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Hangleton Farm Education Ltd v Customs and Excise [2004] UKVAT V19001 (15 October 2004)

EXEMPTION – Riding School – VAT Act 1994 Sch 9, Group 6, Item 1 and Note 1(e) – Compulsory Registration

LONDON TRIBUNAL CENTRE

HANGLETON FARM EDUCATION LIMITED Appellant

- and -

THE COMMISSIONERS OF CUSTOMS AND EXCISE Respondents

Tribunal: Peter H Lawson (Chairman)

Miss S C O'Neill

Sitting in public in London on 20 July 2004

John Martin, Accountant, for the Appellant

Owain Thomas, Counsel, for the Respondents

DECISION

This is an appeal against the compulsory registration of the Appellant for VAT with effect from 1 August 2002. The grounds of appeal are that the Appellant company is a non-profit making organisation whose supplies are wholly exempt from VAT. The Commissioners maintain that it is not a non-profit making organisation and that its supplies are standard rated. The business of the Appellant company is carried on at Hangleton Lane, Ferring, near Worthing, West Sussex.

Evidence was given before us by Mr Christopher Killick Ellis, the sole director of the Appellant company which we shall refer to as "Education".

The Hangleton Farm Equestrian Centre has for many years operated as a riding school and livery yard. Mr Ellis was originally registered for VAT as a sole proprietor providing both activities, but then formed a limited company called Hangleton Farm Equestrian Centre Limited, a business run for profit, which took over the activities in the Spring of 2002. Equestrian was registered for VAT, taking over the previous registration of Mr Ellis with effect from 1 April 2002. It then subsequently deregistered on 19 October 2002, having transferred the educational part of the business to the Appellant company as a going concern.

At a meeting of the directors of Equestrian (Mr Ellis being the only director) held on 2 May 2002 it was resolved that a new company be formed to take over the riding tuition section of the business from an agreed future date. A further meeting of the directors of Equestrian was held on 16 July 2002 when it was resolved that Education would take over the riding tuition section of the business from 1 August 2002.

The Appellant company is constitutionally a non-profit making company. It takes advantage of the VAT exemption afforded to eligible bodies under Schedule 9, Group 6, Item 1 of the VAT Act 1994.

Equestrian still provides livery services. These are treated for VAT purposes as exempt, following the Tribunal decision in John Window v The Commissioners which decided that the supply of livery services was ancillary to the exempt supply of land and hence was itself exempt.

Education is a company limited by guarantee without a share capital and the sole director is Mr Ellis.

On 5 August 2002 a Transfer of Business Agreement was made to transfer the activity of providing education services (i.e. the riding school) from Equestrian to Education which included a licence to occupy or use part of the premises. Also on the same date an equipment hire agreement was made between Equestrian and Education.

The licence agreement provided for Education to be entitled to occupy designated parts of the site of Hangleton Farm Equestrian Centre in return for paying Mr Ellis a licence fee which was set at £700 per month by Mr Ellis himself, plus a percentage of the net turnover of Education per month or other such amount as Mr Ellis might determine.

There was also an equipment hire agreement which provided for various items of equipment at the Equestrian Centre to be hired to Education in return for payment to Equestrian of unspecified monthly sums.

This formalised an Agreement between Mr Ellis and Education which existed on 1 August 2002 and provided for the transfer of the business of providing education (i.e. the riding school) from Equestrian to Education and the remission of subscription income from Equestrian to Education on money held which was payment in respect of Education's services by paid up students on or before the effective date of the licence agreement.

On the basis of the agreements described above, the VAT position of the parties is that neither Education, Equestrian, nor Mr Ellis are VAT registered and no VAT has been accounted for on any supplies now made from the site.

In their initial letter of 6 November 2003, the Commissioners pointed out that, in order for the claim to exemption to be good, Education must be an eligible body in accordance with Note 1(e) to Item 1 of Group 6. Most relevantly, the company must be precluded from distributing, and actually not distribute, any profit it makes.

The Commissioners stated that the question whether or not a company makes and distributes profits is a question of economic substance, and not merely a question of legal form. The fact that a company's Memorandum and Articles of Association prohibits it from distributing profit is not enough. It is also necessary, they said, to examine how the company operates in practice. That approach, they said, is consistent with the guidance of the European Court in the Kennemer case (ECJ case C-174/00) and the Kennemer Golf and Country Club [2002] STC 502. That case concerns the exemption of certain sports services but applies equally to Education.

The Commissioners' Statement of Case was largely based on a letter dated 6 November 2003 from Mr A Brookman, the Senior Officer who issued the direction for the compulsory registration, to Prince Martin & Co the accountants advising the Appellant.

The Commissioners did not admit that the "Transfer of Business Agreement" dated 5 August 2002 and the "Equipment Hire Agreement" of the same date made between Equipment and the Appellant had the legal effect contended for by the Appellant. The Commissioners contended that the Appellant's supplies must be taxable unless they can be shown to be exempt. The relevant exemption provision only applies to an "eligible body" which is a body precluded from distributing, and one which does not distribute, any profit it makes. The Commissioners contended that whilst the Appellant's Memorandum and Articles of Association prohibits it from paying or transferring its income and property to members, in practice it transfers profit to Mr Ellis principally by way of the licence fee which was set at £700 per month.

Further by clause 1.1 of the Licence Agreement the licence fee may be unilaterally varied by Mr Ellis, and since the Appellant does distribute profits, it is accordingly liable to be registered.

The Commissioners contended that it was not enough for the Memorandum and Articles of Association of Education to prohibit it from paying or transferring its income and property to its members. Profit is in practice transferred to Mr Ellis by way of the licence fee. The licence fee itself is capable of being amended unilaterally by Mr Ellis by virtue of clause 1.1 of the Licence Agreement. This allows Mr Ellis to adjust the licence fee to extract precisely the amount of profit he wishes to extract from Education. It would be possible to adjust the licence fee to the precise amount of Education's surplus under clause 1.1 of the Licence Agreement. Therefore, it was the Commissioners' view that Education makes covert distributions to Mr Ellis via the licence fee and it cannot accurately be described as a body which "does not distribute any profit it makes".

Mr Ellis himself gave evidence for the Appellant and we supplement his oral evidence from a statement provided by Mr Martin, his accountant.

Mr Ellis confirmed that he is a director of Hangleton Farm Education Limited, which was originally part of Hangleton Farm Equestrian Centre which he, Mr Ellis, had run as a sole proprietor. The business had originally started in about 1978, purely as a livery yard. In 1982 the business became an Approved British Horse Society Member and able to offer career training for working students, and this business is still carried on. In 1991 the business was accredited as an approved training provider in respect of progressive riding tests for the Association of British Riding Schools.

Between 1987 and 1990 the business became a Manpower Services Commission Managing Agent for the Youth Training scheme, and between 1990 and 1996 it became an approved training supplier for the Sussex Training and Enterprise Council. The business is also accredited for training providers for several colleges in Sussex and as far afield as Warwickshire.

In 1992, following growing interest, the business began offering riding lessons to the general public and for the first few years all lessons were given by Mr Ellis. As the demand for riding lessons increased, other qualified instructors were employed to deliver the increased teaching.

Since 1982, the riding school has traded as an educational establishment and the Commissioners are aware of this.

In March 2002, Hangleton Farm Equestrian Centre Limited was incorporated with an ordinary share capital of £500 wholly owned by Mr Ellis, the sole director, and took over all trading activities from Hangleton Farm Equestrian Centre from which the livery business and the riding were conducted.

Mr Ellis retained personal ownership of all the land and buildings from which the business and the riding school traded. He has charged a monthly rent for the use of the land and buildings from the commencement of trading.

In May 2002, a decision was made to set up a separate company in respect of the riding school activities, run along the lines of an educational body which the Appellant, to all intents and purposes, already was. For this purpose, a company limited by guarantee (and not for profit) was established, namely Hangleton Farm Education Limited, whose Memorandum of Association precludes any distribution of profit to its members.

A separate rental agreement ("the Licence Agreement") was drawn up between Mr Ellis and Hangleton Farm Education Limited, relating purely to the area of land and buildings which were going to be used by them for riding school activities.

Mr Ellis explained that by March 2002, this business was part of an industry in decline. The British Horse Society had decided to investigate the causes of decline and did so. One of the causes which was identified was the provision of significant financial incentives from the EU to farmers to diversify into other business activities. The number of registered equestrian centres declined as competition increased.

Mr Ellis also explained that horse riding insurance is costly and the changes led to massive increases in insurance premiums. Originally cover was unlimited but now only two companies will quote for equestrian insurance and only for cover of £5m or £2m. Significant discounts are available for the £2m limit. Establishing a limited liability company, of course, provides some protection for assets held personally against claims in excess of £2m (our comment).

The idea of incorporating the company, which was arranged by his accountant, Mr White, Mr Ellis thought was a good one. All the trading was transferred to the company along with the horses themselves and all movable items. He had a substantial mortgage on the land and buildings through the Midland Bank for £500,000 and payments on the mortgage were met through his old business account. Mr White advised that the way to pay for the mortgage was to charge rent for the premises. The Midland Bank said they had no objection to this and the company was, as already stated, incorporated in May 2002.

Mr Martin asked Mr Ellis the reason for forming Hangleton Farm Education Limited. Mr Ellis said that he had transferred the VAT number to the new company. This was a sole trader (that no longer exists) and it took over the new VAT number. The original intention was to use a not-for-profit entity.

Rates are now paid by Equestrian which had always been treated as an educational body. It seemed to Mr Ellis to be the logical way to proceed. Mr Martin asked Mr Ellis whether he had considered any other options, e.g. to formalise a structure to cover VAT. Mr Ellis said he had looked at other schemes, for example a limited partnership, but it was more important to be an educational entity, as long as the business was below the VAT threshold.

It was stated in a letter from Mr Martin's firm to Mr Brookman that another reason for adopting the "not for profit" route was that a not for profit educational body is now a prerequisite for the Learning Skills Councils and EU grant funding.

When asked what services he provided to the business , Mr Ellis said "very little". He rode some of the horses each morning. Riding school horses attain a certain level but need to be schooled by experienced riders to keep the level up.

Mr Ellis said he worked 70 to 80 hours per week, of which 20 hours would be maintaining standards. He did not receive any remuneration from Education for this.

Asked about the rental agreement for Education and how the rental figure was arrived at, Mr Ellis said it took two months to start trading, and the two parts of the business were intertwined. As to rent, he looked at the rateable value of the property. The use was shared on a percentage basis, i.e. 40% was allocated to Education and the rest to Equestrian. This was how the £700 a month for his income was arrived at. Rent was charged from the outset. Education started trading in August 2002 and there had been no changes in rent since then.

Mr Martin asked Mr Ellis how the management charge paid by Education to Equestrian was calculated. Mr Ellis provided a schedule for the period 1 August 2002 to 31 March 2003 which showed that the management charges comprised a share of the rates and utility costs. Education paid 40% of the total rates for the site to reflect usage of the site and the water and electricity charges, which could not be separately metered for each business, and had been apportioned according to the number of horses owned by Education or in livery.

There were 95 horses, 15 in Education, 80 in Equestrian. Half of the expenditure on utilities applied to the electricity costs (e.g. nights).

Mr Ellis said that the Education side was not very profitable. It was justified by interested staff. Many of them move on, there is a constant supply. Education supplies a constant stream of new clients. Eventually they become horse owners themselves.

When cross-examined by Mr Thomas, Mr Ellis said that supplies by Education had started in 1982 but the structure had changed since then. Mr Thomas asked whether Mr Ellis was trying to avoid personal liability and Mr Ellis said that was not a factor in the case of Education because it already existed. The riding and livery enterprises were under Hangleton Farm Equestrian Limited. That was responsible for the livery work and Education was used for the riding school.

Mr Ellis accepted that the structure was altered but nothing changed on the ground.

The accounts of Education from 1 August 2002 to 31 March 2003 showed rent paid of £2,100 for seven months. Asked about raising invoices, Mr Ellis said that there were insufficient funds available initially. When the company was established the first day there was no money in the bank and no overdraft facility. The bank granted an overdraft facility at a later date. The riding school was still running.

Asked why Mr Ellis did not arrange for Education not to pay tent or to make it

into a not-for-profit entity because Equestrian was servicing the mortgage, Mr Ellis said the option never arose.

The £700 per month paid to Mr Ellis was derived as to 60% from Equestrian and 40% from Education, and Equestrian pays rent on land and buildings of £60,000 p.a. We understood that this represented or covered interest costs of £60,000 p.a. on the mortgage.

The licence fee of £700 per month went direct to Mr Ellis and the hire charges go to Equestrian, as do the management charges.

Mr Thomas, for the Commissioners, said that there was no dispute on the facts and the Commissioners did not intend to call any evidence. However, at the request of Mr Martin, Mr Andrew Charles Brookman, the senior officer who made the direction for registration would give evidence. In reply to Mr Martin, Mr Brookman said that the Commissioners accepted the educational nature of the business and he agreed that the Education company was legally constituted. Asked by Mr Martin what profit was, Mr Brookman said that it was simply the surplus of income over expenditure. Mr Brookman accepted t that he was not familiar with riding schools and was not an expert on the business.

Asked by Mr Martin why no visit had been made, Mr Brookman said it would not have revealed any new facts. Mr Brookman said that the documents were sufficient, although this might be an unusual situation.

Mr Martin pointed out that Equestrian had been deregistered in October 2002 without any problems but the registration had then been revived. Mr Brookman, in reply, said that some companies were deregistered and some not. The question really was whether the company was non-profit making.

Mr Martin asked whether a partnership would have had the same effect and Mr Brookman said he was not arguing that it was not a genuine partnership.

Mr Thomas, for the Commissioners, said that, whereas prior to the arrangements already described, VAT was accounted for on the riding school supplies, now no VAT is accounted for. The supplies of Education (the horse riding school) which would otherwise be taxable have, it is claimed by the Appellant, been transferred from Equestrian to Education and are now exempt because they were made by an eligible body. However, the Commissioners contended that Education, although precluded from distributing any profit it makes by the Memorandum and Articles of Association, in practice does distribute "profit" for the purposes of VAT law, principally by way of a payment to Mr Ellis of a licence fee which has been set at £700 per month by Mr Ellis himself.

The consequence of the Commissioners' decision was that Education became liable to be registered from 1 August 2002 because it took over the riding school as a transfer of a going concern from Equestrian on that date. The taxable supplies declared by Equestrian (the transferor) on its VAT returns for periods 11/01 to 08/02, amounted to £104,000 and therefore exceeded the registration limit as at 1 August 2002, which was £55,000. Education became liable to register VAT from the transfer date of 1 August 2002 pursuant to the provisions of Paragraphs 1(2)(a) and 7(2) of Schedule 1 of the VAT Act 1994. None of the foregoing was in dispute.

As to the law, Mr Thomas referred to Article 13 of the Fifth Directive and to Item 1 of Group 6 of Schedule 9 of the VAT Act 1994 which refers to the provision by an eligible body of

(a) education,

(b) research where supplied to an eligible body, or

(c) educational training. Note 1(e) provides that an eligible body is a body –

(i) precluded from distributing and does not distribute any profit it makes; and

(ii) applies any profits made from supply a description within this group to the continuance or improvement of such supplies.

The question of whether a body is non-profit making was considered by the ECJ in the Kennemer Golf and Country Club case [2002] STC 502, where the Advocate General identified the criteria which are relevant for identifying a body as non-profit making where he said "that the idea of profit making in this context relates to the enrichment of natural or legal persons – in particular those having a financial interest in the organisation in question – rather than to whether in any given period the organisation's income exceeds its expenditure. The concept of a non-profit making organisation contrasts essentially with that of a commercial undertaking run for the profit of those who control and/or have a financial interest in it."

The ECJ gave guidance as to the meaning of the words "non-profit making" at Para 26 where it said that "an organisation is to be classed as being 'non-profit making' for the purposes of Article 13A(1)(m) of the Sixth Directive, by having regard to the aim which the organisation pursues, that is to say the organisation must not have the aim, unlike a commercial undertaking, of achieving profits for its members …"

Mr Thomas said that, as to distribution of profits, the first element of distribution is the licence fee. Education takes the benefit of a licence by the Licence Agreement granted to it by Mr Ellis and variable at his option.

Mr Ellis owns all the land and buildings in question. Mr Thomas said that there were three elements of distribution of profit from Education which amount to the enrichment of Mr Ellis, namely the licence fee/rent, management fees, and hire of livestock. The licence fee/rent is paid directly to Mr Ellis and the management fees and hire fees are paid to Equestrian of which Mr Ellis is the sole shareholder and from which he is remunerated by payment of rent directly and dividends. These elements all, Mr Thomas submitted, (individually and/or communally) prevented Education being an eligible body.

There were two similar cases which Mr Martin referred to. The first was Chobham Golf Club (Decision No 14867) decided on 22 August 1997, and the second, the Bell Concord case [1989] 4 BVC 51 where the Court of Appeal decided that the words "otherwise than for profit" referred to the object for which an organisation was established and not to its budgeting policy for the time being. It should be noted in this connection that the Chobham Golf Club and Bell Concord cases predate the EJC Kennemer case. It is clear from that decision that what has to be determined "having regard to the objects of the organisation as defined in its constitution and in the light of the specific facts of the case" is whether an organisation satisfies the requirements enabling it to be categorised as a non-profit making organisation.

We have reached the conclusion that the appeal fails because the incontrovertible fact is that the Appellant company cannot obtain the benefit of the exemption under Item 1 of Group 6 in Schedule 9 of the VAT Act 1994 because it fails to meet the criteria to make it an "eligible body" under Note 1(e) of Group 6.

The Appellant company, although precluded by its Memorandum and Articles of Association from distributing any profit does in practice distribute "profit" for VAT purposes by paying a licence fee to Mr Ellis which is variable by him or at his request. It is currently £700 per month but could include a percentage of Education's turnover under the licence agreement. In addition, management fees are paid to Equestrian of which Mr Ellis is the sole shareholder and from which he is remunerated by payment of rent, directors fees, and dividends. Equestrian's accounts show Director's remuneration of £15,000 as well as a £30,000 dividend and £60,000 rent of land and buildings.

In paragraph 16 of their Statement of Case the Commissioners put the Appellant on notice that if they were successful in this case they would seek their costs. We award the Commissioners their reasonable costs accordingly. If they cannot be agreed either party may apply to the Tribunal for directions.

PETER H LAWSON

CHAIRMAN

RELEASED: 15 October 2004

LON/03/1147