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United Kingdom VAT & Duties Tribunals Decisions
You are here: BAILII >> Databases >> United Kingdom VAT & Duties Tribunals Decisions >> KPL Contracts Ltd v Revenue & Customs [2006] UKVAT V19629 (20 June 2006)
URL: http://www.bailii.org/uk/cases/UKVAT/2006/V19629.html
Cite as: [2006] UKVAT V19629
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- and
- a more cogent analysis into the costings prior to embarking upon that course of action;
- clarification as to the advice sought as to whether or not the expenditure would be allowable as a taxable deduction or not, and/or the treatment of the input tax;
- why it chose not to involve the input of external marketing advice (such as that which the company had previously taken).
19629
Value added tax Input tax Supply to taxable persons of goods or services for purposes of business carried on by the taxpayer Supply for purpose of business Two rally cars purchased by the taxpayer to promote business Whether purchase was for the promotion of a business carried on by the taxpayer Value Added Tax Act 1994s.26
BELFAST TRIBUNAL CENTRE
KPL CONTRACTS LIMITED Appellant
THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents
Tribunal: IAN W HUDDLESTON (Chairman)
A F HENNESSEY
Sitting in public in Belfast on 21 March 2006
Mr B Tilly, for the Appellant
Mr James Puzey, for the Respondents
Grounds of Appeal
This Appeal concerns an assessment for over claimed input tax dated 21st September 2004 in the sum of £123,560 (with interest) for the VAT quarters 6/03, 12/03 and 6/04. Since the date of the original Appeal Notice, it is understood that the sum of £8,935, relating to the VAT quarter 06/03, is no longer in dispute.
The Appellant appeals on the ground that it ought to be entitled to deduct input tax relating to the purchase of two Subaru S9 rally cars, on the basis that the expenditure incurred was for a business purpose, namely the marketing and promotion of the Appellant Company.
Relevant Legislation
Article 17(2) of Directive 77/388 ("the Sixth Directive")
Sections 24(1) and 26(1) and (2) of the Value Added Tax Act 1994 ("VATA")
Relevant Case Law
BLP Group plc v Commissioners of Custom and Excise [1995] STC 424
CCE v Rosner [1994] STC 228
Ian Flockton Developments Ltd. v CCE [1987] STC 394
Schemepanel Trading Ltd v CCE [1995] VAT decision no. 13647
Facts
On the 21st May 2002, the business premises of the Appellant Company were the subject of an Inland Revenue raid. Mr. Kevin Lynch (the Managing Director of the Appellant Company) was arrested and taken for questioning. Ultimately the raid did not result either in any criminal prosecutions being brought against the Company or Mr. Lynch, and the Inland Revenue later dropped its enquiries. The Appellant's case centres on the fact that the impact of this raid was of such magnitude that, to counteract the adverse publicity, Mr. Lynch / the Appellant Company, decided upon a course of action to restore the Company's image, which led to the purchase of the two rally cars which, in turn, led to the VAT assessment in dispute.
Mr. Lynch gave evidence about the humble origins of the Appellant Company, and its growth into a successful trading entity. The Company had been started by him as a sole trader, becoming incorporated in the early 90's. It became registered for VAT in November 1994. By the year 2000 it had a turnover of £3.7m, growing to (in the relevant years with which this Appeal is concerned):
• £6.1m in 2001;
• £8m in 2003; and
• £8.5m in 2004.
Mr. Lynch gave evidence that this success arose from three things. In the first place he had positioned the company as a direct contractor and therefore had removed main contractors (and their profit margin), second he had low profit margins but finally, and more particularly, he was dedicated to customer satisfaction and had built a reputation of achieving a two hour response time.
At the operative time, the Company consisted of two trading divisions. The first was involved in the sale and hiring of plant and machinery. The decision appears to have been taken in mid-2003 to cease this business activity on commercial grounds. The second aspect of the business concentrated on the supply and laying of conducting media for the utilities industry. Evidence was given that 85% of that business consisted of medium to long term contracts with public or quasi public bodies, such as BT; the Water Service and NIE. The remaining 15% (measured by turnover) of that business was based on work secured from private contractors.
Mr. Lynch gave evidence to the Tribunal of the impact which the Inland Revenue raid had on he and his family, the staff and staff morale and the business - in the wider sense of its customers, its suppliers and third parties such as banks and financial institutions, from whom it might have acquired plant and machinery on hire purchase type arrangements. In what is a comparatively niche business operating the north west of the Province, the Tribunal had no reason to disbelieve Mr. Lynch's evidence but, at the same time, was satisfied that from the accounts information which was made available to it that there was no perceptible downturn in turnover in the aftermath of the raid. It was acknowledged, however, that the acquisition of a third business, a petrol filling station, contributed to any increase in turnover in the accounting periods 2003 and 2004 (ie after the raid), even if the profitability of the Company did not grow at quite the same rate. For the purposes of this Appeal, however, the Tribunal finds that nothing turns on that.
Evidence was given and copies of Minutes were produced to the Tribunal, of a series of meetings which were held by Mr. Lynch and his senior management team within the Appellant Company in the aftermath of the Inland Revenue raid. The first of these meetings was held on the 24th May 2002 (three days after the Inland Revenue raid) and the minute of the last meeting that was produced to the Tribunal was of a meeting held on the 3rd December 2002. Without rehearsing the detail of those Minutes, briefly they were adduced by the Appellant to show:
(a) the Appellant Company's initial identification of the adverse publicity surrounding the Inland Revenue raid;
(b) the various methods of marketing and promotion that were examined (in some cases loosely) to counteract that publicity; and
(c) the resultant decisions which were taken throughout that period.
The Minutes in themselves showed a rather crude decision making process and revealed an examination (although limited) of a number of marketing choices, such as:
(i) the distribution of flyers;
(ii) advertising within certain various publications;
(iii) sponsorship of various local events and local awards; and(iv) attendance at trade shows.
Aside from those activities, the Tribunal felt that they did show acceptance of a suggestion made by one of Mr. Lynch's colleagues to investigate, initially sponsorship, and then more active involvement in motor cross rallying as a method of promoting the company, culminating in Mr. Lynch's attendance at a local motor event by August 2002. Minutes of a meeting held on the 20th August 2002 suggested that by that stage Mr. Lynch had identified that some involvement within the motor rallying sector would achieve the "quick-fix" impact that he was seeking. At that meeting there was the suggestion of either sponsoring and/or employing a rally driver, but by a meeting held on the 12th September 2002 it appeared from the minutes that Mr. Lynch had decided to become personally involved. Mr. Lynch gave evidence to the Tribunal that he had had no prior involvement in motor rallying, but chose to become involved to demonstrate that he could apply the business strategy that had been so successfully employed in relation to his business to a sporting venture. The view that he expressed was that if he was successful in the rallying field, he could thereby counteract adverse publicity and demonstrate his dedication to achieving results in the sporting as well as in the business field.
The Minutes of the relevant meetings suggest that a costing exercise was to be undertaken, but no evidence was adduced to the Tribunal as to how or if indeed such an exercise was undertaken. Following from the decision to become involved in rallying, the Appellant Company / Mr. Lynch appears to have "tested the water" by the acquisition of a Group N rally car, which was purchased in October 2002 for the sum of £35,000. This was a second hand car and, therefore, was not liable to VAT. Its acquisition was followed the following year by the purchase of a further second hand vehicle at a cost of approximately £215,000. Mr. Lynch gave evidence that his approach was to test his abilities within the motor rallying circuit with the first acquisition and, based on his success, he then embarked upon the acquisition of the second vehicle, which allowed him to compete within a different class of rallying event. Some eighty newspaper clippings were adduced to the Tribunal in support of Mr. Lynch's success in 2003 / 2004. Following from that success the decision appears to have been taken to acquire a new vehicle by hire purchase, and it was acquired at a cost of £355,000 plus VAT on the 1st December 2003, with a subsequent (and last) vehicle being purchased in May 2004 at a cost of £300,000 plus VAT. It is the input VAT payable on these two later vehicles that forms the basis of the current appeal.
In terms of preliminary findings of fact, the Tribunal found:
(a) that Mr. Lynch did not have any previous experience of rallying, nor indeed any particular interest in it prior to the decision to become involved in the sport which was taken around August / September 2002;
(b) that his decision was taken as a result of the Inland Revenue raid, and was motivated by a wish to counteract adverse publicity not in perhaps any overly scientific way, but in an attempt to restore the reputation of the Appellant Company and Mr. Lynch;
(c) that, contrary to the suggestion in the Minutes adduced to the Tribunal, no real investigation was undertaken into the likely cost of becoming involved in motor rallying, nor was any professional advice sought as to whether or not the expenses would be properly allowable for taxation or as input VAT;
(d) that the Company had not appointed external marketing consultants in the face of the Inland Revenue raid, notwithstanding the fact that it had a previous association with a marketing company, which had on a previous occasion developed a marketing strategy to attract an increased customer base;
(e) that the Company had embarked upon the exercise by the acquisition of the first vehicle, to be followed by, initially, the acquisition of a second vehicle following Mr. Lynch's initial success, and ultimately, with the two cars which form the subject matter of this Appeal;
(f) that oral representations were made by the Revenue to the Appellant's auditors in spring 2003 that there would be no follow up from the raid and that, from that point in time until the position was finally confirmed in writing in 2005 by the HMRC, the impact of the raid upon the Company and Mr. Lynch abated;
(g) that although perhaps ill considered when set against the criteria that the Tribunal might expect from an objective viewpoint that, nonetheless, given the nature of the particular appellant (and more importantly Mr. Lynch) the expenditure was on balance incurred to further genuine business objectives and that any personal glory that reflected on Mr. Lynch was (in that context) incidental and not a prime motivation;
(h) that Mr. Lynch's decision to retire from the sport signified (at least in part) that the venture had achieved its objectives and that his decision tended to confirm his evidence that any personal benefit derived as a result of his success was incidental to the main business objective.
Relevant Law
The community law right to deduct input tax is found in Article 17(2) of the Sixth Directive, which provides as follows:
"2. Insofar as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:
(a) value added tax due or paid within the territory of the country in respect of goods or services supplied or to be supplied to him by another taxable person; ."
Section 24(1) of the VAT Act, the domestic counterpart reads:
"(1) Subject to the following provisions of this Section, "input tax" in relation to a taxable person means the following tax, that is to say:
(a) VAT on the supply to him of any goods or services; being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him."
The right to deduct input tax is provided in UK Law by Section 26 of VATA 1994:
"26. Input tax allowable under Section 25
(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 (that is input tax on supplies, acquisitions and importations in 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; ."
The Case for HMRC
Citing these statutory provisions and the cases of BLP and Schemepanel, Counsel for the Respondent made the case that a taxable person is only entitled to deduct those parts of his input tax as are referable to his taxable supplies. He expounded on this view by reference to the High Court decisions of Rosner (supra) as authority for the proposition that there had to be a "direct and immediate link" between the claimed inputs and the taxable transactions of a business. Counsel then went on to make the following points on the case before the Tribunal:
(a) being a utility company, the Appellant's core activities had nothing whatsoever to do with rallying, and therefore there was no direct nor immediate link between the purchase of two expensive rally cars and the outputs of the business;
(b) that the customer base of the business was limited to large organisations, each of whom was likely to have developed systems for awarding contracts, and that therefore to the extent that the underlying purpose of the acquisition of the rally cars was to market the company, that the connection between the choice of rallying as that method and the impact on existing or potential customers within the utilities field was tenuous. In this regard it was established by cross examination that the persons with whom the Appellant Company had to deal in order to secure such contracts numbered not many more than fifty.
Counsel made the point that even if one accepted rallying as a valid method of promoting the Company, one would then have expected the Appellant to exploit its activities in that field with the usual corporate hospitality focused on those motor rallying events where Mr. Lynch participated.
The Case for the Appellant
In the present appeal the Appellant relied squarely on the decision of Ian Flockton Developments - as it had done in its earlier correspondence with HMRC. In that case, the taxpayer company was a manufacturing company of plastic mouldings and storage tanks. The company, being anxious to find new customers, decided to acquire and then keep a race horse, with a view to promoting the company's business. The VAT and Duties Tribunal disallowed the taxpayer company's claim for input tax, that decision being appealed and subsequently being allowed by the High Court on the grounds that the test to be applied in determining whether goods or services which were supplied to taxpayer were used or to be used for the purposes of a business carried on by him was a subjective test and that, therefore, the fact finding tribunal had to consider what was in the taxpayer's mind at the relevant time in order to discover its object.
The Appellant relied on this, without qualification, as authority for its right to deduct input tax.
Counsel for the Respondents, whilst accepting the significance of that case to the present appeal, went on to quote Stuart-Smith J. in that case:
"In such a case as this, where there is no obvious and clear association between the taxpayer company's business and the expenditure concerned, the Tribunal should approach any assertion that it is for the taxpayer company's business with circumspection and care and must bear in mind that it is for the taxpayer company to establish its case and the Tribunal should not simply accept the word of the witness, however respectable. It is both permissible and essential to test such evidence against the standards and thinking of the ordinary businessman in the position of the applicant. If they consider that no ordinary businessman would have incurred such expenditure for a business purpose, that may be grounds for rejecting the taxpayer company's evidence, but they must not substitute that as the test. It is only a guide or factor to take into account when considering the credibility of the witness, and no doubt there will be many other factors which bear on that question which the Tribunal should well understand."
Decision
Clearly, based on that dicta, the balance between what a tribunal might objectively expect on the facts of any given case, and what was genuinely in the mind of a taxpayer, will often be a difficult one for a fact finding tribunal to assess. In the present case the Appellant contended (based on Flockton) little more than that motor racing promoted its business by demonstrating its capacity to achieve results to go from "zero to hero" as appears often to have been quoted in the press cuttings that were adduced to the Tribunal.
Before setting out our conclusions, we see four relevant prepositions of law:
(a) for input tax to be deductible, it must be referable to the taxable supplies made by a business;
(b) as a general principle there clearly should be a nexus between the expenditure and outputs which amounts to a direct and immediate link;
(c) where that "direct and immediate" link is absent, then in assessing whether expenditure is for the purpose of a business or not, one must examine the intention of the company's controlling minds at the time the expenditure was incurred. In approaching that subjective question (and applying the dicta quoted above), it is, however, permissible and indeed desirable to test the taxpayer's case by reference to the standards and thinking of ordinary taxpayers in the position of the taxable person;
(d) that in such cases the burden of proof rests on the taxable person who is seeking to deduct input tax to:
(i) demonstrate how the expenditure is linked to the purpose of the business; and(ii) prove what the intention was when the purchase was made.
In this case, there is no obvious and clear association between the Appellant Company's business as a utility company supplying mainly the public / quasi-public sector and its decision to pursue rallying as a marketing strategy. The relationship between the expenditure and the claim for input tax was not, however, so distinct as to be completely removed from one another as was the case in Rosner. The Tribunal did accept that on the facts there was a business benefit. Applying Flockton, however, the Tribunal would not have accepted a simple assertion that the expenditure was incurred for a business purpose, without the Appellant discharging the burden of proof as to:
(a) its intention in making the expenditure;
(b) the linkage between the expenditure and its purported aims.
In the present case, and based on the evidence before it, the Tribunal did find that the motor sport activity was started by Mr. Lynch / the Appellant Company as a knee jerk reaction to combat the adverse effect of the publicity which surrounded the Inland Revenue raid. The Appellant's case would have been stronger had it produced evidence of:
Nevertheless, whilst the Tribunal is alive to those concerns, it would not wish to impose those objective criteria on a company which, on the evidence before the Tribunal, was governed by Mr. Lynch's personality and intuitive decision making processes as against what the Tribunal might expect to see in a larger company which might operate along the more traditional principles of corporate governance.
In reality this was a small company dominated by Mr. Lynch's personality. In that context the Tribunal found that Mr Lynch had taken the decision to become involved in rallying to promote the business and that the Company acquired the original two cars as a trial venture in order to combat the adverse effect of the bad publicity. At the end of 2003 and in 2004 when the risk of prosecution had abated, the Appellant's track record of success in rallying prompted the Company to acquire two additional vehicles (the VAT treatment of which is in dispute). At that stage little analysis was probably undertaken, but at that time it was reasonable for the Tribunal to infer on the facts before it that the purpose of incurring that expenditure was as much to promote the company's business as it was an attempt to counteract the negative publicity arising from the Inland Revenue enquiry.
Counsel for the Respondent did attempt to make a distinction between Mr. Lynch's personal rehabilitation and personal aspirations, and that of the Company. On balance, however, the Tribunal felt that given Mr. Lynch's personality and his singular importance to the business that the reputations of the two were inextricably linked, and that Mr. Lynch very much regarded himself as the Company, to the extent that any personal advancement was one in the same thing as the advancement of the Company. In coming to this conclusion, the Tribunal had accepted that Mr. Lynch did not have any earlier interest in motor rallying, and accepted his evidence that his recent decision to retire from the sport was motivated in part by the fact that he had achieved his original aim the rehabilitation of both himself and the Company and that no personal advantage was to be secured by continuing in the sport, however successful.
Based on the Tribunal's findings of fact in this case, the Tribunal did accept that the expenditure on the motor sport activity was:
(a) embarked upon (whether wisely or not) to restore the company's image; and
(b) that the decision resulted in a genuinely incurred expense to further that business objective on the particular facts of this case even when tested against the guidance given by Stuart-Smith J in Flockton.
In the final instance the Tribunal was satisfied that motor racing had been intended to promote the Appellant's business by demonstrating its capacity to achieve results. That was the true purpose of the Appellant in incurring the expenditure and that purpose did meet the test of the ordinary businessman in the Appellant's position on the particular facts in this case.
LON/04/1605