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Lime Avenue Sales and Services Ltd Benenden School Trust v Revenue & Customs [2007] UKVAT V20140 (03 May 2007)

20140

INPUT TAX – Abusive practice – Transactions effected with essential aim of attaining relief for input tax – School making exempt supplies – School wanting new study centre – School enters into scheme with school shop company and the School's charitable trust to enable recovery of input tax for construction costs of study centre – Whether Halifax principles preventing abusive practices and redefining taxable transactions are applicable – Yes – EC Council Directive 77/388 Art 17

LONDON TRIBUNAL CENTRE

LIME AVENUE SALES AND SERVICES LIMITED 1st Appellant

BENENDEN SCHOOL TRUST 2nd Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: SIR STEPHEN OLIVER QC (Chairman)

LYNNETH SALISBURY

Sitting in public in London on 27-30 March 2007

Michael Sherry, counsel, instructed by Steve Hodgetts of Baker Tilly, accountants, for the Appellants

Nigel Pleming QC and Adam Robb, counsel, instructed by the general counsel and solicitor to the Commissioners, for the Respondents

© CROWN COPYRIGHT 2007

DECISION

In the first appeal Lime Avenue Sales & Services Ltd ("LASS"), a company wholly owned by Benenden School (Kent) Ltd ("the School"), appeals against the refusal by the Respondents ("Customs") of LASS's claims to recover as input tax the VAT incurred in the periods 08/00 to 02/02 on the construction of a study centre at the School.

In the second appeal Benenden School Trust ("the Trust") appeals against the refusal by Customs to allow the Trust to deduct the tax purportedly charged by LASS on an invoice issued to the Trust dated 13 February 2002 and said to relate to the supply of land and buildings to the Trust.

Background to LASS's appeal : the "Initial Arrangements"

The School needed a new study centre. It already owned the land on which the study centre was to be built. Its predominantly educational supplies are VAT exempt.

LASS had been running the school shop. At all material times it had been registered for VAT.

LASS bought the land on which the study centre (referred to from now on as "Study Centre North") was to be built from the School on 13 February 2001 for £50,000; the transfer also contained a right of repurchase granted to the School. Eight months earlier LASS had contracted with builders and professionals for construction work in the sum of £2,193,866 and for the creation of an access road in a further sum.

The intention was that LASS should sell the land with the completed Study Centre North back to the School for an amount (undetermined at the relevant time) payable by annual instalments.

The Trust agreed to lend some £3 million to LASS (by two loans) to fund the costs of constructing Study Centre North. The first of the loans was secured by a debenture of 2 February 2001.

LASS was duly charged VAT on the building costs and on the fees of the professionals. LASS's expectation, based on VAT advice, had been that it would be able to treat the VAT on the construction and the related professionals' costs as recoverable input tax, repayable to it following presentation of its quarterly returns. By about August 2001 it had become apparent that the Customs would refuse LASS's claims in its quarterly returns on the basis of the emerging Halifax principles. The claims were formally refused by letter of 17 May 2002. The VAT analysis of the claims, so Customs contend, is that they are made in abuse of the right to claim relief for input tax. LASS, they say, is to be treated as if it had neither made nor received any supplies in relation to the construction of the study centre; its VAT returns should not have included any claims for VAT in respect of transactions relating to that project. Properly "redefined", the School is to be treated as having received all the supplies of construction services for use in making the predominantly exempt supplies of education.

The transactions and matters summarised so far are referred to as "the Initial Arrangements".

Background to the Trust's appeal : the "Further Arrangements"

By a transfer agreement of 31 January 2002, LASS agreed to sell the now completed Study Centre North to the Trust for a sum of £2,850,000. The School waived its repurchase rights on the terms that the Trust should give it a similar right.

The Trust, by agreement of 1 February 2002, leased Study Centre North for an "initial rent" of £5,000 to the School. The Trust elected to waive exemption in respect of the land and applied to register itself for VAT on 17 February 2002.

LASS purported to charge VAT on the sale of the Study Centre North to the Trust. The Trust sought to deduct the VAT as recoverable input tax. The Trust charged VAT on the rental charged to the School.

The transactions summarised in paragraphs 10 to 12 are referred to as "the Further Arrangements".

Customs say of the Further Arrangements that, properly regarded in the light of the Halifax decision, LASS's transfer to the Trust and a lease back to the School were not supplies made in the course of any business. Consequently LASS should not have charged output VAT on the transfer and, as a result, there was no corresponding input tax for the Trust to deduct. The "basic economic position" (say Customs in their decision letter of 17 May 2002) is "that the School was always to occupy the study centre once constructed and was always to have the benefit of the construction works".

The parties and the individuals involved

By way of introduction, substantially all the School's supplies are, and have been, exempt supplies. Thus, were the School to have built its own study centre or library for use in its own non-taxable educational business, it would be the end consumer. The VAT on the supplies to it of the construction services and goods relating to the study centre or library would be irrecoverable.

All the relevant facts and circumstances of this appeal stem from the School's VAT status as a provider of exempt supplies and the steps taken to overcome the irrecoverability of the VAT on the construction costs. Evidence of these came partly from documents supplied by the School and its professional advisers and partly from oral evidence. The witnesses were:

(i) Mr James Sanger FCA. He was a member of the Governing Council of the School and the governor responsible for its finances since 1975. He was chairman and director of LASS since it started business in 1984 and he was a trustee of the Trust since 1983.

(ii) Mr Michael Coates FRICS was a member of the Governing Council of the School since 1981. At the material time he was vice-chairman of the Council and chairman of its building committee.

(iii) Mr Charles A A Covell, currently Executive Vice President of City group, became a trustee of the Trust in March 2000 and chairman of the Trust in September 2001.

(iv) Mr Robin Dalton Holmes was School Bursar of the School from 1983 until 2003. At the material times he was a director of LASS.

(v) Mr Steve Hodgetts is a partner in Baker Tilly, accountants. He had joined HLB Kidsons, a predecessor firm, in 1988 and become a partner in 1998. Prior to that he had been an officer of the Customs.

(vi) Mr Gavin Acheson, a member of Farrer & Co LLP solicitors and a partner at the material time, gave evidence as to the intended contents of the lease granted by the Trust to the School on 1 February 2002. The parties had, he said (and this was not disputed by Customs), agreed the inclusion of a rent review clause that had been omitted from the document; he accepted that the rent review machinery did not have to be activated and, if activated, the rent did not have to be increased to the open market rent.

The School

The School, a boarding school for girls, has been long established and run from premises at Benenden near Cranbrook in Kent. The School and its premises (with the principal exception of the study centre to which this appeal relates) are owned by Benenden School (Kent) Ltd, a charitable company. We refer to the School and Benenden School (Kent) as "the School".

LASS

LASS was incorporated in 1984. All its shares were first registered in the School's name in July 2000. Its principal activities have been to operate as a school shop, selling uniforms, books, stationery and personal items. At one stage LASS registered as a distributor of fuel. To mitigate VAT, LASS made prepayments for fuel supplies which were then on-supplied to the School and to some other occupants of the School premises.

The Trust

This was incorporated as a charitable company limited by guarantee in 1983. Fundraising has been a substantial part of its activity. It was registered for VAT with effect from 31 January 2002. Its application for registration had, we were told, described its business as property ownership and rental.

The statutory framework and its application to the transactions in the Initial Arrangements and the Further Arrangements (as sought by the Appellants)

The alleged abuse concerns the steps taken to recover the input tax incurred on the construction costs and on the supply by LASS to the Trust of Study Centre North.

We start with the relevant statute law and its prima facie application to the transactions. We will then set out the relevant passages from the judgment of the European Court of Justice in Halifax (Case C-255/02) [2006] STC 919 explaining how the Customs see them as applying to those transactions.

Entitlement to credit for input tax, in domestic law, is given by sections 25 and 26 of VAT Act 1994 and by Part XIV of the VAT General Regulations. Section 25(1) requires taxable persons to account for and pay VAT in respect of supplies made by them by reference to prescribed accounting periods. Section 25(2) entitles the taxable person on making a claim "at the end of each prescribed accounting period" to credit for so much of his input tax as is allowable under section 26 and then to deduct that amount from any output tax that is due from him. If the credit exceeds the output tax the balance due to the taxable person is known as a "VAT credit".

By section 26(1) –

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

Section 26(2), so far as is relevant, reads:

"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;"

Article 17(1) provides:

"The right to deduct tax shall rise at the time when the deductible tax becomes chargeable."

Article 17(2), so far as is relevant, provides:

"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 … in respect of goods or services supplied or to be supplied to him by another taxable person;"

LASS duly made returns for the periods 08/00 to 02/02 claiming repayment of input tax. The input tax in question was the VAT charged to it on the construction services in respect of Study Centre North. The Customs, in paragraph 17 of their decision letter, stated as their understanding of the Initial Arrangements that:

"The intention was that LASS would account for VAT on an initial amount of £1,000 to be paid by the School on completion of the repurchase agreement. If any further payments were made to LASS within three years of completion, these would be subject to VAT. All amounts paid up after that time would be exempt from VAT."

The funding arrangements, i.e. the loans from the Trust (and from another School-related trust) were treated as exempt from VAT (or outside its scope) and no VAT was charged or recoverable in respect of those transactions.

The sale of the completed Study Centre North by LASS to the Trust for £2,850,000. i.e. the first step in the Further Arrangements, was treated by LASS as a taxable supply. LASS declared output tax on that amount for the VAT period 02/02. The tax charged by LASS on the sale was treated by the Trust as input tax, the Trust having:

(i) claimed VAT registration with effect from 31 January 2002 and

(ii) elected to waive exemption on the property comprised in Study Centre North.

The Trust charged (or intended to charge) VAT on the balance of £5,000 a year rental payments under the lease to the School.

The Halifax decision

The Court (in paragraphs 67-86) starts with a summary of the developing EC principle of "prohibiting abusive practices" and goes on to state that the principle "also applies in the sphere of VAT". There then follow the conditions that have to be present if, in a tax-related context, the abuse principle is to operate. These are:

"74. In view of the foregoing considerations, it would appear that, in the sphere of VAT, an abusive practice can be found to exist only if, first, the transactions concerned, notwithstanding formal application of the conditions laid down by the relevant provisions of the Sixth Directive and the national legislation transposing it, result in the accrual of a tax advantage the grant of which would be contrary to the purpose of those provisions.

Second, it must also be apparent from a number of objective factors that the essential aim of the transactions concerned is to obtain a tax advantage. As the Advocate General observed in paragraph 89 of his opinion, the prohibition of abuse is not relevant where the economic activity carried on may have some explanation other than the mere attainment of tax advantages."

Paragraph 76 applies to both those conditions. It provides:

"76. It is for the national court to verify in accordance with the rules of evidence of national law, provided that the effectiveness of Community law is not undermined, whether action constituting such an abusive practice has taken place in the case before it … ."

Paragraph 80 interprets the first condition set out in paragraph 74 as follows:

"80. To allow taxable persons to deduct all input tax even though, in the context of their normal commercial transactions, no transactions conforming with the deduction rules of the Sixth Directive or of national legislation transposing it would have enabled them to deduct such VAT, or would have allowed them to deduct only a part, would be contrary to the principle of fiscal neutrality and, therefore, contrary to the purpose of those rules."

Applied to the present circumstances, paragraphs 74 and 80 require us, the national court, to determine whether, in the context of their normal commercial operations, the School, LASS or the Trust would have been entitled to deduct the VAT charged in respect of the construction services required to build the study centre. If in the course of their normal commercial operations any of those three entities would have been entitled to deduct that VAT, then the "tax advantage" resulting from the recovery of the VAT charged on the construction costs will not have been contrary to the purpose of the relevant statutory provisions. Paragraph 80 has a relevance to the second condition (in paragraph 75) as well. Transactions carried out in the course of normal commercial transactions are unlikely to have tax advantages as their essential aims.

Paragraph 81 is specifically directed at the second condition set out in paragraph 75:

"81. As regards the second element, whereby the transactions concerned must essentially seek to obtain a tax advantage, it must be borne in mind that it is the responsibility of the national court to determine the real substance and significance of the transactions concerned. In so doing, it may take account of the purely artificial nature of those transactions and the links of a legal, economic and/or personal nature between the operators involved in the scheme for reduction of the tax burden …"

The message here is to see who are behind the transactions relied upon and to identify the artificiality (if any) resulting from their "links". Look behind those and determine the real substance of the transactions involved. So determined, ask whether the essential aim was a tax advantage.

Tax avoidance measures, whether statutory or judge-made, that require actual transactions to be disregarded can only be effective if those measures provide the means of identifying the "real" transactions that fall properly to be taxed. In paragraphs 94 to 97 the Court has done this by requiring an exercise of "redefinition". These read:

"94. It follows that transactions involved in an abusive practice must be redefined so as to re-establish the situation that would have prevailed in the absence of the transactions constituting that abusive practice.

In that regard, the tax authorities are entitled to demand, with retroactive effect, repayment of the amount deducted in relation to each transaction whenever they find that the right to deduct has been exercised abusively … .

However, they must also subtract therefrom any tax charged on an output transaction for which the taxable person was artificially liable under the scheme for reduction of the tax burden and, if appropriate, they must reimburse any excess.

Similarly, it must allow a taxable person who, in the absence of transactions constituting an abusive practice, would have benefited from the first transaction not constituting such a practice, to deduct, under the deduction rules of the Sixth Directive, the VAT on that input transaction."

Our task, as the national court, is therefore to identify the situation that would have prevailed in the absence of the transactions constituting the abusive practice.

The redefinition adopted by Customs

The Customs' attack on the transactions is accompanied by their redefinitions, also contained in their decision letter of 17 May 2002. (The letter was written long before the proceedings in Halifax in the ECJ, but the decision reached by either the route taken by the Tribunal in Halifax or the abuse route produces the same result.) The Customs' decision is based on the following:

(i) LASS's acquisition of the site for the study centre from the School and its intended resale to the School were not supplies made in the course of any business;

(ii) the supplies of construction and professional services in the course of the erection of the study centre were "supplies made to the School and not to LASS";

(iii) when LASS transferred the study centre to the Trust on 31 January 2002 it should not have charged VAT and, to the extent that LASS has accounted to the Customs for that tax as output tax, it should make a recovery claim under section 80;

(iv) the Trust should not deduct VAT in respect of the purchase of the study centre from LASS and

(v) the Trust should not charge VAT on rentals under the lease to the School.

The case for the Customs based on the Halifax "abuse" principle is that LASS and the transactions to which it was a party were introduced into the contractual route solely for the purposes of an attempt to prevent the School from incurring irrecoverable VAT in relation to the construction costs of the study centre. Properly redefined, the Customs say, the construction services were supplied to the School. The Further Arrangements constituted an abusive practice and, properly redefined, required the Trust's acquisition of the study centre and its onward letting to the School to be ignored for VAT purposes. Moreover, even without the application of the abuse principles, the decision of the High Court in Yarburgh v Commissioners of Customs and Excise means that the lease of Study Centre North to the School was not an economic activity; consequently the Trust had no basis for claiming back the VAT charged (absent the applications of the Halifax principle) by LASS on the transfer of 31 January 2002.

The Appellants' arguments

The case for the Appellants (i.e. LASS and the Trust) is, as we understand it, that the Halifax principle applies only to actual transactions. There were none until the Further Arrangements when LASS made a relevant supply (i.e. the sale to the Trust). The Initial Arrangements should therefore be ignored in determining the application of the Halifax principle. By contrast the transactions comprised in the Further Arrangements were actual transactions. The Halifax principle had no effect in relation to the Further Arrangements because LASS's sale of the study centre, i.e. the first of the actual transactions, had been forced on it by commercial exigencies. Those exigencies were the prospect of insolvency faced by LASS and its directors following the refusal by the Customs to repay the VAT charged on the construction services and claimed in LASS's returns for the periods from 08/00 onwards. From the Trust's point of view, its acquisition of and the letting of Study Centre North to the School had been carried out because, by reason of the Customs' refusal to pay the VAT claimed by LASS, the Trust's right to repayment of its loan to LASS was endangered. Consequently, by taking transfer of the study centre in satisfaction of the loan and letting it to the School, LASS was extricating itself from a state of potential insolvency and the Trust was transposing a dubious loan into a secure investment.

The case for LASS and the Trust is that any tax advantage sought from the transactions is not contrary to the relevant legal provisions; thus the first condition for application of the Halifax principle is not present. The overall result of the transactions is for the School to be in occupation of the study centre. Had the School purchased Study Centre North, or contracted directly for its construction, it would have suffered irrecoverable input tax on the whole of the consideration. Instead, it leases the study centre and suffers irrecoverable input tax on the rent it pays. It is submitted that this involves no abuse; rather, it is entirely consistent with the aims and results pursued by the legal provisions in question. Reliance was placed on a decision of the VAT and Duties Tribunal in Weald Leasing Ltd v Revenue and Customs (2007) VAT Dec 20003.

The Trust contend that although the initial rent under the lease of the study centre to the School was small, the Trust had no financing costs and it had the right to activate the rent review machinery; the letting should therefore be regarded as an economic activity of the Trust and as being pursued in the course of a business.

Finally, it was argued for LASS and the Trust that the present circumstances are distinguishable from those in Halifax in two specific respects. It was said, first, that in the present case (unlike in Halifax) the funds for the development were not provided by the ultimate user of the building but by the Trust: and, second, that in the present case (unlike in Halifax) the end position was that the ultimate user occupied the building as tenant under a lease rather than as outright owner of the land.

We will deal with each of those arguments separately and, when doing so, we will summarise the responses made by Customs.

The Initial Arrangements

The issues of fact arise from Customs' contention that the essential aim of the transactions concerned was to secure the tax advantage of obtaining recovery of tax on the construction costs. The Appellants did not deny that tax considerations were present. But their evidence was directed at showing commercial reasons of sufficient significance to displace tax avoidance as the essential aim. In the light of that evidence we have to determine whether commercial reasons existed for making LASS the developer rather than the School. And we have to determine whether, as alleged by the Appellants, "commercial exigencies dictated the transfer of Study Centre North from LASS to the Trust". If those commercial reasons are found to exist we then need to determine whether they were of sufficient significance.

We approach the fact finding exercise by first (in paragraphs 40 to 48) looking at the genesis of the Initial Arrangements and at how they were implemented. In paragraphs 49-51 we summarise Customs' reaction to LASS's claims for relief for tax incurred on the construction costs. We then examine the oral evidence relating to the choice of LASS as the developer.

The origins of the Initial Arrangements

For some years the School had been planning to build a study centre. Over the period 1999 to 2002 the School, in association with LASS and the Trust, received four proposals for schemes designed to enable the recovery of input tax of some £500,000 on construction and professional services to be used in the construction of what became known as Phase I of Study Centre North. The third and fourth proposals were actually implemented and comprised the Initial Arrangements and the Further Arrangements. We are concerned at this stage with the Initial Arrangements. The starting point was, as already noted, that the School was making wholly (or substantially wholly) exempt supplies and so would have been unable to recover input tax if it had carried out the construction work itself.

The first proposal (produced following advice from Kidsons, accountants) involved the School carrying out the development having first leased the site to LASS and obtained an occupational lease-back (to the School). The VAT effect (as the law then stood) would have been for the School to recover the VAT charged on the construction works. The first and subsequent proposals included a "library scheme" that appears to have involved a separate company taking over the library assets from the School and providing them back, as zero-rated supplies, to the School.

The first proposal was abandoned because of changes to VAT announced in the 1999 Budget speech. But before then, on 24 February 1999, the Council Members of the School (that included Mr Sanger who, according to a School Building Committee Minute of a meeting of 19 February 1999, had been "closely involved" in the so-called "VAT deferment" exercise with Kidsons) had resolved that the School should grant the relevant leases to LASS and accept the leases back and should register for VAT. For reasons that will become apparent, we note that there is no evidence of any concerns as to the suitability of the School as the developer of the Study Centre North.

In March 1999 the building project was revised. The school shop, run at all times by LASS and which had been in Phase 1 of the Study Centre North project, was moved to Phase 2. This left LASS's only involvement in Phase 1 as (i) the holder of the head-lease from the School and as landlord under the lease-back to the School and (ii) the library operator for purposes of the library scheme.

By 16 June 1999 Kidsons had made the second proposal to the School. This as we understand it, involved the School carrying out the construction works and recovering the input tax on the sale of the new building to LASS; LASS would then lease back the non-library area to the School. On 17 February 2000 a meeting of the School Council (attended by Mr Sanger among others) took place and the Council decided to implement the second proposal by making a further application to be registered for VAT and authorising the professionals (architects and quantity surveyors) to send out the invitations to tender.

The Initial Arrangements are planned

We come now to the "Initial Arrangements" themselves. The third proposal, which became the Initial Arrangements, involved LASS acting as the developer. It was devised and proposed by Kidsons in a letter of 27 March 2000 to Mr Dalton Holmes, the Bursar. A letter from Kidsons to Mr Dalton Holmes of 13 June 2000 amplifying the proposal contains the following passage:

"I understand the contract has not yet been placed for Phase 1 of the development. In view of this, we have some flexibility prior to implementation of the optimum scenario. I have two similar cases with Customs and although many questions have been asked Customs have either confirmed or denied their approach to such arrangements. I believe they accept from a technical perspective the arrangements are sound but they would clearly like to block the arrangements on the basis of artificiality and the transactions have no other purpose than to mitigate tax. This is extremely difficult for them to enforce from a VAT perspective because a single transaction in a chain of transactions cannot be disregarded. Nevertheless, I would obviously want to suggest commercial reasons for structuring the arrangements in a particular way.

In addition to the above, we must balance the likely resistance/requirements of the Charity Commissioners and we must consider possible exit arrangements that will include the future funding of LASS.

We should perhaps also consider the merits of the School transferring the freehold of the bare land to LASS in order to allow LASS to construct the buildings as mentioned in my previous letter. LASS could then sell the freehold of the completed building back to the School at some future point.

The benefits of such an arrangement appear to be as follows:

There is a clear exit arrangement in that the School eventually ends up with the freehold interest in the areas of the building which it will occupy.

It would remove some of the funding difficulties because the School will in due course make payments to LASS for the purchase of the freehold.

The Charity Commissioners may be happier with it."

We will return shortly to Kidsons's wish "to suggest commercial reasons".

The next day (14 June 2000) Mr Dalton Holmes contacted Farrers. The School had to tell the contractors within a few days who the client was to be. On 15 June the School Council met and resolved to place the order for construction of Study Centre North with Bensons Ltd, builders. Four members of the Council, including Messrs Coates, Sanger and Dalton Holmes, were delegated to resolve whether the School or LASS should be the developer.

LASS becomes the developer

On 8 July 2000, meetings of the School Council, of the Trustees and of the Board of LASS took place at which:

(i) the Council resolved that LASS should construct the study centre and that the School should undertake to LASS to "underwrite" its "financial status";

(ii) the Trust agreed to lend £1m to LASS and

(iii) the directors of LASS resolved "to accept the informal invitation of the School to enter into contract with Bensons.

A communication from the School to LASS followed on 10 July 2000. This recorded the "undertaking" that LASS was to receive £2.25 million from the Trust and from another School-related Trust "together with any further proceeds of the current capital appeal by the Trust". The document went on to say:

"The School undertakes that in the event of any financial shortfall owing to inadequacy of funds, either temporarily or permanently in respect of this project, the School will underwrite the financial position of its subsidiary LASS Ltd by making such funds available as may from time to time guarantee any borrowing by LASS Ltd for this project."

The next day a letter from LASS to Bensons informed Bensons of the undertaking as follows:

"[LASS] has been trading as a VAT registered concern for over 16 years and the School will underwrite its financial position.

The Benenden School Trust will channel all money raised or gifted to it for its appeal to LASS, and by December 2000 this will be well in excess of £2¼ million so that finance is in any case securely in place without any need for bank borrowing."

On 27 July 2000 LASS gave the architect and quantity surveyors similar letters of comfort. On that basis LASS became the developer.

On 19 July 2000 Kidsons wrote to the School recording that under the earlier proposals it would have been necessary, for VAT reasons, for the School to have sold the Study Centre North to LASS within three years of completion. The advice went on to say that "if LASS constructed the building VAT recovery can be improved significantly by spreading the sale of the freehold over say twenty-five years" with the School being given the opportunity to compound and pay full value at that time. On 28 July 2000 Mr Dalton Holmes notified Kidsons that steps had been taken to "enhance" LASS's Board (by appointing Mr Coates, Mr C J Driver (ex headmaster of Wellington) and Mr Jonathan Strang (a chartered surveyor) to the Board).

Customs' reaction to LASS's claims for repayment of tax and LASS's initial response

The first period for which LASS was to claim relief for input tax on the construction costs for the Study Centre North was 08/00. Kidsons had written to Farrers on 25 August 2000 and Farrers responded on 31 August as follows:

"You say … that you plan to make Customs aware at an early stage of the sale back by LASS entering into a contract for the sale of the freehold of the non-library area to the School. I suspect that if this contract is signed at the same time as the transfer of the site from the School to LASS the doctrine of Furniss v Dawson might apply

LASS, through Kidsons, wrote to Customs on 19 December 2000 stating their intention that LASS was to contract to sell the new building to the School; payment was to be made annually "by reference to the current market value of the building over a ten-year period". Customs wrote back on 8 January 2001 setting up a visit.

A meeting between Customs and Kidsons took place on 9 March 2001. By then the Tribunal's decision in Halifax had been released. A letter from Customs records that, while there was no contract yet in existence for the sale of the new building by LASS to the School, the stated intention was for the sale to be effected by an initial payment of £1,000 plus VAT, with the balance being payable over a ten-year period. Customs asked for an explanation of the "business purpose as regards LASS". This was followed up by a letter of 23 March 2001 from Customs seeking information and documents and asking "what the purpose of entering into these arrangements was, supported by relevant contemporaneous documents".

Correspondence and meetings between the School and its professional advisers then took place. On 22 May 2001 Kidson's response to the Customs explained the longstanding trading character of LASS and the fact that it was incurring a risk in its purchase, construction and lease-back arrangements with the School. The letter stressed that:

"Property development will not advance the education of girls, only the finished facilities. It is considered more appropriate for LASS to take the risks of development".

Customs were not apparently convinced. A full letter dated 18 July 2001 from Customs to Kidsons explained why, in Customs' view, the present case could not be distinguished from the circumstances of Halifax. The letter went on to request documents and information falling into six classes. The letter stressed that the documents requested were not limited to letters from Kidsons. Internal memoranda between offices of the School and LASS were said to fall within the request as were documents produced by external advisers.

Appellants' oral evidence as to choice of LASS as the developer

Why was LASS made the developer and funded by the Trust? It will be recalled that from 1998 up until mid-2000, it was intended that the School would be the developer and would enter into the building contract with the building company. Indeed, the first occasion on which it was suggested that LASS might act as developer was in a letter dated 27 March 2000 from Kidsons the tax adviser to the School. That was the occasion on which Kidsons had recommended that there should be "commercial reasons for structuring the arrangements in that particular way". Up until July 2000, there had been no suggestion of any problem in the School acting as developer, nor any suggestion that there was a legitimate commercial reason for LASS to act.

We have noted that in mid-1999 the design of Study Centre North was changed. As a result LASS would have an interest in both Phase 1 and Phase 2. In fact that change reduced LASS's interest in Phase 1 because the library was moved from Phase 1 to Phase 2. However, there was no change in the design of Study Centre North between June 1999 and August 2000 that was material to the choice of developer of Study Centre North. The change in choice of developer from the School to LASS which took place in mid-2000 was not influenced by any change in design. We recognize that LASS had been a trading company since 1984 but there had been no material change in the nature of LASS that gave rise to a legitimate commercial reason for it to act as the developer.

In evidence, Mr Sanger, who was on all three boards and was closely involved in every relevant transaction (though as trustee/director of the Trust he did not, he said, take part in decisions to advance funds to LASS), offered five reasons why LASS had been made the developer. These were, first, that LASS was a VAT registered trading company; second that LASS was going to be involved in Study Centre North; third that LASS had more effective and quicker decision-making processes; fourth that LASS had greater expertise and, fifth, that using LASS would isolate the School from commercial risk. Mr Sanger said that he had discussed these reasons with Mr Dalton Holmes. None of these reasons were, however, supplied by Mr Dalton Holmes in evidence. His "commercial reasons" were that LASS had been chosen as developer to protect the assets funded by the School parents from possible expropriation by an incoming Labour Government and because LASS's ownership would assist in some form of joint venture between the School and the Kent School of Music.

None of the reasons given by either Mr Sanger or Mr Dalton Holmes are reflected in any of the contemporaneous minutes of meetings. Nor were they endorsed by Mr Coates. He accepted that LASS was to have an involvement in Phase 1 of Study Centre North project because of the library, but otherwise he did not endorse any of the reasons advanced by Mr Sanger. (We have already observed that LASS's involvement in the library was itself a VAT scheme.) It is particularly relevant to note that Mr Coates confirmed that the School Building Committee had operated quite satisfactorily in relation to earlier building projects in which the School had acted as developer and that there had been no problems in relation to speed of decision-making or the like. Indeed, at least one of the projects carried out by the School itself had been of a similar size (£2.4 million) to that of Study Centre North.

Nor can we see any substance in Mr Sanger's reason that the use of LASS had the effect of isolating the School from commercial risk. This is because the School agreed to underwrite LASS's financial commitments in relation to Study Centre North and informed the contractor and the other professionals of the agreement. There was, at a much later stage (in October 2001), a suggestion that the School was not permitted to give a guarantee; the underwriting agreement was generally for the benefit of the School and was given in good faith. Those involved in providing the underwriting and giving the comfort letters could not possibly have thought that the School was isolated from commercial risk.

Does the Halifax "abuse" principle apply to the Initial Arrangements?

Customs' grounds for refusing LASS's claims under section 25(2) for repayment of the tax charged on the construction services are based on Halifax principles. We leave for later consideration the question of whether, as the Appellants contend, Halifax can only apply when actual transactions involving onward supplies by the claimant take place. In the meantime we set out five findings that we see to be relevant to the application or otherwise of the Halifax "abuse" principles.

First, we are satisfied that there were no commercial reasons of any substance for using LASS as the developer of Study Centre North instead of the School. Our reasons are in paragraphs 54-56 above.

Second, in the context of its "normal commercial transactions" (see paragraph 80 of Halifax) LASS's participation as developer of Study Centre North was so "abnormal" as to call aloud for an explanation. Normally it ran the school shop. It had made some pre-payments for gas supplies. But a construction project of the scale of Study Centre North was a completely new departure.

Third, the School, in common with similar educational establishments, would not in the context of its normal commercial operations have had the opportunity to create and use Study Centre North without irrecoverable VAT being borne on the construction costs. To allow the Halifax principles to deny the recovery of VAT on those costs would not be contrary to the principle of fiscal neutrality : (see paragraph 80 of Halifax).

Fourth, the Initial Arrangements were implemented in pursuance of a scheme and that scheme was designed by the School and its advisers to achieve the tax advantage of recovery of otherwise irrecoverable tax on the construction costs. Those arrangements were made possible by the linkage that existed between the School and LASS (through directors and shareholding control) and between the Trust and the School. The Trust's main object was to benefit the School and its educational affairs which included the construction of Study Centre North for the School. Mr Sanger held office on all three entities, Mr Dalton Holmes, as bursar, served all three. These features are relevant to the Court's remarks in paragraph 81 of Halifax.

Fifth (and again relevant to paragraph 81 of Halifax) the Initial Arrangements were artificial, as compared with the School developing Study Centre North itself. Making the school shop the developer of Study Centre North and propping it up financially to enable it to contract with the builders and professionals were, we think self-evidently artificial features of the tax scheme.

With those features in mind we turn to the conditions for application of the Halifax abuse principles. Regarding paragraph 74 of the judgment we conclude that a tax advantage has accrued as a result of the transactions comprised in the Initial Arrangements, the grant of which is contrary to the purpose of sections 25 and 26 and Article 17. The School, as the end-user of the construction supplies, does not under the scheme of the legislation have the right to occupy and use Study Centre North without bearing the tax charged on the construction costs. The Arrangements sought to obtain that result and, in so doing, violated the principle of fiscal neutrality. Regarding paragraph 75 of Halifax, we think that that condition also is satisfied. Our conclusion, based on the documentation and the oral evidence, is that the decisions to make LASS the developer and to fund it from the Trust were driven by a desire of the School to recover the otherwise irrecoverable VAT. This was achieved (subject to the impact of the abuse principle) by making use of the School's links with LASS and the Trust.

The "redefinition" of the Initial Arrangements

For those reasons we have concluded that the abuse principle applies to the transactions comprised in the Initial Arrangements. Properly redefined, the relevant transactions are supplies by the builders and professionals to the School.

Appellant's argument on the law

We turn now to the Appellants' argument (at the start of paragraph 33 above) that the Halifax principle cannot apply to the Initial Arrangements. (This argument, as we understand it, is without prejudice to their arguments on the facts that good commercial reasons underpinned both the Initial and the Further Arrangements.) The Appellants' argument is based on the fact that in the course of the Initial Arrangements LASS made no supplies (other than strictly school shop supplies). The "essential aim" (paragraph 75 of the Halifax judgment) of the relevant transactions could not be determined without actual supplies; and when actual supplies were made (as happened when the Further Arrangements took place) an "explanation other than the mere attainment of the tax advantage" was present (see paragraph 87 of the Advocate General's opinion in Halifax). We do not accept the principle underlying that argument. The VAT code gives a right to deduct input tax on supplies made to the taxable person in question in respect of supplies "made or to be made by him". See section 26(2) and Article 17.1. Thus the right arises when the input tax becomes chargeable and not when the taxable person makes his actual outputs. In the present circumstances LASS made the claims for 00/08 onwards during and as a result of the implementation of the Initial Arrangements. These were made in the course of what is alleged to have been a "prohibited abusive practice" (to adopt the Court's expression in Halifax). It is the validity of those actual claims, rather the later transactions, that are in issue.

The Further Arrangements

In the summer of 2001 the Bursar set about organizing a meeting to discuss the Customs' "brush-off" in their letter of 18 July. Mr Hodgetts of Kidsons wrote on 23 July 2001 stressing the need to produce correspondence that would encourage Customs to take a different view but (he wrote) because Kidsons had been engaged to provide VAT advice "any correspondence from me is likely to focus specifically on the VAT savings rather than on any wider issues". Farrers had written on 12 April 2001 describing as "nonsense" and "to be refuted" the suggestion of Customs, in their letter of 15 March 2001, that the sole purpose of the transaction had been to circumvent the spirit and purpose of the VAT legislation. A further letter from Farrers of 31 July went on to say:

"The relatively bullish views that I was expressing at the recent Bursar's meeting were in relation to a slightly different set of circumstances from those which applied in Benenden, I fear, and I would not want you to derive too much comfort from them. In the case of Benenden I think there must be at least a very real possibility that no progress will be made with HM Customs and Excise until Halifax has been decided on appeal. Having said that, clearly I agree with Steve [Mr Hodgetts] that we should review correspondence, although I am afraid that in writing to the Charity Commission for example we did very much mention this as a VAT saving scheme".

The Farrers' Meeting of 14 September 2001

A meeting was fixed for Friday 14 September 2001 "to discuss issues relating to a claim for VAT recovery by LASS". The first item on the Agenda was "a considered respond" relating to Study Centre North. The second was to be the "Library Scheme" and the third was to be "Study Centre South". A further agenda was produced by Mr Dalton Holmes dated 14 September for the meeting to be held the same day. The first item, headed Study Centre North, contains seven points relating to the letter from Customs of 18 July 2001; those points covered disclosure, commerciality, risks of proceeding on appeal and methods of funding LASS (i.e. by external donations, bank overdraft and school loans). Also in the agenda was the library scheme and Study Centre South as topics and finally "Alternate Arrangements".

Manuscript notes of the meeting were made by Mr Dalton Holmes. An attendance note was made by Farrers.

Mr Dalton Holmes' notes record discussions about the steps that might be taken to implement the Study Centre South project and lengthy consideration of the library schemes; there was discussion about "the best scheme for Study Centre North" and whether LASS should sell Study Centre North to the School for occupation; a debate apparently followed about what should be done in the light of Halifax and what should be disclosed. Mr Sanger was noted as saying that the case "is worsened by disclosing".

The Farrers' attendance note shows a full discussion of the disclosure point, the library scheme, the implications of the Halifax decision (with particular reference to Customs' refusal to repay the VAT on the construction services) and it ends with a "Final Thought" attributed to Mr Sanger. This reads:

"J S wondered whether it could be possible for the Trust to call in its debt from LASS on grounds of near-insolvency given the VAT costs which had not at first been budgeted for. To finance the repayment of the debt, LASS would sell the site to the Trust and charge VAT on it. The Trust would then own the site and could lease it to the School at a peppercorn and recover the VAT it had paid to LASS".

Mr Sanger stated in evidence that insolvency had been mentioned only at the end of the 14 September 2001 meeting (as recorded in the Farrer's attendance note). Mr Dalton Holmes, whose agenda and whose note does not refer to insolvency, said that they had been wrestling with the problem of potential insolvency and at the last minute after papers and notes had been packed away Mr Sanger had suggested that the Trust should receive the Study Centre North.

Discussions at Farrers, concerned with the implications of the letter from the Customs of 18 July 2001, raised the need to have different sets of people as shareholders in the School and in the Trust and how to "get money back into Trust". On 24 September 2001 Mr Sanger wrote to Mr Hodgetts of Kidsons about the proposal to sell Study Centre North to the Trust in consideration for the repayment of the loan.

Kidsons are consulted

A letter from Mr Hodgetts of Kidsons to Farrers of 23 September 2001 referred to "the option of LASS selling the new Study Centre North to the Trust in order to repay the loan". It observes that "the loan is in the order of £3.76 million which includes VAT of £560,000 which has not been repaid to LASS". The letter goes on to say that - "We are all aware the validity of the proposed sale is dependent upon [the Trust] having an ability to opt to charge VAT on the building"; it advised that any "connection between the School and the Trust must be broken if we are to proceed with the option". Referring to "the loan problem and accounting issues", it suggests that "the reason for the sale is not solely for VAT purposes" and that Customs could not "advance Halifax principles".

The Trust becomes involved

The same day (25 September) Mr Sanger had a meeting with Mr Charles Covell, the new chairman of the Trust. Mr Covell had been a trustee since March 2000 but he had not until then been able to play any part in the Trust affairs; nor had he known, until then, why the Trust had made the loan to LASS in 2000. At the meeting the two of them discussed the Trust's financial condition. Mr Sanger told Mr Covell about the Halifax decision and its relevance to the Trust because LASS might not be able to recover VAT "and certainly would not be able to do so in the near future". This, Mr Covell was given to understand by Mr Sanger, might well mean that LASS would become insolvent.

LASS's overdraft arrangements

We mention in this connection that a letter from Coutts of 14 August 2001 to Mr Dalton Holmes stated that the overdraft facility to the School could be amended to enable the facility to be used by the School and LASS, subject to the School guaranteeing LASS's liabilities to the bank. On 24 September 2001 Coutts wrote formally offering LASS an overdraft rising to £250,000 on 31 October 2001 in reliance on a guarantee for that amount from the School; this was accepted by LASS on 28 September. On 2 October 2001 Mr Dalton Holmes wrote to tell the bank that the School, being a charity, could not guarantee LASS, a non-charity. On 5 October 2001 the bank wrote back to say that no guarantee would be required. The conclusion we draw from those letters is that LASS's cash-flow requirements were reasonably secure in the autumn of 2001.

Preparations

A propos Kidson's advice in their letter of 23 September on the VAT implications of the Further Arrangements, that the "connection" between the School (the 100% parent of LASS and the Trust) should be broken, we mention that Mr Covell appears to have recognized this as an element in the Further Arrangements when e-mailing Mr Sanger on 23 October 2001. A "cooperative early repayment by LASS" might, so the message went, be seen as a piece of "connected behaviour". The Trust, he advised, should "call in the loan early on an arm's length basis". On 2 October 2001 Farrers produced a "Memorandum on Separation" explaining how to ensure that the Trust and the School did not have members or directors with a controlling influence.

On 27 September 2001 Farrers had produced a draft of a letter to be sent to the chairman of the Trust (Mr Covell). This addressed "some way to support LASS to avoid its insolvency". Farrers sent the draft to Mr Hodgetts of Kidsons; the covering letter (copied to Mr Sanger and Mr Hodgetts) explained that the letter advised on the problems arising out of LASS's "effective insolvency" and asked for comments on the draft. On 28 September 2001 Mr Hodgetts wrote saying that he would be responding to the Customs' letter of 18 July 2001 and would be informing Customs of the sale to the Trust. The Farrers' draft was approved and sent to Mr Covell on 3 October 2001. On 8 October the Trustees held a meeting and approved the proposals.

Informing Customs

By late October 2001 the professional advisers were close to working out the steps involved in the Further Arrangements. A letter from Farrers to Mr Hodgetts of 31 October starts as follows:

"We spoke today on the phone about your draft letter to Customs and the strategy that we are now adopting to try and recover VAT on the construction of Study Centre South. [The parties agreed that this was referring to Study Centre North.]

LASS is now selling the building to [the Trust]. As I understand it LASS will charge [the Trust] VAT on the sale. It will then put in a return to Customs taking a credit for the VAT input on construction against the VAT output on the sale to [the Trust] with the result that nothing is actually paid over to Customs. [The Trust] will then put in a claim for recovery of VAT charged on the purchase of the building, having elected it and registered for VAT. Customs may then have difficulty in resisting [the Trust's] claim since the purchase transaction will have clearly been made for bona fide commercial reasons.

Have I understood the procedure correctly? Please say if I have anything wrong."

The first part of the draft letter to be sent to Customs states that while they believe that the circumstances of Halifax can be distinguished they (Kidsons' clients) have taken the pragmatic view that they would not be able to persuade Customs to make an immediate repayment of input tax. The draft letter, with Mr Sanger's amendments in italics, then reads as follows:

"In the light of the information available to date, LASS, [the School] and [the Trust] must continue to make commercial decisions.

From a budgeting perspective the reluctance of the Commissioners to repay in excess of £500,000 input VAT on the basis of what we consider to be a radical interpretation of the law creates a number of difficulties. As you are aware, LASS has a significant liability to Benenden School Trust which has been exacerbated by the non-recovery of VAT and which it is now struggling to service. It will be appreciated LASS has a need to generate sufficient income and cash to service the loan interest which in turn also creates accounting and direct tax consequences.

In the circumstances, it has been decided that the Trust, a registered charity, will purchase the property from LASS at market value in order to secure the value of its loan investment. The Charities Act requires the Trust to obtain evaluation of the property and the Trust will not be permitted to pay any more than the proper market value for the property.

These arrangements are now being effected and it is LASS that will pay output tax on the sale of the building to [the Trust]. The effect of these transactions will be included in the relevant quarterly VAT returns when the output tax will be offset against the input tax already incurred and retained by you.