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URL: http://www.bailii.org/uk/cases/UKHL/2003/29.html
Cite as: [2003] UKHL 29, [2003] WLR 1387, [2003] 1 WLR 1387, [2003] BVC 341, [2003] 2 All ER 1073, [2003] 23 EGCS 134, [2003] STC 832, [2003] STI 1013, [2003] BTC 5285

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Royal and Sun Alliance Insurance Group Plc v Customs and Excise [2003] UKHL 29 (22 May 2003)

Judgments - Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)

HOUSE OF LORDS

SESSION 2002-03
[2003] UKHL 29
on appeal from: [2001] EWCA Civ1476

OPINIONS

OF THE LORDS OF APPEAL

FOR JUDGMENT IN THE CAUSE

Royal and Sun Alliance Insurance Group plc (Respondents)

v.

Her Majesty's Commissioners of Customs and Excise (Appellants)

ON

THURSDAY 22 MAY 2003

The Appellate Committee comprised:

Lord Steyn

Lord Woolf

Lord Hoffmann

Lord Clyde

Lord Walker of Gestingthorpe

HOUSE OF LORDS

OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT

IN THE CAUSE

Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)

[2003] UKHL 29

LORD STEYN

My Lords,

I have had the advantage of reading the opinions of Lord Hoffmann and Lord Walker of Gestingthorpe. For the reasons they have given I would also allow the appeal and restore the decision of the Tribunal.

LORD WOOLF

My Lords,

In this case I have had the considerable advantage of being able to read the speeches of Lord Hoffmann and Lord Walker of Gestingthorpe in draft. With the majority of the reasoning in those speeches I am able to agree. Unfortunately, however, I find that I am unable to accept their conclusion that this appeal should be allowed.

Notwithstanding the careful reasoning contained in their speeches, I have come to the conclusion that they attach less significance than they should to the special position of a supply of an interest in land, such as the grant of a lease. Subject to exceptions which need not concern us, such a supply can be an exempt supply or, if a taxable person elects to waive the exemption under Group 1 of Schedule 9 to the Value Added Tax Act 1994 ("the 1994 Act") it can be a taxable supply if regulation 109 of the Value Added Tax Regulations 1995 (SI 1995/2518) ("the Regulations") is complied with.

The language of regulation 109 is central to the outcome of this appeal as the Commissioners in their case contend. Regulation 109 is in the following terms:

before that intention is

fulfilled,

Regulation 109 is the converse of regulation 108 but it is not necessary to cite the terms of that regulation, although its presence should not be ignored since it is obviously intended that the choice to which I will refer operates in both directions. The important feature of regulation 109 is that it gives the taxable person six years in which to elect to use or form an intention to use the goods or services concerned in making taxable supplies. Examining the language of regulation 109, which is all important to the outcome of this appeal, more closely it appears that there are contained in the regulation the following relevant requirements:

The taxable person must have incurred an amount of input tax (on supplies to him) which has not been attributed to taxable supplies (by him).

This must be because he had intended for a period of time to use the goods and services (and the leasing of land is a supply of goods) in making exempt supplies.

Before he had fulfilled his intention to use the goods and services in making exempt supplies ( ie "before that intention is fulfilled") he must use or form the intention to use the goods or services in making taxable supplies.

That the change of intention happened during a period of six years commencing on the first day of the prescribed accounting period.

Having referred to regulation 109, it is necessary to apply that regulation to the facts of the present appeal. As they have been referred to by my Lords and in the reported decisions of the court and the tribunal below, it is sufficient for my purposes merely to refer to the fact that the Royal and Sun Alliance Insurance Group Plc ("RSA") had leased accommodation from landlords who had exercised their option to treat the supply as taxable with the result that RSA had to pay input tax in relation to the letting and other services with which they were supplied. Between November 1991 and April 1993 RSA had five properties which became surplus to the requirements of their insurance business. However, having decided to let the properties they had difficulty in obtaining tenants and the accommodation remained vacant for a substantial period of time (with exceptions which can be ignored) until November 1995. On 21 November 1995 RSA made an election to waive the exemption and, accordingly, the supplies constituted by their lettings were a taxable supply in relation to which RSA charged output tax. The election was duly notified to the Commissioners on 21 December 1995.

During the intervening vacant period RSA continued to pay input tax on the rent and other services which RSA paid in order to retain their interest in the premises. They also incurred expenses which would have been taxable in their attempts to let the premises.

It is not in dispute that if RSA had at the outset elected (that is, prior to the relevant dates between November 1991 and April 1993) to treat the lettings as taxable supplies, RSA would have been entitled to credit for the input tax which is now in dispute. RSA would have been entitled to this notwithstanding that the lettings did not take place in fact until after November 1995. However, not having elected RSA did not seek credit for the input tax that was paid from time to time until they made their elections. So the input tax paid did not appear in their periodic VAT returns prior to their making the relevant elections.

Until a landlord has identified the tenant to whom he is going to let premises, frequently it will not make sense to decide whether the letting should or should not be exempt. What the decision should be will depend on the circumstances of the tenant in relation to VAT. If the tenant cannot obtain credit for any input tax payable it will be to the tenant's disadvantage if the lease is a taxable supply. Accordingly he may be prepared only to pay a lower rent then he would be prepared to pay if the letting was exempt. For this reason, it can be sensible for a landlord (here RSA) to defer an election since once he elects he cannot revoke that election. However, until he elects he is not entitled to credit for the input tax which he has paid.

If RSA's submissions are correct, one of the purposes of regulation 109 is to take into account the difficulty of the landlord in this regard. However, if a landlord is to have the benefit of regulation 109 he must comply with its requirements. Here there is no dispute that the election was made during the period specified by the regulation. Nor until RSA elected had the input tax, which they had paid, been attributed to taxable supplies. The input tax could not be attributed because there had been no subletting of the premises and in any event, until RSA did elect, for VAT purposes, the only supplies that RSA could make were exempt. While, if RSA had let the premises before electing they would have made an exempt supply, as the letting followed the election there was no exempt supply to which the input tax could be related.

Once RSA had decided to let the premises as a taxable supply, the position changed. RSA, applying the language of regulation 109 literally, were fulfilling the remaining requirement of that regulation. RSA was a taxable person that had incurred an amount of tax on the lettings of the properties to them. The amount of input tax had not been attributed to taxable supplies by them. This was because they are deemed, not having elected, to have intended to make exempt supplies. However, before they had fulfilled their intention to make the exempt supplies, that is by subletting the premises, RSA had elected to make taxable supplies instead by subletting the premises. Throughout the economic activity remained the same but its taxable nature changed. Finally that change of intention had occurred within the six year period. That being so, I ask rhetorically why should RSA not be entitled to the benefit of regulation 109? This is not a case, as has been suggested, of RSA rewriting history other than the rewriting that the regulation expressly contemplated. If the regulation could not be applied in these circumstances it could not have any meaningful application to the subletting of property. The Commissioners contend that inputs can be consumed by an unsuccessful attempt to make supplies and that the input tax incurred was so used here during the vacant period. But this argument which has no statutory foundation is inconsistent with the express terms of regulation 109, which presupposes that there will be a six year period in which to make an election and after that election there can be a claim for repayment of the tax paid. This is because that tax (in the language of regulation 109 (2)) "has become attributable to taxable supplies". Such attribution accords with article 20(1) of the Sixth Directive.

The Commissioners give a description of a situation where they submit the option that the regulation is intended to provide would be lost. They submit that if a lawyer offers financial services at one time but having failed to obtain any customers the lawyer starts a new business offering legal services then the input tax paid for supplies to the first business would no longer be available and cannot be set off against input tax payable by the second business. I fully accept input tax incurred in relation to one business could not be set off against input tax payable in relation to a different business. There is then no connection direct or otherwise between the supplies. But that is an entirely different situation from the present. Here, throughout RSA were intending to make the same supply; the only matter that was deferred was the decision as to whether to elect that that supply should be taxable, a situation which regulation 109 is, as it seems to me, directly designed to deal. Throughout RSA were intending to make the same supply namely a subletting of the premises. Before the election that would have been an exempt supply; after the election it would be a taxable supply. To make the taxable supply that RSA actually made it had no choice but to comply with the terms of the lease under which it was entitled to sublet the premises. This involved paying rent including the input tax. It could not claim repayment of the input tax until it elected. After it elected the accounting periods would be different in relation to the input tax that RSA had paid prior to election and the output tax RSA in due course received. However, while a taxable person is required to account periodically, as regulation 109(2) itself anticipates, the taxable position over different accounting periods can change so that tax which was not repayable becomes payable. Accounting periods cannot be allowed to control what tax is payable. The accounting periods are the tail not the dog.

My noble and learned friend, Lord Walker, comes to the same conclusion as Lord Hoffmann that regulation 109 is not applicable because of the legislative framework as a whole including the Sixth Directive, and in particular, section 6(14) of the 1994 Act and the language of regulation 85 which he regards (as did Arden LJ in the court below) as being ultimately decisive.

Section 6 of the 1994 Act sets out rules in relation to the time at which a supply of goods or services is to be treated as being made. Section 6 (14) in particular provides, so far as relevant, as follows:

Regulation 85 so far as is relevant, is in the following terms:

Section 6 is necessary to determine when tax is to be payable or repayable. Section 6 is not concerned with whether tax is payable or repayable. Section 6 applies in exactly the same way whether a supply is taxable or not.

I accept that the right approach under section 6 and regulation 85 to both the lettings to and by RSA is to treat them as a series of separate supplies for accounting purposes. However, Arden LJ, in the court below, goes further and says that section 6 and regulation 85 could affect the quantum of tax payable or repayable. No authority supports such a proposition and its doubtful nature is highlighted by the fact that it would mean that the fiscal consequence could differ if the rent was payable quarterly or annually if an election was made during a year of the tenancy. Furthermore, if her reasoning is correct I cannot understand why it could not apply so as to prevent RSA even being able to take credit for output tax paid after election for quarters prior to RSA subletting the premises.

Reading section 6(14), regulation 85 and regulation 109(1) together, I do not find any reason to read regulation 109 other than in accordance with its ordinary meaning. Whereas, but for regulation 109(1) it would not be possible for RSA, in about November 1995, to form an intention to deduct or reclaim the input tax incurred in relation to periods prior to November 1995, in respect of supplies after November 1995 that is what regulation 109 makes possible.

I fully accept the importance of regulation 85 in establishing the time of supply where there is grant of a tenancy or a lease but it cannot apply where there has been no supply by RSA and therefore no consideration payable. Here the issue is not when the supplies were made to and by RSA, this is not in dispute. Where there is a special provision, such as that contained in regulation 109, it must be given effect unless there is good reason for not doing so and regulation 85 provides no such obstacle. As Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769, when there are supplies effect must be given to the time of supply rules, but this cannot be done where there is no more than intention to make a supply. The same reasoning applies to the passage of Lord Hoffmann's speech in Customs and Excise Commissioners v Thorn Materials Supply Ltd [1998] 1 WLR 1106, 1118 F - 1119 E; [1998] STC 725, 738 a-g.

Since I prepared the above opinion, I have read in draft the speech of my noble and learned friend, Lord Clyde. That speech so clearly expresses my own views that if I had not already prepared this speech I would have been content to merely agree with his speech. However, in view of the differing views, which have been expressed as to the outcome of this appeal, I have decided to still give this speech.

I would therefore dismiss this appeal.

LORD HOFFMANN

My Lords,

In 1993 the Royal & Sun Alliance Insurance Group plc ("RSA") decided to dispose of five of its leasehold properties which had become surplus to needs. It advertised for sub-tenants. But the market was weak and it did not succeed in sub-letting any of the properties until after 1995.

This appeal concerns the VAT which RSA was charged by its landlords on the rent and service charges payable during part of the period while the properties were empty. For the purposes of VAT, the grant of a lease of land is a supply of goods or services, depending upon the length of the lease. For present purposes the distinction does not matter; the grant of any interest in land is an exempt supply (of goods or services) unless the landlord has elected to waive the exemption: see Value Added Tax Act 1994, Sched 9, Group 1, para 1 and Sched 10, paras 2 and 3. The landlords of the properties held by RSA had so elected and therefore both the leases and the services provided to RSA were taxable supplies. So the landlords added VAT to their rent and service charge invoices.

RSA made no similar election when it first tried to sub-let the properties. It wanted to keep its options open. It thought that although tenants who carried on businesses making taxable supplies would find a taxable lease more attractive (because they could deduct the VAT), tenants who made exempt supplies might prefer an exempt lease. An election would be irrevocable (para 3(4) of Sched 10) and foreclose RSA's options. On the other hand, until RSA actually elected, it was unable to say that it intended to use the goods or services supplied under the leases to make taxable supplies. So it had to bear the input tax without deduction. Eventually RSA elected for taxation with effect from 21 November 1995. Thereafter, it was allowed to deduct its input taxes.

After the election, RSA claimed repayment of the input taxes it had been paying for the whole of the vacant period before its election ("the vacant unelected period") under regulation 109 of the Value Added Tax Regulations 1995 (SI 1995/2518):

The Commissioners rejected the application and the Value Added Tax and Duties Tribunal (Mr David Demack) upheld their rejection on the ground that there was no "direct and immediate link" between the taxable goods and services supplied to RSA during the vacant unelected period and the taxable supplies it formed the intention of making after that period had ended: [1999] V & DR 336. On appeal to the High Court, Park J [2000] STC 933 disagreed, holding that there was such a link because the supplies to RSA during the vacant unelected period were supplies of the same leasehold property as it intended to sub-let after 21 November 1995 as a taxable supply. The Court of Appeal, by a majority (Aldous and Sedley LJJ; Arden LJ dissenting) [2001] STC 1476 upheld this decision.

Regulation 109 (and its mirror image, regulation 108, which deals with adjustments in favour of the Commissioners) give effect to article 20 of the Sixth Directive (77/388/EEC) which provides that "the initial deduction shall be adjusted according to the procedures laid down by the Member States". It is not suggested that the regulations do not conform to the Directive.

Two points about the regulations should be noted. First, they require that the taxpayer should have first had one intention about the use he proposes to make of goods or services supplied to him and that he should afterwards use them for a different purpose or form an intention to do so. In the case of regulation 109, the first intention must be to use them for supplying exempt services or a mixture of exempt and taxable services. The subsequent use, or intention, must be to supply taxable services.

In the present case, there is no question of an initial intention to use the inputs relating to the leases in supplying a mixture of services. RSA's general insurance business involved supplying a mixture of exempt and taxable services, but each lease was intended to be used in supplying either an exempt sub-lease or (after an election) a taxable sub-lease; one or the other, but not both. In order to come within regulation 109, therefore, RSA must have first had an intention to use the inputs in supplying exempt sub-leases and then used them, or formed an intention to use them, in supplying taxable sub-leases. And that is what RSA says it did.

I mention this point because occasionally, for the purposes of other arguments, RSA stresses that it was never committed to supplying exempt leases. It simply wanted to find tenants and was willing to fall in with whatever VAT arrangements suited them best. But these ambiguities are not consistent with a claim under regulation 109, which is predicated upon a definite intention to make exempt supplies followed by a change of plan.

The second point is that the change of plan must have been in relation to particular goods or services supplied to RSA. The regulation says that it must have intended to use "the goods or services" in making exempt supplies and then used or formed an intention to use "the goods or services concerned" in making taxable supplies. That may seem obvious, but needs to be borne in mind when one considers supplies of a uniform nature made on a continuous basis, like electricity or the use of a telephone. Take, for example, a lawyer who thinks he can do better offering financial services (which are exempt) rather than legal services (taxable). He subscribes for telephone, fax and computer lines for use in his financial service business. Because he is supplying exempt services, the input tax charged by the telephone company is not deductible. But the business is a failure. So he decides to offer legal services after all and continues to subscribe for the same telephone, fax and computer lines. From the time he starts his new business, he can deduct and, if necessary, claim repayment of input tax which he is charged on the telephone services he is receiving. But he cannot form a new intention about the services supplied for the purposes of his old business. They were different services which have already been used. So his decision to make taxable services instead of exempt services does not enable him to make a claim under regulation 109. The services used or intended to be used for making taxable outputs are not the services which were previously intended to be used for making exempt outputs.

That makes it important to identify exactly what goods and services were supplied to RSA by the superior landlords during the vacant unelected period. There are two ways in which one could think of the grant of a time-limited interest in land (such as a lease or licence) as a supply of goods or services. One is to regard it as a single supply of the leasehold estate in consideration of periodic payments of rent and the other lessee's covenants. That is how a real property lawyer would describe the grant of a lease. If that is the right way to look at the supply to RSA in this case, then it first had an intention to use its leasehold estate in making an exempt supply and afterwards decided to use the same estate in making a taxable supply. It would be a change of plan about the use of "the goods or services concerned" within the meaning of regulation 109.

But another way of looking at the matter is to treat the superior owner as granting rights of occupation in successive units of months, quarters, or whatever, depending upon the stipulated intervals for payment of the rent. In that case, the goods or services supplied during the vacant unelected period are different from those supplied afterwards and a change of plan about the use to be made of the leases in the future is not a change of intention about the use of the leases in the past.

In my opinion VAT law has clearly adopted the second analysis for both leases and licences. Section 6(14) of the 1994 Act gives the Commissioners power to make regulations:

Pursuant to this power, the Commissioners made regulations 85 and 90 of the 1995 Regulations, which are in similar terms and deal respectively with leases which are treated as supplies of goods and with services supplied for a periodically payable consideration. I shall quote only from regulation 85:

Before the tribunal, it appears to have been regarded as uncontroversial that a lease involves separate and successive supplies of goods or services, so that the goods and services supplied during the vacant unelected period are not the same as those supplied afterwards. There was no reference to regulations 85 and 90 but the submission of counsel for the Commissioners to this effect is recorded at [1999] V & DR, 336, 354 E, without further comment. But Park J disagreed. He said [2000] STC 933, 947e that the regulation dealt with "the time of a supply" but not "the nature of a supply". So the supply may take place separately and successively, but the goods or services supplied are nevertheless the same. The majority of the Court of Appeal agreed, although Sedley LJ's acceptance of the proposition may have been influenced by his view that VAT was a world "in which factual and legal realties are suspended or inverted:" [2001] STC 1476, 1490. But I find the notion of the same goods or services being supplied over and over again too hard to grasp. In my opinion the plain effect of the regulations is to treat each successive supply as different from the one before. On this point I agree with the tribunal and Arden LJ.

Mr Gammie QC, in his excellent submissions for RSA, did not spend much time trying to defend the view of the majority of the Court of Appeal on this point. He only referred in passing to some comments on section 5(1) of the Value Added Tax Act 1983 which I made in Customs and Excise Commissioners v Thorn Materials Supply Ltd [1998] 1 WLR 1106. That subsection provides that if a person making a supply issues a tax invoice or receives payment before the time when the supply would otherwise be treated as taking place:

I said of this provision (at pp 1115-1116):

Mr Gammie said that it was the same in this case. There was a supply of the same goods, namely the lease, treated as having taken place as to parts of its value on successive dates. But in my opinion the language of regulations 85 and 90 is quite different from the language of section 5(1) of the 1983 Act. The latter speaks of "the supply", in the singular, taking place to some extent at one time and, by implication, to the remaining extent at another time. Regulation 85 says that the goods shall be treated as "separately and successively supplied" on the dates of the invoices or payments. I would therefore reject the analogy.

Mr Gammie's primary argument was that it did not matter that the goods and services supplied during the vacant unelected period were different from those supplied after the new intention to make taxable supplies had been formed. He said that although as a matter of ordinary language one could not use or form an intention to use a right to occupy property for a period which had already passed, that should not prevent reattribution under regulation 109. The economic activity in which RSA had been engaged from the beginning of the vacant unelected period was the letting of property. The fact that it was intending to make exempt sub-lettings meant that it could not claim immediate repayment of VAT on its inputs. But that intention never fructified into any exempt outputs. Instead, it changed its mind and decided to make taxable outputs. So all the inputs, not having been used in making exempt outputs, became cost components in the taxable outputs which, after election, were the only kind which RSA could make.

This argument was attractively presented but in the end I think it is wrong. It is in truth based on a number of principles of VAT law which are not relevant to the present case because they have no application to the right to claim an adjustment under regulation 109.

First, Mr Gammie relies upon the principle that input tax may be deductible even though the input is not directly traceable into any particular output. If the taxpayer is engaged in an economic activity for the purpose of making taxable outputs, the tax on all inputs which are cost components of that activity, even overheads, are deductible. As Advocate General Jacobs said in Abbey National plc v Customs and Excise Commissioners (Case C-408/98) [2001] STC 297, 307:

So, says Mr Gammie, it does not matter that the periods for which rent was paid in the vacant unelected period did not coincide with the period for which the properties were eventually sublet. The earlier rental payments were nevertheless cost components of the later lettings. Indeed, since there were no earlier lettings, they could not have been cost components of anything else. Secondly, it is clearly established that a trader has a right to deduct VAT from the very moment that he embarks upon the relevant economic enterprise and before he has made any outputs. Thus in Rompelman v Minister van Financiën (Case 268/83) [1985] ECR I-655 the Court of Justice held that a trader who decided to acquire property for letting could claim repayment of VAT on the cost of a right to acquire a building which had not yet been constructed, let alone tenanted. In Intercommunale voor Zeewaterontzilting v Belgium (Case C-110/94) [1996] ECR I-857 this principle was applied to allow deduction of VAT on the cost of a study undertaken by a company in order to decide whether to commence an economic enterprise or not, even though it decided not to proceed and never made any taxable outputs. Thirdly, in Belgium v Ghent Coal Terminal NV (Case C-37/95) [1998] ECR I-1 the Court of Justice confirmed that once a right of deduction had been exercised because the inputs were for the purpose of investment work intended to be used in connection with taxable transactions, the authorities may not claim repayment merely because the taxpayer has been unable to use the goods or services for the intended purpose.

All this is clear law, but I do not see how it helps RSA. It shows that if tax is paid on inputs used or intended to be used for an economic activity carried on for the purpose of making taxable outputs, all that tax may be deducted by the trader even though the inputs are not attributable to particular outputs and even though no taxable outputs are actually made. But in the present case, RSA was not carrying on an economic activity for the purpose of making taxable outputs. If it had been, it would have had no need to rely upon regulation 109. The jurisprudence to which I have referred shows that it would have been able to deduct anyway. The claim under regulation 109 is made on the basis that during the vacant unelected period RSA was carrying on an economic activity for the purpose of making exempt outputs. In such a case, there is no right to deduction. On the contrary, the principle in the Ghent Coal Terminal case suggests that, just as a failure to make taxable supplies does not destroy a right of deduction, so a failure to make exempt supplies does not create one.

To go back my earlier example of the lawyer who first embarks upon the economic activity of making exempt supplies of financial services, let us assume that he is wholly unsuccessful in doing so. He does not make a single exempt output. That does not enable him to say that his inputs while he was trying to supply financial services are cost components of his second career in supplying taxable legal services.

Mr Gammie would, I think, accept this last example. But he says that RSA's position is different because it did not first try one economic activity and then switch to another. It was engaged throughout in the same economic activity, namely, letting property. It was at this point that Mr Gammie tended to stress that RSA was never committed to making exempt supplies. It had an open mind on the question. But, as I said earlier, the entire application of regulation 109 is predicated upon the assumption that RSA was at first intending to make exempt supplies. Nevertheless, Mr Gammie says in his printed case that the fallacy in the Commissioners' argument is that they?

But in my opinion that is the right way to approach the issue. The structure of VAT is built upon the notion that there are some economic activities which are taxable and some which are exempt. An activity which is taxable is by definition not the same for VAT purposes as an activity which is exempt. Usually the nature of the activity determines whether it is taxable or exempt. But letting land can be two different economic activities according to whether or not an election has been made. I therefore think that in deciding to elect and make taxable supplies, RSA were in no different position from the person in my example who decided to change from an activity which involved making exempt supplies to a different activity making taxable supplies. If there are still inputs around from the previous activity which can be used in the new taxable activity, like a building which has been constructed for exempt letting and is then used, after an election, for taxable letting, the taxpayer will be entitled to an adjustment: compare Finanzamt Goslar v Breitshol (Case C-400/98) [2001] STC 355, 384, para 52. But he cannot rewrite history.

Finally I must say something about the decision of this House in Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769, upon which Mr Gammie particularly relied. In that case a bank ("Svenska") continuously provided taxable services such as telephone and electricity to another bank ("Branch") from December 1987 but without receiving payment or rendering a tax invoice until 26 June 1992. During that period it deducted input tax on the cost of providing the services to Branch on the ground that it was intending to make a taxable supply. By the time the invoice was rendered and the supply was treated for VAT purposes as having been made, Svenska and Branch were members of the same VAT group and could not make supplies to each other. The inputs and outputs of each group company from and to outside suppliers and purchasers respectively were treated as those of the group. The Commissioners claimed repayment of the input tax deducted on the ground that the goods and services had in fact been used by the group in making exempt supplies (banking services) to its customers. The House held that the Commissioners were entitled to repayment under what is now regulation 108, the mirror image of regulation 109.

Mr Gammie says that Svenska was paying input tax on supplies received from third parties for the purpose of carrying on the economic activity of making taxable supplies of services to Branch. In the event, it never made a supply to Branch but used the services instead in the economic activity of making exempt supplies to customers. So it had to repay all the tax which had been deducted. Likewise in this case, RSA made no deduction on supplies received from its landlords for the purpose of carrying on the economic activity of making exempt supplies. In the event, it never made an exempt supply but used the services in the economic activity of making a taxable supply after its election to waive exemption. So it should be entitled to repayment of all the tax which it failed to deduct.

In my opinion the true basis of the Svenska case is not that the taxable inputs were deemed to have been accumulated and then used all at once by Svenska in making exempt supplies after Svenska and Branch had become part of the same group. Nor does it decide that it is in principle possible for the Commissioners under regulation 108 to reattribute to exempt use the inputs which in real life had already been used with the intention of making taxable supplies, simply on the basis of a later change in the nature of the economic activity. That would be contrary to the principle of the Ghent Coal case. The decision in the Svenska case turned on the special effect of the grouping provisions, which, as the House decided, made it necessary to treat the inputs to Svenska as having been inputs to the group and used by the group to make exempt supplies at the time that Branch so used them. This appears most clearly from the speech of Lord Hope of Craighead (at p 778):

Thus the effect of section 29 of the 1983 Act was that Svenska was treated as never having carried on the economic activity of making supplies of services. It was the group which was treated as having acquired the input services supplied to Svenska and the group which was treated as having used them for the economic activity of making exempt services supplied by Branch. The case is not authority for the proposition that, for the purposes of regulations 108 or 109, one can retrospectively form a new intention about the use of goods or services which have already been used, like the right to occupy premises for a period which has expired.

I would therefore allow the appeal and restore the decision of the Tribunal.

LORD CLYDE

My Lords,

By virtue of section 5 of and Schedule 4 to the Value Added Tax Act 1994 the grant of a major interest in land, defined in section 96 to mean the fee simple or a tenancy for a term certain exceeding 21 years, is to be treated as a supply of goods. The grant of an interest in land for a shorter period is to be treated as a supply of services (section 5(2)). Leasing or letting of immovable property (subject to certain exceptions which do not apply here) is exempt from tax (Group 1 of Schedule 9 to the 1994 Act). But the exemption can be waived (paragraph 2 of Schedule 10 to the 1994 Act). In the context of the present case it was not suggested that there was any relevant distinction to be made between a short and a long lease. In the context of the time of supply rules set out in the Value Added Tax Regulations 1995 separate provisions are made in regulations 85 and 90 in respect of leases treated as supplies of goods and leases treated as supplies of services. But for present purposes the critical elements of these provisions are the same and no distinction need be made in the context of the present case between goods and services. They are to be treated as "separately and successively supplied" at the time of receipt of payment or the issue of a relevant VAT invoice, whichever is the earlier.

The respondent ("RSA") held leases of certain properties. It paid certain sums to its landlord by way of rent and service charges. For a time it occupied most of the properties for the purposes of its insurance business. Its supplies of insurance services were exempt from VAT (section31 of, and Group 2 of Schedule 9 to, the 1994 Act). But it then found the properties surplus to its requirements and decided to sub-let them. The supplies constituted by such subletting would also be exempt from VAT unless RSA waived exempt status for the properties. Exemption had been waived in respect of the supplies of the properties to RSA by its landlord and so those supplies were taxable supplies for purposes of VAT. RSA accordingly incurred input tax in respect of these supplies. Over periods referred to as "the vacant periods" RSA did not occupy the properties but tried to market them to prospective sub-tenants. During these periods the properties were neither let nor occupied. Eventually it succeeded in sub-letting them and it elected to waive exempt status for each of the properties. It then sought to recover from the Commissioners, the appellants in the present appeal, an amount equal to the input tax which it had incurred and paid in respect of the supplies of the properties to it during the vacant periods and before it had elected to waive exemption in respect of them. This is sought to be done under regulation 109 of the Value Added Tax Regulations 1995.

Regulation 109(1) provides:

Some comments may immediately be made on this section. Firstly, the dispute in the present case concerns only the final phrase of this provision. If one seeks to apply the terms of regulation 109(1) to the present case it is clear at the outset that RSA, as a taxable person, had incurred an amount of input tax and that amount had not been attributed to taxable supplies. I understand it to be accepted that the reasons for that non-attribution was because it intended to make exempt supplies. As the appellants put it in their printed case at para 1.3:

Within the time limit of six years and before the intention to make exempt supplies was fulfilled RSA formed the intention to make taxable supplies and indeed fulfilled that intention by sub-letting the properties. The only question arising in the appeal as regards the application of the regulation is whether that intention was an intention to use "the goods or services concerned in making taxable supplies". In answering that question I have not found a direct solution from the reported cases.

Secondly, the "goods and services concerned" are the goods and services referred to earlier as the goods and services intended to be used in making exempt supplies. The regulation requires that those goods and services are now to be used or intended to be used in making taxable supplies. The goods and services must be the same goods and services. That the use of them was at one time intended to be in exempt supplies and at a later time intended to be in taxable supplies should not make them different goods and services. It is to just such a change that the regulation applies.

Thirdly, what is required by the regulation is that the intention to make exempt supplies must not have been fulfilled. If use has been made of the goods and services then the regulation will not apply. What has been done by actual use cannot be undone. But if there has been no history of use at all and no use has been made of the goods and services then an adjustment may be available. The regulation may apply where there has been a failure to make exempt supplies.

Fourthly, the regulation envisages that a passage of time will occur between the start of the original intention to make exempt supplies and the use or intention to use the goods or services in making taxable supplies. Indeed a maximum period of six years is allowed in terms of the regulation. So the regulation may be invoked even although a multiplicity of accounting periods has passed.

In Midland Bank plc v Customs and Excise Commissioners (Case C-98/98) [2000] STC 501, 518, para 19 the European Court of Justice stated, following earlier case law that:

The basic rule for deduction is set out in article 17(1) of the Directive. That has been implemented in section 26(1) and (2) of the 1994 Act. But the Directive allows in article 20 for the making of adjustments to deductions in among other cases the situation where "after the return is made some change occurs in the factors used to determine the amount to be deducted. . . ". By section 26(3) the implementation legislation empowers the Commissioners to "make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above . . . ". Regulation 109 is one of the regulations so made. No one has suggested that it fails to embody the intention of the Directive or exceeds the powers given in the Act.

One argument which has been put forward is to say that the goods had been used or consumed during the vacant periods. But there is no obvious warrant for equating an attempt to use the properties as a use of them. The fact is that they had remained vacant and unused. The properties remained unimpaired during the vacant periods and despite the passage of time there is nothing to justify the conclusion that they had in some sense been consumed.

But then it is said that the past supplies to RSA are a matter of past history and have as it were disappeared altogether. In the present case the goods and services were the interests under the lettings. Those interests no doubt require to be treated as supplied separately and successively for the purposes of the time of supply rules and no doubt what have to be treated as separate grants, separate supplies, can be regarded as having passed into history. But the present case is not concerned with the time of any supply for the purposes of a charge. The case concerns the making of an adjustment under regulation 109 in respect of the right to deduct the input tax which RSA had paid.

Throughout the vacant periods RSA was engaged or seeking to be engaged in the economic activity of sub-letting the properties. That activity remained as one of constant intention throughout the vacant periods and was still the intention when the decision to claim exemption was made. RSA intended throughout to sub-let the properties, although they failed to do so, and at no time during the vacant period were the goods or services put to use. The properties were the same properties all along and it seems to me that there was a direct and immediate link between the interests under the leases and the eventual output transactions constituted by the sub-letting. Had RSA intended from the outset to make taxable supplies no problem about the deductibility of the input tax it paid would have arisen and there would have been no need to resort to regulation 109 and indeed no room to do so. What happened was that it wished for commercial reasons during the vacant periods to keep its options open. In the event no use was made of the goods and services concerned and no exempt supplies were made. In my view the situation is one which the adjustment required by regulation 109 is designed to meet and so satisfy the basic intention of the deduction system in relation to the carrying on of the economic activity of subletting the properties.

I would dismiss the appeal.

LORD WALKER OF GESTINGTHORPE

My Lords,

The Statutory Provisions

Value added tax ("VAT") is essentially an EU tax, imposed by Member States in compliance with EU legislation, of which the most important is the Sixth Directive (EC Council Directive 77/388/EEC). Member States give effect to the EU legislation (and in particular, the Sixth Directive) by national legislation, in the case of the United Kingdom the Value Added Tax Act 1994 ("the 1994 Act") and the Value Added Tax Regulations 1995 (SI 1995/2518) ("the Regulations"). In this appeal neither side has suggested that the United Kingdom government has failed to implement the Sixth Directive correctly. Nevertheless it is convenient to make some references to it (as well as to the 1994 Act and the Regulations) since the general scheme of the national legislation can sometimes be better understood by reference to the Sixth Directive. Moreover decisions of the European Court of Justice naturally refer principally to the EU legislation in laying down some general principles (in particular the principle of fiscal neutrality, and the concept of the "direct and immediate link") which inform the interpretation of the legislation.

Some important general features of the VAT system have been described by the European Court of Justice in Rompelman v Minister van Financiën (Case 268/93) [1985] ECR I-655, 663-664, paras 15-19:

Schul v Inspecteur der Invoerrechten en Accijnzen

[1982] ECR 1409

The proviso in the last sentence of the quotation is important, because it is possible (through the exemption of some economic activities under article 13 of the Sixth Directive) to be a taxable person without making any taxable supplies. In those circumstances the tax does not cascade down from one taxable person to another until the end products or "outputs" (whether goods or services) reach the ultimate consumer. That is one of the complications which detract from the grand simplicity of the tax structure as it has to be considered on this appeal. The other complications are those of the special treatment of the letting of land or buildings, including the so-called "option to tax". I must mention the statutory provisions bearing on these three complicating factors. I can do so fairly briefly because the proceedings below at every stage are reported (the VAT and Duties Tribunal at [1999] V & DR 336, Park J at [2000] STC 933 and the Court of Appeal at [2001] STC 1476) and they cover the relevant provisions of the Sixth Directive, the 1994 Act and the Regulations in some detail.

Article 17(5) of the Sixth Directive deals with the position of a trader whose business is such that his output supplies are partly exempt and partly taxable. The respondent Royal & Sun Alliance Insurance Group Plc ("RSA", so as to include where appropriate all other companies registered as members of the same group) is in that position. RSA is in the business of insurance, which is (under section 31 of, and Group 2 of Schedule 9 to, the 1994 Act) treated as the making of exempt supplies. But as Park J explained (in para 23 of his judgment) typically an insurance company also makes some supplies which are taxable, even though the bulk of its supplies are exempt. That often happens because the insurer owns property leased to tenants or subtenants and held as an investment, and has exercised its option to tax.

Article 17(5) is in the following terms:

This is followed by a proviso enabling Member States to depart from this principle in certain cases. Article 19 provides for the calculation of the deductible proportion. Article 20 provides for the initial deduction to be adjusted "according to the procedures laid down by the Member States," in particular where the deduction made was higher or lower than that to which the taxable person was entitled (but in general there is to be no adjustment for bad debts or for lost or stolen stock).

The significance of the simple form of words "for transactions" in article 17(5) has been explained by the European Court of Justice in BLP Group Plc v Commissioners of Customs and Excise (Case C-494) [1995] ECR I-983, para 19:

This is the concept of the "direct and immediate link" which has played an important (although somewhat intermittent) part in the argument at different stages of the appeal process.

The provisions of article 17 are given effect principally by sections 24, 25 and 26 of the 1994 Act and by Part XIV of the Regulations, made under section 26(3). In particular section 26(3)(c) provides for the Regulations to cover two converse cases:

These two cases are provided for (in reverse order) by regulations 108 and 109. It is sufficient to set out regulation 109, which is of central importance to this appeal:

Under Group 1 of Schedule 9 to the 1994 Act (implementing article 13, para B(b) of the Sixth Directive) the grant of an interest in land (such as the grant of a lease or tenancy) is (if made by a taxable person) an exempt supply, subject to various exceptions which are not material (other than as the subject-matter of some submissions made by each side as to supposed anomalies and absurdities). But under Schedule 10, para 2 (and article 13 para C) a taxable person may elect to waive exemption under Schedule 9 Group 1. By Schedule 10, para 3(1) and (4) an election to waive exemption cannot in general be retrospective, and is irrevocable. The practical consequences of these provisions, and the fiscal and commercial considerations which a landlord and his prospective tenant would have in mind in relation to them, are discussed by Park J in paras 11 to 13 of his judgment.

By the combined effect of section 5, section 96 (1) (definition of "major interest") and Schedule 4, para 4 to the 1994 Act the grant (in England) of a lease for more than 21 years is a supply of goods; the grant of a lease for 21 years or less is a supply of services. The distinction may make a difference in some circumstances, but it was not suggested that it makes any significant difference in this case.

Finally (in regard to the statutory provisions) I must refer to regulations 85 and 90, which seem to have received little attention at the hearing before the Tribunal but featured in the argument before Park J and the Court of Appeal. Section 6 of the 1994 Act sets out rules in relation to the time at which a supply of goods or services is treated as being made. These rules are capable, in some circumstances, of producing surprising and apparently artificial results (see for instance Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769). Section 6(14) provides, so far as material, as follows:

The last words quoted (which Arden LJ in the Court of Appeal referred to as the subsection's "tailpiece") may be important as establishing the width of the power to make this part of the Regulations.

Regulation 85 is headed "Leases treated as supplies of goods". regulation 90 is rather wider, as its heading indicates: "Continuous supplies of services". It is sufficient for present purposes to set out regulation 85:

Regulation 85(2) provides an alternative mechanism for periodic invoices, but keeps the same basic idea of separate and successive supplies at appropriate intervals.

The difficulty of this appeal arises from the need to reconcile these complex provisions in a way which is compatible with the general principles laid down by the European Court of Justice, and which provides a fair result in this case without creating unfairness in other cases. At different stages in the argument each side has, I think, showed some inclination to press supposed anomalies on your Lordships while at other times urging your Lordships to decide the case on its own facts, and not to worry about other hypothetical cases which are not before the House. This is a familiar feature in litigation on complex tax legislation and your Lordships are generally disinclined to go far in considering competing anomalies. Nevertheless it is important to try to discern a coherent structure in the tax.

The Facts and the Proceedings Below

The tribunal (Mr David Demack) had a detailed agreed statement of facts supplemented by agreed bundles of documents and some oral evidence. The tribunal reduced this to eight paragraphs of findings of fact. As the case has progressed through the courts the essential facts have been further refined, and for present purposes they can be summarised very shortly indeed.

RSA had leases of office accommodation from landlords who had themselves exercised the option to tax. Initially RSA occupied the offices for the purposes of its insurance business (making exempt outputs) and so was unable to deduct input tax on rent and service charges which it paid. Then at various dates between November 1991 and April 1993 some of the office accommodation became vacant as it was surplus to the requirements of the insurance business. RSA wished to let it so as to produce rental income. But because of the difficult state of the property market the accommodation remained vacant for a considerable time, that is (with exceptions which can be ignored) until November 1995. On 21 November 1995 RSA made an election (under Schedule 10, para 2 to the 1994 Act) to waive exemption, and the election was notified to the Commissioners on 21 December 1995.

During what were called the vacant unelected periods RSA was trying to sublet the offices, but was unable to achieve a letting. It was of course obliged to continue to pay rent and service charges to its own landlords, although the premises were vacant and unproductive. RSA did not elect to waive exemption at an earlier date because it wanted to keep its options open. It could not foresee whether any prospective subtenant would itself be making taxable or exempt supplies.

Both sides' arguments have varied a good deal during successive stages of the appeal process. It is unnecessary to record the evolving arguments in great detail, but I must attempt a brief summary. The tribunal decided in favour of the Commissioners principally on the ground that there was no direct and immediate link between RSA's inputs between 1991 and 1995 and its taxable outputs thereafter (although that bald summary does scant justice to Mr Demack's very careful analysis and discussion of the submissions made to him). Park J reached the opposite conclusion, largely (although again this does scant justice to his very careful analysis and discussion) on the ground that regulations 85 and 90 were concerned only with the time of supply, and were not concerned (and as a matter of vires, could not be concerned) with its nature. On this point Park J followed the majority of the Court of Appeal in B J Rice & Associates v Customs and Excise Commissioners [1996] STC 581: see especially the judgment of Ward LJ at p 590, considering section 5(9) of the Value Added Tax Act 1983 (the counterpart of section 6(14) of the 1994 Act) but not referring to its "tailpiece". Park J therefore rejected the tribunal's view as to the lack of a direct and immediate link. He said (para 59):

In the Court of Appeal the majority (Aldous and Sedley LJJ) followed Park J in treating the relevant supply (as I understand it, to RSA) as the grant of the lease, despite regulation 85 (see especially the judgment of Aldous LJ at para 76). Arden LJ took a broader view of the scope of section 6(14) and regulation 85 (see paras 44, 45 and 49 of her judgment) and concluded (para 50), as the tribunal had, that there was no direct and immediate link. So the majority reached the same conclusion as Park J on broadly the same grounds.

Discussion

In my opinion Arden LJ was correct in her analysis and conclusion as to the scope of section 6(14) and regulation 85. That does not necessarily involve saying that B J Rice & Associates v Customs and Excise Commissioners was wrongly decided, as it was concerned with a different factual situation (an invoice sent to a client before the consultant was registered for VAT). On this point I cannot usefully add more to the observations of my noble and learned friend Lord Hoffmann, whose opinion I have had the advantage of reading in draft.

However in a further evolution of the argument Mr Gammie QC did not really seek to uphold the reasoning of the majority of the Court of Appeal. He argued that even if the lease held by RSA ought to be regarded as a series of separate and successive supplies to it, those supplies had not been used for any purpose so long as the offices were vacant and unproductive. They were therefore still available, he said, to be attributed to taxable outputs made after 1995.

In support of this proposition Mr Gammie cited a number of well-known authorities, including the decisions of the European Court of Justice in Intercommunale voor Zeewaterontzilting v Belgium (Case C-110/94) [1996] ECR I-857, Belgium v Ghent Coal Terminal NV (Case C-37/95) [1998] ECR I-1and Abbey National plc v Customs and Excise Commissioners (Case C-408/98) [2001] STC 297 and the decision of your Lordships' House in Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769. I agree with Lord Hoffmann that the principles stated in these cases, although not in doubt, do not really assist RSA. Svenska turned on specific statutory provisions about grouping (which might be thought to have produced an artificial result, but arguably the real artificiality lay in Svenska's uncommercial conduct in leaving its output supplies unbilled for so long). Abbey National makes clear that cost components may include overheads, which is not in dispute but does not really get RSA home. Ghent Coal and Intercommunale were concerned with a single economic activity which would have made taxable supplies in due course, had it not been interrupted by compulsory acquisition (in Ghent Coal) or failed to get beyond the stage of a feasibility study (in Intercommunale).

RSA's real grievance, it seems to me (emphasised by Mr Gammie's occasional references in his submissions to his clients having been honest and played fair) arises from the inescapable difference between a trader who makes taxable supplies and a trader who makes exempt supplies. If a trader is in business making only taxable supplies, and finds itself with a rented office or warehouse vacant because of over-capacity, it would be able to continue to deduct the input tax paid to the landlord (assuming the landlord to have opted to tax). That would be so even in the trader saw no prospect of subletting before the end of the lease, and resigned itself to some wasted expenditure. The wasted expenditure would still be a cost component of the business as a whole. It would be comparable (although the analogy cannot be taken too far) to perishable trading stock which had to be written off.

Mr Gammie argued that his clients should not be at a disadvantage because they genuinely did not know what they wanted to do with the vacant offices, and were candid enough to acknowledge that. The point is made in RSA's printed case, para 5.16:

The printed case also (in para 5.18) disputes whether there is any real analogy between perishable goods and:

As I have said, the analogy cannot be pressed too far. But it is an inescapable consequence of the general structure of VAT that a trader who makes partially exempt and partially taxable supplies (or who switches from exempt to taxable supplies) cannot expect precisely the same treatment as one who makes taxable supplies throughout. That would be pressing the principle of fiscal neutrality too far. A trader whose outputs have in the past been wholly or partially exempt must, if he is to be able to reclaim input tax, be able to show that his position meets the fairly precise requirements of regulation 109, which is ultimately derived (through a chain of provisions which I need not repeat) from article 17(5) of the Sixth Directive. Even if successive input supplies of office accommodation can in some sense be described as a continuous chain of supply (which RSA had to pay for in order to avoid forfeiture), it was simply not possible for RSA, in or about November 1995, to use or form an intention to use (the crucial words in regulation 109(1)) separate as supplies of accommodation for successive periods of three months, each of which was then past history. (That is not to say that some past supplies, especially of goods of a permanent nature, might not have come within regulation 109.)

In my opinion the scope of section 6(14) of the 1994 Act, and the language of regulation 85, are ultimately decisive. For these reasons and for the further reasons in the opinion of Lord Hoffmann I would allow this appeal and restore the decision of the tribunal. In accordance with the terms on which leave to appeal was granted I would not disturb the order as to costs below and I would make no order as to costs before the House.

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