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United Kingdom VAT & Duties Tribunals Decisions
You are here: BAILII >> Databases >> United Kingdom VAT & Duties Tribunals Decisions >> Prudential Assurance Company Ltd v Revenue & Customs [2006] UKVAT V19607 (01 June 2006)
URL: http://www.bailii.org/uk/cases/UKVAT/2006/V19607.html
Cite as: [2006] UKVAT V19607
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- This is an appeal by Prudential Assurance Company Limited in a letter of 19 August 2004 against Customs' refusal to allow PAKRA Limited (now called Prudential Health Limited, but we shall refer to it as "PAKRA") to join its VAT group. The Appellant was represented by Mr Andrew Hitchmough and Mr James Rivett; and Customs by Miss Rebecca Haynes.
- In outline the Appellant entered into a joint venture through a jointly owned company (PAKRA) with a South African insurance company, Discovery Holdings Limited (to we shall refer, including its wholly-owned UK subsidiary, Discovery Offshore Holdings Limited that entered into the joint venture agreement, as "Discovery") to market a new type of health insurance product. Discovery required South African Reserve Bank approval before it could invest in PAKRA, so PAKRA started as a wholly-owned subsidiary of the Appellant. PAKRA was also required to be licensed by the Financial Services Authority ("FSA") before it could trade. The joint venture agreement ("the Contract") was conditional on, amongst other things, those two consents. While they were being obtained both parties expended money on set-up costs with the intention of invoicing those costs to PAKRA after consents were obtained, so as to avoid the possibility of their being locked in PAKRA if consents could not be obtained. Up to 18 staff employed by a service company of the Appellant that employed all their staff were working full-time on the project and the Appellant provided the services of other staff in relation to the start-up. The Appellant applied to group PAKRA for VAT purposes during the time before PAKRA became a jointly-owned company when it would be ineligible for grouping. Customs refused such application for grouping as necessary for the protection of the revenue, and this appeal is against such refusal.
- It is not necessary for us to set out the well-known provisions about grouping for VAT. Section 43B(5) of the VAT Act 1994 deals with the refusal of applications for grouping:
- The jurisdiction of the Tribunal is set out in section 84:
- This jurisdiction has been described as an appellate jurisdiction but exercised on supervisory principles, see National Westminster Bank v Customs and Excise Commissioners (1998) VAT Decision 15514 at [5]. The issue is whether Customs could reasonably have been satisfied that there were grounds for refusing the application. It is common ground that we should apply the principles in John Dee Ltd v Customs and Excise Commissioners [1995] STC 941, in particular Neill LJ said at page 952:
- The expression "necessary for the protection of the revenue" has been considered by the Tribunal first in National Westminster Bank:
- Customs adopt the same approach as Xansa in their Business Brief 15/99:
- There have been earlier proceedings relating to this appeal in which the Chairman refused an application by the Appellant for disclosure of relevant parts of the manual that were not published on the basis that he upheld Customs' claim for public interest immunity, see Prudential Assurance Company Limited v HMRC (2006) (not yet reported).
- The following statement of facts were agreed:
- We had a bundle of documents and heard evidence from Mr Kieran Devlin, Senior Tax manager of the Appellant, Miss Linda O'Sullivan, a National Business Manager of the Respondent since April 2002 responsible for co-ordinating and managing the contact between the Appellant and Customs, and Mr Simon Shaw, at the time an anti-avoidance adviser of the Respondent. We find the following further facts and we have also set out the internal decision-making process within Customs more fully in the Appendix.
- Mr Hitchmough and Mr Rivett, for the Appellant contend in outline:
- Miss Haynes, for Customs, contends in outline:
- We start with two preliminary points. First, it must have been clear to any VAT officer that the Appellant always intended to invoice the start-up costs while PAKRA was in its VAT group; if it did not there would have been no point in applying for grouping.
- Secondly, this is an appeal against the decision letter of 19 August 2004 which concludes that the revenue loss goes beyond the normal consequences of grouping because PAKRA will start to trade only after the grouping ceases. At no time did Miss Haynes seek to support this reasoning, for the obvious reason that it makes no sense. She contended that this was not the decision, which was that in the form PG2, but only the expression of the decision, a comment that caused those on Appellant's side of the court to burst out laughing. We cannot agree with her contention. The decision letter is the only means that the Appellant had of knowing the reasons for the decision, and it is against those reasons that they are appealing. It must have been extremely puzzling to them to be told that Customs were concerned that the start of trading was after the ending of the group relationship particularly as they told Customs in the letter of 27 May 2004 accompanying the application that PAKRA would not make any supplies whilst it is a member of the VAT group (see paragraph 9(24) above). They must have wondered what Customs had been doing writing them letters asking lots of questions in the meantime when they had this information from the beginning. Mr Shaw explained (and we accept) that the letter equated the start of trading with leaving the group, in which case the reason for refusal is the same as the PG2 form, but it is highly unsatisfactory that the meaning of the decision letter should be unclear.
- Mr Hitchmough took us and the witnesses were taken in detail through Customs' emails and other material leading up to their decision to refuse grouping. We propose instead to start at the point where their final conclusion had been reached and was put to Policy for approval. We would have been assisted if we could have followed the whole process leading up to this point because it would have enabled us to understand how the conclusions were reached but the material was insufficient to enable us to do so, even after hearing evidence from the Customs' witnesses who were involved. In the Appendix we shall summarise and comment on the events leading up to this point to show why we were unable to follow the process up to the point that a decision was made.
- For convenience we set out again Customs' objections to the application for grouping, as expressed in the form PG2:
- We approach the case by considering first why Customs thought that the Appellant's proposal was contrary to these documents, and whether they were reasonable in so concluding. In so far as we do not know how Customs reached their interpretation of the documents we shall be forced to consider how a reasonable officer would have interpreted them.
- The only information we have about Mr Shaw's interpretation of the Business Plan is his email set out in paragraph 10 of the Appendix to this Decision. Most of this discusses whether the Appellant was proposing to invoice costs in advance of their being incurred. However, on timing he says: "surely no costs should be invoiced until FSA approval is granted?" Since Mr Laney had read the Contract he would have appreciated that this provided for completion (including the subscription for shares) to take place on the business day following the satisfaction of the conditions. It is therefore difficult to see how Mr Shaw could have considered that invoicing after FSA approval was something different from what the Appellant was proposing to do. At the very least he should have asked the Appellant to explain it (as he did in relation to an apparent conflict in their letters).
- We turn to how a reasonable officer would have read the Business Plan, which, it should be remembered, is a document intended for obtaining FSA approval. The passage quoted in paragraph 10(1) above, refers to the parties incurring their own costs up to the "point of launch;" that these will be transferred into PAKRA "once FSA approval has been received" thereby creating a liability; and then "at this point in time" both parties will subscribe the share capital. This is followed by the pro-forma balance sheet "at the date of authorisation" showing both the capital and the liability. It is apparent that the description is loose, particularly in relation to timing; FSA approval is only one of eight conditions and the South African Reserve Bank approval might have been later, but it assumes that the FSA approval was the only (or the last) condition (which is perfectly natural in the context because this is the only condition that the FSA were concerned about). The transfer of the costs and the subscription of share capital occur at the same "point in time" but necessarily one must precede the other; there is no statement that the share capital must come first. Another confusing factor is that it is the costs up to the point of launch which are to be transferred and one would expect the launch to be after both the transfer and the subscription for the share capital. (In fact, the subscription took place on 13 September 2004 and trading started on 3 October 2004, but that is to use hindsight.) Further, a note to the pro-forma balance sheet states that they are being prudent in assuming that all the start-up costs estimated for the whole of 2004 have been incurred prior to launch. The author of the Business Plan must be using the time of authorisation, completion and launch as equivalents. We do not think it right to subject the Business Plan to minute linguistic analysis when the timing of these events was not critical to its purpose. The most that can be said that the transfer of the costs occurs at much the same time as the subscription but there is nothing to require the subscription to come first. Assuming (contrary to the facts as known later, see paragraph 20 below) that the FSA gave consent and following their consent the Contract was completed on the following business day according to its terms by the subscription of share capital, one cannot imagine that if the FSA had been asked if it cared whether the invoicing occurred immediately before the subscription or immediately after, they would have had any preference. A pro-forma balance sheet had been given showing both the invoiced costs and the share capital "at the date of authorisation." Their interest was the solvency of the company and it would not assist this if there was a moment when the capital had been subscribed and then the liability appeared, rather than the liability occurring first and then the subscription for capital. (If it is objected that invoicing first creates an insolvent company, since the only liability was to the shareholders who were immediately putting in capital, this does not seem to matter.) All the FSA were interested in was that at the time of approval the costs were a liability that was in the pro-forma balance sheet. Accordingly we do not consider that a reasonable officer reading the Business Plan would come to the conclusion in he PG2 form under the heading Details/Background that "both the business Plan and the Prudential's letter of 21/07/2004 clearly set out that the two parties…will not re-charge these [costs] to PAKRA until Discovery has subscribed for shares and the joint venture is up and running"; and under the heading Recommendations that "the Business Plan sets out that neither party will pass on any set up costs effectively prior to PAKRA becoming in-eligible to be a member of the Prudential VAT group."
- Since Miss Haynes contended that it was relevant that the invoicing was in fact before FSA (formal) approval we should point out that, since the "minded to grant" letter of 6 August 2004, which made formal consent subject to the auditors confirming that the share capital had been subscribed, was not seen by Customs before refusing the application for grouping, she is using hindsight to argue this. Anyone reading the business plan and the Contract would assume that FSA authorisation, one of the conditions to which the Contract was subject, would precede completion, which was scheduled to be on the next business day, and accordingly would precede the subscription for the share capital.
- Mr Shaw clearly thought the letters from the Appellant were important because he went back to the Appellant for clarification (see Appendix paragraphs 11 to 14). The letter of 21 July 2004 is mentioned under the heading Details/Background in the form PG2 as something that "clearly set out that the two parties will incur set up costs in relation to the proposed PAKRA activities and will not re-charge these to PAKRA until Discovery has subscribed for shares and the joint venture is up and running" and the 28 July 2004 letter is an attachment to the form. These letters are even less definite about the timing of these events than the Business Plan. They say: "Should the joint venture proceed, then the two parties will charge the start-up costs they have incurred to PAKRA which will be funded by share capital injected by the two parties…" (letter of 21 July 2004) and "In the more likely event that the joint venture proceeds, both Prudential and Discovery will charge the set up costs they have incurred to PAKRA. Prudential and Discovery's preference would be for Prudential to charge their internal staff costs to PAKRA whilst it is still a 100% subsidiary and a member of Prudential's VAT group so that this could be done without crystallising a VAT charge" (letter of 28 July 2004). Mr Shaw has therefore read "should the joint venture proceed" as meaning that it has been completed by the subscription for the shares, because in his email of 26 July 2004 he says "Am confused by the interaction of Kieran's comments in the attached letter [21 July 2004] that PAKRA would not be invoiced by Pru until actually a JV, with the VAT group application that suggests pre-invoicing." In saying this he seems not to be aware that the Contract makes clear that first the conditions (one of which is FSA approval) must be satisfied, then completion (including the subscription for the shares) will take place on the next business day. Very sensibly he went back to the Appellant in Customs' letter of 26 July 2004 asking about the apparent conflict between this statement in the letter of 21 July 2004 and the original application which makes it clear that the Appellant intended to invoice while PAKRA was in he group. Mr Devlin replied saying that both statements were correct, implying that he saw no conflict, and making the statement quoted above from the 28 July 2004 letter. It had therefore been made absolutely clear that invoicing will take place while PAKRA was in the group, a point that must have been obvious to Mr Shaw in any case because otherwise grouping would have served no purpose. How was it therefore that he wrote the opposite in the form PG2, that "Prudential's letter of 21/07/2004 clearly set out that the two parties will incur set up costs in relation to the proposed PAKRA activities and will not re-charge these to PAKRA until Discovery has subscribed for shares and the joint venture is up and running"? And why did he refer to the apparent conflict in the next bullet point: "Notwithstanding the above point, Prudential have made clear to us that they wish to invoice £13m to PAKRA whilst it is within the Prudential VAT group…"? The only explanation we can think of is that this passage under the heading Details/Background was written before the reply of 28 July 2004 was received and this section was not changed. This might explain why neither letter is mentioned under the heading Recommendations, which relies solely on the Business Plan for this statement, perhaps because reference to the letter of 21 July 2004 was deleted from that part of the form following the receipt of the 28 July 2004 letter. In summary, we do not understand how the Appellant's letters can possibly have led Customs to believe that the Appellant was saying that they would do the opposite of what it must have been obvious to them that the Appellant wanted to do.
- Mr Shaw placed less reliance on the Contract, merely that invoicing was proposed to be earlier than the Contract "appear[s] to allow." All we know about Customs' knowledge of the Contract is Mr Laney's note (Appendix paragraph 5) which contains nothing to support this statement; indeed in stating that invoicing would be while the group existed and then analysing the Contract without noting any conflict, it implies the opposite. Mr Shaw does not seem to have referred to the Contract in anything else we have seen, although Miss O'Sullivan told us (and we accept) that she and Mr Shaw revisited the Contract when preparing the PG2 form but in the absence of any notes we do not know what they concluded or why. In the light of the statement in the Appellant's two letters that both parties will charge the costs, it is even less likely that the Appellant doing so necessarily before completion would be in breach of the Contract.
- We are not therefore sure whether there is any need for us to analyse the Contract, or whether it matters if the Contract does provide that invoicing would take place after subscription for the share capital, because it is clear that invoicing would take place while PAKRA was grouped; if that involved an amendment to the Contract one would assume that it would take place. However since the point was argued we will give our view on the meaning of the Contract. For convenience we set out clause 46(2) of the Contract again:
- We have no means of knowing why Mr Shaw also considered that the Contract: "provides that, effectively, Discovery will subscribe for shares in PAKRA once certain pre-agreed conditions have been met. Effectively this enables Prudential to control when PAKRA moves from wholly owned to 50% owned and hence when it will become ineligible for VAT grouping." Again there is nothing in Mr Laney's summary of the Contract to support this conclusion and Mr Shaw does not say anything about the Contract in anything we have seen. Mr Shaw's evidence was that he regarded this point as important and he was saying in effect that the parties could delay subscription for the shares until after invoicing in an artificial way. At the most a reasonable officer would have concluded from the definition of the Completion Date that both parties could have postponed completion (including the subscription for the shares) or could have brought it forward by waiving the conditions, but the Appellant on its own certainly could not control when PAKRA left the VAT group. But if one starts with the proposition that the Appellant obviously intended to invoice while PAKRA was in the group there was plenty of time to do so without any artificiality by invoicing on the day on which the last of the conditions were satisfied, or earlier in the next business day than the time of completion.
- We would make the further criticisms of the form PG2:
- In summary, our problem is therefore that in relation to the Business Plan we do not know why Mr Shaw read it in the way he did, and we do not consider that a reasonable officer would have so read it. So far as the Appellant's letter of 21 July 2004 is concerned, again we do not know why Mr Shaw read it in the way he did but in any case the Appellant had explained in his letter of 28 July 2004 why that was a misreading. We have no information about why Mr Shaw thought that invoicing would be earlier than the Contract appeared to allow, but we accept that he could reasonably have thought this. Everything seems to have turned on Mr Shaw's understanding from the Business Plan that invoicing would not be until after FSA approval, coupled with his understanding that the statement about the joint venture proceeding in Mr Devlin's letters meant after the subscription for shares by both parties. Mr Shaw seems to have conflated FSA approval, completion and the subscription for shares and, in the decision letter, starting to trade. The Contract clearly separates obtaining the consents from completion which follows one business day later.
- Customs have no objection to the invoicing of the costs in principle. Their objection is solely that it is contrary to their reading of the Business Plan and Contract. The question for us is whether a reasonable body of Commissioners could conclude that grouping that in principle should be allowed should be refused because it was proposed to invoice the costs at a time that was contrary to the Business Plan and to be earlier than the Contract appeared to allow. If the Business Plan had contained a definite statement that the costs would not be invoiced until after subscription for the shares this might well have been a good point. If the Appellant tells the FSA it will do one thing and tells Customs the opposite, Customs might well object, but we do not know why Mr Shaw read it in this way and we do not consider that a reasonable officer would so read it way particularly as we cannot see any reason why the FSA would be interested in whether the costs were invoiced before or after the subscription for the shares. Customs' reliance on the Contract is less definite and we do not know whether Mr Shaw had read clause 46 but reliance on the Contract and the Appellant's letters both fail to appreciate that it was obviously the Appellant's intention to invoice during grouping. If that were contrary to the Contract that was a problem for the Appellant in its relations with Discovery, not a matter of concern for Customs. There was no reason why Customs should assume that what the Appellant is clearly going to do must be in breach of contract; the opposite would be a more reasonable assumption. Secondly, even if it were in breach of contract, thus giving Discovery a right to object, we cannot see that this is of relevance to determining whether refusal of grouping is necessary for the protection of the revenue.
- We must consider whether the decision to refuse grouping was necessary for the protection of the revenue. The situation we are dealing with is the start-up phase expected to last from the proposed start of grouping of 1 June 2004 until August or September (it was in fact until 13 September 2004). During this period PAKRA was necessarily a 100 per cent subsidiary of the Appellant because Discovery could not invest in it without South African Reserve Bank approval. It was uncertain during this period whether consents from the FSA and the South African Reserve Bank would be forthcoming. It was entirely commercial not to start employing people in PAKRA when the venture might not go ahead. For example, it would have involved taking people out of the Appellant's final salary pension scheme and starting a new PAKRA scheme for a few months and, if the consents were not obtained, putting them back into the Appellant's scheme. The costs involved are salary costs (the third party costs are agreed not to involve any tax saving through grouping). If, as is the approach of Business Brief 15/99, all the group members were one company Customs regard any revenue loss on supplies between them when the recipient was unable to reclaim the input tax, to be a natural result of grouping. That is the case here. The timing of the ending of the grouping depends on circumstances outside the control of the parties: FSA and Reserve Bank of South Africa approval. They could agree to delay the ending of grouping but since the point of the joint venture on which they have spent millions of pounds in start-up costs is to trade and they cannot start trading until subscription for the shares, there is no incentive to delay for any tax reason. We conclude that there is no basis for saying that any tax saving is otherwise than the natural result of grouping.
- However, our jurisdiction is not to substitute our own decision, but to consider whether the Commissioners could not reasonably have been satisfied that there were grounds for refusing the application. The grounds on which they refused it were essentially that the Appellant could in some artificial way influence the timing of the ending of grouping, and was proposing to insert the invoicing into this timing as an artificial step solely to gain a VAT advantage. As explained in the previous paragraph there was nothing artificial in the timing of the ending of grouping. Our conclusion is that Customs could not reasonably have been satisfied that there were grounds for refusing the application, and therefore the refusal of grouping was irrational. In addition it took into account an irrelevant matter, the supposed artificiality of invoicing immediately before the ending of eligibility for grouping contrary to the Business Plan (which did not so provide), the letters from the Appellant (which could not reasonably have been read to so provide), and the Contract (which might indeed be read as so providing but which the parties were free to amend). If we had had a reasoned explanation for Customs' understanding of these documents we might well have concluded that while we did not agree with them they were reasonable conclusions. Without knowing the explanation we have to consider reasonableness in terms of what a reasonable officer would have understood from the documents. What we seriously lacked was a short note in the papers saying what part of the document was relied on to draw a particular conclusion and why it was thought to be material to the question they were deciding.
- Accordingly we allow the appeal. We direct Customs to pay the Appellant's costs of, incidental to, and consequent upon, the appeal to be assessed in default of agreement by a Taxing Master of the Supreme Court of Justice in England and Wales by way of detailed assessment on the standard basis.
- Although it is not necessary to our decision we set out in the Appendix a summary of Customs' decision-making process and some comments on each step, not to be critical of it, which we are, but to point out the difficulty it has caused us in deciding this appeal. As will be seen from the Appendix the reasoning in the form PG2 submitted to Policy for approval of the decision to refuse grouping does not follow from anything that has gone before. Ideas are thrown out (which is as it should be) but are then dropped without any record of the reason why, or perhaps they were followed up but there is no record of it. Nobody was clearly co-ordinating the replies from Mr Shaw and Policy. More importantly, when Mr Adetosoye of Policy asked pertinent questions, such as what was the abuse, all we know is that a meeting took place of which there is no record, immediately following which informal endorsement was given, followed by formal endorsement recording the same reasons as the form PG2. But, as we have seen, the decision letter was stated to be on another basis. Mr Shaw's evidence, which we accepted, was that the decision letter equated starting to trade with ceasing to be eligible for grouping and the appeal was argued on the basis that the reasons given in the PG2 were Customs' reasons. But we could not tell from the papers what led Mr Adetosoye finally to endorse the decision to refuse. The current Manual on grouping at paragraph 58.6, which was not issued until after the time we were considering, states that officers must keep good notes of the entire process, including written records of all the factors that the officer took into consideration when making the decision, and details of the reasons for exercising the powers. If this guidance had been applicable at the time we would not have considered that there was a clear audit trail in this case. Such a trail should enable us to see the process from the beginning to the end, including why ideas were dropped, why conclusions were drawn from documents, and particularly including notes of the important meeting at which the final decision was taken and the precise abuse that the meeting concluded was present. Had the writer of the decision letter had such a document in front of them it would be easy for him to set out in the decision letter, which is the only document normally seen by the taxpayer, the precise reason for the decision.
- 3 June 2004. Linda O'Sullivan (a National Business Manager responsible for co-ordinating and managing the contact between Customs and the Appellant) receives the application and emails it to Mr Simon Shaw (a Customs' anti-avoidance adviser) saying that "it looks at bit odd to us." Although Mr Hitchmough criticised the lack of explanation (which Miss O'Sullivan told us was primarily the short-term duration of the grouping and the large amount to be invoiced), we consider that at this early stage it was quite reasonable to seek Mr Shaw's views without identifying the oddity, and Mr Shaw considered it quite normal. Mr Shaw worked from an office in Cheadle but was often in London where Miss O'Sullivan is based.
- 4 June 2004. Mr Shaw replies by email initially considering that any tax saving may be the normal consequences of grouping but including the statement "if they are seeking to invoice a higher proportion of the costs in that period [when in the group] I would be minded to think that would be unacceptable…." and suggesting that Miss O'Sullivan obtain a copy of the business plan. He has identified a good point about the possibility of invoicing while in the group costs that relate to period after the grouping ends, which he rightly pursued.
- 7 June 2004. Mr Shaw and Miss O'Sullivan agree a letter to the Appellant asking eight questions including asking for copies of the contracts and business plan and asking, relevantly to the problem that Mr Shaw had identified: "what proportion of the new venture set up costs will be incurred whilst it is eligible for VAT grouping as part of the PAC VAT group?"
- 17 June 2004. Mr Devlin (Senior Tax Manager of the Appellant) replies sending the agreements but declining to send the business plan on the grounds of its extreme confidentiality. The services are described as HR, IT consulting, legal and compliance, finance, tax, internal audit etc. In reply to the question quoted above he says: "Current estimates are that PAKRA's total setup costs will be in the region of £30m to £35m. As indicated in my letter of 27 May, current expectations are that Prudential would incur [our italics] in the region of £13m costs (£6m third party and £7m internal) prior to PAKRA becoming a 50-50 joint venture." Since the letter of 27 May 2004 accompanying the application for grouping stated that these figures will be invoiced while eligible for grouping Customs now know that there is no proposal to invoice in advance of their being incurred.
- 2 July 2004. Mr Laney (tax technician working in the same room as Miss O'Sullivan) after considering all the contracts prepares a four page note summarising the position, saying that it does not appear to be an aggressive attack on the revenue, but that the case is not clear cut. Suggested options were accepting grouping, liaise with policy, or conducting further investigations. We would describe this as an excellent note which identifies the parts of the contracts that he considers relevant and states the reasons for his proposals. Unfortunately something that perhaps contributed to later misunderstandings is that it merely states that Discovery's investment is expected in August or September 2004 without stating what was the impediment to its investing earlier. So far as timing of the invoicing is concerned the note clearly states that invoicing will take place while PAKRA is in the group. The note also refers separately to further "supplies made by the PAC after the start of the JV."
- 5 July 2004. Miss O'Sullivan emails Mr Laney's note to Mr Kershaw (policy dealing with taxable persons) (with a copy to Mr Shaw and Mr Laney) for his initial thoughts stating that Mr Shaw has been consulted and is of the view that this is tax avoidance and that she agreed with him. In evidence to us Mr Shaw agreed that he could not at that stage know whether it was avoidance. However, Miss O'Sullivan thought that Mr Shaw did consider it to be avoidance. This is unhelpful. Policy are being sent Mr Laney's note but unidentified avoidance is referred to in the email which is contrary to the balanced tone of the note. If Mr Shaw had identified a different problem from the one in his email of 4 June 2004 we do not know what it was.
- 6 July 2004. Mr Kershaw emails a reply asking whether the Appellant is trying to disguise what is really a joint venture as something else during these first few months and suggesting further study of the contracts. He concludes that if that is not the case, he did not think that Customs could use their revenue protection powers as any saving was a normal consequence of grouping. He then adds a note to Mr Shaw saying "…is this a contrived structure to save VAT costs which we should be challenging rather than a normal commercial procedure for setting up a JV?" One would expect Mr Laney who had read the documents in detail to have commented on the genuineness of the joint venture, which would be apparent from the Contract. Although Mr Kershaw has requested further study of the Contract there is no evidence of whether this was done, or what was the result if it was.
- 7 July 2004. Mr Shaw emails all parties saying that he has a gut feel that the delayed creation of the joint venture is structured so as to gain a VAT advantage. Although Mr Hitchmough criticised the use of gut feelings we would not wish to say anything to discourage this; it may be a good indicator for an experienced anti-avoidance officer to use. But it must be the start of the analysis. Mr Shaw then lists some considerations and concludes "In short, unless the bus plan etc is very convincing (and I think we should ask Pru directly for an explanation of the unusual timings in this situation if needs be) my gut feel is we will still need to mount an argument to refuse grouping even if the JV is not yet a JV!" This last phrase is in complete contrast to Mr Kershaw's email and we are left without knowing why Mr Shaw thinks that grouping should be refused even though there is a good reason for the delayed start of the joint venture. Although he suggests that the Appellant should be asked directly for an explanation of "the unusual timings" if needs be, this was never done. Mr Laney must have known from the Contract that there were no unusual timings (the timing was dependent on FSA and South African Reserve Bank approvals) but so far as we know he never comments. At this point we see things going wrong, we infer because information about the Contract is in Mr Laney's hands not Mr Shaw's. Some information is available to officers generally through the electronic folder, but the Contract was not on it as it was lengthy (and nor was the Business Plan because of its confidentiality, but Mr Shaw had an email copy). Miss O'Sullivan told us (and we accept) that Mr Shaw could take extracts from the Contract but she did not know if he did.
- 7 July 2004 Mr Laney drafts a letter to the Appellant which is approved by Mr Shaw and sent to the Appellant. This asks whether PAKRA was incorporated with the intent of using it for the joint venture, whether any of the conditions in the Contract have been satisfied, and:
- Next the Appellant is persuaded to provide the Business Plan which Miss O'Sullivan emails to Mr Shaw at 10:04 on 12 July 2004. At 10:41 he replies by email:
- "To what extent are the set up costs in 3.1.1 (see table) of £18.7m going to be incurred whilst a member of the VAT group.
- 3.2 (page 34) explains how costs will be recharged to PAKRA once FSA approval is received. Has this been received yet? If not when is it expected? The explanation reads to me as though both parties are (initially) funding their own development costs and then recharging these once FSA approval is given. This sounds that any other costs are proper to PAKRA and should not be 'pre-invoiced' by Pru whilst PAKRA is VAT grouped with it. Will be interesting to reconcile that with the costs that Kieran has said they intend to invoice—surely no costs should be invoiced until FSA approval is granted?
- Page 39 sets out the directors of PAKRA. Funny how those that work for Discovery don't seem to have been made directors yet? I'm sure the fact that this could take 'control' away from Pru (for VAT group purposes, though of course they still appear to be the only shareholder) is merely coincidental.
- On 21 July 2004 Mr Devlin replies to the questions in the letter of 9 July 2004, saying that PAKRA was incorporated for the joint venture, that none of the conditions have been satisfied and, in relation to timing:
- 26 July 2004. Mr Shaw emails Miss O'Sullivan saying that he is confused by the reply "that PAKRA would not be invoiced by Pru until actually a JV, with the VAT group application that suggests 'pre-invoicing'." "Pre-invoicing" now seems to mean invoicing in advance of what he understands to be the proper time, rather than, as in Appendix paragraph 10, in advance of the costs being incurred. He is therefore reading the phrase "should the joint venture proceed" as meaning after the joint venture takes effect, which he has previously equated to being after FSA approval (Appendix paragraph 10). While we see the logic of a joint venture existing only when there were two parties to it, it is obvious that what Mr Devlin means is that invoicing must be before the joint venture is finalised otherwise there would be no reason for the grouping application.
- 26 July 2004. Mr Laney drafts a further letter to the Appellant which Mr Shaw approves asking for an explanation about what Mr Shaw saw as the apparent conflict between the application letter saying that £13m will be invoiced while PAKRA is in the group, and the 21 July letter.
- 28 July 2004. Mr Devlin replies saying that both statements are correct and that:
- 4 August 2004. Mr Shaw finalises the submission to Policy on form PG2, see the extracts quoted in paragraph 10(4) of our Decision, which Miss O'Sullivan forwards to Mr Adetosoye (Mr Kershaw's boss, Mr Kershaw being on leave) in Policy. The endorsement of Policy is required for refusing grouping. We have no means of knowing the source of the statement under the heading Details/Background that the Appellant can control when PAKRA leaves the group as there has been no previous reference to this. The next bullet makes the point that the Business Plan and the Appellant's letter of 21 July 2004 "clearly set out" that it will not recharge the costs until Discovery has subscribed for shares. There is no record of why he now considered the Business Plan clearly to say this; he had previously, correctly, understood that costs would be invoiced after FSA approval. The continued reference to the letter of 21 July 2004 is surprising as Mr Devlin had already explained in his 28 July 2004 letter that this understanding of the 21 July 2004 letter was wrong. The letter of 28 July 2004 is attached to the form PG2 but is not referred to in it.
- Under the heading Recommendations in the form PG2, the same statement is made about the Business Plan (but here there is no reference to either of the letters) and the conclusion is drawn that this pre-invoicing leads to a revenue loss, and is an artificial step inserted solely to gain a tax advantage by invoicing earlier than the Contract appears to allow. Here, as in Appendix paragraph 12, Mr Shaw's use of the expression "pre-invoicing" has changed its meaning from invoicing in advance of the time to which the costs relate, which was the meaning in his email of 12 July 2004 (Appendix, paragraph 10), to invoicing in advance of the date that (he considers) the Business Plan and Contract states. The problem that this gives us is that if this reliance is being placed on the Business Plan the only previous statement about the Business Plan is Mr Shaw's email of 12 July 2004 where he is clearly referring to the different possibility of invoicing while PAKRA is in the group costs relating to a period after the ceasing of grouping. The point about invoicing in advance of the costs being incurred has gone away without any evidence about why, and has changed to a concern about invoicing in advance of the time said to be stated in the Business Plan about which we have no previous reference, other than that invoicing will be after FSA approval. This conclusion about the Business Plan is critical to the refusal but we have no knowledge of what led Mr Shaw to his conclusion, which is different from his stated conclusion at the time that invoicing will be after FSA approval. This conclusion is stated to be supported by what the Contract "appears to allow" but we have had no previous reference to this. We know from Miss O'Sullivan that she revisited the Contract when preparing the PG2 but we do not know what led her or Mr Shaw to their conclusions about the Contract. In other words, the reasoning in the form PG2 is entirely new and not supported by anything of which we have an earlier record. How the reasoning was arrived at (and equally why all previous objections have gone away) we simply do not know, which is the reason why in our decision we are forced to start with the form PG2.
- 5 August 2004 at 12:03. Mr Adetosoye emails back saying:
- What is the exact nature of the supply? Do we mean supply of staff?
- Are there presently any disregarded supplies between Prudential Assurance and PAKRA?
- Are there any commercial reasons for the pre-invoicing?
- We need to be clear on the abuse, and on 1st reading of the submission, our view is that direction under schedule 9A may be more appropriate because of exit nature of the scheme."
- 5 August 2004. Mr Adetosoye and his head of department Mr Warr have a meeting with Mr Shaw that day at which Mr Shaw persuades him that the reference to Schedule 9A is misconceived. At 16:30 Mr Adetosoye emails his interim response endorsing the recommendation to refuse grouping saying "The reply will have to highlight in clear terms the nature of the abuse and why we think that this goes beyond the normal consequences of VAT grouping." He mentions that he is there the following day but on leave the following week. Mr Dann is asked to draft the formal response. There is no note of the meeting but it is described by Customs' Solicitor's Office in correspondence as a short meeting at which the PG1 [which, it is understood, should be PG2] form was used as the basis for the discussions. Mr Adetosoye had previously made the good point that he was unclear about the nature of the abuse but we do not therefore know why he was persuaded that the abuse is that stated in the PG2, which is the basis for the formal refusal, see Appendix paragraph 20.
- 9 August 2004. Miss O'Sullivan and Mr Shaw email Mr Warr (knowing that Mr Adetosoye is on leave) a draft decision letter.
- 17 August 2004. Mr Philip Dann of Policy issues the formal written endorsement of the refusal to Miss O'Sullivan. This follows the reasoning in form PG2, adding
- 17 August 2004. Miss O'Sullivan, having found that Mr Warr was also on leave, chases Mr Adetosoye who has returned from leave. On the same day he emails that with a very minor amendment he is content with the draft. One would expect him to have said that the draft did not comply with what he said above (Appendix, paragraph 18) about highlighting in clear terms the nature of the abuse, but he did not.
- 19 August 2004. The decision letter is sent stating that because the Appellant has stated that the supplies will be invoiced while PAKRA is in the group notwithstanding that PAKRA will not trade until it has left the group, this leads to a revenue loss going beyond the normal consequences of grouping. Apart from being asked a total of 12 questions in three letters this is the first time the Appellant is told of what Customs are concerned about. They are told that invoicing before the date of start of trading is objectionable, which makes no sense at all, and is far from highlighting in clear terms the nature of the abuse and why this goes beyond the normal consequences of VAT grouping, that Mr Adetosoye asked for. The only explanation that ties this letter in with the form PG2 seems to be that the draftsman (presumably Mr Shaw) was using starting to trade as equivalent to the subscription by Discovery for its shares which is similar to his conclusion that the reference in the Appellant's letters to the joint venture proceeding meant the subscription for the shares, and is reminiscent of the author of the Business Plan using time of authorisation and launch as equivalent. Mr Shaw's evidence was that the letter meant that invoicing took place earlier than the time when it should have done, in which case the reason for refusal in the decision letter is to be understood as being the same as that in the form PG2 and the formal endorsement of refusal of 17 August 2004. It is unsatisfactory that one needs evidence of witnesses to understand the meaning of the decision letter.
19607
GROUPING – whether refusal of application for grouping of wholly-owned subsidiary intended to become 50% owned on grant of regulatory consents was reasonable – no – appeal allowed
LONDON TRIBUNAL CENTRE
PRUDENTIAL ASSURANCE COMPANY LIMITED Appellant
- and -
THE COMMISSIONERS FOR HER MAJESTY'S
REVENUE AND CUSTOMS Respondents
Tribunal: DR JOHN F AVERY JONES CBE (Chairman)
CYRIL SHAW FCA
Sitting in public in London on 8 to 10 May 2006
Andrew Hitchmough and James Rivett, counsel, instructed by PricewaterhouseCoopers LLP for the Appellant
Rebecca Haynes, counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents
© CROWN COPYRIGHT 2006
DECISION
"The Commissioners may refuse an application, within the period of 90 days starting with the day on which it was received by them, if it appears to them—…
(c) in any case, that refusal of the application is necessary for the protection of the revenue."
(4A) Where an appeal is brought against the refusal of an application such as is mentioned in section 43B(1) or (2) on the grounds stated in section 43B(5)(c)—
(a) the tribunal shall not allow the appeal unless it considers that the Commissioners could not reasonably have been satisfied that there were grounds for refusing the application,
(b) the refusal shall have effect pending the determination of the appeal, and
(c) if the appeal is allowed, the refusal shall be deemed not to have occurred.
"It seems to me that the 'statutory condition' (as Mr Richards termed it) which the tribunal has to examine in an appeal under s 40(1)(n) is whether it appeared to the commissioners requisite to require security. In examining whether that statutory condition is satisfied the tribunal will, to adopt the language of Lord Lane, consider whether the commissioners had acted in a way in which no reasonable panel of commissioners could have acted or whether they had taken into account some irrelevant matter or had disregarded something to which they should have given weight. The tribunal may also have to consider whether the commissioners have erred on a point of law. I am quite satisfied, however, that the tribunal cannot exercise a fresh discretion on the lines indicated by Lord Diplock in Hadmor. The protection of the revenue is not a responsibility of the tribunal or of a court."
Miss Haynes also referred us to the statement by Griffiths LJ in R v Chief Registrar of Friendly Societies ex p. New Cross Society [1984] QB 227, 260 that one should take a broad view of the decision and not allow ourselves to be bogged down in minutiae:
"In a decision involving the weighing of many complex factors it will always be possible to point to some factors which should arguably have been taken into account or left out of account; even if they should have been, the court should not intervene unless it is convinced that this would have resulted in the decision going the other way."
The same point was made by Sir John Donaldson MR in R v Social Services Secretary ex p. Wellcome Foundation Ltd [1987] 1 WLR 1166, 1175.
"72.
In our judgment the protection in question under section 43(5A) may be against any loss of revenue which is not de minimis whether or not it follows from the normal operation of grouping. It certainly covers an artificial avoidance scheme but it also covers a straight forward case which would not be characterised as avoidance or as abusive, to use Mr Cordara's adjective.
…
While the considerations in respect of grouping are not the same as those in respect of requirements for security, we consider that the principle is the same and that before exercising their powers Commissioners must in law consider more than whether there is a risk or likelihood of loss of revenue. Put another way, the prerequisite for refusal of the application is that the Commissioners must consider refusal to be "necessary" for the protection of the revenue and that on appeal the Tribunal must consider whether in forming their view that refusal was necessary the Commissioners acted unreasonably, took into account some irrelevant matter or disregarded something to which they should have given weight, see John Dee at page 952g."
The Tribunal in Xansa Barclaycard Partnership Ltd v Customs and Excise Commissioners (2004) VAT Decision 18780 took a slightly different approach:
"44. Turning specifically to the application of the approach in the National Westminster Bank case to section 43C, we do not consider that the power in section 43C(1) and (2) is limited to "schemes that abuse grouping" although it clearly does encompass artificial avoidance schemes. But we feel that the phrase used by the tribunal in paragraph 72 that "it also covers a straightforward case which would not be characterised as avoidance or as abusive" if read without more and in isolation from its context in the decision, is open to interpretations that do not reflect fully the need for the proper balance of factors relevant to the section 43C power parallel to that stated by the tribunal in paragraph 74. Without seeking to lay down a general rule, we consider that the somewhat narrower approach adopted by the Commissioners, as explained by Mr Warr in evidence to us, expresses the width of the section as we see it. Mr Warr adopted the phrase that the revenue loss went "beyond the normal consequences of grouping". This is the wording used by the Commissioners in the formal direction issued on 16 April 2003 (set out at paragraph 3 above). We do not seek in this decision either to criticise the Commissioners' precise wording as if it were part of section 43C, or ourselves to adopt such wording. But there must, in our view, be something present other than a completely "straightforward" application of the rules before the Commissioners can act to protect the revenue under that section. In the specific context of degrouping under section 43C we would consider that a case that is entirely "straightforward" yet presents a perceived need to protect the revenue is one for legislative rather than executive intervention. For this reason, we do not consider that the wording used by the Commissioners in the formal direction on this point is either wrong in law or inappropriate."
"In future, we will not normally use our revenue protection powers when we consider that the revenue loss follows from the normal operation of grouping. By this, we mean the "revenue loss" which occurs because VAT is eliminated on the value added by a group member, when a supply takes place between two group members. This includes the loss arising from supplies between group members being disregarded, where the recipient of the supply would not normally be able to deduct that VAT because it makes exempt supplies. We would normally consider such revenue loss, the same as if the VAT group members were all one company, to be a natural result of grouping.
Where we consider that there seems likely to be a revenue loss that goes beyond the accepted result of grouping, we will feel entitled to use our revenue protection powers. When deciding in any particular case whether to refuse a VAT group application, or to expel a company from a VAT group, we will bear in mind the decision in National Westminster Bank. Paragraph 74 of that decision says—
"the phrase 'necessary for the protection of the revenue' must be considered as a totality and involves a balancing exercise in which the Commissioners must weigh the effect on the Appellant of refusal of grouping against the loss of revenue likely to result from grouping".
Weighing the likely revenue loss against the administrative cost of using our powers
When considering whether or not to use our revenue protection powers, we will aim to follow this approach. If we have concerns that the revenue loss does go beyond the accepted consequence of VAT grouping, we will ask for relevant information about the administrative savings that grouping brings in the particular circumstances, and an estimate of the revenue impact of grouping. We will normally ask you to comment on the impact on your business of any refusal or removal on our part. For example, you may incur extra costs in having to submit an extra VAT return, or in having to account for VAT on supplies between group members. The extent of these costs will depend on how your accounting systems are set up.
We will weigh any likely abnormal revenue loss against the administrative cost to you of our refusal or removal. When that revenue cost significantly outweighs the administrative cost we will consider invoking our powers."
(1) The Appellant is a wholly owned subsidiary of Prudential plc and is the representative member of the Prudential UK VAT group, registered for VAT under VAT registration 235 3237 81. The Appellant is a United Kingdom based company and is an established provider of insurance products in the United Kingdom.
(2) Discovery Holdings Limited is a South African company, with company registration number 1999/007789/06, that provides, inter alia, health insurance in South Africa.
(3) The Appellant and Discovery are not connected persons.
(4) The Appellant and Discovery entered into discussions about a joint venture to carry on a health insurance business in the UK that would utilise the knowledge and expertise of Discovery in this market sector together with the strength of the Prudential's brand and infrastructure. Discovery Holdings Limited, Discovery Insurance Intermediary Services Limited and Discovery Offshore Holdings Limited entered into an exclusivity letter with the Appellant concerning the negotiations which prevented the parties from negotiating with commercial competitors.
(5) Ultimately, the Appellant and Discovery formed an agreement to proceed with the venture by way of a joint venture company. PAKRA, a newly formed off-the-shelf company, was incorporated on 20 February 2004 in anticipation of a Shareholders Agreement entered into on 1 March 2004. The Shareholders Agreement, entered into by the Appellant, Discovery and PAKRA set out the terms upon which the joint venture was to be formed and operated.
(6) On 1 March 2004 the following agreements were entered into in addition to the Shareholders Agreement:
(a) Interim Services Agreement between (1) the Appellant and (2) PAKRA;
(b) Interim Services Agreement between (1) Discovery Holdings Limited ("DHL") and (2) PAKRA;
(c) Discovery Insurance Intermediary Agreement between (1) Discovery Insurance Intermediary Services Limited and (2) PAKRA;
(d) Deed of Guarantee and Indemnity between (1) PAKRA, (2) the Appellant and (3) DHL; and
(e) Consortium Relief Agreement between (1) the Appellant, (2) Discovery Offshore Holdings Limited and (3) PAKRA.
Regulatory requirements
(7) Under South African law, Discovery was required to obtain regulatory approval from the South African Reserve Bank before it could invest in the joint venture as the joint venture was incorporated outside of South Africa. Until such time as regulatory approval was obtained Discovery could not acquire shares in the proposed joint venture vehicle.
(8) Before the joint venture vehicle could commence trading it would, as a provider of insurance products, require authorisation from the FSA in the United Kingdom. Approval from the FSA was therefore critical to the joint venture being able to trade.
(9) Before Prudential and Discovery could proceed with the planned joint venture it was therefore necessary that approvals were held from both the South African Reserve Bank and the FSA.
The establishment of PAKRA
(10) At incorporation the authorised share capital of PAKRA was £1,000 divided into 500 A Ordinary Shares of £1 each and 500 B Ordinary Shares of £1 each. At the time of incorporation one A share was issued to the Appellant so that PAKRA was initially 100% owned by the Appellant.
(11) Article 5 of the Articles of Association of PAKRA provides that the issued shares of PAKRA should always consist of an equal proportion of A and B shares. The joint venture company had to be formed prior to an application being made to the Financial Services Authority. However, Discovery's ability to invest in PAKRA was restricted prior to gaining approval from the South African Reserve Bank. At this time Discovery had not received regulatory clearance from the South African Reserve Bank and could not yet therefore acquire shares. For this reason, and due to the gaining of regulatory approval being a pre-condition to the Shareholders Agreement dated 1 March 2004, the parties consented to the departure from the strict terms of the Articles of Association.
(12) Interim approval from the South African Reserve Bank was received on 6 May 2004, however this approval was only valid for three months. As this three month period expired on 6 August 2004, prior to approval having been given by the UK FSA, an extension of this approval had to be sought by Discovery. The South African Reserve Bank extended the approval on 6th September 2004.
(13) On 6 August 2004 the FSA verbally notified that it was 'minded to approve' the regulatory clearance. The 'minded to approve' was subject to certain conditions that would only be fulfilled on completion day and therefore the actual FSA approval would only be given after completion.
(14) On 6 September 2004, approval had been obtained from the South African Reserve Bank and the minded to approve notification had been received from the FSA. Completion could therefore take place under the Shareholders Agreement.
(15) The initial approval issued by the FSA was in the name of PAKRA Limited. However, following the change of name, approval was required in the name of Prudential Health Limited. The final approval was therefore eventually received on 17 September 2004.
(16) On 13 September 2004, the necessary clearances having then been received, the authorised share capital of PAKRA was increased and 150,000 A shares were issued to the Appellant and 150,001 shares were issued to Discovery. At this point PAKRA became a 50:50 joint venture and ceased to be 100% owned by Appellant.
(17) PAKRA subsequently commenced trading on 3 October 2004 as Prudential Health Limited.
Costs of establishing PAKRA
(18) The costs of establishing PAKRA were in the main the responsibility of the Appellant. All of the work required to set up the joint venture was provided by the Appellant with the Appellant incurring these set-up costs up to the point the joint venture was established at 13 September 2004.
(19) The set-up costs incurred by the Appellant related to the recruitment of employees to undertake the set-up of the joint venture with these employees to be transferred from the Appellant's payroll to the joint venture company on the establishment of the new business. In addition, the Appellant provided its existing employees to administer finance systems, accounts payable, human resource systems and information technology support for the new business and also engaged legal experts and consultants to assist in the establishment of the joint venture.
(20) This approach to establishing new businesses by utilising the systems and business support from within the Prudential was, and is, normal practice within the Appellant's group. It is also the normal practice of the Appellant to continue to provide business units with the support of central systems and administration and to VAT group those businesses, so that VAT is not chargeable on the recharge of such costs. Customs have historically accepted such applications for VAT grouping.
(21) The primary responsibility for the set up costs lay with the Appellant. Discovery recharged approximately £1,630,017 of costs to PAKRA on 9 September 2004 and subsequently £145,728 on 10 November 2004.
(22) The amounts invoiced by the Appellant to PAKRA for the set up costs of the joint venture were as follows:
(a) invoice 00424 dated 10 September 2004 in the sum of £2,661,048.17 plus VAT in respect of services provided up to the end of August 2004;
(b) invoice 00425 dated 10 September 2004 in the sum of £614,389.17 plus VAT in respect of services provided during September 2004.
(23) Of the amounts invoiced £1,211,397.96 related to external costs and £2,039,039.98 related to internal costs plus a disbursement of £25,000 in respect of a FSA licence application fee. The VAT charged on these costs was recovered by the Appellant in full in its VAT return for the period 09/04.
Application for VAT group registration
(24) On 27 May 2004 the Appellant made an application to the Respondents for PAKRA to be included in the Prudential VAT group. It was stated in the application that PAKRA did not expect to make any supplies whilst it was a member of the VAT group. The Appellant also stated in the application that, as was the case at the time, it was estimated that the Appellant would invoice PAKRA in the region of £13m for set up costs of the joint venture. Approximately £6m of this amount was expected to relate to external costs and £7m to internal costs.
(25) On 3 June 2004, following receipt of the VAT grouping application, Miss Linda O'Sullivan of the Respondents, requested advice from Mr Simon Shaw in the Policy Business Services Taxes Team at the Respondents in relation to the Appellant's application.
(26) On 4 June 2004 Mr Shaw responded advising Miss O'Sullivan to request a copy of PAKRA's business plan. Mr Shaw also suggested that PAKRA's application may need to be considered in terms of tax avoidance.
(27) On 7 June 2004 the Commissioners requested a copy of PAKRA's business plan and any agreements or contracts entered into between the parties in relation to the joint venture.
(28) On 17 June 2004 the following agreements were provided to the Commissioners: Interim Services Agreements; Brand Licence and Distribution Agreement; Discovery Insurance Intermediary Agreement; Deed of Guarantee and Indemnity; Consortium Relief Agreement; and Shareholders Agreement. For reasons of confidentiality the PAKRA business plan was not provided to the Commissioners at this time.
(29) On 5 July 2004 Miss O'Sullivan sent an email to Mr Peter Kershaw of the Taxable Persons & Input Tax Team at the Commissioners seeking his advice as to whether tax avoidance was a relevant consideration in relation to the Appellant's application.
(30) Mr Kershaw responded on 6 July 2004 stating that if, on consideration of the agreements, it was determined that PAKRA was eligible to join the Prudential VAT group, then "we do not think that we could argue that we could use our revenue protection powers where a trader joins a group registration in order to benefit form the group's in-house expertise – we are inclined to view this type of situation as being a normal consequence of grouping."
(31) On 7 July 2004 Mr Shaw sent an email to Mr Kershaw stating "I agree with your thoughts re the JV. My own gut feel is that the delayed creation of the JV is structured as such so as to gain a VAT advantage".
(32) On 9 July 2004 the Respondents replied to the Appellant's letter of 17 June 2004 addressing the Appellant's concerns about providing the Commissioners with a copy of PAKRA's business plan and raising various queries in relation to the establishment of the joint venture.
(33) The Business Plan for PAKRA was subsequently sent to the Commissioners on 12 July 2004.
(34) Following further correspondence between the parties, on 4 August 2004 Ms O'Sullivan sent an email to Mr Ade Adetosoye, a colleague of Mr Kershaw, in relation to the Appellant's application. Mr Adetosoye and Mr Phillip Dann from the Taxable Persons & Input Tax Team at the Respondents sent subsequent correspondence to Miss O'Sullivan culminating in a letter of recommendation from Mr Dann advising that "the application to include PAKRA within the PAC VAT group should be refused on the grounds that it is part of a contrived process to avoid a substantial VAT cost". Mr Dann concluded that "we agree that the scheme appears to have been contrived in order to avoid VAT. It would result in a revenue loss which goes beyond the accepted consequences of VAT grouping. We therefore endorse your decision to refuse PAKRA to be admitted to the PAC VAT group pursuant to the provisions of Section 43B (5) (c) VAT Act 1994. Please advise PAC accordingly."
(35) On 19 August 2004 the Commissioners sent a letter to the Appellant entitled "Notice of refusal to admit PAKRA into the Prudential VAT group for the protection of revenue" which concluded that the inclusion of PAKRA within the Appellant's VAT group would lead to a revenue loss that goes beyond the normal consequences of VAT grouping.
(36) On 15 September 2004 the Appellant sought a local reconsideration of the Respondents' refusal to allow VAT grouping. In this letter the Appellant advised the Respondents that the amounts actually charged by Prudential to PAKRA were significantly lower than those communicated to the Respondents in the Appellant's application dated 27 May 2004.
(37) On 15 September 2004 the Appellant sent a further letter addressed to the Respondents advising that on 13 September 2004 the share capital structure of PAKRA was changed through the issue of shares to the Appellant and Discovery (see paragraph 9(16) above). The Appellant made an application to exclude PAKRA from the Prudential VAT group and submitted an application for the standalone registration of PAKRA.
(38) Following further correspondence between the parties, on 17 December 2004 the Respondents advised that the application for VAT grouping had been refused on the grounds of 'protection of the revenue' under section 43B(5)(c) Value Added Tax Act 1994. The Commissioners stated that the loss of VAT on both the original and revised amounts to be charged to PAKRA by the Appellant that were provided to the Respondents constitute a significant loss to the revenue.
(1) The Regulatory Business Plan submitted to the FSA (date unknown) was sent to Customs on 12 July 2004. It contains a list of estimated implementation and pre-launch costs estimated to be incurred in 2004 totalling £18.7m. It then states:
"Both parties are funding their own internal development costs up to the point of launch. Once FSA approval has been received both parties will transfer these costs into PAKRA creating a liability within PAKRA. At this point in time both partners will transfer into PAKRA the necessary capital required to cover not only the regulatory/statutory requirements but also sufficient capital to cover the payment of these liabilities to each shareholder."
This following by a balance sheet at the date of authorisation showing the cash contributed as share capital less this liability of £18.7m balanced by share capital of £30m and a loss of £18.7m.
(2) The Contract between the Appellant and Discovery runs to 103 pages and is conditional on FSA and South African Reserve Bank approvals (plus six other matters which were under the control of the parties). Certain clauses, including clause 46 dealing with costs (see below) were excluded from the conditionality of the remained of the Contract. The Completion Date was defined as the first business day after the satisfaction (or waiver) of the last of the conditions (or such other date as is agreed between the parties).
(3) Clause 46(2) dealt with One-off Costs (defined as costs incurred after the date of the Contract in connection with the establishment of PAKRA and the carrying on of its business, not being costs dealt with under another agreement) as follows:
"At a time and in the manner to be agreed between the parties in accordance with clause 6.1 (Requirement for approval), the Company [PAKRA] shall reimburse each of Prudential and Discovery for all One-off Costs which have been approved by the Executive Committee (such approval shall include a vote in favour by at least one member appointed by Prudential and one member appointed by Discovery."
The provisions relating to the appointment of the Executive Committee and the method of approval under clause 6.1 were subject to the conditions to which the Contract was subject. Mr Devlin told us (and we accept) that there was an Executive Committee operating from the beginning. At least in some instances, for example the application for grouping, which required the consent of both parties under clause 6.1, that clause was also being operated before completion because we saw a note of 13 May 2006 that "At the ExCo meeting on 6th May 2004, it was agreed in principle that PAKRA would become a member of the Prudential VAT group up to the point of investment by Discovery." What actually happened in relation to the costs was that in late August or early September 2004 the finance directors of the two parties exchanged emails agreeing the figures and they were then invoiced.
(4) The submission to Policy for approval of the decision to refuse grouping was made on form PG2 [Policy Group] on 4 August 2004. This included the following:
"Details/Background
• The joint venture agreement provides that, effectively, Discovery will subscribe for shares in PAKRA once certain pre-agreed conditions have been met. Effectively this enables Prudential to control when PAKRA moves from wholly owned to 50% owned and hence when it will become ineligible for VAT grouping.
• Both the Business Plan and Prudential's letter of 21/07/2004 clearly set out that the two parties will incur set up costs in relation to the proposed PAKRA activities and will not re-charge these to PAKRA until Discovery has subscribed for shares and the joint venture is up and running. Thus we would not expect PAKRA to incur any costs until the point where it is not eligible to be VAT grouped.
[The letter referred to in reply to a letter of 9 July 2004 from Customs asking "Would you also please explain why PAKRA is to incur set up costs in advance of the joint venture partner subscribing for shares and how AAKRA is funded in order to pay these costs" states: "Should the joint venture proceed, then the two parties will charge the startup costs they have incurred to PAKRA which will be funded by share capital injected by the two parties…" In addition a further letter dated 28 July 2004 was one of the attachments. This stated: "In the more likely event that the joint venture proceeds, both Prudential and Discovery will charge the set up costs they have incurred to PAKRA. Prudential and Discovery's preference would be for Prudential to charge their internal staff costs to PAKRA whilst it is still a 100% subsidiary and a member of Prudential's VAT group so that this could be done without crystallising a VAT charge."]
• Notwithstanding the above point, Prudential have made clear to us that they wish to invoice £13m to PAKRA whilst it is within the Prudential VAT group, so as to avoid manufacturing VAT on staff costs etc. Of this £13m we understand from the Prudential that £6m will be in respect of third party costs. The VAT on this £6m will fall as a cost either to Prudential or PAKRA depending on when it was invoiced. Thus the real revenue loss would be the VAT on £7m.
• Given that the plans for PAKRA make no provision for this charge until after PAKRA would be ineligible to VAT group, I see the invoicing arrangements as a contrived state of affairs engineered to gain PAKRA an unacceptable VAT advantage.
…
Recommendations/conclusions/views
…. The Business Plan sets out that neither party will pass on any set up costs effectively prior to PAKRA becoming in-eligible to be a member of the Prudential VAT group. Notwithstanding that, Prudential has informed us it intends to invoice PAKRA prior to this point and whilst PAKRA is a member of its VAT group.
Given this pre-invoicing by the Prudential leads to a revenue loss (the supply would not be liable to VAT by virtue of the intra group disregard) we need to consider whether this revenue loss is a normal consequence of VAT grouping. We do not believe this to be so as we believe that this pre-invoicing is an artificial step inserted solely to gain a VAT advantage (i.e. PAKRA avoids a VAT cost on supplies to it from the Prudential which are invoiced to PAKRA earlier that the agreements between the joint venture partners appear to allow and whilst PAKRA is a member of the Prudential VAT group."
(5) The attachments to the form PG2 were the application for grouping and accompanying letter, extracts from the business plan (Mr Shaw did not know which but Miss O'Sullivan said it was the passage quoted above), the letter of 26 July 2004 to the Appellant and their reply of 28 July 2004. These were attached because Miss O'Sullivan thought that Policy did not at the time have access to the electronic folder containing them (the facility was being rolled-out in stages), but in fact Policy did have access to it. A note is added that they have a further 500 pages of agreements and the business plan but they do not consider that they have a significant bearing on the issue.
(6) Policy gave a formal endorsement of the decision to refuse grouping on 17 August 2004 on the basis that the documents did not provide for invoicing of the costs until after PAKRA was ineligible to be grouped, and so the invoicing arrangement were contrived to gain an unacceptable VAT advantage.
(7) The decision letter dated 19 August 2004 refusing grouping stated that:
"You have confirmed that PAC intends to invoice PAKRA for such supplies whilst PAKRA is within the PAC VAT group, notwithstanding the fact that the agreements you have supplied to us make clear that PAKRA will not trade until, effectively, it is not eligible for inclusion within the PAC VAT group.
On the basis of that information, the Commissioners believe that the inclusion of PAKRA in the PAC VAT group will read to a revenue loss which goes beyond the normal consequences of VAT grouping."
(8) The FSA "minded to grant the application" letter of 6 August 2004 was subject to four conditions, one of which was confirmation from the external auditors that the proposed capital of £30m has been issued and is fully paid up. This caused a conflict with the Contract which was conditional on FSA approval and the subscription of capital could not take place until completion, meaning the date when the conditions were all satisfied (or other agreed date). Necessarily therefore the parties must either have acted on the "minded to grant" letter as if it were the consent (which we consider any reasonable businessman would have done), or perhaps more pedantically waived the consent and completed the Contract, or (which amounts to the same thing) agreed to complete early by agreeing an earlier Completion Date (see paragraph 10(2) above). The terms of the "minded to grant" letter were not known to Customs at the time of the decision letter.
(9) The decision to refuse grouping was reviewed and upheld although after the reviewing officer had asked further questions and had been critical of certain features of the original decision. Since this is an appeal against the original decision we do not deal further with the review.
(1) Customs cannot have been reasonably satisfied that it was necessary for the protection of the revenue to refuse the Appellant's application for grouping.
(2) Customs took into account irrelevant matters:
(a) They considered that the Appellant was engaged in tax avoidance, structuring the joint venture artificially so that for a time PAKRA was a 100 per cent subsidiary
(b) Invoicing at the time was contrary to the Contract.
(3) Customs disregarded matters to which they should have given weight including the increased VAT burden if grouping was not allowed; did not put to the Appellant that they considered that it was motivated by avoidance; failed to take into account the existence of other joint ventures in the Appellant's VAT group; disregarded the Contract; and formed the view that there would be little additional cost associated with refusal but did not put the question to the Appellant (contrary to Business Brief 15/99).
(4) Customs acted in a way no reasonable body of Commissioners should have acted by not setting out in the decision letter the true reason for the refusal; did not keep notes of their decision-making process; did not give proper attention to the documents, put forward only 3 pages of documents to Policy as a result of which Policy could not take a balanced decision; Policy initially took the erroneous view that Schedule 9A was relevant; did not take up the Appellant's offer of a meeting; and did not have sound operational procedures such as keeping notes of meetings.
(1) PAKRA would be ineligible for grouping when it became a 50/50 joint venture with Discovery.
(2) The Business Plan and correspondence indicated that the parties intended to incur set-up costs which would not be recharged to PAKRA until the joint venture was up and running (at which time it was ineligible to be a member of the Appellant's VAT group. The funding of the recharged expenses was to be derived from the share capital injected by the parties.
(3) Notwithstanding that intention the Appellant wished to and did invoice PAKRA for these costs whilst it was in the VAT group (and before FSA approval) so that the set-up costs could be charged "without crystallising a VAT charge" (their letter of 28 July 2004)
(4) Accordingly it appeared that the invoicing arrangements were contrived to gain an unacceptable VAT advantage going beyond the normal consequences of VAT grouping.
Reasons for our decision
"Details/Background
• Both the Business Plan and Prudential's letter of 21/07/2004 clearly set out that the two parties will incur set up costs in relation to the proposed PAKRA activities and will not re-charge these to PAKRA until Discovery has subscribed for shares and the joint venture is up and running. Thus we would not expect PAKRA to incur any costs until the point where it is not eligible to be VAT grouped.
• Notwithstanding the above point, Prudential have made clear to us that they wish to invoice £13m to PAKRA whilst it is within the Prudential VAT group, so as to avoid manufacturing VAT on staff costs etc. Of this £13m we understand from the Prudential that £6m will be in respect of third party costs. The VAT on this £6m will fall as a cost either to Prudential or PAKRA depending on when it was invoiced. Thus the real revenue loss would be the VAT on £7m.
• Given that the plans for PAKRA make no provision for this charge until after PAKRA would be ineligible to VAT group, I see the invoicing arrangements as a contrived state of affairs engineered to gain PAKRA an unacceptable VAT advantage.
Recommendations/conclusions/views
…. The Business Plan sets out that neither party will pass on any set up costs effectively prior to PAKRA becoming in-eligible to be a member of the Prudential VAT group. Notwithstanding that, Prudential has informed us it intends to invoice PAKRA prior to this point and whilst PAKRA is a member of its VAT group.
Given this pre-invoicing by the Prudential leads to a revenue loss (the supply would not be liable to VAT by virtue of the intra group disregard) we need to consider whether this revenue loss is a normal consequence of VAT grouping. We do not believe this to be so as we believe that this pre-invoicing is an artificial step inserted solely to gain a VAT advantage (i.e. PAKRA avoids a VAT cost on supplies to it from the Prudential which are invoiced to PAKRA earlier that the agreements between the joint venture partners appear to allow and whilst PAKRA is a member of the Prudential VAT group."
Essentially the objection is that the proposed invoicing while PAKRA is in the group is contrary to what is "clearly set out" in the Business Plan and the Appellant's letter of 21 July 2004, and is earlier than the Contract "appears to allow."
"At a time and in the manner to be agreed between the parties in accordance with clause 6.1 (Requirement for approval), the Company [PAKRA] shall reimburse each of Prudential and Discovery for all One-off Costs which have been approved by the Executive Committee (such approval shall include a vote in favour by at least one member appointed by Prudential and one member appointed by Discovery."
There is nothing in the papers or the evidence to say how Customs read this clause (if indeed they read it at all). Mr Laney's note states that the costs will be invoiced while PAKRA is in the group, but the source of this remark may be the letter accompanying the application for grouping rather than the Contract. It seems odd that clause 46 was expressly excluded from the conditionality applying to the rest of the Contract, while its operation was made subject to clause 6.1 and to approval by the Executive Committee, both of which were subject to the conditionality of the Contract. It is also the case that, unless the Contract becomes unconditional and the share capital is subscribed, PAKRA would never have any funds with which to pay the costs, in which case there is no apparent need for clause 46(2) to be unconditional. While it was in fact the case that clause 6.1 and the appointment of an Executive Committee were acted on before completion (see paragraph 10(3) above), this was not known to Customs and it would certainly not have been assumed by the draftsmen of the Contract. We are unable to think of any explanation for drafting the Contract in this way but it is a carefully drafted contract and we expect that there is an explanation. The issue with which we are concerned is whether invoicing the costs before completion is in breach of the Contract. A possible interpretation, which Mr Devlin identified when giving evidence, is that reimbursement (meaning payment) of the One-off Costs would be expected to be after completion (one of the events at which was the subscription for shares), but that it said nothing about invoicing. But this does not explain why the clause was not conditional. We certainly do not find that it would have been unreasonable for an officer to have concluded from the terms of the Contract that it did prevent invoicing before completion. However, more importantly we do not consider that the terms of the Contract are material because the parties could vary them and it was clear that, whatever the Contract said, invoicing was always intended to be before completion. Even assuming that such invoicing by the Appellant was in breach of the Contract it is not clear why this should concern Customs. They should be protecting the revenue, not Discovery's interests. (In fact Discovery invoiced its costs on 9 September 2004 and the Appellant on 10 September 2004, prior to completion on 13 September 2004, but this is a matter of hindsight.)
(1) It is internally inconsistent by saying that the contracts do not have a significant bearing on the issue when the terms of the Contract were relied on both for the statements that the Appellant could control the timing of PAKRA ceasing to be eligible for grouping, and the timing of invoicing was earlier than the Contract appears to allow.
(2) Invoicing prior to the supposed time stated in the Business Plan is described in the second quoted paragraph under the heading Recommendations as "pre-invoicing" which in the context must mean invoicing earlier than permitted. In other contexts, notably Appendix paragraph 10 Mr Shaw used the expression to mean invoicing costs in advance of their being incurred.
(3) Such "pre-invoicing" is described under the heading Recommendations as an artificial step inserted solely to gain a VAT advantage without any explanation about why this was artificial. A more reasonable reading was that there was time to invoice between the conditions being satisfied and completion on the next business day.
JOHN F AVERY JONES
CHAIRMAN
RELEASE DATE: 1 June 2006
LON/04/2392
APPENDIX
Summary of Customs' decision-making process
"Would you also please explain why PAKRA is to incur 'set up costs' in advance of the joint venture partner subscribing for shares and how PAKRA is funded in order to pay these costs. Please also explain what protection (if any) Prudential has from the risk that PAKRA may incur such costs and the he joint venture partner does not invest in the venture."
This is an odd question since they know from the application letter that the Appellant and Discovery, rather than PAKRA, are incurring the set-up costs.
…
I would have liked to have seen some cashflow forecasts for the first year of operation (to see if the costs Kieran has told us about are being incurred earlier than planned), as that would help our case. However, the FSA approval date will still be interesting. The 'missing' Discovery Directors also makes me think the set-up is being contrived so as to gain a VAT advantage—to follow up from Peter Kershaw's email—it looks very much like a genuine JV that is artificially being made top look like a 100% sub of Pru to gain a VAT advantage. And we can't allow that!"
Mr Hitchmough criticised him for replying in such a short time. We do not regard this as entirely fair. If he was only interested in timing of the invoicing it is not difficult to find reference to this in a short time even though the Business Plan is 132 pages long (there is an index). What is surprising—which might point to insufficient time being taken—is that the first and second quoted bullet points raise the question that has already been answered by the Appellant (see Appendix paragraph 4 above) that the £7m internal costs would be both incurred and invoiced while eligible for grouping. Apparently this did not convince Mr Shaw we do not know why not. It seems to be supported by the figures in the Business Plan; the 2004 total costs of £18.7m does not seem to be out of line with the estimated figure of £13m up to August or September in the application letter (the proportion on a time basis, assuming equal monthly expenditure, to the end of August is £12.5m and to the end of September is £14m). But if he thought cash flow forecasts were necessary to confirm this he never asked for them. In the second bullet point he makes the point that invoicing will not occur until after FSA approval, which is correct, but it seems from later events that he equates this with the subscription of capital and the start of the joint venture. It should be noted that in the second bullet point "pre-invoiced" clearly in the context means invoicing costs that relate to the future; the use of the same term in a different sense will be relevant later. The answer to the fourth bullet point is contained in the Contract which Customs (Mr Laney) have had since the 17 June 2004 letter. It is that until the Contract is completed Discovery have no shares (because they need South African Reserve Bank approval first) and it is by virtue of their shareholding that they appoint their directors. Here again the problem seems to be that Mr Shaw does not know the contents of the Contract and Mr Laney, who does, does not comment. The final paragraph after the bullet points reaches the preliminary conclusion that the set-up is contrived on the basis of something that we are sure Mr Laney could have told him was obviously wrong. Indeed he may have done so as there is no future reference to this point but there is no record that he did.
"You may have misunderstood the position regarding setup costs. PAKRA itself is not incurring any setup costs at present. Instead the setup costs are being incurred by Prudential and Discovery. This has been necessary to minimise the time from when the the appropriate authorisations and approvals are obtained (conditions A and B) to when the joint venture business can commence trading. Should the joint venture proceed, then the two parties will charge the startup costs they have incurred to PAKRA which will be funded by share capital injected by the two parties. Should the joint venture not proceed, then no charges would be made to PAKRA and both Prudential and Discovery would be left with aborted costs."
"In the more likely event that the joint venture proceeds, both Prudential and Discovery will charge the set up costs they have incurred to PAKRA. Prudential and Discovery's preference would be for Prudential to charge their internal staff costs to PAKRA whilst it is still a 100% subsidiary and a member of Prudential's VAT group so that this could be done without crystallising a VAT charge."
One might have expected that Mr Shaw would realise that he has misunderstood the meaning of "if the joint venture proceeds" but there is no record of what he understood. In fact the letter seems to be ignored in the next item.
"You need to expand on this a bit further so that we can establish what the abuse is. The questions that we need answers on are:
Although it is agreed that point 4 is based on a misunderstanding, it is interesting that he is not persuaded about there being an abuse (which is similar to the reaction of his colleague Mr Kershaw, see Appendix paragraph 7). Unfortunately we never see the answer to his question of what is the abuse.
"Given that the plans for PAKRA make no provision for this charge until after PAKRA would be ineligible to VAT group, it would appear that the invoicing arrangements are contrived to gain PAKRA an unacceptable VAT advantage which goes beyond the normal consequences of VAT grouping."
Here we have confirmation that the refusal is in fact based on Mr Shaw's reading of the Business Plan and what the Contract appears to allow, which are the conclusions for which we have no supporting reasoning.