. We accept, of course, that according to that
principle different types of economic operators in comparable situations be
treated in the same way in order to avoid distortion of competition within the
internal market (NCC Construction Danmark A/S v Skatteministeriet (Case
C-174/08) [2010] STC 532, at para 44). However, we do not consider that a
transaction which involves a taxable supply can be compared to one that does
not, so as to give rise to any breach of the principle of equal treatment. Furthermore,
as we have described, BLP also makes clear that deductibility may depend
on a trader’s choice as between taxable and exempt supplies. It is accordingly
not contrary to any principle if input tax is deductible for a trader who
finances vehicles through HP transactions, even if it would not be deductible
if the trader instead provided simple loan finance.
75. Mr Thomas also
referred us to Levob Verzekeringen BV and another v Staatssecretaris van
Financiën (Case C-41/04) [2006] STC 766, at para 24 where the ECJ referred
to the economic purpose of a transaction in determining whether the transaction
was a single supply or multiple supplies. We agree that economic purpose,
objectively ascertained, is an important element in such cases, and also in a
fair and reasonable attribution under a partial exemption special method (St Helens School, at [77]). However, we do not accept that the purpose of
the supply of the vehicle in an HP transaction is, as Mr Thomas submitted, to
give rise to a supply of credit. The economic purpose of VWFS is not simply to
supply credit; it is to supply credit on hire purchase terms. It may be the
case that, according to those terms, the supply of the vehicle cannot take
place without the supply of the credit, and that the supply of the vehicle lacks
the normal characteristics of a simple sale of goods, but that does not in our
view change the essential economic characteristics of an HP transaction, objectively
ascertained, namely that it is one indivisible transaction that comprises, for
VAT purposes, two supplies, one taxable and one exempt.
76. We do not regard
the objection that the business of VWFS would consistently be in a repayment
position for the HP transactions as leading to the conclusion that a fair and
reasonable attribution must avoid this result. Mr Thomas argued that VAT
should not produce a long term repayment at any stage in the transaction chain
unless either a reduced rate applies to the supplies made by the trader or a
loss is made in the income stream. We agree that it is artificial to attempt
to characterise the supply of the vehicle as being at a loss, but that is not
the reason for the deduction of the input tax. That deduction arises because
the input tax is a cost component of the HP transactions, and is thus a cost
component of each of the constituent supplies. The consequence of a repayment
does not arise solely because of that attribution; it arises because of a
combination of the agreed direct attribution to the sale at cost of a vehicle
of input tax incurred on its acquisition and the attribution of part of the
overheads input tax. In considering a fair and reasonable method of
attributing the input tax referable to overheads, we do not regard the
consequence of VWFS being in a repayment position in this respect as compelling
the exclusion of the taxable supply of the vehicle from the equation, when the
proper analysis is that input tax on overhead costs is a cost component of the
hire purchase transactions, and so in part a cost component of that taxable
supply.
77. Our conclusion
therefore is that a partial exemption special method that provides for the
partial attribution of the residual input tax incurred by VWFS to the taxable
supplies of vehicles that it makes under the HP transactions is fair and
reasonable, whereas one that does not so provide is not fair and reasonable.
As this is the only dispute on the methodology adopted by VWFS, it follows that
we decide that VWFS’s methodology is fair and reasonable, and HMRC’s proposed
methodology is not.
Decision
78. For these
reasons, we allow this appeal.
Costs
79. Any application
in respect of costs must be made within 28 days of the date of release of this
decision.
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.
ROGER BERNER
TRIBUNAL JUDGE
RELEASE DATE: 18 August 2011
