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Banbury Visionplus Ltd & Ors v Revenue and Customs [2005] UKVAT V19266 (26 October 2005)

19266

VALUE ADDED TAX – partial exemption – opticians' stores - special methods based on floor area agreed in 1997 and 1998 – special methods terminated by the Respondents in 2004 so that standard method applied – whether jurisdiction of the Tribunal is full or limited – limited – whether decision to terminate special methods was a reasonable decision - yes – if jurisdiction was full whether disputed decision secured a fair and reasonable attribution of input tax – yes - appeal dismissed - VATA 1994 Ss 24 – 26; VAT Regulations 1995 SI 1995 No. 2518 regs 101 and 102

LONDON TRIBUNAL CENTRE

BANBURY VISIONPLUS LIMITED

BLETCHLEY SPECSAVERS LIMITED

EASTBOURNE VISIONPLUS LIMITED

LICHFIELD VISIONPLUS LIMITED

Appellants

- and -

HM REVENUE AND CUSTOMS

Respondents

Tribunal : DR A N BRICE (Chairman)

MR P D DAVDA FCA

Sitting in London on 11- 15 and 18 - 19 April 2005

Jonathan Peacock QC, instructed by Deloitte & Touche LLP, for the Appellants

Owain Thomas of Counsel, instructed by the Solicitor for Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2005

DECISION

The appeals

Banbury Visionplus Limited, Bletchley Specsavers Limited, Eastbourne Visionplus Limited and Lichfield Visionplus Limited (the Appellants) are all companies in the Specsavers Optical Group Limited group of companies. The companies in the group operate a well known chain of High Street opticians' stores. Each store is run by a separate company which is separately registered for the purposes of value added tax; there is no group registration. Each company has lodged a similar appeal and there are altogether in excess of 450 appeals. It has been agreed that the four Appellants should be the lead cases in these appeals.

Each company appeals against a decision of the Respondents dated 2 January 2004 to terminate the Respondents' previous approval of a partial exemption special method based on floor area. The decision had the effect that the partial exemption standard method applied. We were asked to give a decision in principle on the issues in the appeal and not to determine the amount of input tax recoverable by each company.

The legislation

Section 24 of the Value Added Tax Act 1994 (the 1994 Act) defines input tax as tax on the supply to a taxable person of goods or services used for the purpose of a business carried on by him. Section 25(2) provides that a taxable person is entitled at the end of each accounting period to credit for so much of his input tax as is allowable under section 26 and then to deduct that amount from any output tax that is due from him. Section 26 contains the provisions which describe the input tax allowable under section 25 and the relevant parts of section 26 provide:

"26(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period … as is allowable by or under regulations as being attributable to supplies within subsection (2) below.

(2) The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business:

(a) taxable supplies; …

(3) The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above, … . "

Thus section 26(2) makes it clear that the only input tax for which credit may be given is that attributable to taxable supplies made by the taxable person. This means that input tax attributable to exempt supplies made by the taxable person does not give any entitlement to credit.

At the relevant time the regulations made under section 26(3) were regulations 99 to 111 of the Value Added Tax Regulations 1995 SI 1995 No 2518 (the 1995 Regulations) and particularly regulations 101 and 102.

Regulation 101 is headed "Attribution of input tax to taxable supplies". It provides that, subject to regulation 102, the amount of input tax which a taxable person is entitled to deduct is the amount attributable to taxable supplies. This is calculated by attributing to taxable supplies the whole of the input tax used exclusively in making taxable supplies; by providing that no part of the input tax used exclusively in making exempt supplies is attributable to taxable supplies; and by providing that, where supplies are used to make both taxable and exempt supplies, the amount of input tax attributable to taxable supplies is that proportion of the input tax used to make both taxable and exempt supplies which the value of the taxable supplies bears to the value of total supplies. The calculation under regulation 101 is thus an outputs based, or values based, or turnover based, calculation. This method of attributing input tax to taxable supplies is called the standard method and input tax on supplies which are not used to make either exclusively taxable supplies or exclusively exempt supplies is called residual input tax (or sometimes non-attributable input tax).

Regulation 102(1) provides that the Respondents may approve or direct the use by a taxable person of a method other than that specified in regulation 101. A method approved or directed under regulation 102 is called a special method. Regulation 102(3) provides that a taxable person using a special method shall continue to use that method unless the Respondents approve or direct the termination of its use. Regulation 102(4) provides that any direction under regulation 102(1) or (3) shall take effect from the date of the direction or from such later date as the Respondents shall specify.

Thus the effect of regulations 101 and 102 is that the standard method applies unless a special method has been approved or directed and, if a special method is terminated without the approval or direction of another special method, then the standard method applies.

The issues

The Appellants argued that the special method which was terminated secured a fair and reasonable attribution of residual input tax as between taxable and exempt supplies within the meaning of section 26(3) and that the standard method did not do so. The Appellants also argued that the jurisdiction of the Tribunal was full and not limited but that, if it were limited, then the decision to terminate the special method was not a reasonable decision. The Respondents argued that the jurisdiction of the Tribunal was limited; that the decision to terminate the special method was a reasonable decision; and that, even if the jurisdiction of the Tribunal were full, the special method which was terminated did not secure a fair and reasonable attribution of residual input tax within the meaning of section 26(3) whereas the standard method did.

Thus the issues for determination in the appeal were:

(1) whether the jurisdiction of the Tribunal is full or limited;

(2) if the jurisdiction of the Tribunal is limited, whether the decision to terminate the special method was a reasonable decision; and

(3) if the jurisdiction of the Tribunal is full, whether the termination of the special method secured a fair and reasonable attribution of input tax within the meaning of section 26(3).

The evidence

Eight green bundles of documents were produced by the parties. Oral evidence was given on behalf of the Appellants by: Mr Matthew Jon Briggs, manager of the opticians' store operated by Eastbourne Visionplus Limited; Mr Paul Francis Carroll, BSc, MCOptom, MBA, a director of Southport Visionplus Limited and a qualified optometrist; Mr Hugo Dominic Lord, BSc, FRICS, the Director of Property Services for Specsavers Optical Superstores Limited; Ms Gillian Morris, Director of Tax of Specsavers Optical Group Limited; and Professor Stephen Thomas Parrish BSC, PhD, FCOptom, ILTM, a Visiting Professor of Optometry and Ophthalmic Dispensing at Anglia Polytechnic University and a part-time practising optometrist.

Oral evidence was given on behalf of the Respondents by; Mr Bruno Murray Giordan, a Partial Exemption Specialist Officer of HM Customs and Excise; Professor Mohammed Jalie, a Visiting Professor of Optometry at the University of Ulster who was, before his retirement in 1996, a practising optician; and Mr Alfonsas Antanas Pernavas, an Officer of HM Customs and Excise and the National Business Manager for Specsavers Optical Group Limited.

On the second day of the hearing we went to Eastbourne and made a site visit to the store operated by Eastbourne Visionplus Limited. We found the site visit informative and helpful.

The facts

We make our findings of fact on the basis that our jurisdiction could be either appellate or supervisory. From the evidence before us we find the following facts.

The structure of the group

Specsavers Optical Group Limited (Group) has its principal office in Guernsey and is not registered for value added tax. Group is responsible for the day-to-day strategic decisions of the group and also supplies central administrative functions, such as accountancy, administration, marketing and tax services, to the companies in the group for a fee. Although the group of companies does not comprise a value added tax group, and although each company is separately registered for value added tax, historically the group has been dealt with by the Respondents as if it were a value added tax group and Group represents all the companies in their dealings with the Respondents. Group prepares all the accounting and company secretarial records, and the value added tax returns and corporation tax returns, for all the companies in the group.

The companies in the group operate in the United Kingdom. Their main trading activity is the sale and dispensing of prescription spectacles and contact lenses. The companies in the group have either a dual structure or a single structure.

Most companies have a dual structure which consists of both a wholesale and a retail company. The wholesale company is typically called by the name of the town in which it operates followed by the word Specsavers Limited. So in Banbury the wholesale company is called Banbury Specsavers Limited. The shares in each wholesale company are owned as to 100 A shares by two directors (50 each) and as to 100 B shares by Group. The directors are the professional opticians who run the opticians' store in that town and the A shares entitle the directors to the net profits of the business. The B shares do not carry the right to any profits but do carry the right to appoint the chairman at meetings of the shareholders. Thus, by means of its shareholding, Group keeps control over the stores and regulates how they do business; for example, it imposes a condition on all group companies that they are required to undergo a total store refit every five years.

Where there is a dual company structure the wholesale company buys in spectacle frames, contact lenses, solutions and accessories (optical goods) from Group and sells them on at a mark-up to the retail company which, in turn, sells them on to customers with the associated dispensing services. (Thus the retail company makes very little profit on optical goods because such profit is made by the wholesale company; the retail company makes its profit on the supply of dispensing services.) In a dual structure company it is also the wholesale company which pays the rent for the shop (which is occupied by both companies), pays for shop-refitting, and purchases or leases any equipment that is required. Most overheads are invoiced to the wholesale company except for staff and professional costs which are invoiced to the retail company.

In the dual company structure the retail company is owned by the wholesale company and is typically called by the name of the town in which it operates followed by the words Visionplus Limited. So Banbury Visionplus Limited is the dual structure retail company operating in Banbury. The retail company operates the store and makes supplies to customers. In the dual company structure both the wholesale company and the retail company are separately registered for value added tax. However, as each wholesale company is fully taxable, and so does not need a partial exemption method, in this appeal the Appellant in a dual structure company is the retail company only. Of the Appellants in this appeal, Banbury Visionplus Limited and Lichfield Visionplus Limited are retail companies in a dual company structure.

Other companies have a single structure which consists only of the retail company which operates the store. Typically a single structure company would be called by the name of the town in which it operates followed by the words Specsavers Limited or Visionplus Limited. Of the Appellants in this appeal, Bletchley Specsavers Limited and Eastbourne Visionplus Limited have a single company structure. Single structure companies are owned in the same way as wholesale companies but when they buy in optical goods from Group they buy them at such a price that they make a profit when they sell them on to customers with the associated dispensing services. In this Decision we refer to all the companies which make supplies to customers, that is both the dual structure retail companies and the single structure companies, as retail companies.

Of the total business of the retail companies about 75% is the supply of dispensed spectacles, 10% is the supply of dispensed contact lenses; 10% is sight tests; and 5% other supplies (including optical goods). The population of the United Kingdom is estimated to be around 59 million. Approximately 62% of the population wear spectacles and approximately 5% use contact lenses. In 2001-2002 it was estimated that 16,986,000 eye tests were carried out. Over 90% of all spectacle sales are the direct result of an eye test. Following an eye test 69% of people have a changed or new prescription.

The value added tax position of the retail companies

When an optician supplies dispensed spectacles or contact lenses to a customer he makes two supplies for value added tax purposes. One is a supply of the optical goods and the other is a supply of the dispensing services. The supply of the optical goods its taxable and the supply of the dispensing services is exempt under Schedule 9 Group 7 Item 1 and Note (2) of the 1994 Act (see Leightons v The Commissioners of Customs and Excise [1995] STC 458 and Southport Visionplus Limited v The Commissioners of Customs and Excise [2001] VAT Decision No. 17502). The Association of British Dispensing Opticians has stated that the purpose of the dispensing function is to translate an optical prescription into an order for a pair of spectacles, or other optical appliance, appropriate to the individual patient's needs. It is possible for an optician to make a taxable supply alone (for example, new spectacle frames for existing lenses although the retail companies in this appeal very rarely sell frames alone) or an exempt supply alone (for example, a sight test) but most supplies are of dispensed spectacles or contact lenses which consist of both a taxable and an exempt supply.

Where both a taxable and exempt supply is supplied to a single customer the single price paid by the customer has to be allocated, for the purposes of calculating output tax, in part to the taxable supply of the goods and in part to the exempt supply of the dispensing services. In this appeal the retail companies allocate the single selling price by reference to the direct costs involved in making the supply. This produces the result that, for output tax purposes, 33% of a supply of dispensed spectacles is taxable and 67% is exempt. For contact lenses the result is 43% taxable and 57% exempt. Similarly residual input tax has to be apportioned between the taxable and exempt supplies made by the Appellant using a partial exemption method under regulation 101 or regulation 102. At no time before 2004 did the retail companies in the group use the standard method under regulation 101. From about 1992 the companies used a special method based on floor area. We therefore describe first a typical customer's use of the floor area in a retail company's store and then the floor layout as we saw it in the Eastbourne store.

A typical customer's use of the floor area

All the stores operated by the companies in the group show a marked similarity. Group has a model store layout which ensures that each store looks like all the other stores and this reinforces the Specsavers brand. Each store uses a colour scheme which is established by Group and the furnishings are also of a standard design. All the floor plans follow a very similar arrangement although this has to be varied to suit each individual site. The model store layout provides a number of different plans for a range of stores. The range moves from a small store of 1,000 square feet with a minimum of one test room and 1,000 spectacle frames on display to a large store of 4,000 square feet with a minimum of 5 test rooms and 1,600 frames on display and there are other examples in between. (Thus the number of spectacle frames on display does not increase in proportion to the floor area.)

A customer seeking to purchase a pair of dispensed spectacles enters a store into the frames display area. There he is either greeted by a dispensing assistant or frame adviser or walks through the frames display area to the reception desk. On the way to the reception desk the customer can, if he wishes, "browse the frames". The frames are displayed according to price and the price marked is for the complete spectacles with standard lenses. At the reception desk the customer gives his or her personal details and may then move to a separate appointments desk so that an appointment for a sight test may be booked. The customer may be able to make an appointment for the same day or the appointment may be for another day.

When the customer attends the appointment he enters the store through the frames display area and goes direct to the appointments desk where he is initially directed to a waiting area. An optical assistant then carries out a series of pre-tests after which the customer returns to the waiting area. The optometrist then collects the customer and takes him or her to a consulting room for an eye test. A medical history is taken from the customer and the results of the pre-tests are explained. The eye test then takes place and dispensing advice is given. The optometrist explains to the customer the options available in both spectacles and lenses, asking about the customer's lifestyle. For example, a customer who is wearing bi-focal lens, and whose occupational demands indicate that he would be better served by varifocal lens, would be so advised. Also a customer who is allergic to nickel would be advised not to choose frames with a nickel content and would also be advised which frames would be suitable. Again some customers might be advised to choose frames with an adjustable bridge. And a customer who played sport would be advised to choose robust frames. Advice about lenses might also be given; for example a customer who used a computer regularly might be recommended to have a particular lens type. At the end of the eye test the optometrist gives a written prescription. At that stage the customer can decide to pay for the prescription (an exempt supply) and leave the store. Most customers, however, then proceed to choose some spectacle frames.

A customer who wishes to choose spectacle frames is taken to the dispensing area and handed over to a frames adviser or dispensing assistant and the dispensing advice about lenses and frames is repeated. The frames adviser or dispensing assistant will then accompany the customer to the frames display area and shows the customer a selection of suitable frames bearing in mind the dispensing advice already received. The customer tries on some frames and chooses about four or five which he or she likes. At this stage the frames adviser will offer advice and assistance on the type of frame that will suit the customer and which will comply with the dispensing advice. A customer might ask the frames adviser whether what they have chosen is suitable and the frames adviser might say that they are, or are not, or might suggest that the frames are discussed with the dispensing optician.

When the customer has made his initial choice of frames he is taken to a dispensing desk where the dispensing optician discusses the lenses required, the various lens options available, and the suitability of those options for the chosen frames. In certain cases a customer might be advised to prefer a different frame shape. At this stage of the process the frames initially selected by the customer are subjected to the professional advice and judgment of the dispensing optician who advises on the final selection. It is possible that none of the frames initially selected will be suitable for the lens type required by the customer and so the customer will once again have to visit the frames display area and make a further choice of frames.

When both frames and lenses have been chosen the dispensing optician takes a number of facial measurements and completes a form with details of the requirements of both the lenses and the frames. The form and the chosen frames are then sent to the in-store laboratory which carries a stock of lenses. At this stage the customer may either wait in the waiting area for the work to be done or, more likely, may leave the store and return later. In the in-store laboratory the correct lenses are cut, polished and shaped to fit the chosen frames. The finished spectacles are then checked to make sure that they comply with the prescription and all relevant standards and are then sent to the reception desk. If the customer has left the store he is then informed that the spectacles are ready for collection. When the customer returns to the store he is directed to the waiting area. The dispensing optician takes the customer to a dispensing desk; the customer tries on the spectacles; and the dispensing optician makes any necessary adjustments to the frames to secure a perfect fit.

Customers expressing an interest in contact lenses are given information at the reception desk. Alternatively, during or after an eye test the optometrist might suggest contact lenses instead of spectacles. If, after the eye test, the customer decides that he wishes to purchase contact lenses, he is handed over to a contact lens optician who takes him to a consulting room for a contact lens assessment and fitting. The contact lens optician fits some trial lenses and asks the customer to leave the store and walk around for about half an hour. When the customer returns he is taken to the consulting room to see how the lenses fit. If the customer wishes to proceed with the purchase he is then handed to a contact lens assistant who takes the customer to a contact lens teaching area and instructs the customer on inserting, removing and cleaning the lenses. If the required lenses are in stock the customer will take them away; if they are not in stock they will be ordered and the customer will return later to collect them.

Repeat supplies of contact lenses can be ordered by telephone or on the internet.

The floor layout of the Eastbourne store

The Eastbourne store is located near the railway station and on a typical High Street retail area. The front of the store is open plan and customers on the street who are passing the store can see the displays of spectacle frames through the windows. This part of the store is brightly lit. The windows are also used to display advertisements and lists of opening times. In the front window of the Eastbourne store we saw an advertisement for contact lenses and also an advertisement for two pairs of dispensed spectacles for the price of one. The advertisements were positioned in such a way that they were also readable from the inside of the store. The door of the store is of glass and a customer entering the store enters the frame display area. In addition to displaying about 1,000 different spectacle frames, the display area also contains leaflets and advertisements which appear throughout the store. Most of the advertisements relate to the supply of dispensed spectacles or contact lenses. There is no seating provided in the frames display area. The customer has to walk all the way through the open plan frames display area to the reception desk. Near the reception desk is an under-stair storage room.

If the customer wanted to book an appointment, say for an eye test, he would be directed to the appointments booking desk which is yet further into the store. Passing the reception desk he enters another area which contains two dispensing desk areas and a contact lens teaching area. Here the lighting is more subdued. The dispensing areas contain narrow tables with a seat at each side. This area also contains an "options box" with a number of sample lenses to show the customer what each lens looks like. The dispensing areas, although open plan, do have five-feet high partitions so that conversation between patient and dispensing optician sitting at the dispensing desks can be confidential. Also, the dispensing optician may have to take some facial measurements for which privacy is required. On the other hand the contact lens teaching area is not partitioned and is visible both from the frames display area and from the dispensing desk area.

Having moved through the dispensing desk area and the contact lens teaching area the customer finds the appointments desk. Near that desk is a waiting area and two consulting rooms. If the customer wants an eye test he first waits in the waiting area and is then shown into a pre-test room which is further into the store where there are also other test rooms, lavatories, filing space for clients' records, and storage space. The final area, right at the back of the store, contains another test room, a staff room and a storage space. The upper floor contains a laboratory and storage space, a training area, offices and lavatories. The laboratory is used to store lenses; to cut and finish lenses for spectacles; to check finished spectacles; and to repair spectacles.

On a typical day at Eastbourne there will be one member of staff at the reception desk, two frames advisers in the frames display area; one person booking appointments at the appointments desk; three persons doing pre-tests; four optometrists carrying out eye tests; and eight dispensing opticians or dispensing assistants.

1996 – proposals for a new special method

The special methods which were terminated by the disputed decisions were agreed in 1997 and 1998. On 31 July 1996 Ms Morris of Group wrote to Mr Bennett of the Respondents with a proposal for a new partial exemption special method for all the retail companies in the group. The proposal was to include companies which later joined the group and to exclude companies which left the group. Where in any town there was a dual company structure the wholesale company would be fully taxable and the special method would apply only to the retail company; however, certain overheads would be re-charged from the wholesale company to the retail company in accordance with a stated percentage. (This arrangement was included at the request of Mr Bennett.) The basis for apportionment of residual input tax would be in accordance with the average floor area used to make taxable supplies as a percentage of the amount of floor area used to make taxable supplies and exempt supplies. An average percentage would be calculated using a representative sample of stores which would not be less than 10% of stores currently trading. There would be an annual revision to reflect changes in the group.

These proposals were considered by Mr Bennett who visited one of the stores. Correspondence followed in which the issues discussed included the floor area calculation; the re-charge of overheads from the wholesale companies to the retail companies; the representative sample stores; the floor space measurement methodology; and the concept of zoning or weighting rental costs. As this concept was taken forward into the special methods the subject of this appeal we now describe it more fully.

The concept of zoning or weighting rental costs

Zoning is a widely used and long established method of valuing retail property. It is based on the premise that the front part of a retail store is more valuable than the rear because it is at the front of a store that customers are enticed to enter; the deeper the store the harder it is to entice customers in and so the assumption is that rental values decrease as one goes deeper into a store. Thus the concept of zoning is based on the assumption that the front 20 feet of a retail store (known as zone A) is more valuable than the next 20 feet (known as zone B) which is more valuable than the next 20 feet (known as zone C) and so on to the back of the store.

Zoning is used by property advisers to assess the rent of a ground floor retail store of a certain size (usually above a minimum and below 10,000 square feet). Mr Lord gave as an example the proposed acquisition of a store with four 20 ft zones from A to D. If the store had a 20ft wide frontage then each zone would be 400 square feet (20 x 20) and the total area of the store would be 1,600 square feet. If the landlord were to propose a rent of £53,500 per annum, and one had to determine whether that were a fair and reasonable rent, one would calculate the rent "in terms if zone A". This would be done by taking the area of zone A (400 square feet), half the area of zone B (200 square feet), one-quarter of the area of zone C (100 square feet) and one-eighth the area of zone D (50 square feet). That would give a total of 750 square feet "in terms of zone A". The proposed rent of £53,500 per annum would then be divided by 750 which would give a figure of £71.33 per square foot. That price would then be compared with the price "in terms of zone A" of similar stores in the same area. This method of valuation ensured that a lower rent would be appropriate for a store with a smaller frontage but a larger rear area than for a store with the same total area but where most of the area was at the front of the store.

We accept the evidence of Mr Lord that rent is one factor of many which would be considered in deciding whether to lease a property. Location is another. If it were decided to take a lease then the lease would state the total rent without mentioning zoning. We also accept the evidence of Mr Lord that landlords prefer the front of the store to contain the display area, rather than consulting rooms, because they want their shopping centres to appear as retail areas.

The 1997 special method for single structure companies

On 18 September 1997 the Respondents sent a formal offer to Group of a proposed partial exemption special method to apply to single structure companies in the group which offer was accepted by Group the same day. The special method provided that the whole of the input tax used exclusively in making taxable supplies was deductible and that no part of the input tax used exclusively in making exempt supplies was deductible. The input tax used in making both taxable and exempt supplies (residual input tax) was first to be divided between rent and all other costs.

The recoverable proportion of the residual input tax relating to non-rent costs would be determined having regard to the following formula:

Taxable floor area

Taxable and exempt floor area

Frames display areas and laboratories were taxable floor areas; pre-testing areas, testing rooms, contact lens teaching areas and dispensing areas were exempt floor areas; and areas not exclusively used as taxable or exempt areas, namely, stores, staircases, waiting areas, offices, staff rooms, kitchen areas, lavatories and dis-used areas, were excluded floor areas and did not enter into the calculation.

The special method went on to provide that average floor area percentages would be calculated using an agreed representative sample of nine single structure stores. Ms Morris chose the representative sample and used hand drawn plans of the nine stores and made the calculations. When Ms Morris had applied the fraction of taxable floor area over taxable and exempt floor area for the nine representative stores it gave a result of 66.6%. For the single structure companies this was then treated as the recoverable proportion of all residual input tax other than input tax on rent.

At the hearing we saw computer assisted design plans which showed the taxable areas (cross-hatched) the exempt areas (dotted) and the excluded areas (white). Eastbourne was a single structure store and on the Eastbourne plan the whole of the frames display area was shown as a taxable area except for an area at or about the reception desk which was marked as an excluded area. There was no indication on the plan of the fact that all customers (including those coming to obtain exempt or mixed supplies) walked from the door to the reception desk. There was also a storage area next to the display area which was marked as taxable but should have been an excluded area. The dispensing areas and the contact lens teaching area were marked as exempt areas except for a pathway in the middle which was marked as an excluded area. The consulting rooms were marked as exempt areas but the waiting area, and the desk for booking appointments, were marked as excluded areas. The pre-test room and test rooms were marked as exempt whereas the lavatories and filing space for clients' records were marked as excluded; the storage space was marked as taxable but should have been marked as excluded. At the rear of the store the other test room was marked as exempt, the staff room was marked as excluded and the storage space was marked as taxable although it should have been excluded. On the upper floor the laboratory and storage space were marked as taxable (whereas the storage space should have been excluded) and the training area, the offices and the lavatories were all marked as excluded. The excluded areas amounted to about half of the total floor area.

The special method for single structure companies went on to provide that the recoverable proportion of residual input tax relating to rent was to be calculated by what was referred to as a weighted floor area method. The weighting was in line with commercial property zoning of rents and was: zone A – 100%; zone B - 50%; zone C - 25%; zone D - 12.5%; and all other areas 8.33% of zone A. The computer assisted design plan of the Eastbourne store showed the zoning areas. The frames display area was shown as occupying zones A and B and the reception desk was almost on the boundary between zones B and C. (However, for rental purposes, the under-stair storage area was excluded from zone B because it was incapable of retail use.) Zone C contained the dispensing desks and the contact lens teaching area and zone D contained the waiting area, the desk for booking appointments and two consulting rooms. Zone E contained the pre-test room and test rooms, lavatories, filing space for clients' records, and storage space and Zone F contained another test room, the staff room and storage.

Using the same nine representative sample stores the floor area calculations were weighted using the given ratios for each zone. That meant that more of the input tax on rental was attributed to zone A than to zone B and more to zone B than to zone C and so on. It will be recalled that on most plans, zones A and B were treated as taxable areas (for the display of spectacle frames) whilst the zones to the rear of the store were treated as mainly exempt areas. The application of the weighted or zoned method gave a recovery rate of 86%. This was then treated as the recoverable proportion of all residual input tax on rent.

The special method went on to provide that the rent (86%) and non-rent (66.6%) results for all nine stores in the representative sample were to be calculated for a calendar year and a single combined average recovery rate obtained. The calculations showed that this came to 69.2% taxable and 30.8% exempt for single structure stores. Those percentages were then to be applied to all the residual input tax of each single structure store in order to determine the amount of residual input tax to be recovered in each accounting period. Thus 69.92% of all the residual input tax of a single structure store was recoverable. The method was subject to review and could be withdrawn at any time. It was to be used for at least two years or until such time as approval for its use was withdrawn.

The 1998 special method for dual structure companies

After 1997 the correspondence about a proposed partial exemption special method for dual structure companies continued. At this time the Inland Revenue were making some enquiries about the dual structure companies and so the agreement of a special method was delayed. Another difficulty arose from the fact that, in a dual structure company, it is the wholesale company which purchases the optical goods, pays the rent of the shop, pays for shop-refitting and purchases or leases any equipment that is required. The wholesale company also arranges for the advertising, some of which relates to the sales in the retail store and some of which is a share in national advertising. Most overheads are invoiced to the wholesale company except for staff and professional costs which are invoiced to the retail company. Thus the wholesale company receives mostly taxable supplies and, as all the supplies it makes are taxable, recovers input tax in full. It is the retail company which makes some exempt supplies and which cannot recover all its input tax. The Respondents were, in particular, concerned that, where supplies were made to the wholesale company it could recover all the input tax whereas the benefit of some of those supplies also accrued to the retail company which should, it was thought, therefore bear some of the cost. The Respondents therefore requested that there should be a re-charge of some costs from the wholesale to the retail company.

On 6 October 1998 a final offer was made by the Respondents about a partial exemption special method for dual structure retail companies which was accepted by Group. The method proposed was very similar to that for the single structure companies except for one difference. This was that the special method for dual structure retail companies provided for an additional step to be inserted after the attribution of input tax used exclusively in making taxable or exempt supplies and before the steps dealing with residual input tax. This additional step provided that residual input tax in the retail company was to include a proportion of certain expenditure of the wholesale company which was to be notionally re-charged to the retail company in different proportions for: advertising (in-store and national); rent; rent-related expenditure; computers; motor expenses; shopfitting; and other overheads.

The agreed representative sample for dual structure retail stores was nineteen such stores. The calculations resulted in average figures of recoverable residual input tax of 89.06% for rent costs and 68.26% for non rent costs. However, there were wide variations because the recoverable percentages for non-rent costs varied by up to 20% between different stores. There was to be a review every three years or earlier if either party considered that the method no longer produced a fair and reasonable result.

There was a second difference between the way in which the special method for dual structure retail companies was applied in practice and that was that the separate percentages for rent costs and non-rent costs were not combined to give a single average recovery rate. For dual structure retail companies the percentage for non-rent costs was applied to each dual structure retail company's non-rent costs and the separate percentage for rent costs was applied to each dual structure retail company's rent costs. Nevertheless, as far as the special method was concerned, the separate percentages for rent costs and non-rent costs should, in theory, have been combined to give a single average recovery rate.

2002 - The review of the 1997 and 1998 special methods

In April 2002 Mr Pernavas of the Respondents became responsible for the value added tax affairs of the group and in October 2002 he visited Group in Guernsey to examine the working of the special methods among other things. He had concerns about: the inconsistency between the apportionment of a supply for output tax purposes between taxable (33%) and exempt (67%) supplies and the recovery rates of residual input tax (69.2% taxable and 30.8% exempt for single structure companies); the way in which the floor area calculation worked in practice and, in particular, the treatment of the frames display area as wholly taxable when he was of the view that that area contributed to the promotion of all the goods and services supplied and should therefore be an excluded area; and the dual structure of some companies and the notional re-charge of expenditure from the wholesale company to the retail company. He mentioned these matters to Group at the time. Between October 2002 and May 2003 he consulted Mr Giordam on a number of occasions about matters which caused him concern in the way in which the special methods were operating. Mr Giordan gave advice to Mr Pernavas and assisted him in his correspondence with Ms Morris of Group. It was Mr Giordan who decided that it was appropriate to give the direction which is the subject of this appeal.

On 14 May 2003 Mr Pernavas and Mr Giordan had a meeting and on 20 May 2003 a meeting was held attended by Mr Pernavas of the Respondents and Ms Morris of Group with others. Mr Pernavas raised concerns about the floor area method, about zoning (which would only be a concern if the floor area method continued), about the relationship between the calculations for apportioning output tax between taxable and exempt supplies and the calculations leading to recoverable proportions of residual input tax; and about the way in which, for the dual structure companies, the residual input tax in the retail company was to include a proportion of certain expenditure of the wholesale company which was to be notionally re-charged to the retail company in stated proportions. During the meeting Mr Pernavas agreed to set out his concerns in these areas in writing. After the meeting Mr Pernavas had discussions with Mr Giordan and Mr Giordan helped with the drafting of the letter of 4 July 2003.

On 4 July 2003 Mr Pernavas wrote to Ms Morris raising four points. These were: that it was not appropriate for a single partial exemption special method to be agreed for all companies of the same structure and that each registration should have its own method; that the use of the un-weighted floor area ratio did not produce a fair and reasonable attribution of residual input tax; that in the dual structure companies the notional re-charge of certain expenditure from the wholesale company to the retail company was inappropriate because the partial exemption special methods of the retail companies should not relate to the fully taxable wholesale companies which were separate value added tax registrations; and that there should be some consistency between the results of the partial exemption method of attributing residual input tax on the one hand and the apportionment for output tax purposes of the single price of a pair of dispensed spectacles between taxable and exempt supplies on the other hand, especially as both calculations were based on cost. The letter concluded that, as the agreed special method did not result in a fair and reasonable recovery of input tax, proposals for an alternative method should be submitted by 30 September 2003.

Ms Morris replied on 29 July 2003 and sent detailed comments on the matters raised by Mr Pernavas. She did not accept that there was any need to revise the 1997 and 1998 special methods. She asked that no deadline be set for the submission of an alternative partial exemption special method until a time when discussions on the principles had been exhausted.

On 5 September 2003 Mr Pernavas wrote to say that the current divergence of views led him to believe that there was little prospect of reaching agreement in the near future and, if satisfactory proposals were not received, the Respondents would consider directing a method under regulation 102. However, to enable Group to formulate proposals the deadline was extended until 31 October 2003 and the correspondence continued. The letter of 5 September 2003 mentioned the issues of: the use of the representative sample of companies to reach a recoverable proportion of input tax applicable to all companies of the same structure, the use of the floor area method, the notional re-charges; and the comparison between the partial exemption calculation and the cost apportionment for output tax purposes. It did not mention zoning. On the subject of the notional re-charges the letter stated that in future the wholesale companies should raise tax invoices for any taxable supplies to the retail companies and the amount should represent the open market value of the supplies. If this were not done the Respondents might issue a direction under paragraph 1 of Schedule 6 of the 1994 Act.

On 29 September 2003 Ms Morris replied to say that no time limit should be set; she also suggested that if Mr Pernavas wished to examine plans or discuss the design of the stores with the store designers he was invited to do so "in the course of negotiating an updated special method based on floor area". On the subject of the notional re-charges Ms Morris asked Mr Pernavas to confirm in writing that the wholesale companies must issue invoices to the retail companies and that this would be "without prejudice to the remainder of the existing partial exemption method"; she stated that the re-charges were, by agreement with the Respondents, at open market value.

On 24 October 2003 Mr Pernavas wrote to say that, if it became necessary for the Respondents to direct a method, then the standard method was one of the likely alternatives. He could not extend the deadline and would consider taking steps to direct a method if acceptable proposals were not received by 31 October. On the subject of the notional re-charge he confirmed that any non-retail taxable supplies between any independent value added tax registrations must be properly invoiced and accounted for. He added that the amounts of the re-charges specified in the special method for dual structure retail companies did not represent the open market value and the re-charges were not recognised as taxable supplies between independent registrations.

On 27 October Ms Morris asked for the second deadline to be extended. This was not done because Mr Giordan was of the view that, as Ms Morris had given no indication that she accepted the Respondents' views, it was unlikely that approvable proposals would be received, even if the deadline were extended. On 1 November 2003 Mr Pernavas wrote to say that the Respondents were considering the direction of a method and that the 1997 and 1998 special methods could not be used by any new company registering for value added tax after 1 February 2004. On 5 November 2003 Mr Pernavas wrote to each group retail company using either the 1997 or 1998 special methods and said that the Respondents were considering the termination of the special methods and the possible direction of an alternative method.

There was a further meeting on 25 November 2003 attended by Ms Morris, Mr Pernavas, Mr Giordan and others. Discussions took place about the 1997 and 1998 special methods and, in particular, the representatives of the Respondents said that use of the floor area ratio did not produce a fair and reasonable attribution of residual input tax. They repeated that if no proposals capable of approval were received the Respondents would take action to ensure that a fair and reasonable recovery of input tax was achieved. They said that the form of any alternative method that they would direct had not yet been decided. Ms Morris invited them to visit a store; that invitation was accepted but no arrangements were made. Ms Morris said that there was no reason to propose an alternative method as the current special methods were fair and reasonable. In view of the impasse it was agreed that the Respondents would issue a direction giving a minimum of three months' notice.

The internal memoranda

On 30 December 2003 Mr Giordan wrote to Mr Pernavas about the termination of the special methods and summarised his concerns about the ways in which the methods were operating. These included: that the special methods were agreed with Group but might not be legally enforceable in respect of companies who were independently registered for value added tax; that it was impractical to verify that the samples used as a basis for the methods were truly representative; that new registrations were automatically entitled to use the special methods without any additional approval from the Respondents; that many of the retail companies could claim to be fully taxable because the business had effectively been segregated to reduce the amount of exempt input tax to below the de minimis levels and this had been further distorted by the manipulation of the structure of the dual stores to reduce the exempt input tax; that the floor area method was not appropriate; that the comparison of the outputs calculation with that for input tax indicated that the special methods were not fair and reasonable; and that the notional re-charge had no place in a partial exemption calculation.

(The reference to the de minimis levels is a reference to the provisions of regulation 106 of the 1995 Regulations which provides that where input tax attributable to exempt supplies does not amount to more than £625 per month on average and does not exceed one half of all the input tax for the relevant period then such input tax is treated as attributable to taxable supplies.)

Mr Giordan concluded his letter of 30 December 2003 by stating that the special method was not fair and reasonable. He considered other special methods (including a transaction based method) but formed the view that they were not appropriate. He was of the view that the standard method would give a fair and reasonable result for that business and was simple to operate. He concluded therefore that it was appropriate to terminate the special methods with the result that the standard method would apply.

On 7 January 2004 Mr Giordan prepared an internal memorandum which set out rather more fully the points he had considered in authorising the direction of the termination of the special methods and the advantages of the standard method. That memorandum also contained some comments about the dual structure companies. In describing the organisation of Group the memorandum discussed the dual structure companies and stated::

"The effect of the dual stores from the VAT point of view is that the retailer remains within the de minimis tests. There appears to be no other purpose for the structure. The only supplies made and received by the dual stores that would not be made if it were a single store are the supplies between the wholesaler and the retailer."

In considering the existing methods the memorandum stated:

"For the dual methods there is an additional step in that expenditure that is incurred in the wholesale company is to be "notionally" re-charged to the retail company. Effectively this enables the retail company to claim input tax on costs incurred by the wholesale company."

In considering why the standard method was fair and reasonable the memorandum stated:

"Whilst I have reservations about the dual structure stores, since they appear to be designed with the sole purpose of avoiding sticking VAT, I am satisfied that the different structures of the dual company stores does not affect whether the standard method will give a fair and reasonable result. Any tax loss due to the dual structures will need to be dealt with outside the remit of the partial exemption method"

In setting out the factors which were not considered in making the direction the memorandum recorded:

"I have not taken into account the fact that the current registrations are all below the de minimis test and that a significant proportion will no longer be upon using the standard method. The de minimis test is applied following a partial exemption method, but for it to achieve the effect specified in the Sixth Directive of ignoring insignificant input tax, it must be applied to a method that is fair and reasonable. The purpose of issuing the termination notices is to ensure that the method applied is fair and reasonable, and hence the de minimis test can be applied correctly."

In addition I have not considered the effect of the dual store arrangements (as opposed to the notional re-charges) on the recoverability of input tax in considering whether the current methods are fair and reasonable. Whilst the structure appears set up to avoid sticking tax, this is neither a reason why the current dual store method is not fair and reasonable nor a reason why the standard method would or would not provide a fair and reasonable attribution of input tax in relation to the single stores."

The decision letters

On 2 January 2004 the Respondents directed the termination of the special methods as from 1 April 2004 which had the effect that all the companies had to account for value added tax using the standard method. Two standard letters were sent, one to each dual structure retail company and one to each single structure company. The letter to all the single structure companies gave five reasons for the change and the letter to all the dual structure retail companies gave the same five reasons and one more.

The letters of 2 January 2004 began by saying that the Respondents had concluded that the current partial exemption special method did not secure a fair and reasonable attribution of input tax. The reasons given in the letter to the dual structure retail companies were: (1) that the current method relied upon figures provided by a representative sample of stores and not on the actual use by each company; (2) that the calculation of the recoverable input tax was based on a floor area calculation which was not a good proxy for use; (3) that in any event the attribution of floor areas to taxable and exempt use was not agreed and, for example, the display areas, which were treated as being used to make only taxable supplies, should be treated as being used to make both taxable and exempt supplies; (4) that it was not appropriate to apply a weighting mechanism to the floor area calculation based on a notional rental value adjustment as the single supply of renting the whole shop could not be sub-divided (this was a reference to the zoning calculation); (5) that it was inappropriate for the notional re-charge of costs from a wholesale company to be included in the special method which applied to a retail company as the latter should not include costs incurred by a separate legal entity; and (6) that there should be some similarity between the results of the apportionment of the output tax due on the taxable and exempt supplies made by the company and the results of the partial exemption calculation as both were determined by a method which apportioned the costs of the supplies; as the results of the two calculations were widely divergent that indicated that the partial exemption special method did not achieve a fair and reasonable result.

The reasons given in the letter to the single structure companies were the same except that reason (5) was omitted.

Both letters concluded that, as there was a fundamental disagreement about the amount of input tax which should be recovered, the Respondents had decided to direct the termination of the current partial exemption special methods and not to direct alternative special methods as they were satisfied that the standard method gave a fair and reasonable result. However, the Respondents were still prepared to consider proposals for replacement partial exemption special methods. No proposals were subsequently made by Group.

The effect of the decision letters

The effect of the change from the special methods to the standard method was to increase the amount of residual input tax which was irrecoverable. The actual amounts differed from store to store but in Eastbourne it more than doubled. The actual recovery rates for the four Appellants became within 4% of each other and very close to the taxable percentage of a supply of dispensed spectacles (33%).

The correspondence about the output tax apportionment

From July 2003, while the parties were corresponding about the partial exemption special methods, correspondence also took place between Ms Morris and the Respondents about the output tax apportionment as the Respondents thought that the taxable element was too low whereas Group thought that it was about right. However, on 25 November 2003 the parties agreed to postpone their discussions on that issue.

Invoices and the notional re-charge

It was not until April 2004 that invoices were raised between the wholesale companies and the retail companies in respect of the notional re-charge of a percentage of the expenditure of the wholesale company to the retail company.

Reasons for Decision

Before turning to consider the issues in the appeal we summarise the legislative framework.

The legislative framework

Article 17 of the Sixth Directive (77/388/EEC) describes the origin and scope of the right to deduct input tax. Article 17.2 states the general rule and provides that, in so far as goods or services are used for the purposes of his taxable transactions, the taxable person is entitled to deduct, from the tax which he is liable to pay, tax due or paid in respect of goods or services supplied to him by another taxable person. Thus the concept of use is brought in at a very early stage and applies to all claims for input tax. The first sub-paragraph of Article 17.5 provides that, where goods or services are used by a taxable person, both for transactions mentioned in Article 17.2 (taxable supplies) and for transactions in respect of which input tax is not deductible (exempt supplies), only such proportion of the tax shall be deductible as is attributable to the taxable supplies, the proportion is to be determined in accordance with Article 19.

Article 19 contains the provisions for the calculation of the deductible proportion under the first sub-paragraph of Article 17.5 (that is where goods or services are used to make both taxable and exempt supplies). Article 19.1 provides that the deductible proportion shall be made up of a fraction having as its numerator the total amount of turnover each year attributable to transactions in respect of which tax is deductible under Article 17.2 and 17.3 (taxable supplies) and having as its denominator the total amount of turnover each year attributable to transactions included in the numerator and to transactions in respect of which tax is not deductible (taxable and exempt supplies). Thus Article 19 establishes that, where goods or services are used to make mixed supplies, that is supplies which are both taxable and exempt, the normal method of attribution is by way of a fraction of which the numerator is the value of taxable supplies and the denominator is the value of all supplies (taxable and exempt). As the concept of use has already been established in Article 17.2 the Directive thus indicates that, in the words commonly used about input tax, output values can be a good proxy for use for the normal purposes of partial exemption (attributing input tax between taxable and exempt supplies).

However, Article 17.5 continues by providing that member states may, among other things, "(c) authorise or compel the taxable person to make the deduction on the basis of the use of all or part of the goods or services". Thus the later part of Article 17.5 permits member states to depart from the output values-based fraction mentioned in Article 19 and to authorise or compel a taxable person to make the deduction on another basis including that mentioned in Article 17.5(c), namely on the basis of the use of all or part of the goods or services.

Turning now to the national legislation we begin with section 24 of the 1994 Act. That section defines input tax as tax on the supply to a taxable person of goods or services used for the purposes of his business. So again the concept of use is introduced at a very early stage. Section 26 provides that a taxable person is entitled to credit for so much of his input tax as is attributable to taxable supplies made by him and that the Respondents shall make regulations for securing a fair and reasonable attribution of input tax to these supplies. So the over-riding principle underlying the regulations is that the attribution must be fair and reasonable. Regulation 101 enacts the standard method set out in Article 19, namely the output values-based method. However, in cases where an output values-based method does not give a good proxy for use, regulation 102 enacts the later provisions of Article 17.5 and provides that Customs and Excise can agree or direct a special method to attribute residual input tax between the taxable and exempt supplies made by the taxable person.

For input tax incurred by a taxable person on supplies to him after 31 December 2003 regulation 102A provides that, if a taxable person is using a special method which does not fairly and reasonably represent the extent to which goods or services are used by him in making taxable supplies, the Respondents may serve on the taxable person a notice setting out their reasons for the notice and stating that the effect of the notice is that regulation 102B applies. Regulation 102B provides that the taxable person shall calculate the difference between any attribution already made by him and an attribution which represents the extent to which the goods or services are used by him in making taxable supplies and account for the difference.

With that framework of the legislation in mind we turn to consider the issues in the appeal.

Issue (1) – Is the jurisdiction of the Tribunal full or limited?

The first issue is whether the jurisdiction of the Tribunal is full or limited. We use the term "full jurisdiction" to mean that, even if the disputed decision was a reasonable decision, we should decide for ourselves whether it secured a fair and reasonable attribution of input tax within the meaning of section 26(3). We use the term "limited jurisdiction" to mean that we should confine ourselves to considering whether, in making the direction to terminate the special methods, the Respondents made a reasonable decision.

For the Appellants Mr Peacock argued that the jurisdiction of the Tribunal was full having regard to the words of section 83(e) of the 1994 Act. He relied upon Merchant Navy Officers Pension Fund Trustees v The Commissioners of Customs and Excise (1996) Tribunal Decision 14262 at paragraphs 6 to 10 and 26; Cliff College Outreach v The Commissioners of Customs and Excise (2001) Tribunal Decision 17301 at paragraphs 34 and 35; University of Exeter v The Commissioners of Customs and Excise (2003) Tribunal Decision 18117 at paragraphs 35 to 38; and Optika Limited v The Commissioners of Customs and Excise (2003) Tribunal Decision 18627 at paragraphs 131 to 135. Mr Peacock distinguished Aspinall's Club Limited v The Commissioners of Customs and Excise (2002) Tribunal Decision 17797 at paragraphs 41 to 44 which reached the conclusion that the jurisdiction of the Tribunal was limited on the basis that there were no issues of primary facts to be resolved whereas in this appeal there were disputed facts.

For the Respondents Mr Thomas argued that the jurisdiction of the Tribunal was limited. He went on to argue that the actual nature of the jurisdiction had to be determined by reference to the statutory context within which the decision was made. In this appeal the relevant statutory context was in regulation 102 which, by the use of the word "may", gave the Respondents a discretion. He cited J G Whitelaw v The Commissioners of Customs and Excise (1989) Tribunal Decision 5354 and BMW (GB) Ltd v The Commissioners of Customs and Excise (1997) Tribunal Decision 14823.

In considering the arguments of the parties we note that a number of the Tribunal decisions referred to by Mr Peacock decided that, in similar circumstances, the Tribunal had a full jurisdiction. In 1996 in Merchant Navy Officers the parties agreed that the jurisdiction of the tribunal was a full jurisdiction; the Tribunal did not decide the point but proceeded on the basis that its jurisdiction was not limited. In 2001, in Cliff College Outreach, the Tribunal reached the same view as being the only conclusion consistent with the words of section 83(e) which did not confine the jurisdiction of the Tribunal to the validity of the decision to terminate a special method; however, there the Tribunal also concluded that it could not substitute another special method. However, in 2002, in Aspinall's Club, the Tribunal took a different view but Cliff College Outreach was not cited. In 2003 in University of Exeter the Tribunal followed Cliff College Outreach and decided that its jurisdiction was full and later in 2003 in Optika Limited the Tribunal did the same.

However, in 1997, in BMW (GB) Ltd the Tribunal decided that its jurisdiction was limited to deciding whether the decision to issue a direction (terminating one method and directing another) was a reasonable decision. In reaching that decision the Tribunal followed the principles established by the judgment of the Court of Appeal in John Dee Limited v Customs and Excise Commissioners [1995] STC 941. At paragraph 62, the Tribunal summarised the principles as follows:

"62. From the authorities which we have considered we have identified a number of principles. First, there is no right of appeal to the tribunal unless that right is given by statute. Secondly, in considering the extent of the right of appeal it is necessary to look at the statutory provisions which apply to the specific decision being appealed. Thirdly, if the statutory provisions relating to the specific decision being appealed confer a discretionary power on Customs and Excise then the jurisdiction of the tribunal is limited to determining whether the discretionary power was properly exercised. Fourthly, to decide whether the discretionary power was properly exercised the tribunal must look at the "statutory condition" (if any) for the exercise of the discretionary power. Fifthly, in examining whether the statutory condition was satisfied, the tribunal must consider whether Customs and Excise acted in a way which no reasonable panel of Commissioners could have acted, or whether they took into account some irrelevant matter, or disregarded something to which they should have given weight, or whether they erred in law. Sixthly, in considering these matters the tribunal should limit itself to considering facts and matters which were known when the disputed decision was made. And, finally, the tribunal cannot exercise a fresh discretion."

We adopt those principles because they are derived from a judgment of the Court of Appeal which is binding on us. We also adopt the principle in John Dee that where it is shown that a decision of the Respondents was erroneous, because of their failure to take account of some relevant matter, a tribunal could nevertheless dismiss an appeal if the decision would inevitably have been the same had account been taken of the relevant matter.

Applying those principles to the facts of the present appeal we first look to see if a right of appeal is given by statute. It was agreed that the jurisdiction of the Tribunal in this appeal derived from s 83(e) of the 1994 Act which provides that an appeal shall lie to the Tribunal with respect to "the proportion of input tax allowable under section 26". Next we look at the statutory provisions which apply to the specific decision being appealed. These are found in regulation 102 which provides that the Respondents "may" approve or direct the use of a special method which has to be used until the Respondents approve or direct the termination of its use. In our view the effect of regulation 102 is to confer a discretion on the Respondents both to approve or direct a special method and to approve or direct the termination of its use. We next look for the statutory condition for the exercise of the discretionary power and, in this appeal, that statutory condition is "for securing a fair and reasonable attribution of input tax" within the meaning of section 26(3).

In our view it follows that the jurisdiction of the tribunal is limited to determining whether the discretionary power in regulation 102 was properly exercised having regard to the statutory condition in section 26(3). We should, therefore, consider whether the Respondents acted in a way which no reasonable panel of commissioners could have acted, or whether they took into account some irrelevant matter, or disregarded something to which they should have given weight, or whether they erred in law. We should limit ourselves to considering facts and matters which were known when the disputed decision was made. And we cannot exercise a fresh discretion. It would be otherwise if there were to be an appeal against a decision relating to the operation of the standard method; there section 83(e) gives the right of appeal but the statutory provisions would be found in regulation 101 where the Respondents do not have a discretion. In such an appeal the Tribunal would have a full jurisdiction.

Mr Peacock argued that most of the matters mentioned in section 83 concerned the exercise of a discretion by the Respondents and gave as an example the issue of an assessment under section 73 where the Respondents had a discretion whether to assess but where the jurisdiction of the Tribunal was a full jurisdiction. However, that argument may reinforce our view because section 83(p) provides that not only is there an appeal against an assessment but also against the amount of the assessment and so the full jurisdiction is given specifically. The part of section 83 at issue in John Dee was section 83 (l) which gives a right of appeal against "a requirement of any security" under what is now paragraph 4(1A) or (2) of Schedule 11 which provides that "if they think it necessary for the protection of the revenue the Respondents may require security". Section 83(l), by itself, seems to confer a full jurisdiction but, when it is read together with the statutory provisions which give the Respondents a discretion, it becomes clear that the jurisdiction is limited.

We record that it appears from the Tribunal decisions cited by Mr Peacock that the remedy for an appellant if an appeal succeeded under either the full or the limited jurisdiction would be the same; namely that the disputed decision would be abandoned so that, in this appeal, the special methods would be deemed to have continued to apply. No tribunal appeared to be of the view that it could exercise a fresh discretion.

Our conclusion on the first issue in the appeal is that the jurisdiction of the Tribunal is limited to deciding whether the disputed decision was reasonable. However, in case we are wrong about that we have also gone on later to consider whether, even if the disputed decision was a reasonable decision, it did in fact secure a fair and reasonable attribution of input tax within the meaning of section 26(3).

Issue (2) –Was the disputed decision reasonable?

The second issue in the appeal is whether the disputed decision was a reasonable decision. In this context a reasonable decision means one in which the discretionary power given to the Respondents was properly exercised; in which the Respondents did not act in a way which no reasonable panel of Commissioners could have acted; did not take into account any irrelevant matter; did not disregard something to which they should have given weight; and did not err in law. However, if it is shown that a decision of the Respondents was erroneous, because of their failure to take account of some relevant matter, we can nevertheless dismiss an appeal if the Respondents' decision would inevitably have been the same had account been taken of the relevant matter. In considering these matters we should limit ourselves to facts and matters which were known when the disputed decision was made. We cannot exercise a fresh discretion.

As argued this issue raised the following questions:

(a). Were the reasons for the decision reasonable?

(b) Was it reasonable to terminate the special method so that the standard method applied? and

(c). Was the process of decision-making carried out in a reasonable manner?

We consider each of these questions separately.

Question (a) Were the reasons for the decision reasonable?

For the Appellant Mr Peacock argued that the reasons relied upon by Mr Giordan for the disputed decision were misconceived.

Before considering each reason in turn we recall the legislation. Section 26 provides that the amount of input tax for which a taxable person is entitled to credit is so much of his input tax as is attributable to taxable supplies made by him. It is, therefore, necessary to identify both the input tax for which credit is sought and the supplies made by the Appellants The residual input tax at issue in this appeal is tax on the following supplies made to the Appellants: some rent (some rent is exempt), building repairs, rates, water charges, property management, security, cleaning, insurance, light, heat, telephone, maintenance and repair of equipment, taxable staff expenses, post and stationery, software licence fees, professional fees, and advertising. Accordingly, what we have to decide is how the input tax on these supplies made to the Appellants should be attributed between their taxable and exempt supplies. Most of the taxable supplies made by the Appellants are the taxable portions of the supplies of dispensed spectacles and contact lenses, in short the optical goods sold by the Appellants. For output tax purposes the taxable portions have been identified as 33% of total supplies.

With that background in mind we turn to consider each of the reasons given by the Respondents for the termination of the special methods, with the result that the standard method applied, to see if those reasons were reasonable.

Reason (1) – the representative sample

The first reason for the termination of the special methods was because they incorporated figures provided by a representative sample of stores and did not relate to the actual use of inputs by each retail company. We remind ourselves that the context in which the representative samples were used in the special methods was in the allocation of floor area as between taxable floor area on the one hand and taxable and exempt floor area on the other. This allocation was done for a limited number of representative stores and it was this fraction which established the recoverable proportion of residual input tax for non-rent costs for all the group retail companies of the same structure.

The reasons why Mr Giordan concluded that the representative samples were not appropriate were: that there was no practical method of verifying whether the stores chosen by Group as being representative were representative of the use of the input tax by all the stores; that it was not appropriate for the recovery of input tax by one registered trader to be determined by reference to the independent activities of other registered traders; that although, when considered as a whole, the correct amount of input tax should be recoverable, this would not be true for any of the individual registrations because a trader who had a greater proportion of taxable supplies would suffer an under-recovery of input tax and one that had a lower proportion of taxable supplies would enjoy an over-recovery of input tax.

For the Appellants Mr Peacock argued that the use of representative samples gave a good proxy for use because the business activities of all the companies were similar. He referred to Notice 700/57 issued in August 2004 and entitled "VAT: Administrative agreements entered into with trade bodies" which indicated that the Respondents agreed representative methods with traders who were all members of a value added tax group. Paragraph 5 gave details of an agreement with the Association of British Factors which set out a formula for input tax apportionment which members could use as a special method after approval from their local value added tax office. He also referred to paragraph 6 which gave details of an agreement with the Finance Houses Association in 1984 which stated that 15% of input tax relating to hire purchase credit could be regarded as being properly attributable to the sale of the goods in respect of which the credit is granted. He also referred to Barclays Bank plc v The Commissioners of Customs and Excise (1991) Tribunal Decision 5616. Finally, he argued that, even though the use of the representative sample meant that some companies in the group recovered more input tax, others recovered less and overall the correct amount of tax would be recovered.

For the Respondents Mr Thomas argued that there was no objection to a special method agreed at a general level and then used by individual taxable persons. What was objectionable was the setting of a percentage recovery rate which did not reflect the individual circumstances of each trader and which was not subject to approval by the Respondents for each trader.

In considering the arguments of the parties we start with the statutory language. Section 26 makes it clear that the amount of input tax for which a taxable person is entitled to credit is that attributable to taxable supplies made by the taxable person. This language is repeated in regulation 101. In our view the statutory language assumes that a separate calculation will be made for each taxable person. This does not mean that a separate method is required for each taxable person but it does mean that if a special method for a particular class of taxable persons is agreed then it should be separately approved for each taxable person and the calculations of the recoverable percentages for each taxable person should be done separately having regard to the actual figures for that taxable person. Those percentages should then be applied to the actual input tax of each taxable person.

What we mean could be demonstrated by reference to the special method for single structure companies. It would, for example, be possible to have a special method for all the single structure companies in the group which stated that the recoverable proportion of the residual input tax for each such company was to be determined having regard to the method of taxable floor area divided by all floor area. That method would then be applied to the floor area of each company, rather than to a representative sample of companies, and the resulting fraction would be applied to the residual input tax of each company.

Our second reason for concluding that the use of the representative sample does not give a fair and reasonable attribution of input tax for each company is that it will never give the right answer for each company. We were shown some figures at the hearing which were meant to show that, if the agreed floor area method were to be applied separately to each of the four Appellants, and not to a representative sample, each Appellant would achieve a lower recovery of input tax. What these figures demonstrated to us was, that if the floor area method were to be applied separately to each of the Appellants, (or indeed to any individual retail company), each company would achieve a recovery which was different from that achieved by the use of the special method. In other words, the special method did not give a fair and reasonable attribution of each company's input tax.

In this connection we consider the arguments of Mr Peacock that the Respondents often agreed special methods with traders or trade representatives. We do not think that it is possible to equate the companies in the Specsavers group on the one hand with companies in a value added tax group on the other. The companies in the Specsavers group are all separately registered for value added tax and are all separate taxable persons. Companies in a value added tax group are treated as a single taxable person. The agreement with the Association of British Factors specifically provided that each member was required to seek the approval of their local value added tax office before applying the formula. The 1984 agreement with the Finance Houses Association was withdrawn in 2000. We have referred to the decision in Barclays Bank Plc which referred to an agreement reached in 1984 between The Commissioners of Customs and Excise and the Committee of London Clearing Banks which was adopted by the appellant in that appeal. However, we accept the evidence of Mr Giordan that the Respondents no longer agreed a percentage for traders in a particular sector because those whose recovery rate was lower than the agreed percentage used the agreed percentage and those whose recovery rate was higher ignored the percentage. Thus we regard it as reasonable for Mr Giordan to conclude that it is no longer appropriate for the recovery of input tax by one registered trader to be determined by reference to the independent activities of other registered traders.

Our third reason for concluding that the use of the representative sample does not give a fair and reasonable attribution of input tax for each company is because the special method for single structure companies, combining as it did the 66.6% for non-rent costs and the 86% for rent costs to give an overall percentage of 69.2% which was then applied to all single structure companies, could not give a fair and reasonable attribution for each company. For example, if a company had rent costs of £2,000 and non-rent costs of £4,500 making a total of £6,500 the application of the 69.2% would give a figure of £4,498. But if the 66.6% had been applied to the non-rent costs and the 86% to the rent costs the amount recovered would be £4,717, a difference of £219.

Our fourth reason for concluding that the use of the representative sample does not give a fair and reasonable attribution of input tax for each company is because some stores paid value added tax on their rent and some did not. However, even those single structure stores which did not pay tax on their rent were allowed to apply the overall recovery fraction of 69.2%. Accordingly, the use of the overall recovery fraction of 69.2% meant that single structure stores which did in fact pay tax on rent were able to claim less input tax than the amount to which they were entitled whereas stores which did not pay any tax on rent were able to claim more than the amount to which they were entitled. In effect, some stores were denied input tax recovery on all their rent because other stores were not charged tax on their rent. (This defect did not apply in practice in the same way to dual structure retail stores because if such a company did not pay value added tax on its rent no recovery percentage would in practice be applied to its rent costs. However, if the dual structure company's special method were to be applied as written the anomaly would remain.)

Our fifth reason for concluding that the use of the representative sample does not give a fair and reasonable attribution of input tax for each company is because the sample was hard to audit. In 1997 and 1998 the samples were chosen by Ms Morris. It was not shown that the samples were not representative but it would have been very difficult for the Respondents to check that they were. We agree with Mr Giordan that there was no practical method of verifying whether the stores chosen by Group as being representative were representative of the use of the input tax by all the stores.

Our final reason for concluding that the use of the representative sample does not give a fair and reasonable attribution of input tax for each company is because the special methods provided that the figures produced by the representative samples in 1997 and 1998 applied to new companies joining the group at whatever time and the Respondents had no opportunity of deciding whether that was appropriate for each company.

We therefore conclude that the special methods, because they incorporated figures provided by a representative sample of stores and did not relate to the actual use of inputs by each retail company, did not produce a fair and reasonable attribution of residual input tax and that Mr Giordan was reasonable to so conclude.

Reason (2) - the floor area method

The second reason for the termination of the special methods was that the calculation of the recoverable input tax was based on a floor area calculation which was not a good proxy for use. We remind ourselves that the context of the floor area calculation in the special methods is that residual input tax is recoverable in the proportion that the amount of taxable floor area bears to the amount of taxable and exempt floor areas.

The reasons why Mr Giordan concluded that the floor area calculation was not a good proxy for use were: because even on the Appellants' figures only 46.5% of the residual input tax had any link at all to floor area and 53.5% did not; because he was of the view that, in any event, the Appellant's figures were over-stated; and because less than half the floor space was attributed to either taxable or exempt supplies.

For the Appellants Mr Peacock argued that the use of the floor method had been agreed in 1997 and 1998 and so it must be assumed that it was then thought to give a fair and reasonable result. Mr Giordan did not understand how the floor area method worked. All the input costs had a clear nexus to the floor area of a store and so were the best proxy for the allocation of such costs.

We start with Mr Giordan's first reason which was that the floor area calculation was not a good proxy for use because, even on the Appellants' figures, only 46.5% of the residual input tax had any link at all to floor area and 53.5% did not. We saw an analysis prepared by the Appellants of all expenditure bearing input tax for all the stores in the group for the year ending on 31 May 2004. The analysis placed the items of taxable expenditure under four headings, namely, property costs; costs directly related to property; costs indirectly related to property; and other expenses. This analysis indicated that, of all taxable expenditure, 30.41% related to property costs; 2.59% related to costs directly related to property; 13.51% related to costs indirectly related to property; and the remaining 53.49% related to other expenses. Costs which were treated as property costs were: rent, building repairs, rates and water and property management fees. Costs which were treated as directly related to property costs were security, cleaning, insurance, light and heat. Costs which were treated as indirectly relating to property were telephone, maintenance and repair of equipment, promotional advertising and merchandising costs. And costs which were not treated as relating to property included staff expenses, post and stationery, software licence fees, professional fees, and advertising by leaflets, brochures and on television. Television advertising amounted to 21.67% of the total. This analysis therefore shows that, even on the Appellants' view, less than half of all taxable inputs related to property.

Turning to Mr Giordan's second reason, like him we do not agree with the inclusion of telephone, maintenance and repair of equipment, promotional advertising and merchandising costs as being property related. That would mean that the proportion of all costs which are not property-related would rise to 67%.

Mr Giordan's third reason was that the use of the floor area fraction did not give a fair and reasonable attribution of input tax because less than half the floor area was allocated to taxable or exempt supplies. This was borne out by the evidence at the hearing where, on the plans we saw, the excluded areas amounted to about 50% of total area (just under half in some stores and just over half in others). The excluded areas were left out of the fraction in the special methods on the assumption that the use of the excluded areas as between taxable and exempt supplies would be in the same ratio as the use of the other areas between wholly taxable or wholly exempt supplies. However, there was no evidence to support this assumption. For example, in the Eastbourne store, the waiting area was shown as excluded space and so the assumption was that it was used for both taxable and exempt supplies in the proportion of 69% taxable and the rest exempt. However, the waiting area was used by customers waiting to make an appointment for an eye test (exempt), waiting for a pre-test (exempt), waiting for an eye test (exempt), waiting for a dispensing optician (exempt) or waiting for a contact lens fitting or teach (exempt). It would not normally be used by customers purchasing solely optical goods as many of these were available at the reception desk. The waiting area might be used by a customer who wanted new frames fitted to existing lenses (although that is rarely done by the Appellants). We accept that the waiting area was also used by customers who were collecting finished dispensed spectacles but, in our view, it was reasonable to conclude that the waiting area was not used in the proportion of 69% taxable and the rest exempt.

On the plans we saw only about one third of total space was devoted to making taxable supplies. As we know that the results of the application of the floor area fraction gave a recovery rate of 66.6% that does not appear to reflect the fact that only one third of floor area was actually shown as taxable space.

We therefore conclude that the special methods, because they incorporated calculations by reference to floor area, did not produce a fair and reasonable attribution of residual input tax and that Mr Giordan was reasonable to so conclude.

Reason (3)- the actual attribution of floor areas

The third reason for the termination of the special methods was that the actual attribution of floor areas to taxable and exempt use was not agreed and, for example, the display areas which were treated as being used to make only taxable supplies, should be treated as being used to make both taxable and exempt supplies.

The reason why Mr Giordan concluded that the actual attribution of different floor areas to wholly taxable and wholly exempt use was not appropriate was because, although the frame display areas were treated as being used to make wholly taxable supplies, the costs used to create the frames display areas were cost components of both taxable and exempt supplies. This was because the supply purchased by customers was in fact a mixed supply of (taxable) frames and (exempt) dispensing services; because the frames display areas were also used for advertising dispensed spectacles and contact lenses which were both taxable and exempt supplies; and because no allowance was made for the fact that a customer who wanted to purchase only an exempt supply (an eye test) or a mixed supply (of dispensed spectacles or contact lenses) had to cross the frames display area to reach the reception desk or the appointments desk and the dispensing areas.

In considering these reasons we begin with the plan of the Eastbourne store where the whole of the frames display area (apart from the excluded area around the reception desk) was shown as taxable and this made no allowance for the fact that all customers, including those who had come to purchase exempt supplies or mixed supplies (for example, a pair of spectacles), had to walk from the door to the reception desk through the whole of the frames display area. No pathway was shown on the plan which had been used to calculate the percentages for the special method but, if a pathway had been shown, then the amount of floor space attributable to taxable supplies would have been reduced by 30% in Eastbourne; 28% in Bletchley; and 36% in both Banbury and Lichfield.

It is also relevant that a customer who was given dispensing advice in an exempt area, and then went to the frames display area to choose spectacle frames on the basis of this advice, was treated as entering a fully taxable display area when what the customer was purchasing was a mixed supply of dispensed spectacles. Or a customer could have chosen a frame in the display area and then been advised in an exempt (dispensing) area that it was unsuitable and then entered the display area again armed with that advice. Again, all customers on entering the store were met and greeted in the display area even though they may have come to purchase only exempt supplies. Yet again, the display area contained advertising most of which related to mixed supplies (spectacles or contact lenses) whereas the display area was marked as fully taxable.

Finally, we bear in mind that what most customers purchase from the Appellants is a mixed supply of dispensed spectacles or contact lenses. That mixed supply makes it even more difficult to allocate space to wholly taxable or wholly exempt supplies. We accept the evidence of Professor Jalie that the initial process of frame selection is part of the dispensing process. In the final examination for a dispensing optician's qualification over 40% of the examination is concerned with the selection and fitting of frames.

We therefore conclude that the actual attribution of the floor areas under the special methods did not produce a fair and reasonable attribution of residual input tax and that Mr Giordan was reasonable to so conclude.

We also add that, in the Eastbourne store, the laboratory was shown as a fully taxable area but it was also used for checking spectacles which is a dispensing function and therefore exempt. And of course the storage areas were marked as taxable when they should have been excluded. However, these matters were not known to Mr Giordan when he made his decision; if they had been they would have confirmed his view that the actual attribution of the different floor areas to wholly taxable and wholly exempt use was not appropriate.

Reason (4) – the principle of zoning

The fourth reason for the termination of the special methods was that it was not appropriate to apply a weighting mechanism to the floor area calculation based on a notional rental value adjustment (zoning) as the single supply of renting the whole shop could not be sub-divided. We remind ourselves that, in the context of the special methods, the principle of zoning was applied only to rent costs and weighted those costs depending upon how much taxable and exempt floor area appeared in each zone. The result was a recovery rate of rent costs of 86% for single structure stores and 89.06% for dual structure retail stores. This was as a result of the fact that zones A and B (the higher value zones) mainly contained what were shown as taxable areas and the other low value zones mainly contained what were shown as the exempt and excluded areas.

The reasons why Mr Giordan concluded that the use of the principle of zoning was not appropriate were: because the Appellants received a single supply of renting the whole shop which could not be sub-divided; because the Appellants did not pay more rent for one part of the premises than for another; because the Appellants did not use the front of the shop more than the back of the shop but used the whole shop simultaneously; and because the use of the zoning mechanism distorted the recovery calculation.

We are of the view that the application of the principle of zoning in order to weight the costs of rent when calculating a recovery rate to be applied to rent costs is not appropriate because the concept of zoning is a valuation tool only; it does not represent the consideration for the supply of the lease or letting for which supply the consideration is the whole rent. It is not the case that the landlord charges more for zone A than for zone B; the landlord charges a single rent for the whole premises taking into account all the relevant factors, including, for example, location. Zoning is only used for valuation purposes and to compare the rents for properties of a similar size and location but with a different frontage. It is not conclusive in deciding what rent is actually charged. Further a typical customer in an optician's store has to use the whole store. Such a customer has to go deeper into the store to find the reception desk and would then use the waiting area, the pre-test room, the consulting rooms and the dispensing area all before purchasing a pair of dispensed spectacles.

We therefore conclude that the use of the principle of zoning under the special methods did not produce a fair and reasonable attribution of residual input tax and that Mr Giordan was reasonable to so conclude.

Reason 5 – consistency between the output tax and the input tax fractions

The fifth reason for the termination of the special methods was that there should be some similarity between the results of the apportionment of the output tax due on the mixed (taxable and exempt) supplies made by the Appellants on the one hand and the results of the partial exemption calculation on the other as both were determined by a method which apportioned the relative costs of the supplies; the fact that the results of the two calculations were widely divergent indicated that the partial exemption special method did not achieve a fair and reasonable result.

The reason why Mr Giordan concluded that there was an inconsistency between the results of the special methods and the output tax apportionment calculation was because the two calculations gave widely divergent results when it was to be expected that the results should be similar.

For the Appellants Mr Peacock argued that the apportionments for the purposes of output tax excluded overhead costs whereas it was those costs which were dealt with in the partial exemption special methods and so the results could not be consistent. The costs apportioned for the output tax calculation were mainly staff costs which were mainly used to make exempt supplies. It could not be said that most of the overhead costs were used in that way. For the Respondents Mr Thomas argued that the results of the special methods, which indicated that nearly 70% of residual input tax was referable to the making of taxable supplies, were inconsistent with the output tax calculations which indicated that two-thirds of supplies made by the retail companies were exempt.

We have already found that the output tax apportionment for a supply of dispensed spectacles is 33% taxable and for contact lenses is about 43% taxable. For the purposes of residual input tax the results of the application of the special methods were 69.2% taxable for single structure companies and, for dual structure companies, 89.06% taxable for rent costs and 68.28% taxable for non rent costs. We have also found that supplies of dispensed spectacles and contact lenses amount to 85% of the total supplies made by the Appellants. Other supplies made are fully exempt eye tests and fully taxable optical goods. It is also relevant that the actual recovery rates of residual input tax under the standard method (about 30%) were a little less than the output tax apportionment for spectacles (67% exempt and 33% taxable).

We are of the view that there should be some consistency (although not a complete similarity) between the output tax apportionment and the input tax recovery rate; although they need not give an identical result they should be of a similar order of magnitude. As 85% of each business consisted of the supply of dispensed spectacles and contact lenses it is not unreasonable to assume that most of its overheads would be used to make those supplies in approximately similar proportions. Any difference could be explained by the fact that there was a different output tax apportionment for contact lenses and that there were also wholly taxable supplies (of optical goods) and wholly exempt supplies (eye tests).

We accept that there was an unresolved difference of view between the parties about the output tax apportionment but in that context the Appellant was arguing that it was fair although the Respondents were arguing that the taxable fraction should be reduced. However, we have used the figures which were acceptable to the Appellants.

We therefore conclude that the wide divergence between the results of the apportionment for output tax purposes and the results of the special methods were a good indication that the special methods did not produce a fair and reasonable attribution of residual input tax and that Mr Giordan was reasonable to so conclude.

Reason (6) – the notional re-charge for the dual structure companies

The sixth reason for the termination of the special methods only applied to the dual structure companies and was that it was inappropriate for the notional re-charge of costs from a wholesale company to be included in the special method which applied to a retail company as the latter should not include costs incurred by a separate legal entity. The context of the notional recharge had the effect of adding to the residual input tax of the retail company an agreed proportion of tax on certain expenditure which expenditure was actually incurred by the wholesale company.

The reasons why Mr Giordan concluded that the notional re-charge had no place in a partial exemption calculation were: because input tax incurred by a separately registered trader should not be recoverable by another trader; because in theory the special method could result in more than 100% of the input tax being reclaimed although the method had not been operated in that way; and because although the notional re-charge had been included at the request of Mr Bennett of the Respondents, Mr Giordan was of the view that the matter should have been dealt with as a normal commercial transaction.

On the wording of the method we are of the view that the inclusion of the notional re-charge in the special method for dual structure companies was inappropriate. On the wording of the method it could be concluded either that the retail company could claim credit for part of the input tax incurred by the wholesale company or that both companies could claim the same input tax. We do not wish to comment on the reason for the dual structure arrangement, as it was not the subject of evidence or argument at the hearing, but on the basis that it exists as we have found, then, as a result of section 26, it is only the wholesale company (which is a separate taxable person) which is entitled to deduct the input tax on the supplies which are made to it. Under section 26 the retail company has no entitlement to deduct any of that input tax as the supplies are not made to the retail company. There is certainly no authority for two companies to deduct the same input tax.

It was put to Mr Giordan in evidence at the hearing that the notional re-charge did not work in practice in that way and that what happened was that the amount of input tax notionally re-charged by the wholesale to the retail company remained with the wholesale company and only the wholesale company actually claimed a deduction for that input tax on its returns. However, the amount re-charged to the retail company in effect increased the amount of input tax which was irrecoverable by the retail company. In making its returns the retail company would calculate the residual input tax on supplies made to it and would deduct the amount of input tax calculated under the special method as being irrecoverable, that latter being notionally increased by the re-charge.

An agreed example of the way in which the notional re-charge worked in practice was put to us at the hearing. The first assumption was that, in a dual company structure, the wholesale company incurred input tax of £7,000. The wholesale company would claim credit for the full £7,000 as its input tax and, as it was a fully taxable company, would recover it all. The second assumption was that, in accordance with the percentages agreed as part of the special method, £5,000 of the £7,000 input tax was notionally re-charged to the retail company. The third assumption was that the retail company incurred its own input tax of £2,700. It would then add to its own input tax the notionally re-charged £5,000 from the wholesale company giving a total of £7,700. To that it would apply the irrecoverable fraction of 31.74% for non rent costs which gave the sum of £2,443.98 as irrecoverable input tax. The retail company would then claim input tax of £256.02 being its own input tax of £2,700 less irrecoverable input tax of £2,443.98.

The basis of the example ensures that the right person claims the input tax and also ensures that there is no double recovery but in our view it is not appropriate for inclusion in a partial exemption special method. What it does is to provide that the retail company's right to recover its own input tax is restricted by reference to input tax recovered by the wholesale company which is a different taxable person. In our view, the identified problem, which was that supplies were made to the wholesale company which was fully taxable and which could recover all the input tax whereas the benefit of some of those supplies also accrued to the retail company which was partially exempt should have been solved by requiring the wholesale company to invoice the retail company for the amount of the supplies the benefit of which accrued to the retail company. The wholesale company would then pay output tax on such invoices and the retail company could claim input tax to the amount recoverable following its partial exemption calculation.

We therefore conclude that the inclusion of the notional re-charge in the special method for the dual structure companies was inappropriate and did not secure a fair and reasonable attribution of each company's residual input tax and that Mr Giordan was reasonable to so conclude.

Our answer to question (a), therefore, is that the reasons for the disputed decision were reasonable.

Question (b) Was it reasonable to terminate the special method so that the standard method applied?

The second issue in the appeal is whether the disputed decision was a reasonable decision. The second question arising out of this issue is whether it was reasonable for Mr Giordan to terminate the special method so that the standard method applied.

The reasons why Mr Giordan concluded that it was fair and reasonable for the standard method to apply were: because he considered other special methods, including methods based on transactions, inputs, input tax and staff time, but concluded that the method most reflective of the use of the input tax was the standard method based as it was on output values; because the standard method was simple for the Appellants to operate; because the standard method was simple for the Respondents to verify; because the standard method was based on the use of costs by the individual trader rather than on the activities of other traders; because the standard method produced a result similar to the apportionment for output tax purposes; and because the standard method would adapt to the changing circumstances of each business.

For the Appellants Mr Peacock argued that it was not reasonable to force the Appellants to use the standard method which was a blunt instrument and which was less reasonable than the special methods they had been operating. When the Respondents exercised their discretionary powers under regulation 102 both the result and the method directed had to be for the purpose of securing a fair and reasonable attribution of input tax under section 26(3) and he cited Merchant Navy Officers and University of Exeter. The Respondents should also consider any alternatives there were to the special methods which were terminated and must not terminate a method if to do so would result in the use of a method which was less fair and reasonable. The alternatives to be considered by the Respondents included the possibility of serving a notice under regulation 102A.

For the Respondents Mr Thomas argued that it was fair and reasonable for the Respondents to terminate the special method with the result that the standard method applied. The standard method provided a good proxy for the use of input tax. The standard method gave a fair result where costs were largely incurred in the same tax year as outputs were made and that was the case in this appeal. The standard method was also fair where all the costs related to all the supplies made and the taxable supplies did not consume more or less input tax than the exempt supplies and that was also the case in this appeal.

In evidence Mr Giordan accepted that the standard method was a broad brush calculation and was based on the ratio of taxable supplies to all supplies. It also assumed a relationship between the values of the different categories of supply (taxable and exempt) and the taxable costs used in making the supplies; in other words it assumed that £1 of taxable outputs and £1 of exempt outputs used the same amount of taxable costs. Any partial exemption method had to reflect use and in this appeal he was satisfied that the standard method did reflect use.

Dealing with the points made by Mr Peacock, we do not agree that the standard method is less fair and reasonable than the special methods. From our discussion of question (a), and the reasons for making the disputed decision, it will be seen that we are of the view that the special methods did not secure a fair and reasonable attribution of input tax We agree that the exercise by the Respondents of their discretionary powers under regulation 102, and the method directed, must be for the purposes of securing a fair and reasonable attribution of input tax and we are of the view that the standard method will achieve that result. Mr Giordan did consider a number of alternatives (including, as he mentioned in evidence, the possibility of serving a notice under regulation 102A) and concluded, reasonably in our view, that the standard method was more fair and reasonable than any of the alternatives.

We conclude that it was reasonable for Mr Giordan to terminate the special method so that the standard method applied; for the reasons given by Mr Giordan, the standard method does give a fair and reasonable attribution of input tax and he was reasonable to so conclude.

Question (c) – Was the process of decision making carried out in a reasonable manner?

The second issue in the appeal is whether the disputed decision was a reasonable decision. The third question arising out of this issue is whether the process of decision making was carried out in a reasonable manner.

For the Appellants Mr Peacock argued that the decision-making process of the Respondents was flawed as the officers had closed their minds before they had had discussions, failed to enquire into the relevant facts, and made unwarranted assumptions as to the true position of the stores and the companies in the group. He argued that Mr Giordan, who made the disputed decision, had no experience of the opticians' industry and took no real steps to acquire such experience. He did not visit a group company's store. He did not consider the papers leading up to the approval of the special methods in 1997 and 1998 and relied upon the irrelevant factor of tax avoidance. He had decided that the special methods were not fair and reasonable before the letter of 4 July 2003 was sent to Group and the letter of 4 July 2003 concluded that the special methods did not result in a fair and reasonable recovery of input tax without hearing the views of the Appellants. The deadline for proposals was very short and much of the time was spent by the Appellants waiting for responses from the Respondents. Also, the correspondence did not set out all the Respondents' concerns thus not giving Group an opportunity to make representations.

We consider each of these claims in turn.

We first ask whether Mr Giordan and Mr Pernavas closed their minds before they had had discussions. The discussions began with the meeting on 14 May 2003 and continued in correspondence until another meeting on 25 November 2003. In evidence Mr Giordan accepted that, when the letter of 4 July 2003 was written, he was not interested in any response from Group other than proposals for alternative methods and he had then closed his mind as to whether the special methods were fair and reasonable (as he was firmly of the view that they were not). He set the deadline of 30 September 2003 without waiting for a written response to his letter of 4 July 2003 because he had already concluded that the special method was not fair and reasonable because of the notional re-charge issue. However, at that time he was not considering whether to make a direction. From that we infer that he hoped that agreement would be reached about an alternative special method. Thus right up to November 2003 Mr Giordan had not decided to make a direction and remained open to persuasion about the possibility of an alternative special method. He had not closed his mind to any proposals to be made by Group. What he had closed his mind to was the continuation of the existing special methods and that, in our view, was reasonable. Without going into too much detail it would have been obvious that a taxable output fraction of 33% and an input recovery rate of 69.2% were very likely to be advantageous to the Appellants.

Turning to Mr Peacock's claims that Mr Pernavas and Mr Giordan did not enquire into the relevant facts nor take certain steps we have found that Mr Pernavas and Mr Giordan accepted the invitation made at the meeting on 25 November 2003 to visit a store but no arrangements were made. In evidence which we accept Mr Giordan agreed that, when he drafted the letter of 4 July 2003, he had not seen the papers dealing with the agreement of the special methods in 1997 and 1998 but he did see those papers before the direction was made; in any event, although Mr Giordan did not consider the 1997 and 1998 files in July 2003 he was aware of the terms of the methods themselves.

We do not accept that Mr Giordan relied upon the irrelevant factor of tax avoidance. His memorandum of 7 January 2004 makes it clear that he did not.

As far as the deadline for proposals is concerned, it is not, in our view, appropriate to compare the time scale for the approval of the 1997 and 1998 special methods with the time scale for the termination of the special methods. The agreement of the 1998 special method was subject to delay because the Inland Revenue were making some enquiries and that factor did not affect the time-table for the termination. Also, the deadlines given by the Respondents during the discussions preceding the termination only related to the submission by Group of proposals; they were not deadlines for the approval of another method. The fact is that the deadline was first given on 4 July 2003 and no attempt was made thereafter by Group to propose another special method. We are of the view that Group were not going to make proposals for an alternative special method. In the deadlines given they did not submit any proposals and they had not done so at the date of the hearing, even though invited to do so by the decision letters. When it was put to Ms Morris in cross-examination that the letters which she had written to the Respondents about their concerns with the special methods made no concession whatever to the fairness of the methods she replied "That is tactics for you". In our view it was part of the tactics of the Appellants not to make proposals for another special method. From that it follows that, however much the deadline was extended, it would have achieved no purpose and Mr Giordan was reasonable to so conclude.

We also do not accept that the correspondence did not set out all the Respondent's concerns. At the meeting on 14 May 2003 Mr Pernavas told Group that he had four concerns, namely, the floor area method, zoning, the lack of consistency between the output tax and input tax fractions and the notional re-charge. He did not mention the use of the representative samples or the actual use of the floor areas. However, in our view, the floor area method and the actual use of floor areas are very similar and if, in principle, a floor area method is not regarded as a suitable method then the actual use of floor areas becomes irrelevant. The letters of 4 July 2003 and 5 September 2003 did deal with the representative sample and also dealt with the floor area method, the notional re-charge and the input tax/output tax fractions. They did not deal with the actual use of the floor area nor with zoning but again we are of the view that if, in principle, a floor area method is not regarded as a suitable method then the actual use of floor areas, and the concept of zoning, become irrelevant. Thus we are of the view that the correspondence did set out all the Respondents' concerns and gave Group plenty of opportunity to make representations. The Respondents indicated that they would consider any special method proposed by the Appellants but none has, so far, been proposed.

Our answer to the third question is, therefore, that the process of decision making was carried out in a reasonable manner.

Conclusions about the second issue

On the second issue in the appeal our conclusion is that the disputed decision was a reasonable decision; that is, that the discretionary power given to the Respondents was properly exercised; the Respondents did not act in a way which no reasonable panel of Commissioners could have acted; did not take into account any irrelevant matter; did not disregard something to which they should have given weight; and did not err in law. However, even if the Respondents did fail to take account of some relevant matter we are of the view that their decision would inevitably have been the same. In considering this issue we have based our decision on facts and matters which were known when the disputed decision was made.

Thus we conclude that, if the jurisdiction of the Tribunal is limited, the decision to terminate the special methods was a reasonable decision.

Issue (3) – Did the disputed decision secure a fair and reasonable attribution of input tax?

The third issue in the appeal is, if the jurisdiction of the Tribunal is a full jurisdiction, and even if the decision of the Respondents was a reasonable decision, whether the disputed decision secured a fair and reasonable attribution of input tax within the meaning of section 26(3).

It will be clear from what we have said in relation to issue (2) that we are of the view that the special methods operated by the Appellants until 2004 did not secure a fair and reasonable attribution of input tax within the meaning of section 26(3) and that the standard method does secure such a fair and reasonable attribution. In considering this issue we do not have to restrict ourselves to facts and matters which were known when the disputed decision was made. However, nothing that has become known since then has changed our views.

Decision

Our decisions on the issues for determination in the appeal are:

(1) that the jurisdiction of the Tribunal is limited;

(2) that the decision to terminate the special method was a reasonable decision; and

(3) that, if we are wrong in our decision on issue (1), and if the jurisdiction of the Tribunal is full, then the disputed decision did secure a fair and reasonable attribution of input tax within the meaning of section 26(3).

That means that the appeal is dismissed.

Costs

Both parties asked for their costs in the event that they were successful.

Under Rule 29(1)(b) WE DIRECT that the Appellants shall pay the costs of the Respondents of and incidental to and consequent upon this appeal to be assessed on the standard basis by a Taxing Master of the Supreme Court or a district judge of the High Court of Justice in England and Wales by way of detailed assessment

DR NUALA BRICE

CHAIRMAN

RELEASE DATE: 26 October 2005

LON/2004/0299

LON/2004/0322

LON/2004/0424

LON/2004/1530

26.09.05

[This Decision was first released to the parties on 26 July 2005.

This version of the Decision removes matters which are commercially sensitive.]