United Kingdom VAT & Duties Tribunals Decisions

Royal & Suin Alliance Plc v Customs and Excise [2004] UKVAT V18842 (18 November 2004)

18842

VAT — partial exemption and out-of-country supplies – relationship of methods of attributing residual input tax

Preliminary issues:

(1) whether Commissioners had power under para 1(1) Schedule 11 VATA 1994

a. to conclude agreement with appellant as to manner of attributing supplies within reg 103(1) of VAT Regulations 1995; and

b. to embody such agreement in letter together with approval of partial exemption special method within reg 102(1)

(2) whether letter provided for manner of attributing supplies within reg 103(1) falling outside scope of that regulation.

MANCHESTER TRIBUNAL CENTRE

ROYAL & SUN ALLIANCE PLC  Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE Respondents

Tribunal: Mr J D Demack (Chairman)

Mr A E Brown FCA

Sitting in public in Manchester on 22 and 23 September 2004

Mr Michael Conlon QC instructed by the taxation manager of RSA for the Appellant

Mr Paul Harris of counsel instructed by the Solicitor for the Customs and Excise for the Respondents

© CROWN COPYRIGHT 2004


 


DECISION

Introduction

1. In 1999 the appellant company, Royal & Sun Alliance plc ("RSA"), invited the Commissioners of Customs and Excise to agree what included a partial exemption special method ("the Method") for input tax calculation. Subject to amendments and conditions, on 13 October 1999, by letter of that date ("the Letter") they agreed the Method and authorised its use. Subsequently, allegedly in reliance on the Method, RSA submitted voluntary disclosures seeking repayment of input VAT underclaimed. RSA explained the legal basis of its claims in a letter to the Commissioners of 12 September 2002 in this way:

"The claims for 1999, 2000 and 2001 are made on an identical basis. They relate exclusively to input tax attributable to out-of-country supplies. The Method was agreed pursuant to regulation 102(1) of the VAT Regulations 1995. We are advised by Leading Counsel that this regulation must be read subject to regulation 103. Regulation 103(1) provides that input tax that is a cost component of out-of-country supplies is to be attributed according to the extent the costs are used for such supplies. It follows that this attribution is a separate step in the VAT recovery calculations and does not form part of the Method. This principle is clear from the decision of the House of Lords in CCE v Liverpool Institute of Performing Arts . . . Counsel also advises that, under the terms of the Method, residual input tax is recoverable according to a value-based formula (see Appendix B of the Method). The terms of this allow the value of out-of-country supplies to be included in both the numerator and denominator of the formula. It follows that our claims are made in accordance with the law (found in regulations 102 and 103(1)) and the terms of the Method."

2. "Out-of-country supplies" is a phrase coined by the House of Lords in the case of CCE v Liverpool Institute of Performing Arts [2001] STC 891 ("LIPA") to describe supplies of services made to overseas recipients. That case establishes that the UK standard method of attribution, now to be found in regulation 101 of the Value Added Tax Regulations 1995 ("the Regulations") applies only to UK taxable supplies.
3. On 14 November 2002 the Commissioners refused RSA's claims, characterising them as an attempt ". . . to withdraw from the [Method] retrospectively (by submitting claims for previous tax years); selectively (by changing only part of the agreement) and unilaterally." (An approved special method must continue to be used unless the Commissioners "approve or direct the termination of its use" (regulation 102(3) of the Regulations), and retrospective amendments are permitted only with the agreement of the Commissioners (regulation 102(4)).
4. The Commissioners contend that the Method comprises two separate agreements, namely:

1) approval of a partial exemption special method (made under regulation 102 of the Regulations); and

2) an agreement as to the manner of calculating the extent to which goods and services are used in making out-of-country supplies (made under the Commissioners' powers of care and management of VAT contained in para 1(1) of Schedule 11 to the Value Added Tax Act 1994 (the 1994 Act)).

5. The parties have agreed that, for the sole purpose of resolving the issues of principle referred to in para 7 below, certain recharges for services procured on behalf of, and onwardly supplied to, RSA's overseas subsidiaries are consideration for supplies of services falling within Schedule 5 to the 1994 Act.
6. The appeal originally came before us on 9 February 2004, but had to be adjourned as the Commissioners required disclosure of certain RSA internal materials to enable them properly to consider a claim that the Method did not cover out-of-country supplies. The Commissioners maintain that RSA has still not made full disclosure, but in order to make progress have agreed with it certain preliminary questions the answers to which may completely resolve the dispute between the parties. For the purposes of the preliminary issues only, we must assume that:

1) the out-of-country supplies in point fall within the scope of the Method; and

2) the cost components of the out-of-country supplies are also used in part for supplies made by RSA in the United Kingdom.

7. The preliminary questions we are required to answer are these:

1) Did the Commissioners have power under paragraph 1(1) of Schedule 11 to the 1994 Act:

(a) to conclude an agreement with RSA as to the manner of attributing input tax to supplies within regulation 103(1) of the Regulations; and

(b) to embody such agreement in the Letter together with the approval of a partial exemption special method under regulation 102(1)?

2) Did the Letter provide for a manner of attributing input tax to supplies within regulation 103(1) which falls outside the scope of that regulation, in particular because it employs a value of outputs calculation at Appendix B?"

The Facts

8. We take the facts from an agreed statement provided by the parties.
9. RSA is the ultimate holding company of the Royal & Sun Alliance Group ("the Group"). The Group was formed in 1996 as the result of a merger between Royal Insurance plc and Sun Alliance plc ("'the merger"). Following the merger RSA adopted a divisionalised structure similar to that previously operated by Royal Insurance plc
10. RSA owns a number of subsidiaries established in the United Kingdom. The main business activity of RSA and its subsidiaries is the writing of life assurance and general insurance business for United Kingdom policyholders. The life assurance business ceased to sell new policies with effect from 1 September 2002. Other business activities in the relevant period included estate agency (sold in October 2003) and investment management of assets (including real property).
11. In addition to its United Kingdom subsidiaries, the Group includes subsidiaries established outside the United Kingdom. These overseas subsidiaries are in approximately fifty countries worldwide, but mainly the United States of America, Canada, Australia and Denmark. A number of the overseas subsidiaries are insurance businesses within their own territories. Where appropriate such subsidiaries are registered for VAT, or its equivalent, in their own territories.
12. RSA is, and at all material times was, registered for VAT as the representative member of a group registration. Much of the Group's insurance income is VAT exempt. Accordingly, RSA is partially exempt and unable to recover its input tax in full. RSA's tax year runs from 1 January to 31 December. For the tax year 1999 RSA calculated its residual VAT recovery rate at 15.56 per cent; for the tax year 2000 at 5.11 per cent ; and for the tax year 2001 at 16.32 per cent.
13. Following the merger, RSA began discussions with the Commissioners on the use of a partial exemption special method. For practical purposes the framework of such method was based on the special method previously approved for Royal Insurance plc. The underlying principle of the discussions was to agree a method which involved direct attribution of input VAT: input VAT used, or to be used, exclusively in making taxable supplies, or in carrying on activities for which there is a right to deduct would be deductible in full; input VAT used, or to be used, exclusively in making exempt supplies or in carrying on activities for which there is no right to deduct would not be recoverable. Any remaining input VAT would be allocated to identified business sectors. Separate apportionment calculations would be made for each sector. Where goods or services were procured by one sector for use by another sector, input VAT would be recoverable according to the recovery rate of the sector consuming or benefiting from the supply.
14. Between March 1997 and October 1999 the framework of the method under discussion changed very little. Agreement was delayed because of discussions about the estate agency part of the business and whether the value of insurance outputs should include insurance premium tax. The Method was finally approved by the Commissioners and set out in the Letter. It took effect from 1 January 1997.
15. The relevant parts of the Letter read thus:

"2. The Method

… You are to calculate your deductible input tax . . . on the following basis:

(a) Identify all the goods and services you receive which are used, or to be used, by you exclusively in making supplies for which there is a right to deduct. The input tax thereon is deductible.

(b) Identify all the goods and services you receive which are used, or to be used, by you exclusively in making supplies for which there is no right to deduct or in the carrying on of any activity other than the making of supplies which carry the right to deduct. The input tax thereon is not deductible.

(c) Any remaining input tax is to be allocated to the agreed sectors shown in Appendix A to this letter . . . on the same basis that input tax is specifically identified and allocated by means of the accounting systems within Royal & Sun Alliance.

You should then determine the deductible portion of any remaining input tax to two decimal places by carrying out separate calculations for each sector.

These calculations are to reflect the extent to which the goods and services on which the goods and services on which non-deductible input tax is incurred are used in making supplies for which there is a right to deduct . . .

Please note that:

a. Supplies which carry a right to deduct are taxable supplies:

outside the scope supplies with the right to deduct (these are supplies made outside the UK which would be taxable supplies if made in the UK or certain supplies specified in the Value Added Tax (Input Tax) (Specified Supplies) Order 1992);

exempt supplies with the right to deduct (these are supplies specified in the Value Added Tax (Input Tax) (Specified Supplies) Order 1992).

b. Supplies which do not carry a right to deduct. These are supplies within the EC and any non-specified supplies made outside the EC which would be exempt supplies if made in the UK;

exempt supplies with no right to deduct.

3. Taxable and exempt supplies

Taxable supplies referred to in the attached appendices, shall be deemed to include taxable supplies which are outside the scope of the tax with a right to deduct input tax. Likewise, any reference to exempt supplies shall be deemed to include supplies which are outside the scope of the tax without a right to deduct input tax."

16. Appendix A to the Method includes, as Business Sector 1, "Head Office". Appendix B sets out the manner of apportionment. So far as material it provides:

"1. Head Office

"Recovery of any non-attributable tax shall be determined by:

Total value (excluding VAT) of taxable and specified

supplies of the Royal and Sun Alliance plc VAT group x non-attributable Total value (excluding VAT) of taxable, exempt, input tax

specified and non-specified supplies of the Royal and

Sun Alliance Group plc VAT group"

17. Business Sector 1, "Head Office", comprises RSA, Royal Insurance Holdings plc and Royal & Sun Alliance Insurance p1c (excluding General Business areas).
18. Initially following the merger, certain costs of managing the Group's investment in its UK and overseas subsidiaries (referred to at that time as shareholder expenses) were incurred by RSA. They were treated for corporation tax purposes as attributable to RSA and were not recharged.
19. In 1998 a new division of RSA known as Worldwide Group Office ("WGO") was set up. The purpose of WGO is to co-ordinate the evolution of the Group into a global insurer and provide corporate and strategic guidance for the benefit of the Group's subsidiaries worldwide. RSA, through WGO, is authorised to enter into contracts with third parties on behalf of the group. In addition to its strategic activities, WGO's role developed into that of procurement agency, for consultancy and information technology supplied by external providers to the Group as a whole. As WGO's functions expanded it was necessary, for UK corporation tax purposes in particular, for WGO to develop a principle of charging other group companies, both within and outside the UK for services it provided to them.
20. At the time the Commissioners approved the Method in October 1999, RSA, through WGO, was charging overseas subsidiaries for services it provided to them. At that date the RSA intended to continue supplying such services. It contemplated increasing the amount and type of such services but did not know precisely what the future amounts and types would be. By the end of 1999 WGO was raising substantial recharges for services procured on behalf of, and onwardly supplied to, RSA's overseas subsidiaries. Thereafter, in the tax years 2000 and 2001, WGO raised recharges falling into three main categories:

(a) transfer pricing recharges;

(b) central accounting unit recharges;

(c) specific projects (in respect of consultancy and it procurement)

(together referred to as "the recharges").

21. In the case of category (a), the recharges were agreed between WGO and the respective overseas affiliates depending on the nature of underlying costs. For category (b), the recharges were based on the value of premiums booked by each subsidiary through the Central Accounting Unit. For category (c), the recharges varied according to the type of consultancy/IT project and were agreed on the basis of the use by the affiliate of the software licence or of the functionality.
22. In the tax years 1999-2001, RSA calculated its input VAT and its VAT returns on the basis that all VAT incurred on WGO expenditure was residual and non-attributable.
23. In January 2002, RSA's tax department undertook a review of VAT accounting. One issue highlighted in the review was a possible underclaim of input tax attributable to out-of-country supplies between 1999 and 2001. Consequently on 22 February 2002 it made a protective claim to the Commissioners for category (a) supplies for the tax years 1999 and 2000. Following discussions with the Commissioners, the claim was revised and additional claims for category (b) supplies were made on 3 April 2002. The claims were further revised and a claim for an example supply in category (c) was added for 2000 on 31 May 2002. On 12 September 2002, RSA made additional claims for input VAT underclaimed relating to category (a), (b) and (c) supplies for the tax year 2001. The revised claims for 1999 and 2000 and the claim for 2001 total £1,750,488. As mentioned earlier, the Commissioners refused RSA's claims on 14 November 2002, and it is against their refusal that it now appeals.

The Law

24. 1. European Community Law

Article 17 of the EC Sixth VAT Directive ("the Sixth Directive") provides the right to deduct input VAT. The entitlement is in respect of input VAT on expenditure used for: (1) taxable transactions; (2) economic activities carried out in another country which would be taxable if made in the taxable person's country; and (3) certain exempt supplies to customers established outside the Community (articles 17(2)(a) and (3)(a) and (c)). Article 17(5) goes on to provide that where expenditure is used partly for deductible transactions, it may be deducted in part.

Article 17(5) opens in this way:

"(5) As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which [VAT] is deductible, and for transactions in respect of which [VAT] is not deductible, only such proportion of the [VAT] shall be deductible as is attributable to the former transactions.

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

Article 19 is entitled "Calculation of the deductible proportion", and in relevant parts reads as follows:

"1. The proportion deductible under the first sub-paragraph of Article 17(5) shall be made up of a fraction having:

as numerator, the total amount, exclusive of [VAT], of turnover per year attributable to transactions in respect of which [VAT] is deductible under Article 17(2) and (3),

as denominator, the total amount, exclusive of [VAT], of turnover per year attributable to transactions included in the numerator and to transactions in respect of which [VAT] is not deductible. . ." .

Article 17(5) continues at the third sub-paragraph:

"However, the Member States may:

(a) authorise the taxable person to determine a proportion for each section of his business . . .;

(b) . . .

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

It is agreed that case law makes it clear that the entitlement to deduct arises where there is a direct and immediate link between the expenditure and output transactions in respect of which VAT is deductible. This is intended to relieve a trader entirely of the burden of VAT where the expenditure is for activities which are themselves subject to VAT or so treated (the "neutrality" principle). It is for the national court to apply the direct and immediate link to the facts and surrounding circumstances of each case: see e.g. Midland Bank plc v CCE (Case C-98/98) [2000] STC 501; BUPA Purchasing Limited and others v CCE [2003] STC 1203 ("BUPA") and CCE v Southern Primary Housing Association Limited [2004] STC 209.

Relying on art. 17(5)(c), the UK introduced sections 24(1) and 26(2) of the 1994 Act. The former subsection defines "input tax" as including the Vat on certain specified goods or services "used or to be used for the purpose of any business carried on or to be carried on . . ."; while section 26(3) empowers the Commissioners to make regulations "for securing a fair and reasonable attribution of input tax to supplies within section 26(2)". The relevant regulations are Part XIV of the Regulations, which replace Part V of the Value Added Tax (General) Regulations 1985.

25. 2. The Regulations

Regulation 101 of the Regulations provides the standard method of calculation. Key features of that method are: (1) the attribution to taxable supplies of input tax on such goods and services as are used exclusively for taxable supplies (recovered in full): and (2) the attribution (and disallowance) of input tax on such goods and services are used exclusively for exempt supplies. This is generally described as the principle of "direct attribution". Non-attributable input tax i.e. VAT on expenditure used indiscriminately for all transactions of the taxable person (usually called "residual input tax"), is recoverable in part. In the standard method this calculation is made using a formula based on the value of outputs: regulation 101(1)(d). That sub-paragraph reads:

" (d) there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies 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". (emphasis added)

Regulation 103 provides for the attribution of input tax to out-of-country supplies. Subject to exceptions not relevant in the instant case, this regulation directs that input tax:

"used or to be used . . . in whole or in part in making . . . [out-of-country supplies] . . . shall be attributed to taxable supplies to the extent that the goods or services are so used or to be used expressed as a proportion of the whole use or intended use"

"Use" is not defined.

26. 3. The LIPA case

The interaction of regulations 101 and 103 was clarified by the House of Lords in the LIPA case. LIPA made taxable and exempt supplies within the UK. It also made out-of-country supplies in the form of advertising services supplied to a German company. LIPA operated the standard method which required non-attributable input tax to be recovered according to a formula based on the ratio of the values of taxable to total outputs. The issue was whether the value of out-of-country supplies should be used in the numerator and denominator of the formula. The Court of Appeal considered that "taxable supplies" in what is now regulation 101 excluded foreign supplies, and that "all supplies" in regulation 101 included taxable supplies and exempt supplies but did not include foreign supplies. The court held that new regulation 103 was intended to constitute a separate regime from new regulation 101 for foreign and other specified supplies. The taxpayer's appeal to the House of Lords was dismissed, their Lordships holding that art 17(5) coupled with art. 19 of the Sixth Directive did not insist on a value based approach to the apportionment of residual input tax. Member States were entitled to require that deduction be made on the basis of the use of all or part of the goods or services

27. 4. Special methods

Regulation 102(1) of the Regulations provides (with certain exceptions not relevant to the instant case) that:

"Subject to . . . regulation 103, the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 . . ."

This is referred to as a "special method". Most special methods require direct attribution of input tax to the greatest extent possible: in effect they repeat regulation 101(1)(a) to (c). The Method is so framed. Where special methods differ from the standard method is in relation to non-attributable input VAT. It is common to find "sectorisation" i.e. where non-attributable input is allocated, on one or more bases, to separate sectors within the business. Calculation of the deductible proportion within each sector is then on a basis such as a value of outputs ratio, transaction count, use, or sometimes a combination of factors. It may be so framed that, in a value of outputs calculation, certain output values are included and others excluded. In essence, therefore, a special method is directed primarily at allocating and apportioning non-attributable input VAT.

Submissions for RSA

28. Mr Conlon QC, for RSA, submitted that RSA's accounting for the out-of-country supplies was initially incorrect in two respects. First, the values of the out-of-country supplies were omitted from the apportionment formula calculations in Appendix B to the Method; and, secondly, input tax incurred on cost components of the out-of-country supplies as treated as Head office overheads, and therefore non-attributable. In short, RSA made no attempt to attribute the input tax to any specific outputs.
29. Mr Conlon observed that regulation 102(1) and, consequently, any special method is expressly subject to regulation 103. He claimed that it follows that, just as with the standard method, the attribution of input tax to out-of-country supplies must be carried out as a separate step: and attribution is to be based on use and on nothing else, the reasoning of the House of Lords in LIPA supporting this (see particularly per Lord Scott of Foscote at paragraphs 36 and 37). He maintained that the Commissioners confirm this analysis in Business Brief 12/01 and at paragraph 7.3 sixth sub-paragraph, of VAT Notice 706/02, which states:

"If you have an approved special method, the calculation of "out-of-country" and specified supplies must be applied before carrying out the special method"

The Notice continues:

"Alternatively, it can be incorporated into a special method, providing you obtain prior approval from your local VAT Business Centre."

30. Mr Conlon accepted that, in principle, the Commissioners "could probably conclude" two separate agreements with the taxpayer within a single document, see The Labour Party v CCE (2001) Decision 17034. However, he contended, neither that case nor GUS Merchandising Corp Ltd v CCE (No. 2) [1995] STC 279, on which the Commissioners also rely, is authority for the proposition that the Commissioners can agree to override the plain words of a regulation. As the tribunal noted at paragraph 57 of the decision in The Labour Party:

"On the words of the legislation alone we would conclude that Customs and Excise had power to allow or direct the use of a special method in any way they see fit. There is nothing in the legislation to prevent Customs and Excise from combining the allowing or directing of a special method with the exercise of any other power, including the agreement of a method of apportioning input tax between business and non-business supplies".

31. In contrast to the position on out-of-country supplies, Mr Conlon observed that the VAT legislation is silent on the method of apportioning between business and non-business transactions.
32. Even if, in principle, the Commissioners were entitled to agree a special method which also dealt comprehensively with out-of-country supplies, Mr Conlon submitted that there must be at least a doubt as to whether the Method achieves this. On the face of it, it purports to approve, subject to amendments and conditions, RSA's "proposals to use a partial exemption special method". Nothing is said about regulation 103 or contracting out of it.
33. Mr Conlon accepted that the Method undoubtedly permits the values of out-of-country supplies to be included in the formula used to calculate residual input tax. However, he submitted, that is not the same as substituting a value based calculation for the purpose of attributing VAT to out-of-country supplies in the first place.
34. Paragraph 2(c) of the Method concerns "remaining input tax" allocated to business sectors. Mr Conlon further submitted that, even if we were to find that the Method clearly covers all types of input tax, the input tax used or to be used for out-of-country supplies can be accommodated within paragraph 2(a) of the Method. Whether that is done, or a discrete calculation performed (as he contended LIPA requires), he maintained that the end result should be the same.
35. Mr Conlon observed that there is nothing in the Method or in the legislation which precludes a taxpayer subsequently correcting an incorrect input tax attribution. That such a right exists is well-settled: see, for example, Ampleforth Abbey Trust v CCE (1998) Decision 15763 and University of Sussex v CCE (1999) Decision 16221 and The Labour Party.
36. In the instant case a correction of attribution is, in Mr Conlon's submission, appropriate. If it were to be assumed that paragraph 2(a) of the Method potentially covers input tax on the cost components of out-of-country supplies, both that paragraph and the principles of regulation 103 require enquiry to be made as to the extent of use, or intended use, to support the activity which gives rise to the right to deduct. By way of example, Mr Conlon invited the tribunal to consider a purchase invoice received by the taxpayer for 571 plus VAT of 100. If that were recharged (with or without mark up) to a UK customer input tax of 100 was fully deductible. The VAT was a cost component of the onward taxable supply. He continued, consider next that 285.50 plus VAT was recharged to each of two UK customers. Again VAT of 100 was deductible because it was a cost component of two onward supplies. Suppose, however, the taxpayer recharged 285.50 plus VAT to one UK customer and retained the balance as part of its overheads in a partially exempt business. Mr Conlon submitted that it could not be contended that 100 of VAT was a deductible as input tax: but 50 of VAT would be deductible because the cost component had been used exclusively to that extent for taxable supplies. Put another way, he contended that half the input had been used exclusively for taxable supplies, and half exclusively for exempt supplies.
37. Mr Conlon maintained that that approach was endorsed in the BUPA case where Park J, at paragraphs 34 and 40, concluded that inputs and input tax could be apportioned on a percentage basis when considering the extent to which they were attributable to taxable supplies. That was, claimed Mr Conlon, an example of the application of the principle of fiscal neutrality: see paragraphs 41 to 48 of the judgment.
38. He submitted that the attribution principles illustrated in the penultimate and last preceding paragraphs apply equally to both out-of-country supplies and UK supplies.
39. If, contrary to the above submissions, we were to consider that VAT which is a cost component of specific recharges consisting of out-of-country supplies falls within a residual value-based calculation under the Method, he submitted that the Commissioners do not have power to approve or direct such a calculation in the instant case.
40. Section 26(3) of the 1994 Act enables the Commissioners to make regulations "for securing a fair and reasonable attribution of input tax" to taxable supplies, out-of-country supplies and other specified supplies. Part XIV of the Regulations is the exercise of that power. Regulation 101 prescribes the standard method and is subject to regulation 102. As LIPA shows, the standard method does not encompass input tax attribution to out-of-country supplies, which have their own regime in regulation 103. Regulation 102 provides that the Commissioners may approve or direct a special method. That power is expressly "subject to regulation 103". Mr Conlon submitted that Regulation 103 is unequivocal. It is not subject to any other regulation; and contains no words such as "save as the Commissioners may otherwise allow or direct." Although the enabling powers in section 26 of the 1994 Act are quite widely drawn, section 26(4) makes it clear that any derogations may only be contained in regulations.
41. Section 58 of the 1994 Act provides that "Schedule 11 shall have effect . . . with respect to the administration, collection and enforcement of VAT". Paragraph 1(1) of Schedule 11 provides that "VAT shall be under the care and management of the Commissioners". Mr Conlon contended that where a regulation, such as regulation 103, has been made within clear enabling powers, it is simply not open to the Commissioners to override its plain meaning: that goes far beyond the concepts of administration, or care and management.

Submissions for the Commissioners

42. Most helpfully, Mr Harris, counsel for the Commissioners, expanded on his submissions to explain in detail the way in which the Commissioners maintain that the relevant provisions of the Sixth Directive have been implemented in domestic legislation, and how the legislation deals with the problems raised in the instant case.
43. But first we should mention that Mr Harris maintained that what RSA is seeking to achieve is a substantial amendment to the terms of the Method. He claimed the effect of such an amendment would be to remove from its scope some of out-of-country supplies by treating them separately, whilst leaving the remainder of the Method for UK supplies and the remaining out-of-country supplies.
44. He opened his submissions by observing that dual use inputs (residual inputs) need to be "attributed" (see art 17(5)) in some way, in part to deductible uses and in part to non-deductible uses. According to art 17(5), second sub para, art 19 provides the "standard" method of carrying out the attribution of dual-use supplies. But the third sub-para of art 17(5) introduces a series of choices as to the basis of attribution available to Member States. The purpose of the art 17 regime is to allow deduction in so far as the use of the inputs is a deductible one. Where there is dual-use of an input, the regime of art 17(5) is to permit deduction of that proportion of input tax "attributable " to deductible "uses". Art 19 then provides a "standard" method of "attribution" of "use". The mechanics of the art 19 attribution method are, in fact, actually based on turnover values, ie the value of deductible outputs as a proportion of the value of all outputs.
45. However, Mr Harris noted, it may be that attributing input tax on dual-use supplies under the art 19 method will not exactly reflect how those dual-use supplies are in fact used: on the other hand it may prove a fair and reasonable proxy for use. The rationale behind the adoption in art 19 of a value-based proxy is important in the instant case. The reason is that the Sixth Directive's objective of attributing dual-use supplies according to the deductible nature of the "use" is very difficult to achieve accurately in practice, and value-based methods are easy proxies to use. The most accurate method - tracing every single input cost component through to end use - may be literally impossible. In practice, therefore, some proxy for the actual precise use of dual-use inputs must be employed. And the Sixth Directive contemplates methods other than the outputs-value based attribution method of art 19. Art 17(5)(c) permits the authorisation or direction of an attribution method "on the basis of use of all or part of the goods or services". Prima facie this may be confusing, since the defining concept of the deduction is already "use". Nevertheless, Mr Harris contended that art 17(5)(c) is distinguishable from art 19, because it is a permissive provision for Member States, referring generally to "on the basis of use", and does not descend to specifics. Yet another alternative to the art 19 method (at art. 17(5)(a) and (c)) is a sectorisation approach. Under this alternative, no specific "basis" for the method of attribution is mentioned in the Sixth Directive at all; the mechanics of the attribution calculation are left to Member States.

(a) UK Domestic implementation

46. In its domestic law, particularly in the Regulations, the UK has relied on art 17(5)(c) to employ a "use-based method" in all cases requiring an attribution of dual-use inputs; it does not employ the art 19 method in domestic legislation at all.

(b) The standard method

47. More particularly, the UK has enshrined in the Regulations a specific use-based method for whenever its UK "standard method" in regulation 101 is not put in place. Although the regulation 101 method appears similar to the art 19 attribution method, it is not the same; the UK method employs a ratio of "taxable" supplies to "all supplies". Further, the UK method also relates solely to UK taxable supplies, not to all supplies (see LIPA). This, despite the regulation 101 method being similar to the art 19 standard method, is an implementation of a different, use-based method under art 17(5)(c). In the light of the same difficulties of 100 per cent accurate attribution of dual-use supplies previously referred to, the actual attribution method in regulation 101(d) employs "values" as proxy for use (and, as it happens, they are "output values", just as in art 19). Thus, the UK standard method is a "use-based" method, albeit that the attribution calculation employs an outputs-value-based proxy.

(c) UK partial exemption special methods

48. Regulation 101 is "Subject to regulation 102", which gives power to the Commissioners to "approve" or "direct" the use of a "method other than that specified in [regulation] 101" to attribute residual input tax. Such other methods are commonly referred to as "partial exemption special methods"("PESMs'). A directed or approved PESM stands in place of the regulation 101 method for any particular trader.
49. The UK has again relied on art 17(5)(c) to implement regulation 102. Thus, PESMs are all intended to be operated ". . . on the basis of use of all or part of the goods or services". Whilst PESMs are intended to be operated "on the basis of use", there is still a range of attribution calculation methods that can be employed as use-based proxies in any particular PESM.
50. The key point is that, whatever method of attribution is employed, it must result in what the Commissioners consider to be fair and reasonable attribution of residual input tax (see s. 26(3) of the 1994 Act). Frequently, traders suggest a particular proxy for use in a PESM, sectorisation often being chosen. However, anything that produces a fair and reasonable outcome of attribution of use is potentially acceptable.

(d) The scope of regulationss 101 and 102: LIPA

51. LIPA establishes that the method of attribution in regulation 101 applies only to UK (taxable) supplies: thus it leaves attribution of dual-use out-of-country supplies (and specified supplies) to be dealt with by other means. Strictly, LIPA does not deal with PESMs in regulation 102, but the Commissioners do not seek to distinguish that case on the basis that it concerned the standard method of attribution, whereas the instant case involves a PESM. In LIPA, the Commissioners' successfully argued that regulation 103 establishes a separate code for determining the amount of input tax relevant to the making of out-of-country supplies. In other words, the Commissioners have long taken the view that the regulation 103 regime is conceptually distinct from the regulation 101 and 102 regimes.
52. Accordingly, out-of-country supplies (and specified supplies) cannot be the subject of a true PESM, whether "approved" or "directed" under regulation 102. Rather, out-of-country supplies have a different regime applied – that under regulation 103. Indeed, regulation 102 begins with the words, "Subject to . . . [regulation 103] . . ." To this extent, it appears that the parties are agreed.

(e) Regulation 103

53. Regulation 103 provides for the "attribution" of dual-use out-of-country supplies (and specified supplies), given that attribution of them does not fall within regulation 101, or a PESM under regulation 102.
54. Against this background, the Commissioners understand RSA to contend that the parties:

a) were incapable, as a matter of law, of coming to an agreement in the Letter as to the attribution of RSA's out-of-country supplies; or

b) at any rate, were incapable of reaching the agreement the Commissioners contend they did reach in the Letter, because it does not provide for a use-based attribution of out-of-country supplies.

55. Contention (a) appears to be founded on LIPA; and contention (b) on the reference in regulation 103 to "used or to be used". Mr Harris submitted that both contentions are mistaken.
56. He explained that regulation 103 works by attributing out-of-country supplies expressly according to use, just as all other methods of attribution do in the UK. A trader typically proposes a value-based proxy from the variety of potential value-based proxies. If the Commissioners are satisfied that it results in a fair and reasonable attribution of out-of-country supplies, they will agree to its use.
57. Mr Harris contended that the Commissioners are entitled to agree in this manner in respect of out-of-country supplies given (1) the objective in s. 26(3) of the 1994 Act of using regulations to secure a fair and reasonable attribution of residual input tax; and (2) under their powers of care and management of VAT contained in para 1(1) of Schedule 11 to the 1994 Act. The Commissioners' position is that an agreement made under the powers contained in para 1(1) of Schedule 11 as to the regulation 103 supplies made by a taxpayer is binding unless and until altered by mutual consent. If the regulation 103 agreement is reached at the same time as, and in conjunction with, an agreed PESM for a particular trader, the Commissioners' objective is to reach an overall outcome for those arrangements that is fair and reasonable.
58. He maintained that that is what happened in the instant case. RSA simultaneously made joint proposals to the Commissioners as to both a regulation 102 PESM for residual UK supplies (employing a value-based proxy for use) and an attribution of residual regulation 103 out-of-country supplies (again employing a value-based proxy for use). RSA's joint proposals together formed one overall understanding, which came to be expressed in the Letter. Having examined RSA's proposals, and concluded that overall they were fair and reasonable, the Commissioners accepted them for future use by RSA.
59. In reaching the overall "agreement" in the Letter, Mr Harris submitted that there was no stepping outside the scope of regulation 103 by the Commissioners in respect of the out-of-country supplies it encompassed, whether on the ground of the precise attribution methods that it sets out or otherwise. On the contrary, he maintained, the value-based calculations in the appendices to the Letter are simply proxies for attributing on the basis of use, just as they are in respect of the UK supplies element of the Letter. Moreover, they are use-based proxies put forward by RSA itself.
60. Mr Harris then dealt with the lawfulness of dual-function agreements. He submitted that there is no legal impediment to dual-function documents such as the Letter being "agreed" and operated. Certainly there is nothing in the Regulations, the 1994 Act or the Sixth Directive; nor is there any policy reason.
61. Agreements very similar to the Letter have been expressly approved by the tribunal (see The Labour Party), and are common in practice. If we were upset the Method on the grounds of vires, we should not only conclude that The Labour Party was wrongly decided but also cause massive upheaval in the world of partial exemption. The point is clearly made by the Commissioners in Business Brief 12/01:

"If your approved 'special method' already deals with 'out-of-country supplies' and 'specified' exempt supplies then you need not take any action following the House of Lords decision [in LIPA]. But, if your 'special method' does not deal with these supplies you need to deal with them under regulation 103(1) before you apply your special method".

62. The same point is made in VAT Notice 706/02, on which RSA relies (see para 29 above).
63. Consequently, Mr Harris submitted, both of the Commissioners' documents are "authority" for what happened in the instant case when the Letter was issued.

Conclusion

64. We have most carefully considered the submissions of the parties, and would thank them for the assistance they have given us in reaching our conclusion.
65. In so far as out-of-country supplies are concerned, we agree with the parties that they cannot be dealt with under a PESM, but must be dealt with under the discrete mandatory regime for which regulation 103 provides. We observe that that regulation provides for input tax on out-of-country supplies to be "attributed to taxable supplies to the extent that the goods and services are so used or to be used expressed as a proportion of the whole use or intended use". In other words, the regulation makes specific provision for recovery of the input tax attributable to supplies within regulation 103 which are to be treated as taxable supplies, but leaves it to be inferred that input tax on exempt regulation 103 supplies is irrecoverable. And since the tax on dual-use regulation 103 inputs is to be attributed to taxable supplies "to the extent that they are so used or to be used", some mechanism must be found whereby that attribution may be made. In the absence of any provision whatsoever in that behalf, by default as it were, it appears to us that the Commissioners must deal with the matter under the care and management powers contained in para 1(1) of Schedule 11 to the 1994 Act. We therefore hold that the Commissioners had power under the said para 1(1) of Schedule 11 to conclude an agreement with RSA as to the manner of attributing residual input tax on its out-of-country supplies based on use.
66. However, we observe that since the regulation 103 regime is discrete, it follows that the input tax on out-of-country supplies must be dealt with totally separately from that on supplies covered by a PESM. Therefore the calculation of residual input tax under a PESM cannot include residual input tax on out-of-country supplies.
67. As we understood him, Mr Conlon accepted that the Commissioners are able to enter into dual-function agreements, there being no legal impediment to them. We accept Mr Harris's submission that there is nothing in the Regulations, the 1994 Act, or the Sixth Directive why such agreements should not be made; nor is there any policy reason.
68. In the circumstances, we hold that the Commissioners were empowered to enter into a single agreement with RSA dealing both with the residual input tax on out-of-country supplies and a PESM under regulation 102.
69. It will be recalled that Mr Harris submitted that regulation 103 works by attributing out-of-country supplies expressly according to their use. He added that a trader typically proposes a value-based proxy from the variety of potential proxies available, such proxies being contemplated in art 19 of the Sixth Directive and being more accurate and easy to use than calculation by use itself. In the instant case, RSA selected a value-based method, and the Commissioners agreed that it might use it for the purpose. In our judgment, they were entitled to agree to its use, again exercising their powers in para 1(1) of Schedule 11 to the 1994 Act.
70. We hold that the Letter provided for a manner of attributing regulation 103 supplies falling within that regulation.
71. As we indicated at the outset, we were required to deal with certain preliminary issues and no more. It remains to be seen what course the appeal will now take. Further directions would seem inappropriate at present, so that we consider it necessary only to invite each party within 56 days of the release date of this decision to inform the Manchester Tribunal Centre of its position. Each party shall be at liberty to make any applications it considers necessary.

DAVID DEMACK

CHAIRMAN

RELEASE DATE: 18 November 2004

MAN/03/109