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Madgett & Ors (t/a The Howden Court Hotel) v Revenue & Customs [2006] UKVAT V19719 (18 August 2006)

19719

TOUR OPERATORS MARGIN SCHEME – Hotel selling packages including travel – Travel bought-in – Apportionment of package price between in-house and bought-in supplies – Returns used Method 2 in VAT guide – TOMS Leaflet requiring cost apportionment – Whether mandatory cost apportionment compatible with EU law and authorised by art 7 of TOMS order 1987 – No – Appeals against assessments based on TOMS leaflet 709/5/88 allowed – EEC 6^th Dir (388/77/EEC) Art 26 – VATA 1994 s 53 – VAT (Tour Operators) Order 1987 S.I. No. 1806 art 7

LONDON TRIBUNAL CENTRE

T P MADGETT, R M BALDWIN and MRS MADGETT Appellant

T/A THE HOWDEN COURT HOTEL

- and -

THE COMMISSIONERS FOR HM REVENUE AND CUSTOMS Respondents

Tribunal: THEODORE WALLACE (Chairman)

ALBERT L ROBINSON FHCIMA, FCFA, MRSH

Sitting in public in London on 19 & 20 July 2001, 12-15 May 2003 and 14 September 2004

Hon Jeremy Woolf, instructed by Rice-Jones and Smiths, Solicitors, for the Appellant

Nicholas Paines QC and Andrew Macnab, instructed by the Solicitor for the Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2006

DECISION

This appeal concerns VAT assessments from 1 May 1988 to 31 October 1993 and 1 May 1994 to 31 October 1995 under the Tour Operators Margin Scheme on the Appellants who operated a hotel in Torquay. After reductions the assessments to 31 October 1993 total £24,560; those to October 1995 were £13,356. At the relevant time some ninety per cent of the Appellants' customers came from the North of England paying a package price which included the coach journey, a day trip and insurance. The coaches were not owned by the Appellants who bought in the transport services. The dispute concerned the apportionment of the package price between the in-house supplies which were standard-rated and the bought-in transport which was zero-rated.

The case has been running since 1992 and initially concerned assessments up to 30 April 1991. It started before a differently constituted Tribunal (chairman, P M F Horsfield QC) which decided in 1995 in Decision No.13009 that the Appellants were not tour operators. On appeal Mr Justice Brooke [1996] STC 167 referred the question whether the Appellants were tour operators to the European Court of Justice and returned the matter to the Tribunal to consider referring further questions. This the present Tribunal did in 1997, see Decision No.14757. The replies by the Court of Justice to the Tribunal's questions reported at [1998] STC 1189 did not resolve the dispute. This decision involves the interpretation and application of the replies, and in addition a series of issues including quantum which had been held over by agreement pending the replies to the questions referred to the Court of Justice. Although the assessments were consequent on the margin scheme, the only impact of the scheme is on the valuation of the in-house element resulting from the apportionment under the scheme of the package price between the coach and hotel elements. This is because the coach element, which was the only bought-in element and thus the only margin supply, was zero-rated, whereas the hotel element which was not a margin supply was standard-rated.

Since the hearings in 2001 and 2003, the Court of Justice has on 6 October 2005 given its decision in My Travel plc v Customs and Excise Commissioners (Case C-291/03) [2005] STC 1617 which was also concerned with the interpretation of Article 26 of the Sixth Directive in relation to the apportionment by a tour operator of inclusive prices covering both in-house and bought-in supplies. A further hearing had been deferred pending that decision. Following the decision in My Travel, the Appellants made further submissions in a letter dated 15 March 2006; Customs responded on 10 July 2006. Neither party requested a further oral hearing.

The assessments in the present case were made on the footing that the Appellants were tour operators subject to the Tour Operators Margin Scheme ("TOMS") which came into force on 1 April 1988 under the Value Added Tax (Tour Operators) Order 1987 ("the TOMS Order") S.I. No.1806. The order was made under section 37A of the VAT Act 1983, now section 53 of the VAT Act 1994. Some of the provisions of the Margin Scheme were specified in VAT Leaflet 709/5/88 issued on 1 April 1988. The legal basis of the leaflet is article 7 of the 1987 Order which provides for the value of a designated travel service to be determined by the difference between sums paid to and paid by the tour operator in respect of the service "calculated in such manner as the Commissioners of Customs and Excise shall specify." The leaflet, which is mandatory, is therefore a form of tertiary legislation. Leaflet 709/5/88 has since been replaced by successive leaflets of which the latest is 709/5/04. The UK legislation was designed to implement Article 26 of the Sixth Directive. It now appears clear from the decision of the Court of Justice in My Travel that the UK legislation and in particular the TOMS leaflet did not implement Article 26 correctly.

The Appellants accounted for VAT on the basis that they were not tour operators and apportioned the inclusive package payments which they received between the transport and the hotel elements on the basis of market values using Method 2 in Appendix H to the VAT Guide (see now paragraph 32.2.3 of Notice 700 issued April 2002). The transport element was zero-rated under Group 8 of Schedule 8 to the 1994 Act; the hotel element was standard-rated. In carrying out the apportionment the Appellants used the hotel charges made by them to non-package guests and the coach fares which independent travellers from the North of England would have had to pay to a coach company with an addition for the day trip and insurance (see Decision No.14757 at para 46). Output tax declared for the three years to 30 April 1991 totalled £63,614. The assessments under the TOMS scheme were calculated using a cost-based apportionment as required under Section II of Leaflet 709/5/88; assessments for periods 07/88 to 04/91 were issued on 26 February 1992 and totalled £13,688 but were progressively reduced following the appeals to £7,830 on 29 June 1993. Customs now accept that further reductions are necessary. The Appellant has also appealed against subsequent assessments covering periods up to 10/93 and 07/94 to 07/95; those assessments are also covered by this decision.

In response to the questions posed by the High Court in Case C-308/96 the Court of Justice ruled as follows:

"Article 26 of the Sixth Directive applies to a hotelier who, in return for a package price, habitually offers his customers, in addition to accommodation, return transport between certain distant pick-up points and the hotel and a coach excursion during their stay, those transport services being bought in from third parties."

The Appellants accepted that they were therefore covered by the margin scheme, the transport not being purely ancillary.

The questions referred by the Tribunal in Case C-94/97 which was joined with the High Court reference were as follows:

"If it is determined in Case C-308/96 that the provisions of Article 26 of the Sixth Directive apply to operations of the kind in issue in the present case,

1. On the proper interpretation of Article 26, where in a single transaction a tour operator provides a service to the traveller part of which is supplied to the tour operator by other taxable persons (bought-in) and part of which is supplied by the tour operator from its own resources (in-house), on what basis is the tour operator's margin under Article 26(2) to be calculated?

2. Is Article 26 to be interpreted as

(a) requiring the apportionment of the total amount received by the tour operator from the traveller between bought-in and in-house supplies by reference to the cost of the components; or

(b) as authorising member states to require apportionment by reference to such costs (i) generally or (ii) in the case of operations of the kind in issue in the present case; or

(c) as leaving such apportionment to be made in accordance with the normal principles for determining the taxable amount under Article 11?"

The reply of the Court to these questions was as follows:

"On a proper construction of Article 26 of the Sixth Directive, where a trader subject to the article effects, in return for a package price, transactions consisting of services supplied partly by himself and partly by other taxable persons, the VAT scheme under that article applies solely to the services supplied by third parties. A trader may not be required to calculate the part of the package corresponding to the in-house services by the actual cost method where it is possible to identify that part of the package on the basis of the market value of services similar to those which form part of the package."

On return to the Tribunal, the following matters were still in dispute:

(a) Were Customs entitled to require the Appellant to use a cost-based apportionment in the present case?

(b) Is the market-value basis limited to the deduction of the market value of similar in-house supplies from total package supplies so as to determine both the bought-in and the in-house elements?

(c) Was the TOMS Leaflet ultra vires the 1987 Order and the Act? If so what are the consequences?

(d) If the Appellant could be required to use the costs basis of apportionment, are the in-house costs under TOMS limited to supplies for the direct benefit of the customer as with bought-in supplies?

(e) What is the correct quantum on the TOMS leaflet cost basis?

(f) Were the original assessments in January 1992 made to best judgment?

In the light of the decision of the Court of Appeal in Customs and Excise Commissioners v Pegasus Birds Ltd [2004] STC 1509, which came after the 2004 hearing, the Appellants abandoned the challenge to best judgment.

The facts

The first two Appellants were registered from 24 May 1985 when they took over the hotel in partnership. At that time the Tour Operators Margin Scheme was not in operation and VAT was therefore due on normal principles. In October 1986 following a meeting the Appellants wrote to Customs stating that they were using 25 per cent for the zero-rated coach element based on costs and enclosing their calculation. After the first year the Appellants changed to a market value basis apportionment without informing Customs.

When the Margin Scheme was introduced in April 1988 the Appellants did not consider that it applied to them and continued to make returns using a market value apportionment.

Nothing happened until a control visit following a repayment claim for £10,100 for period 01/91 which arose primarily from fixed asset additions.

On 25 February 1991 Mr Skilling, a Customs officer, visited the hotel for 3 hours and saw Mr Madgett. Although we were told that he is still in the Customs service Mr Skilling was not called as a witness in the appeal. A visit report by him was produced dated 18 December 1991 covering this visit and a further visit on 13 May 1991.

On 26 February 1991, the day after the visit, Mr Madgett wrote to Mr Skilling confirming that he had calculated the zero-rated percentage of coach holidays by applying Method 2 in Appendix H of the VAT Guide. This involved an apportionment, based on the fare of £40 charged by National Coaches to transport people to Torquay and on the average charge by the Appellants to private guests of the hotel for the same period as a coach holiday, and resulted in a factor of 24% for the transport element.

Mr Skilling's report shows that he checked the VAT returns for periods 07/88 to 01/91 against the main records and examined the annual accounts to 30 April 1989 and 30 April 1990.

Mr Skilling checked the VAT account against the purchase day book for numerical accuracy and a random selection of purchase invoices. He checked period 01/91 in depth : 90 per cent of the inputs related to three invoices for building work on an extension to the bar and three extra rooms. He checked overall credibility using the 1990 accounts and noted that it was satisfactory. He noted that the hotel was closed in the winter and that the occupancy rate was 75 per cent.

Mr Skilling noted this,

"It is patently obvious that Mr Madgett is not an example of an average Torbay hotelier. Business is well run, records are well kept, the hotel is run as a business, there is a set pricing policy – reviewed annually, and tight controls appear to be exercised upon the business.

Business is predominantly coach based (95%+). Mr Madgett carries out annually a calculation to establish the zero-rated element of the business. This calculation is based upon Appendix H Notice 700 i.e. apportionment on the basis of market values; rather than use the Tour Operators Margin Scheme."

The 1990 accounts showed income from guests as £171,081 and income from the bar as £19,784; this was of course before the bar extension. There was an addition of £6,188 for "own accommodation". We infer that this addition was in reality a contra against expenditure to reflect own use for income tax purposes, rather than income. We return to the 1990 accounts shortly when setting out the method of calculating the assessment.

On 31 January 1992, having obtained the accounts up to 30 April 1991, Mr Skilling wrote that after lengthy and protracted consultations the Headquarters section had decided that the Appellants had either to use the Margin Scheme as in the Public Notice or to account at standard rate on 7/47ths of total takings less the cost of coaches bought in. He wrote,

"I fully appreciate that this answer is probably not the one you wanted to hear; and that by operating the above schemes, you will either create vastly greater amounts of work for yourself, or alternatively end up accounting for more VAT than in the past."

The letter stated that the Appellants were required to use one of the two options. He enclosed calculations which showed VAT underdeclared for three years totalling £13,644.

Mr Skilling included a schedule headed "Example of Margin Scheme using Y/E 30.4.90 figures" on which the initial assessments for that year were based. The figures which we show in the second column were not in the schedule but are the figures used by Customs for the reduced assessment in June 1993 (see paragraph 27 below). The figures in the third column were put forward in January 2006.

		Jan 1992	June 1993	Jan 2006
A =	Add up selling prices of all supplies, i.e. sales (exclude Bar Takings, Phone, Machines - and account for separately) Figure is tax inclusive (includes VAT).	£196,743	£189,250	£188,476
C =	Add up the cost (to you) of your zero rated Scheme supplies (e.g. bought in 52 seater coach transport)	£ 15,055	£ 15,055	£ 15,055
D =	Add up the cost of UK in-house standard rated supplies. (Do not include any UK VAT you were charged if it is recoverable) then add 15% to this total (see attached sheet).	£120,495	£108,507	£ 69,103
G =	C + D	£135,550	£123,562	£ 84,158
H =	A – G	£ 61,193		£ 104,318
M =	C x H ÷ G	£ 6,796
N =	D x H ÷ G	£ 54,396	£ 57,680	£ 85,657
O =	D + N	£174,891	(£166,187)	£154,760
P =	O x 3/23	£ 22,811	£ 21,676	£ 20,186
	Add back output tax on bar, machines etc.	£ 2,967
	OUTPUT TAX	£ 25,778

Compare output tax per this calculation to that already declared, and adjust under/over payment in next return (July return).

D - Exclude overhead expenses which apply to the whole supply (e.g. Advertising, Admin Costs).

Provisions	£ 26,714	£ 22,262	£ 21,371
Payroll	£ 38,845	£ 37,636	£ 20,427
Insurance (Building)	£ 1,706	£ 1,422	£ 585
Hire of Equipment (if it relates to hotel accommodation)	£ 603	NIL	NIL
Laundry/Cleaning	£ 4,883	£ 4,297	£ 3,544
Establishment (adjusted for bar) Rates	£ 9,239	£ 7,576	£ 3,166
Light and Heat	£ 6,020	£ 4,816	£ 2,063
Repairs and Renewals	£ 8,431	£ 8,284	£ 2,889
Depreciation of plant and equipment	£ 2,115	£ 1,903	£ 583
Repairs	£ 649	£ 584	£ 222
Entertainment	£ 5,574	£ 5,574	£ 5,240
	£104,779	£ 94,354	£ 60,090
	+ 15%	+ 15%	+ 15%

The figure at Step D in column one, namely £120,495, was £104,779 plus 15 per cent. The output tax figure of £25,778 compared with £21,976 declared and £3,802 was therefore shown in the January 1992 calculations as underdeclared for the year. The figure for the reduced assessment was £1,135 lower which is £2,667. On the January 2006 figures the amount underdeclared comes down to £1,177. The initial assessment had the effect that the zero-rated element was only 11.1 per cent for that year : on the basis of the figures in the right hand column that element increases to 17.9 per cent.

Assessments totalling £13,688 were issued on 26 February 1992 for periods 07/88 to 04/91, of which £3,799 was for the four periods to April 1990, the difference arising from rounding down. The assessments had in fact been raised on 30 January 1992 before the letter referred to at paragraph 19.

The figure of £196,743 at Step A is the £171,081 income from guests shown in the accounts plus 15 per cent VAT. The figures listed at Step D were identical to those shown in the accounts; although the words "adjusted for bar" appeared after "Establishment", no adjustments were made.

The accounts showed "deposits in advance" as a liability, being £774 down from the previous year.

The assessments for 1988-89 and 1990-91 were based on the accounts for those years calculated on a similar basis.

A 1991 leaflet produced by the Appellants for package customers coming by coach referred to a musical evening on Day 2, Dancing with our resident DJ on Day 3 and Party Time with our resident trio on Day 6. Days 1 and 7 were for travel by coach, with an excursion on Day 4. The season opened on March 30 and ended on November 1. The weekly package tariff varied from £105 for the first week to £184 for two weeks in early August inclusive of breakfast and an evening meal.

A leaflet for 1993 showed the weekly package tariff as varying from £120 weekly for two weeks in April and the last week in October to £190 weekly in high season from 24 July to 6 August and showed 5 day pre-Christmas breaks in November at £95. Both leaflets refer to "Entertainment in Hotel".

A 1992 leaflet for guests not travelling by coach showed the tariff as varying from £157 per person for a double room to £178.50 in high season. Again it mentioned entertainment.

The initial assessments for 07/88 to 04/91 were reduced after the initial appeal to £8,954 on 26 October 1992 and further reduced to £8,573 on 21 December 1992 and to £7,830 on 29 June 1993 of which £2,665 was for the four periods to 04/90. A letter from Customs of 18 September stated that default interest was being inhibited. The allowances against in-house costs in the reduced assessment in June 1993 were as follows:

Provisions – 1/6^th for private and staff

Rates – 18% for domestic and bar

Lighting and heating – 20% domestic and bar

Laundry/cleaning – 12% domestic and bar

Wages - £1000 secretarial £209 barman

Insurance – 1/6^th domestic

Hire of telephone system – 100%

Depreciation - £206 for bar

The resultant figures for the year to April 1990 have been shown at paragraph 20 above in the second column. The further reductions in the third column are agreed apart from insurance, repairs, removals, rates, depreciation and entertainment which the Appellants contend should be excluded.

Assessments for periods 07/91 to 01/93 were initially raised on 22 April 1993 in the sum of £7,989. The Appellant appealed in May 1993. Those assessments were increased by £3,641 on 29 June 1993 to £11,630.

Assessments for periods 04/93 to 10/93 were raised on 13 December 1993 totalling £5,100. These included Mrs Beryl Madgett who became a partner on 18 February 1993. Further assessments totalling £13,356 for periods 07/94 to 10/95 were made on 8 March 1996. The Appellants' accountants wrote on 18 March 1996 to Customs advising that they were formally appealing, however no appeal was in fact lodged with the Tribunal until 20 June 2006. Customs did not object to the application for leave to appeal out of time and we gave leave.

Mr Madgett made two statements which were put in evidence. He was not cross-examined. He has since made a third statement.

In his first statement dated June 1996 he said that the hotel was a Georgian Villa, set in 1½ acres with 35 bedrooms, a licensed bar, dining room, games room and ballroom. Most guests were retired. During the high season from Easter to end-October and Christmas, about 90 per cent came from the North of England on a package including coach travel and a sight-seeing trip around Devon. Two permanent residents had been living at the hotel since 1992 and 1994. Students from Keale University were accommodated on a pre-season trip. The permanent staff consisted of a housekeeper, maintenance man, receptionist and chef throughout the year; during high season staff increased from four to eleven or twelve with chambermaids, waiters, kitchen porters and a barman. All of this was in line with the evidence accepted by the Tribunal in 1995 in Decision No.13009.

Mr Madgett made a further statement in June 2002; at this time a considerable number of documents had been lost in a fire in September 2000. This statement was based on recollection and on the remaining records which included the wage books.

He said that the bar represented 10% of floor space and private accommodation represented 20%. He estimated that 30% of heating and lighting was attributable to non-TOMS guests, bar, private accommodation and to permanent staff during the winter.

He said that 20% of laundry was attributable to non-TOMS guests, the bar, private use and staff.

He said that £1,881 was spent on the barman in 1988-89, £209 in 1989-90 and £3,999 in 1990-91 including national insurance. He stated that £4,368 was spent on a secretary but did not specify the year; this included a payment to Mrs Madgett. He attributed 8% of staff costs to non-TOMS guests. In his statement he put forward total reductions in wages attributed to in-house TOMS supplies of £8,399 (1988-89), £7,214 (1989-90) and £11,071 (1990-91). These figures did not take account of core staff costs out of season.

He claimed all of the entertainment as non-TOMS on the ground that the commercial reason for providing entertainment was to increase bar sales : the entertainment expenses being £4,386 (1988/89), £5,574 (1989-90) and £4,421 (1990-91). We note that this was before the bar extension

He estimated that 25% of rates and insurance was attributable to the bar, to non-TOMS guests and to private use.

ECJ replies

We now turn to the issues now in dispute, starting with the first two matters identified in paragraph 8 above both of which arise from the replies of the Court of Justice.

At paragraph 46 of its decision the Court of Justice said this,

"In those circumstances – bearing in mind that it is common ground in the present case that calculation of the VAT on the margin for the bought-in services by using one alternative or the other in principle gives the same figure for VAT – a trader may not be required to calculate the part of the package corresponding to the in-house services by the actual cost method where it is possible to identify that part of the package on the basis of the market value of services similar to those which form part of the package."

The latter part of the paragraph is replicated exactly in the last sentence of the second reply (see paragraph 7 above).

The opening words "In those circumstances" clearly refer to the discussion in the previous four paragraphs of possible methods of apportionment where the "actual cost method used by the United Kingdom government" was compared with a market value based on the hotel prices charged to non-package customers.

The common ground then referred to is a mystery since much of the problem in this appeal arises from the increased VAT assessed by reason of the application of the actual cost method which resulted in attributing a much lower proportion of package sales receipts to the zero-rated supplies than the 24% used by the Appellants. Mathematically the actual cost method on Customs' calculation in June 1993 gives £23,063 attributable to zero-rated supplies in 1989/90 (£189,250 less £166,187); the calculation of January 2006 gives a figure of £33,716. No figure has been given in evidence for an amount derived by deducting a figure derived from the price of the accommodation to non-package customers and there was no evidence as to the number of package customers. Mr Woolf told us that the deduction method would produce a worse result for the Appellants than the TOMS method. We see no reason to doubt this.

We note that, at paragraphs 1.12 and 3(c)(vii) of his written submissions to the Court of Justice, Mr Woolf submitted that the Leaflet method weighted the apportionment in favour of in-house standard rated supplies; this also appeared at paragraph 55 of the Report for Hearing.

It appears that the explanation for the statement at paragraph 46 of the judgment that it was common ground that the alternatives give the same figure lies in the words "in principle". On this approach the Court was saying that they ought to give the same figure rather than that they do so in fact. Mr Paines agreed that the only common ground was that the calculations should give the same result.

At paragraph 26 of its judgment in My Travel the Court said this,

"It must be stated that the fact that those two methods result in calculation of a similar tax liability seems, in as much as it appears between dashes in paragraph 46 of the judgment in Madgett and Baldwin to be a superfluous factor."

Submissions

Mr Woolf submitted that the words of the reply by the Court of Justice (see paragraph 7 above) were not prescriptive but gave to the trader the option of using a market value basis. Although the Advocate-General had referred at paragraph 76 of his opinion to deduction of the market value of the in-house services, the Court had not used the term "deduction". Mr Woolf said that there was no reason why the Court should have intended to preclude a full market-value based apportionment. If the price was to be apportioned by deduction, it would be more logical to deduct the smaller element rather than the greater. A deduction exercise was arbitrary. At paragraph 34 the Court said that Article 26 was an exception only to be applied to the extent necessary. Without TOMS there would be the normal flexibility as to apportionment.

Mr Paines said that the effect of the reply by the Court of Justice was that the option of departing from the cost basis was only available when it was both simpler and not distortive. The clear implication of the reply was that where it was not possible to identify the in-house element by the market value of similar services, the trader might be required to use the actual cost method. "Possible" meant reasonably possible without being complex or distortive. He said that the Court of Justice had not answered question 2(a) referred by the Tribunal, it had in effect answered question 2(b) saying that Member States were authorised to require cost apportionment subject to the proviso and it had rejected the option posed in question 2(c). He said that, reading paragraph 46 of the decision of the Court together with paragraph 45 which referred to paragraph 76 of the Advocate-General's opinion, the proviso referred to the market value deduction method and not to a full market value apportionment. He accepted that by reason of the proviso the Appellant was entitled to use the deduction method to identify the in-house element of the package.

Conclusions as to ECJ replies

We do not find it at all easy to understand the effect of the replies to questions 2(a), (b) and (c), not least because the Court of Justice did not address the questions referred directly. Although expressed in the negative, the implication must be that where it is not possible to identify the in-house element of a package price on a market value basis a trader may be required to use the actual cost method. The reply clearly does not state that the trader is so required by Article 26 and therefore again by implication means that where it is not possible to identify the in-house element on a market value basis Member States are authorised to require a cost basis. It seems to us that the answer to question 2(a) was therefore "No" and that the answer to question 2(b) was a qualified "Yes". In a case where there has been no requirement under reply 2(b), the answer to question 2(c) must be "Yes", however the alternatives appear to be those set out in paragraphs 43 to 45 of the judgment of the Court.

In their further written submissions following the decision in the Court of Justice in My Travel, the Appellants said that the Court had rejected a completely prescriptive approach to apportionment. In determining market values, the Court said that account could be taken of average values and prices charged by other suppliers. They submitted that it was difficult to see why account should not be taken of coach prices charged by the only company providing coach travel. The Appellants reiterated that at the first hearing Customs had accepted that the method of apportionment used by the Appellants was reasonable if cost apportionment was not required; it was for this reason that the appeal was allowed in Decision No.13009. The Appellants contended that the Tribunal's conclusion in Decision No.14757 that the cost based apportionment in the TOMS Leaflet was ultra vires unless such method was required by Community Law was correct; there was nothing in My Travel to suggest that the Tribunal's conclusion was wrong; the Court of Justice emphasised that the Leaflet was in general not consistent with Community law because market value was more appropriate.

Following a direction by the Tribunal, Customs responded on 10 July 2006 to the Appellant's submissions. They stated that the judgment in My Travel did not alter their view that the Appellants only had the option of a cost apportionment or deduction of the market value of in-house supplies; the Court had referred the mechanics of valuation back to the Tribunal and Customs awaited the outcome. They submitted that the judgment provided that where a market value could not be established or where a cost based method was an accurate method a cost based method could be used.

We observe that in the present case the Appellants were offered an option in Mr Skilling's letter of 31 January 1992, however it was the wrong option being based on deduction not of the market value of similar in-house supplies but of the cost of the coaches bought-in, see paragraph 19 above. The Leaflet itself gave no option.

Mr Paines accepted in argument that the Appellants were as a matter of law entitled to use the alternative of deducting market value of in-house supplies; we observe however that, although they were so entitled under Community law, they were not given that choice either when the assessments were made or when the returns were made. His proposition that the option of departing from a cost basis is available only where a market value basis is simpler is clearly incorrect in view of paragraph 23 of the decision of the Court of Justice in My Travel where it was said,

"use of the criterion of market value is not subject to the condition that it must be simpler to use than the actual cost method."

In My Travel the Court of Justice went beyond its judgment in Madgett and Baldwin and said that in principle the value of the in-house element must where possible be identified on a market value basis. At paragraph 35 the Court said this,

" a … tour operator who, in return for a package price, supplies to a traveller services bought in from third parties and in-house services must, in principle, identify the part of the package corresponding to his in-house services on the basis of their market value where that value can be established, unless he can prove that, for the tax period under consideration, the method based on the criterion of actual costs accurately reflects the actual structure of the package."

At paragraph 36 the Court said that it is for the Tribunal "to assess whether it is possible to identify the part of the package corresponding to the in-house services on the basis of their market value." In our judgment the assessment of whether it is so possible must be on the footing of assessing whether that basis would produce a proper attribution which in principle would not materially affect the result which would apply on normal principles of attribution. If this were not the case the Article 26 scheme would not be applied "only to the extent necessary to achieve its objective", see paragraph 34 of the judgment in Madgett and Baldwin. The apportionment should not distort the value of the non-TOMS supply. It is however clear that the liability under differing methods does not have to be identical, see paragraph 24 of My Travel.

Much of the complaint of the Appellant in the present case arises from the complexity of the calculations required for a costs based apportionment and on the higher VAT due as compared with the basis used by the Appellant. That complexity was a major cause of the delay in giving this decision, see paragraph 91 below. It is however now apparent from paragraph 39 in My Travel that Article 26 is not intended to simplify accounting requirements and may require "fairly technical apportionments of … package prices."

No evidence has been produced as to whether the in-house elements can be properly identified on the basis of their market value. Customs did not invite such approach no doubt because it would be contrary to the TOMS leaflet. The Appellants did not pursue it because it appears that it would produce a higher VAT liability.

On issue (a) at paragraph 8 we conclude that Customs were not entitled under Community law to require a cost based apportionment, there being no evidence that a market value apportionment was not possible. The judgment in My Travel stated that the Appellant only had a very limited right to use a cost apportionment. There is no suggestion that Customs were entitled to impose such a basis.

We now turn to consider issue (b), whether on the basis of the Court's replies the market value of the in-house element of the package can only be identified by reference to market value of similar services. This is only relevant to this appeal if we are incorrect on issue (a).

As a concept such a method of apportionment is unusual and was not suggested by either party in the earlier hearings before the Tribunal. The word "deduction" was not used by the Court in its decision, however the Court did refer in paragraph 45 to paragraph 76 of the opinion of the Advocate-General where he proposed the deduction of the market value of the in-house services in order to obtain the value of the bought-in services, stating that such method had been suggested by the taxpayer and the Commission. This appears to have been a misunderstanding since the Commission referred to a fair apportionment at paragraph 16 of its written submission rather than to a deduction and the Appellant opposed such a method.

Apportionment on a normal market value basis involves valuing all elements of a package and the decision of the Court contains no reference whatsoever to the market value of the bought-in element, namely the coach services. Furthermore in My Travel the Court referred only to the market value of the in-house element.

The actual words of the reply in Madgett and Baldwin are of course central. In the last sentence of paragraph 2, the phrase "that part of the package" clearly refer back to the part corresponding to the in-house services. It is less clear to what the words "services similar to those which form part of the package" refer. If the Court envisaged apportionment by reference to all the components of the package, then the words "part of" appear to be unnecessary. On the other hand, if the Court envisaged looking only at the in-house element, we would have expected the word "that" to appear before "part of the package" as it does in the line before. After considerable hesitation we incline to the view that, in the context of the whole decision and in particular the references to the Advocate-General's opinion, the Court did envisage, as the alternative, the valuation of the consideration of the in-house element solely by reference to the value of services similar to that element and did not refer to a market value apportionment taking account also of the value of the bought-in element. We accept Mr Woolf's observation that such a deduction exercise is arbitrary: we would normally expect the profit-margin on a package to be lower than that on independent sales. It is however clear from the judgment in Madgett and Baldwin and that in My Travel at paragraph 41 that the exercise does involve ascertaining the market value of the in-house services. Paragraphs 42 to 44 of My Travel are solely directed at ascertaining the market value of in-house services. The answer to issue (b) at paragraph 8 is therefore "Yes."

The ultra vires issue

The next issue, issue (c), is whether in prescribing the compulsory use of the cost method when apportioning part of the package consideration to the in-house supply, which is not a designated travel service, the Leaflet was ultra vires the powers conferred on the Commissioners by article 7 of the Value Added Tax (Tour Operators) Order 1987 (1987 S.I. No.1806). Article 7 provides as follows:

"… the value of a designated travel service shall be determined by reference to the difference between sums paid or payable to and sums paid or payable by

the tour operator in respect of that service, calculated in such manner as the

Commissioners of Customs and Excise shall specify."

We now consider that issue in the light of the decision of the Court of Justice in Madgett and Baldwin that Article 26 of the Sixth Directive authorises member states to require an actual costs apportionment only where the market value alternative is not possible, and the further decision in My Travel that the in-house element must in principle be based on the market value of corresponding in-house services where that value can be established, unless the trader can prove that for the period in question a cost apportionment accurately reflects the actual structure of the package, see paragraph 35 of My Travel.

In paragraphs 73 to 77 of our earlier decision (No.14757) we concluded that, as a matter of purely domestic law, the Appellant would succeed. All that article 7 empowered the Commissioners to do was to specify how the margin on the designated travel services (or bought-in supplies) should be calculated; it did not provide for them to specify how the sums paid to the tour operator for the in-house supplies should be calculated. We concluded, however, that since national legislation should be interpreted in the light of the Community legislation, power to specify a cost-based apportionment for determining the consideration attributable to in-house supplies should be implied in article 7 of the Order if Article 26 of the Sixth Directive provides for such apportionment.

Mr Paines submitted that paragraph 76 of our 1997 decision was not correct and that the TOMS Leaflet method was within article 7 of the 1987 Order without the need to refer to Article 26. He said that any method of calculating the difference between the sums paid to and those paid by a tour operator for bought-in services necessarily involves identifying the in-house element of the total package price. Here there was a mixed supply for a single consideration, so that apportionment was necessary. Section 10(4) of the VAT Act 1983 (section 19(4) of the 1994 Act) merely provided for the consideration for part to be "such part of the consideration as is properly attributable to it." He said that the consideration could only be properly attributable on a market value basis if Article 26, as interpreted by the Court of Justice, permitted it. He said that at paragraph 42 the Court said that a unit of reference was necessary to identify the consideration for the in-house services and that it went on at paragraph 46 to authorise a requirement for a cost based apportionment in the generality of cases in order to determine the in-house element. He said that accordingly article 7 of the 1986 Order should be interpreted consistently with Community Law as permitting the Commissioners to specify the method of valuing the in-house services since this was necessary by reason of paragraph 42 and that the reply provided for the requirement of a cost-based method.

Mr Woolf said that there was nothing in the decision of the Court of Justice precluding the Appellant from apportioning in accordance with section 10(4). It would be surprising if the proper attribution of a mixed supply was altered by the fact that part of the supply was subject to TOMS. He said that the costs basis under the Leaflet, with different costs for in-house and bought-in supplies, was not rational since there should be the same basis for both elements. While the United Kingdom may have been authorised to use a cost basis of apportionment, it was not required to do so by Article 26. Clearly where a market value basis is not possible, a cost basis must be used, but that is the position under section 10(4).

Conclusions as to vires

At paragraph 34 of its Decision in Madgett and Baldwin the Court of Justice said that the scheme under Article 26 is an exception to the normal rules which must be applied only to the extent necessary to achieve its objective. From this it seems to follow that the consideration for the in-house supply should not be substantially altered by the fact that it is part of a package which contains a TOMS element. Any substantially different result will produce a distortion which the scheme of VAT is designed to avoid. However the result does not have to be identical, see My Travel.

It is implicit in the scheme of the Directive that where there is a single consideration for a mixed supply a method must be found of apportioning the consideration on a logical and consistent basis. This is the case with any mixed supply part of which is exempt or zero-rated. At paragraph 42 of Madgett and Baldwin the Court of Justice said that it is necessary to determine a unit of reference to be used as an alternative to the consideration to identify the in-house element. In general the consideration for a supply is determined on a subjective rather than objective basis, see Naturally Yours Cosmetics Ltd v Customs and Excise Commissioners (Case 230/87) [1988] STC 879 at paragraph 16.

However, while in order to determine the consideration attributable to the in-house element a unit of reference is required, in the light of the answers of the Court of Justice in both Madgett and Baldwin and My Travel it is now clear that a cost apportionment may not be required where the market value of similar services can be established and that a cost apportionment may not be used unless it is shown that it accurately reflects the actual structure of the package.

It was expressly stated in the reply of the Court of Justice in Madgett and Baldwin that a trader "may not be required" to use the actual cost method where the in-house element of the package can be identified on the basis of the market value of similar services. The Leaflet made no exception to the requirement for a cost based apportionment. In My Travel the Court stated that the in-house element must in principle be identified on the basis of the market value of similar services where this is possible. Again the Leaflet conflicted with this.

The requirement in the Leaflet to identify the in-house element of the consideration for the package by a cost apportionment was in our judgment contrary to Article 26 as interpreted by the Court of Justice. It was not authorised by the express terms of the 1987 Order. The 1987 Order cannot be interpreted as impliedly permitting such requirement under Community Law because this would be contrary to Article 26. The result is that the requirement for a costs apportionment was ultra vires the 1987 Order and the Commissioners failed to specify any manner of calculating the margin under Article 7. The consequence of this is that although the margin on bought-in supplies is taxed under the 1987 Order the apportionment of the package price between in-house and bought-in supplies falls to be made on normal principles. The apportionment by the Appellants under Method 2 in Appendix H was only challenged on the basis that it conflicted with the TOMS Leaflet.

It is now necessary to consider what is the result of the conclusion that the mandatory costs apportionment under the TOMS Leaflet was contrary to EU law and was outside the powers of the Commissioners under article 7 of the 1987 Order.

It might be open to the Appellant to rely on the direct effect of the interpretation by the Court of Justice of Article 26, although it is not clear whether the provisions of Article 26 are sufficiently precise, see Becker v Finanzamt Münster-Innenstadt (Case 8/81) [1982] ECR 53. However the Appellant does not wish to rely on direct effect since it does not wish to identify the consideration attributable to the in-house element by reference to the market value of supplies to its non-package customers.

It is clear beyond argument that it is not open to Customs to rely on the Directive against the Appellant in circumstances where the United Kingdom has failed to implement the Directive correctly, see Marshall v Southampton and South-West Hampshire AHA (Case 152/84) [1986] ECR 723.

The question then arises as to the validity of an assessment made on a basis which is contrary to European Union law and is ultra vires UK Law. If the Tribunal merely applies what the law ought to have been, this would be contrary to the principle in Marshall. On the authority of the recent decision of the Court of Appeal in Pegasus Birds Ltd it is not open to the Tribunal to find that the assessment was not made to best judgment since there is no suggestion that the assessing officer did not make an honest and genuine attempt to assess the tax due on the basis of the TOMS Leaflet. In any event the requirement for best judgment is not directed at whether the law has been correctly understood and applied.

In our judgment all the Tribunal can do is to consider the assessment without regard to the requirements in the TOMS Leaflet.

The Tribunal hearing before Mr Horsfield in 1995 was conducted on the footing that if the Appellants were not tour operators they would succeed and on this basis the Tribunal allowed the appeal. The appeal to the High Court was confined to the tour operator issue, see [1996] STC 167 at 169a. It is clear it was not contended that, apart from the requirement for a cost apportionment under the TOMS Leaflet, the use by the Appellant of Method 2 in Appendix H to the VAT Guide (now Notice 700 para. 32.2.3) was not legitimate. If the apportionment under Method 2 had been in issue, the conclusion by the Tribunal that the Appellant was not a tour operator would not have decided the appeal. In those circumstances the conclusion that the requirement under TOMS Leaflet for a cost apportionment was ultra vires must result in the appeal being allowed and the assessments being reduced to nil.

In-house costs if Leaflet was not ultra vires

In case our conclusions under paragraphs 57 and 71 to 76 are wrong, we turn to consider the dispute between the parties as to the in-house costs under the Leaflet. The higher these costs are, the higher the attribution to standard-rated supplies. These costs, which are item D in paragraph 20 above, are already sharply lower than those used for the original assessment.

Customs have informed the Tribunal that they will accept the figures in the third column of paragraph 20. This does not however resolve all issues on cost apportionment since the Appellants contend that the cost of depreciation, insurance, rates, entertainment and repairs and renewals should be excluded from the calculation.

Leaflet 709/5/88, contained surprisingly few direct references to costs or purchases. Paragraph 6 after setting out bought-in supplies covered by the scheme stated this:

"These items are regarded as your overheads and not covered by the scheme:

(a) minor items that you buy in, such as travel bags to give to customers;

(b) items such as the cost of printing brochures, the cost of advertising; and

(c) the cost of hiring or employing representatives at airports or resorts."

Paragraph 11 included the following:

"You cannot reclaim as input tax any VAT on purchases that you make to resell as margin scheme supplies …

You can reclaim as input tax UK VAT you incur on your overheads (paragraph 6) and purchases that you make for the purpose of your in-house supplies (paragraph 8)."

Paragraph 18 started as follows:

"The cost to you of your purchases for resale as margin scheme supplies is the price that you pay for them after the deduction of any quantity or other discounts or price reductions."

Part I specified the final annual calculation and adjustment. It stated at the top in capital letters:

"YOU MUST USE THE ACTUAL FIGURES FROM YOUR FINANCIAL ACCOUNTS FOR THE YEAR JUST ENDED."

The relevant parts for this appeal were Steps A, C and D. Step A was the selling prices of all supplies in the year containing margin scheme supplies. Step C was "the cost of your zero-rated margin scheme supplies …" Step D was "the cost to you of any UK in-house standard-rated supplies …" excluding VAT if recoverable but adding 15% (the VAT rate at that time) to the total. These were the basic components for the calculations by Mr Skilling at paragraph 20 above. The other steps followed from them arithmetically.