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United Kingdom VAT & Duties Tribunals Decisions
You are here: BAILII >> Databases >> United Kingdom VAT & Duties Tribunals Decisions >> University of Sheffield v Revenue & Customs [2007] UKVAT V20174 (22 May 2007)
URL: http://www.bailii.org/uk/cases/UKVAT/2007/V20174.html
Cite as: [2007] UKVAT V20174
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- This is an appeal by the University of Sheffield ("the University") against assessments to tax of £119,764 and £2,220,268 made by Her Majesty's Commissioners for Revenue & Customs ("HMRC") on 30 January 2004 and 6 February 2004 respectively. The former assessment related to input VAT allegedly overclaimed by the University in period 01/01; and the latter also to input VAT allegedly overclaimed, but in this case in periods 04/01 to 07/03 inclusive. The assessments reflect HMRC's decision that:
- The assessments were made because HMRC consider that PFR is undertaken by universities in the main to advance human knowledge. It is generally a condition of grants made to fund such research that the outcome is published in the public domain and is freely available. HMRC consider that PFR is not a business activity linked to other business activities e.g. because, to quote the decision letter, "such a link is too distant to convert what is essentially a non-business activity into a business activity". Consequently HMRC maintain that PFR is not concerned with taxable supplies, and thus a taxpayer has no right to deduct related input tax.
- In contrast, the University claims that VAT incurred on expenditure which formed a cost component of its PFR activity in the assessment periods, i.e. research funded by grants from research councils, government departments and charities, was input tax since such activity was an economic activity for VAT purposes.
- In its Notice of Appeal, given on 16 May 2005, the University first claimed that the assessments were made outside the one year time limit provided by section 73(6)(b) of the Value Added Tax Act 1994 ("VATA") because HMRC had information from the British Universities Finance Directors Group ("BUFDG") in 1997 which indicated that they considered PFR to be a business activity; and when the University made its 01/01 return it supplied information indicating that it treated PFR as a business activity. The University maintained that HMRC decided to assess it only because of a change in their policy in 2003, and a realisation that treating PFR as a business activity was a mistake of law.
- Secondly, the University contended that the assessments were not made to the best judgment of HMRC because they had taken the view that the exclusion of the T-element (i.e. the teaching element) of the Higher Education Funding Council of England ("HEFC") grant from the partial exemption calculation used in the assessed years undervalued the exempt supplies of the University; yet HMRC chose to exclude the T-element from the business / non-business apportionment used for the assessments. The University submitted that HMRC had adopted that method in order to correct a perceived imbalance in the University's partial exemption calculation, and that was impermissible.
- On 7 March 2007, the University added a third reason for appealing, namely:
- The University was represented in the appeal by Adam Rycroft, a senior VAT manager with KPMG, and HMRC by James Puzey of counsel. They produced an agreed bundle of copy documents, and Nigel Dismore, an officer of HMRC, gave oral evidence.
- From the evidence, I find that the University is a charity providing education and undertaking research in the course of its business and otherwise. It registered for VAT on the tax being introduced in 1973. Although the majority of its supplies are exempt from tax, as it does make some taxable supplies, it is a partially exempt trader. To deal with its residual input tax, on 14 September 1998 it agreed with HMRC a partial exemption special method ("PESM") in which residual input tax was attributed to taxable supplies by reference to the value of supplies. In the letter setting out the terms of the PESM, HMRC indicated that the method, to be used from 1 August 1998, would be influenced by their discussions with BUFDG and its advisers. Excluding income relating to specified peripheral activities, the agreed PESM fraction was:
- Universities receive PFR in the form of grants, some of which are not recognised by HMRC as representing "consideration" for VAT purposes. As mentioned earlier, the grants are made by the HEFC, research councils, charities and by government departments. Those made by HEFC are in two parts, the T-grant and the R-grant (research grant). HEFC determine the amount of T-grant by reference to a University's teaching activity, and the R-grant by reference to its research activity. But despite the grants being calculated in that fashion, they are paid as a single sum, and may be applied as a university chooses.
- Despite earlier taking a different view, HMRC now consider that in a value-based PESM, the value of exempt education will be undervalued if only "consideration" is included in the calculation; and to correct any such imbalance, they suggest that, as a first choice, a university taxpayer include the T-grant within the denominator of its partial exemption fraction. As mentioned above, in the PESM agreed with the University in 1998, the T-grant was not included in the denominator of the partial exemption fraction.
- In order that I might properly understand HMRC's position, as set out in paragraph 6 above, Mr Dismore, who deals with technical matters in the educational and charitable fields, offered the following explanation of how historically universities had generally treated PFR, and recovered any input VAT attributable to it. When VAT was first introduced in the UK, universities argued that they would have difficulty in meeting the potentially complex record keeping requirements demanded of taxpayers by the VAT system. In 1972, the Commissioners for Customs and Excise (whom, for convenience, I propose to include in the expression "HMRC"), agreed with the Committee of Vice Chancellors and Principals ("CVCP"), as representing the universities, a simplified method whereby universities could calculate their recoverable VAT. Essentially, they were allowed to use such a method in return for flat-rates of VAT recovery, but could not recover VAT on their overhead costs, which could extend to overheads associated with research. That method was used by the university sector until 1990 when, in an appeal by Edinburgh University, (1990) Decision No. 6559, the tribunal decided that because universities had the right in law to recover the VAT on overheads relating to taxable supplies, the method did not give a fair and reasonable result. In the seven years following the Edinburgh University decision, a number of other universities took advantage of it and made retrospective claims. They did so notwithstanding that most of their financial systems remained unable fully to comply with the VAT accounting requirements. Nevertheless, HMRC continued to allow use of the CVCP method alongside unsophisticated overhead cost recovery methods. But, by 1997, as many universities were moving away from the CVCP method, adopting alternative partial exemption (and "business/non-business") methods and had established proper accounting systems, HMRC considered the CVCP method had become redundant. Consequently, they withdrew it, indicating to the CVCP the need for universities to agree methodologies both for partial exemption purposes and in relation to business / non-business calculations.
- On 10 October 1997, HMRC issued a statement of their policy ("SOP") on the whole issue of input tax recovery by universities. Whilst the document mainly focused on partial exemption, it also dealt with research in the following terms:
- BUFDG, which claimed to represent the university sector in the same way as CVCP, responded to the SOP by submitting to HMRC a document entitled "Grant income and VAT recovery: a fair and reasonable approach". In addressing the question of how research funding, particularly that provided by the research councils and charities, should be treated, the document said:
- In paragraph 2.19 of their document, BUFDG contended that:
- BUFDG expressed a similar view about charity funded research at paragraphs 2.6 and 2.20 of their document:
- And at paragraphs 4.15 and 16 of their document, BUFDG claimed that research which was a stepping stone to further research and which might result in commercial exploitation years later should also be treated as an activity leading to taxable supplies.
- HMRC responded to BUFDG's document on 14 July 1998, mainly focusing on partial exemption. Annex D to the response addressed the treatment of research council and charity grants, and, in differentiating between commercial research and research council / charity funded research, made the point that:
- HMRC concluded Annex D, saying that:
- HMRC thus made plain that each university's claims for input tax recovery would be considered individually (both in the context of partial exemption and business / non-business), and each would be expected to propose a suitable methodology to determine a fair and reasonable level of VAT recovery.
- Those universities that contended that their PFR was a business activity, as the University did, then claimed:
- Those universities that contended that their PFR activity was carried out in the course or furtherance of their business claimed to meet all three tests, and thus that they did not have to attribute any of their input VAT to non-business activities.
- For many universities there was no advantage in VAT terms in treating their PFR as a non-business activity as there was little opportunity to exploit the reliefs available to them, and a clear disadvantage in that they would have to restrict their input VAT. But other leading research universities, which during the early part of the present century received substantial development funds from the Wellcome Foundation, constructed purpose-built research centres. If the research to be carried out therein was undertaken otherwise than in the course or furtherance of business, the universities would have the opportunity of exploiting the relief in Group 5 of Schedule 8 to VATA, or Extra-Statutory Concession 3.19. Those universities contended that their PFR was a non-business activity (i.e. they agreed with Customs 1997 SOP).
- Thus by 2001 there were two schools of thought within the university sector as to how PFR should be treated. One school maintained that PFR was a business activity; the other contended that it was a non-business activity.
- HMRC's position was, and remains, that they were prepared to accept that if a university genuinely undertook research projects funded by public sponsors with the intention of producing intellectual property for commercial exploitation, rather than simply producing research outcomes for general publication, then those projects were a business activity. HMRC also accepted that if a university supplied research or IPRs to a commercial organisation for consideration, it too was a business activity, even if subsidised in part by grant funding. They further acknowledged that a link with other business activities might be sufficient to make the research carried out in furtherance of a university's business activities provided there was a clear nexus between those activities and the research. However, HMRC considered that curiosity-driven basic research funded by research councils, charities and government, was a non-business activity unless closely linked to the supply of education to post-graduates engaged in the research.
- At the time HMRC withdrew the CVCP guidelines, most universities included all, or a substantial part, of their PFR in the denominator of their partial exemption method calculations, such that their overall VAT recovery position remained the same irrespective of the school of thought to which they belonged.
- HMRC pragmatically took at face value claims that research was a business activity from those universities advocating that line and, equally, did not dispute claims that research was a non-business activity from the opposing school of thought, although they put to proof universities which were claiming zero-rated relief for the construction of buildings that the buildings would be used for non-business purposes.
- As maintained in paragraph [22] above, late in 2001, HMRC were faced with a number of cases of universities making claims for zero-rating relief on the costs of constructing new buildings. The claims were made on the basis that the buildings were to be used for charitable "non-business" research (see item 2(a), Group 5 of Schedule 8 to VATA). The universities making the claims contended that their PFR was a non-business activity for VAT purposes and therefore the buildings would be used "by a charity … otherwise than in the course or furtherance of a business" (see note (6) to Group 5 of Schedule 8 to VATA). But, as item 2(a) only relieves the construction of buildings used "solely" in that way and the universities could not rule out at least some business use, HMRC considered them to be seeking permission to apply Extra-Statutory Concession 3.29 which allows zero-rating relief where a new building is to be constructed and used at least 90 per cent for qualifying, i.e. non-business, purposes.
- Those cases were referred to Mr Dismore. In evidence he said that the references were made because the universities in question had not been attributing any of their input VAT to "non-business" activities, so that HMRC inferred that they had been treating all their research, including that they had been claiming as non-business, as a business activity: the universities were changing the way they treated PFR for VAT purposes simply to secure zero-rating relief on the construction of their new buildings.
- Mr Dismore then prepared new guidance for HMRC's officers. In paragraphs 39 to 46 of his judgment in University of Southampton v Commissioners of Revenue and Customs [2006] STC 1389, Warren J dealt with it at some length in the following terms:
- As mentioned in paragraph [30] above, HMRC took a pragmatic view of the universities' situation because PFR had, in the main, been included in the denominator of their partial exemption calculations. (If it had been excluded or also included in the numerator in any particular instance, HMRC considered that further investigation as to the nature of the research being carried out would have been required).
- Following circulation of the 2003 guidance, the HMRC assurance officers dealing with universities which had satisfactorily established that they conducted significant research but were treating PFR as a business activity, as the University was, approached the universities and informed them of the need to provide supporting evidence of business activity.
- On 24 October 2003, Mr Dismore telephoned Mr Bennett, the University's taxation accountant, and explained the need for the University to provide supporting evidence of business activity. Mr Bennett responded saying that the University had recently changed its taxation advisor to KPMG, and was reconsidering its stance on PFR. It was then arranged that HMRC would write to the University setting out their views on business activity, and explaining what they considered necessary to support a claim for input tax attributable to PFR. In their letter, also dated 24 October 2003, HMRC pointed out that the University did not carry out a business / non-business apportionment of its input VAT, and from that they inferred that it considered its PFR projects exclusively business activities. They asked it to provide evidence in support of that position, and indicated that they would assess for any overclaimed input VAT. The University did not reply to their letter, and on 30 January 2004 HMRC made an assessment for input tax overclaimed in period 01/01 on the basis that the University had failed to provide evidence that VAT totalling £119,764 had been used for business purposes.
- In the absence of information from the University, the assessed amount was based on income figures in the University's PESM, obtained by HMRC in March and May 2002, and the figures for PFR taken from its HESA return, obtained by HMRC in November 2003. (Mr Dismore explained, and I accept, that HMRC discovered late in 2003 that the contents of HESA returns could be obtained from HESA. Consequently, they purchased information relating to a number of universities, including the University, from that authority).
- The whole of the calculation prepared by the assessing officer, Mr French, took the following form:
- Mr Dismore, who was responsible for determining how the tax assessed should be calculated and who generally assisted Mr French, elaborated on that calculation in evidence saying that in the months prior to October 2003, HMRC tried to persuade the University to correct the imbalance they perceived in its PESM as a result of its excluding T-grant in the denominator of the calculation by including it. They did so on the basis that in a values-based PESM, such as that used by the University, the value of exempt supplies of teaching might be understated if that value were based solely on the consideration received, i.e. excluding grant income. Consequently, in HMRC's view, in such methods the taxable supplies in the numerator were, in most cases, at "full value" whereas exempt income from education was at less than "full value". If the exempt supplies were based solely on consideration there might be a distortion in the partial exemption calculation because the method did not compare like with like. Although one way to correct such an imbalance in the partial exemption method was to include the T-grant as a "proxy", it was by no means the only possible proxy, and not necessarily a truly representative one: each case had to be considered on its own merits. (Until 2005, when it agreed a new PESM with the T-grant in the denominator, the University argued that, in its case, it was not a fair proxy. In the PESM agreed in 2005 the fraction was:
- Mr Dismore explained that it had never been HMRC policy to say that the inclusion of the T-grant as a proxy to correct an imbalance in the values-based PESM of the University was the only way to correct any undervaluation.
- He conceded that had a similar imbalance existed in the business / non-business methodology HMRC adopted in dealing with the University, a proxy to address it would have been required. In his view, the business / non-business methodology ultimately used in the assessment process contained no such imbalance. (The University had sought a business / non-business apportionment based on the following fraction:
- Mr Dismore also explained that, in the absence of alternative proposals from the University and given the limited data available to HMRC he considered, a "broad brush", "single input tax pot" income-based method to be the fairest one to use. In so deciding, Mr Dismore appreciated that the University might have had some overhead inputs which were taxable at different rates depending on whether they were used for business or non-business activities; e.g. fuel and power, which might have been taxed at the lower rate of VAT when used for non-business purposes (although, as the University had maintained all its research was business, Mr Dismore thought this unlikely), and/or inputs which had been treated as an overhead for partial exemption purposes (i.e. used for both taxable and exempt activities) but which might have been used exclusively for business. However, as the only input tax data HMRC had was from the PESM calculation, Mr Dismore was not in a position to make such a distinction. He therefore instructed Mr French to make plain to the University that, if it provided revised figures, HMRC would be prepared to consider them with a view to adjusting the assessments if appropriate. Mr Dismore added that HMRC would have been perfectly happy to exclude input tax on fuel and power from the calculation once the University had determined its non-business use of those inputs, as, by definition, that determination would have affected the relevant apportionment. However, no such proposal was put to them.
- Mr Dismore said that he contemplated apportioning the University's overhead inputs using the income based method described in paragraph 33.5 of Notice 700; i.e. determining its "business VAT" (i.e. input tax) on overheads by reference to the ratio of "business income" (i.e. income from taxable and exempt supplies) to "total income" (i.e. business income and non-business income from grants etc). However, as HMRC did not know how "non-business income" was used by the University, other than PFR grants which they knew had to be spent on non-business activity, Mr Dismore concluded that including all non-business income might have been unfair, as the higher the denominator, the lower the University's "business percentage" and overall input tax recovery. He also considered that it would be fairer to the University if the activities funded by the two "types" of comparable income included in the calculation (i.e. "business" income from taxable and exempt supplies, and "non-business" income) consumed tax bearing "overhead" inputs in more or less the same way. It was his view that those inputs were consumed by contract research (and teaching) on the one hand and PFR on the other (what he described as "active non-business activity") in more or less the same ratio as business income to PFR income, but the same could not necessarily be said for other non-business income sources (what he described as "passive" or low input-consuming activities).
- He therefore decided to limit the denominator to business income and PFR grants, excluding from it all other non-business, i.e. grant, income, even though it might have been used in whole or in part for PFR. He did so on the basis that by including only the actual consideration from business activities received in the numerator, and only the actual consideration received plus funding from PFR grants in the denominator, the calculation was sufficiently "balanced" to produce a fair result. That was because, unlike in the PESM, it was likely that neither the business income nor non-business income used for PFR was included at "full value", i.e. it was likely that other grant funding was used to support both business activities and PFR, e.g. T-grant might support non-business research as well as exempt education. R-grant, although undoubtedly used to support PFR, might also support exempt / taxable research.
- As Mr Dismore considered himself unable to determine the extent of any subsidy (such as grant income, donations, endowments and income from investments), he decided to limit the University's income in the calculation as he did, effectively comparing "unsubsidised business income" with "unsubsidised non-business income". He added that had he approached the business / non-business calculation suggested by the University, i.e. only to address the subsidy used to support the business activity, and ignore the probable subsidy for non-business research, HMRC would have been faced with the same distortion as they had identified in the University's PESM, namely a "top-heavy" numerator.
- Mr Dismore dealt with a claim by the University that HMRC viewed its PESM as not giving a fair approximation of use because it excluded from the fractional attribution the T-element of the University's grant funding from HEFC, thus undervaluing its exempt outputs, explaining that that was why HMRC did not include the T-grant in the numerator and denominator of the method used to assess its over-claimed input tax. Mr Dismore accepted that HMRC had been in discussion with the University about its PESM, and had been unable to agree with it the extent to which, if at all, the T-grant should be included in that method. He further explained that he chose not to include the T-grant in the numerator (or indeed the denominator) of the calculation because he had decided to limit business income from taxable and exempt supplies. In the absence of other information, he used the denominator of the PESM for the purpose.
- On 2 February 2004, HMRC received an email from Mr Bennett including spreadsheets "outlining the amount the University should be assessed for". The workings included in the spreadsheets were based on the methodology HMRC had used in calculating the amount assessed for period 01/01, but combining that method with the University's PESM in one calculation. No mention was made in the workings of the T-grant. Mr Dismore explained that he assumed from the statement in the email that the figure for input tax overclaimed revealed by the workings was the amount for which the University should be assessed, and that it therefore accepted that HMRC's methodology was fair and reasonable.
- HMRC accepted that the method used by the University, as contained in the email, produced a fair overdeclaration of deductible input tax for the periods 04/01 to 07/03 inclusive, and so used the figures provided as the basis for the assessment notified on 6 February 2004. But as the University based its calculation of overclaimed input tax in those periods by reference to its PESM figures, HMRC indicated that for the future they were not prepared to accept a "combined partial exemption / non-business method". However, they did say that they were content for the figures used for the "non-business method" to be derived from the PESM, if that were easier for the University to administer. (HMRC accepted that it was open to the University to adopt any method it wished for the purpose, provided that it produced a fair and reasonable result).
- The University raised no objection to the method used by HMRC to calculate the tax assessed. It did, however, enter into negotiations with them concerning the application of fuel and power relief, and the "Lennartz accountancy" available to it in relation to its non-business activities.
- In cross examination, two questions were put to Mr Dismore, the answers to which, whilst in part covered by my consideration of the remainder of his evidence, warrant separate, special attention. First, he was asked why, since he now accepted that including the HEFC T-grant in the business/non-business method was fair and reasonable, he considered it unfair and unreasonable to include it in the calculation of the tax assessed on the University.
- He explained that the effective operation of the VAT code required the attribution or apportionment of VAT incurred by a taxpayer between business and non-business to be carried out before any partial exemption calculations were made – a point made in HMRC's letter of 30 January 2004. The basis of the attribution must, in isolation, produce a fair and reasonable result, i.e. the outcome of any calculation must reflect the business use of overhead VAT costs. That figure represented the taxpayer's input tax, and had to be carried forward to the taxpayer's PESM calculation.
- Mr Dismore explained the partial exemption calculation as being a distinct and separate step subsequent to a taxpayer's attribution of supplies to business and non-business elements in the computation of its VAT liability: it should be able to stand up to scrutiny on its own merit as producing a fair and reasonable attribution of overhead input tax to taxable supplies. But, he accepted, it was also true that both calculations were steps in the process of determining how much of the VAT incurred by the taxpayer was ultimately recoverable by it. He then asked: what happened if a taxpayer adopted methodologies which, when viewed independently, produced a fair result, but when combined together might not produce a fair measure of the taxable use to which the relevant inputs were put? In answer he observed that one option was to consider alternative methodologies; but what if, as in the case of the University, the taxpayer wished to use income based methods for both steps?
- Mr Dismore claimed it was to address that "breakdown" that he offered in the letter of 30 January 2004 to allow the University to add the T-grant to its "business income" figure in the business/non-business calculation provided it amended its then PESM to include that grant in the denominator of that calculation. Although, in his view, the effect of adding the T-grant to the "business income" figure would have resulted in the amount of VAT treated as input tax being overstated if viewed in isolation, Mr Dismore was satisfied that, once the adjustment to the PESM calculation had been taken into account, i.e. the addition of the T-grant to its denominator, the end result of both calculations would have been a fair representation of the University's taxable use of inputs.
- Accepting that so increasing the business percentage could have worked against the University when it came to determining eligibility for VAT relief, in the context of another possible distortion identified by Mr Bennett in his email of 2 February 2004 (the inclusion of non-business grants from research funders in the PESM), Mr Dismore made clear in the letter of 6 February 2004 that, in any claim for relief, "credit" for that income would be given (i.e. it would be added to the PFR income figure), notwithstanding the fact that it was excluded to avoid "double counting" in the business / non-business calculation. That is to say, although HMRC accepted that an adjustment to the business / non-business calculation was appropriate in those circumstances, the correct business percentage, if it were to be relied on in isolation, e.g. for relief purposes, had to be reworked based on their specified methodology, i.e. income from taxable and exempt supplies as a percentage of that income plus income from PFR projects.
- However, as at the time the assessments were made, the University did not include the T-grant in its PESM calculation, the distortive effect contemplated in Mr Dismore's offer did not exist and therefore, in his view, there was no justification for including it in the business / non-business calculation.
- In fact, as Mr Dismore believed the University acknowledged, the distortion was confined to the PESM because of the undervaluation of exempt supplies in that calculation. That distortion was addressed subsequently when the University agreed its new PESM which included the T-grant. HMRC in turn stood by their offer to include the T-grant in the non-business calculation so that, overall, they considered that thereafter a fair and reasonable attribution of input tax to taxable supplies would be achieved.
- The second question put to Mr Dismore in cross examination was this: if he were prepared to exclude the HEFC research grant from the calculation used to assess, and accepted that, in excluding it, the result was a fair and reasonable determination of business use of inputs, why did he now maintain that the research grant represented "non-business use"? Mr Dismore explained that his decision to exclude the research grant (and other income) from the assessment calculations arose from the necessity to consider the calculation in the context of the methodology used as a whole: as he had adopted a methodology based on the income that he could categorically identify as being used either for a business activity (i.e. income from taxable and exempt supplies) or a non-business activity (i.e. income from PFR projects that could only be used for that purpose), he did not think it fair arbitrarily to assign other income streams to those activities. However, if the method was varied to include subsidies used to support business activity (i.e. some or all of the T-grant), then a similar adjustment to reflect subsidisation of PFR was also necessary to maintain the "balance" of the method. That would have brought the HEFC research grant into play, as it was clear from numerous sources that its main application was to support PFR. Thus, Mr Dismore considered a fair and reasonable attribution was produced by the ratio of unsubsidised business income to that income plus unsubsidised PFR project income. He also accepted that a fair result would have been produced if the calculation comprised business income plus subsidies as a percentage of all income, as that would have been a balanced equation. However, that option was not open to HMRC, as the relevant data required, i.e. how other income was applied to support those activities, was not available at the time the assessments were made.
- However, Mr Dismore did not accept that simply adding the T-grant to the numerator and denominator of the fraction, without also addressing the imbalance that would have created in the calculation (which would have meant examining how the HEFC research grant and other income was applied), would have produced a fair and reasonable result for HMRC would have been faced with the same distortion as they identified in the 1998 PESM, i.e. a "top heavy" numerator attributing too much input tax to business activity than that activity actually used.
- Section 31 of VATA makes provision for Schedule 9 which in turn sets out various supplies which are exempted from VAT. Group 6 of Schedule 9 exempts supplies of education by eligible bodies, into which category the University falls.
- The provisions relating to the making of assessments which are relevant, all of which are to be found in VATA, are the following:
- The requirement to carry out an apportionment of VAT as relating to a person's business activities arises by reason of the requirements of section 24(1) of VATA which restricts the definition of "Input tax" as follows:
- Section 26(1) of VATA provides that:
- The regulations referred to in section 26(1) are contained in the VAT Regulations 1995 (SI 1995/2518), and in particular for the purposes of this appeal in Regulations 101 and 102.
- Regulation 101 provides the basis for the "standard" method of apportionment, Regulation 101(1) providing that:
- Regulation 101(2)(d) provides the basis for apportioning "residual" input tax:
- The use of methods other than Regulation 101 to calculate the amount of VAT to be attributed to activities giving rise to the right to claim credit of input tax is allowed by virtue of Regulation 102 of the VAT Regulations, which provides at 102(1):
- Regulation 102(3) and (4) provide:
- Mr Rycroft made his submissions on the best judgment / quantum issue on the sole ground that HMRC should have included T-grant in the calculation of the tax assessed for they took the view that it should have been included in the University's pre-2005 PESM. He maintained that the T-grant should have been included in both the PESM and the business / non-business apportionment.
- It is plain from Mr Dismore's evidence, which I accept in its entirety both as to its factual content and as to the reasons he considered in arriving at the sums assessed and those he determined to ignore, that HMRC had little information on which to construct a business / non-business apportionment in late 2003 and January 2004. They were thus faced with the prospect of being out of time to assess period 01/01 under the three year rule (see section 73(1) VATA). In their letter of 24 October 2003 they sought information from the University on which to base an assessment, but received no response from it. Thus, consistently with the dicta of Woolf J in Van Boeckel v Commissioners of Customs and Excise [1981] STC 290 at page 292, HMRC used such information as they had to calculate the tax assessed on the University.
- Mr Rycroft contended that HMRC excluded the T-grant from the business / non-business method to correct what they perceived to be an imbalance in the PESM. I am unable to accept that contention: in evidence, Mr Dismore explained, and I accept, that in determining the apportionment method his objective was to achieve a result, fair and balanced in itself. What he did was to place known income from supplies in the numerator of the fraction he used, and known income from supplies plus known income from PFR in the denominator. I accept Mr Dismore's claim that, had he included the T-grant in the fraction, it may have unbalanced the result because the grant can support both exempt education (business) and non-business research. Had he included the T-grant, it would then have been inconsistent for him not to include other grant income, such as the R-grant. And had he included all income in the denominator with business income in the numerator, the result would have been assessments in far larger sums.
- By restricting the apportionment method to "unsubsidised business income" and "unsubsidised non-business research income", HMRC used figures which were known and, in my judgment, balanced. Had they included the T-grant in the business income, it would have produced the unbalanced result HMRC found in the PESM because it would have overstated the University's business use of inputs without allowing for the inclusion of additional non-business grant income.
- Mr Rycroft alleged that by inviting the University (in their letter of 30 January 2004) to make representations and adduce evidence which might result in the method of calculation being adjusted, HMRC admitted that they did not believe their calculation correctly to determine the amount of goods and services "used" for the respective purposes of the University's business and non-business activities. They were thus in breach of their overriding obligation to determine the correct amount of VAT due, and the assessments were not made to best judgment. The courts had accepted that there were circumstances where an assessment, challenged as not having been made to best judgment, should be discharged in its entirety, and others where the tribunal should make a direction specifying the correct amount (see Commissioners of Customs and Excise v Pegasus Birds Ltd [2004] STC 1509). In the instant case, Mr Rycroft submitted that I should discharge the assessments in their entirety to censure HMRC for assessing the University to more VAT than they believed due from it. Alternatively, he contended that I should reduce the assessments to the amount properly due, i.e. to the amount shown in the Schedule to my decision.
- I am unable to accept those submissions. As Mr Puzey observed, HMRC have always accepted that the inclusion of the T-grant in the PESM is a proxy because the exempt supply of education is undervalued – a position the University now accepts. However, the use of the T-grant as a proxy is but one way of addressing that issue, and in certain cases may not be appropriate: each case must be considered on its own facts. The method to be used must be fair and reasonable, and was so in the instant case. Had Mr Rycroft adduced evidence in support of the Schedule, I might have been able to reduce the assessments. As he did not do so, I am unable to consider a reduction.
- Mr Puzey further submitted, and I accept, that HMRC did not assess for a figure in excess of that they believed due from the University: they came to a conclusion on the material before them, and satisfied the tests for best judgment referred to in Pegasus Birds. The exclusion or inclusion of the T-grant is a matter for argument, and not a question of best judgment.
- I hold that the assessments under appeal were made to HMRC's best judgment, and the quantum thereof should not be disturbed.
- In relation to the time limit issue, Mr Rycroft maintained that HMRC had known since 1998 that the University was treating PFR as a business, and until 2003 were operating under a mistake of law that such activity was properly to be viewed as a business. I am unable to accept that reasoning. As Warren J observed at paragraph 44 of his judgment in University of Southampton, the differences between the guidance offered by HMRC in 2002 and 2003 marked "a shift in position". However, he added, "But I doubt they indicate any, or any significant, change in principle or view of the law. Whether PFR generally, or a particular PFR project, is or is not an economic activity or a business remains a question of fact". As Mr Puzey observed, it was that "shift in position" that led to HMRC questioning the University's treatment of PFR in their letter of 24 October 2003: it was asked to substantiate, with evidence, the fact that it was entitled to treat PFR as a business. When it failed to do so, HMRC concluded that it could not be so demonstrated, and made the assessments under appeal. He submitted, and again I accept, that until that question had been asked and answered (or not, as the case may be) HMRC were not in possession of facts capable of leading to an assessment.
- Mr Puzey, correctly in my judgment, rejected an attempt by Mr Rycroft to fix HMRC with constructive knowledge that the University was not entitled to treat its PFR as a business, submitting that constructive knowledge was insufficient to start the clock ticking under section 73(6)(b) of VATA, see The Post Office v Commissioners of Customs and Excise [1995] STC 749 at pages 754 and 755. Mr Puzey did accept both that it was perfectly possible for PFR to be a business activity in certain circumstances, and that HMRC were required to make enquiries in each case as to whether it was being correctly treated, saying that it would be wrong to make an assessment based on assumptions.
- Mr Puzey maintained, and once again I accept, that until in November 2003, when HMRC obtained a copy of the University's HESA return showing PFR for 2000, they were unable to make an assessment. In the absence of information requested from the University, it was not until the HESA figures were to hand, and could be used with the relevant partial exemption figures, that HMRC were in a position to make the assessments.
- In the instant case, I find that the evidence of facts required to make the assessments was not before HMRC until November 2003 at the earliest. I am therefore satisfied that the assessments under appeal were made within the time limit for which section 73(6)(b) of VATA provides.
- I dismiss the appeal.
20174
VAT — input tax — deductibility of input tax — university undertaking publicly funded research (PFR) — whether PFR a business activity so that related input tax deductible — no — appeal dismissed
MANCHESTER TRIBUNAL CENTRE
THE UNIVERSITY OF SHEFFIELD Appellant
- and -
THE COMMISSIONERS FOR
HER MAJESTY'S REVENUE AND CUSTOMS Respondents
Tribunal: David Demack
Sitting in public in Manchester on 30 March 2007
Adam Rycroft, senior VAT manager with KPMG, for the Appellant
James Puzey, counsel, instructed by the General Counsel and Solicitor for HM Revenue and Customs for the Respondents
© CROWN COPYRIGHT 2007
DECISION
(1) the University's publicly funded research ("PFR") is a non-business activity; and
(2) input VAT incurred on PFR is wholly irrecoverable and input VAT incurred on commercial research projects must be treated as "non-attributable" if students are involved in the project.
"The assessment is excessive and it does not recognise in the method used income received from the Higher Education Funding Council of England for the purposes of funding education. The Appellant contends that such income should be included as it is now accepted by both the Appellant and HMRC that it acts as a fair proxy for exempt business use within the Appellant's business."
In other words, the University contended that by excluding the T-grant (the teaching grant) from the business / non-business calculation, HMRC knowingly understated the business income of the University to its detriment.
"Numerator: All taxable income at 17.5%, 5% and zero rate, AND outside the scope income with entitlement to input tax recovery (Normally EU based).
Denominator: From the HESA [Higher Education Statistics Agency] return – Paras 2a, b, c, d, e – 3b, c, d, e, f, g, h, i – 4a, b, d, f, g. 3b to I will exclude amounts which do not relate to any onward supply, except EU Commission funded research."?? Is this correctly quoted?
Put in simpler terms, the PESM fraction may be stated as follows:
Taxable Supplies
Taxable and exempt supplies (not including T-grant)
"7. HEFC grants which support general academic research which is not for business purposes should be excluded from partial exemption calculations and an appropriate business / non-business calculation undertaken to determine the input tax to go forward to the partial exemption calculation.
8. Research Council grants are not considered to fund taxable activity rather to fund research where no supplies are arising. It [sic] should not be included in partial exemption calculations and the question of restriction for non-business use should be considered."
"2.6 Research Council Grants … the HE ["Higher Education"] Institutions retain the intellectual property rights [arising from this research] which Research Councils require them to exploit commercially, should the opportunity arise (see paragraph 2.13 below).
2.13 Grants are allocated by Research Councils on the basis that a recipient institution will exploit the intellectual property rights commercially should the opportunity arise"
"Research Council grants therefore are merely subsidies for what will ultimately be taxable activities and, since they are not consideration for a supply, should not be included in an incomes based partial exemption calculation. To the extent however that supplies arise out of research funded by the Research Council grants, those grants would be a subsidy for that activity and should be so included in the partial exemption calculations."
"2.6 … the results of [charity funded research] are generally shared between the HE institution and the charity which they will exploit commercially should the opportunity arise.
2.20 Research which is funded by charity grants where the HE institution retains the intellectual property rights are also merely subsidies for what will ultimately become taxable activities and should also be excluded from the incomes-based partial exemption calculations on the grounds that they are not consideration for a supplies. If supplies arise out of the exploitation of the research funded by charity grants, those grants should be included in the partial exemption calculations as being subsidies for those activities in the period. However, if the intellectual property rights pass to the charity, research which is funded by charity grants will result in an exempt supply as the research will be provided by one eligible body to a body which is also an eligible body by virtue its charitable status."
"Research councils fund research where in many cases no intellectual property rights (IPRs) are created, with the result that no taxable supplies are made. Consequently, the question of a restriction for non-business use needs to be considered. The BUFDG submission states that HE institutions retain any IPRs which may arise from research funded by Research Councils and that these might lead to taxable supplies. But Research Council grants fund or subsidise research, not the exploitation of IPRs. The submission provides no evidence that taxable supplies or royalties from IPRs are undervalued.
The Submission fails to take into account the use of Research council grants to fund or subsidise student education, although this is clearly supportable from evidence within the Submission … this would support the inclusion of these grants in the denominator [of partial exemption methods] rather than the numerator."
"The need [is] to focus on the real objective which is to obtain a fair and reasonable apportionment of input tax. This can only be done in the context of the individual circumstances of each institution."
(a) that a university would be carrying out its research activity in the course or furtherance of its business if it were doing so with the intention of making further supplies if the research was successful, even if supplies were not ultimately made;
(b) that research intended to be used internally either to further additional research or to improve the provision of education was still a business activity because it was carried out in furtherance of the overall business of the university; and
(c) that research which utilised fee-paying post-graduate students to carry out all or some of the research was a business activity, or the project would then appear to be closely linked to the exempt supply of their education.
"[39] … Guidance produced in 2002 distinguished between (i) commissioned research (e g for a sponsoring commercial organisation for a fee) where the client received the right to exploit the outcome of the research and (ii) university-led research which was initiated by the university itself and was funded in whole or in part by research grants. Commissioned research was regarded as a business whereas university-led research was not necessarily so regarded. The only research which could categorically be viewed as a non-business activity was research: (i) which was solely grant funded; (ii) where there was clearly no intention to produce exploitable intellectual property rights; (iii) where there was no discernible student involvement (i e professional researchers only); and (iv) where the outcome of the research was not intended to further directly the university's other business activity. The relevance of (ii) and (iv) to negating business use is obvious; the relevance of (iii) is based on the proposition that student involvement (particularly by graduates in the furtherance of work on a higher degree) could be viewed as part of the university's supply of educational services. The guidance concluded that non-business research was the exception rather than the rule. It showed, however, that the commissioners regarded the question as one of fact in any particular case.
[40] Mr Milne [counsel for the university] emphasises, and agrees almost entirely with, paras 12, 13 and 16 of the Guidance (paragraphs (i) to (iv) above reflecting para 16 of the Guidance). In particular:
a. In para 12, the commissioners stressed that grant funding does not in itself make the research a non-business activity. Although it was acknowledged that genuine grants are not consideration for a supply, the research activity could nonetheless be a business activity and could generate supplies. Two examples are given, the second being that a university—
'will clearly be carrying out its research activity in the course or furtherance of its business if it is doing so with the genuine intention of making further supplies (taxable or exempt) if the research is successful e.g. the exploitation of IPR. This will be the case even if supplies are not made ultimately, e.g. because the research fails.'
b. In para 13, the commissioners stated that the nature of the activity is more difficult to determine where the university does not intend to produce IP and expressed their view that—
'… where research is intended to be used internally either to further additional research or to improve the provision of education, the activity is still a business because it is carried out in furtherance of the overall business of the University. For example, the results of a research project may not in itself be intended to produce exploitable IP; however, its outcome is intended to be used to further another or later project which is intended to produce IP; or the outcome of the research is used to enhance the provision of education at the University …'
[41] In May 2003, further Guidance was prepared. This represented a change of position from accepting that PFR was likely to be a business activity to a position where the more likely position was that it was not a business activity. But, consistently, one there sees a recognition that there is no hard-and-fast rule and the question is ultimately one of fact. The Guidance repeated that grant funding did not of itself make the research a non-business activity, repeating in substance the examples provided in the earlier Guidance. However, the commissioners stated that it was no longer the position that they would take at face value without investigation claims that PFR is undertaken with a view to developing exploitable IP rights. Further they addressed the argument that, where research was intended to be used internally to further additional research or to improve the provision of education, the activity remains a business activity because it is carried out in furtherance of the overall business of the university. The commissioners were 'no longer inclined to accept this argument unless clear business imperatives can be demonstrated' a matter enlarged on in para 18 of the Guidance.
[42] Further, as to student participation in research, the commissioners were no longer willing to treat PFR as a business activity 'solely by virtue of the fact that fee paying students are involved'. This followed from a change in their understanding of how students actually participate in research. That would not preclude, I think, any particular university from establishing that its own students participated in such a way that a relevant business link existed.
[43] The commissioners were no longer prepared to take claims that PFR constituted a business without supporting evidence. Accordingly, if a university claimed that its research was driven by business imperatives, they required evidence to support that contention on a project by project basis. Indicators would include: (i) whether the PFR is of a type which would produce commercially exploitable IP rights; (ii) what evidence is available to support the contention that the exploitation of IP rights was a specific reason for the research; (iii) whether there was an intention to publish in the public domain the results of the research; (iv) whether the IP rights were to be passed on to a third party or to belong to the researcher; and (v) the university's record in exploiting IP rights from PFR.
[44] The differences between the two Guidance notes mark a shift in practice. But I doubt they indicate any, or any significant, change in principle or view of the law. Whether PFR generally, or a particular PFR project, is or is not an economic activity or a business remains a question of fact. Whereas, in the past, the commissioners were prepared to accept at face value claims that the university intended to exploit IP rights (and thereby to establish the relevant PFR as a business activity), for the future it would require evidence, and would do so on a case by case basis. The potential for commercial exploitation, and the intention to exploit any such potential, are no doubt factors, and important factors, in the overall picture. Whether or not there is such potential and whether there is such intention are not matters on which it is possible to draw an a priori conclusion either way but no doubt the factors adumbrated by the commissioners in the Guidance will be highly relevant in reaching a conclusion. However, the question whether a particular piece of PFR is a business activity or not must be answered (whether by the commissioners or the tribunal) in the light of all the facts before them.
[45] As a matter of principle, the commissioners must surely be correct in saying, as they do in the later Guidance, that whether or not a project is business or non-business must be determined by the facts of the case in point i e on a project-by-project basis. No doubt, for any given university, there will be factors which apply to each and every one of its projects; but there are bound to be factors which are unique to individual projects, and in particular, the potential for exploitation of IP rights may differ significantly between projects. The status of a particular project must be assessed by reference to the facts relevant to that project albeit in the context of the activities of the university concerned as a whole, although it may be that included in the relevant factual matrix will be facts relating to other PFR projects (as indeed the commissioners seem to recognise in the fifth factor mentioned at the end of [43] above).
[46] Whether it is correct to look, as the commissioners suggest in the Guidance, at the intention of a university in relation to the exploitation of PFR might be open to question in the light of the approach in Halifax [2006] STC 919, [2006] 2 WLR 905. However, if the result of PFR is, in a particular case, exploited so that there is clearly economic activity at the end of the day, an objective assessment of the facts might be made at an earlier stage to show that the PFR is part of a larger activity intended to extend into the future."
"Schedule A: Assessment for period ending 31 January 2001
I have calculated my assessment on the assumption that the University determined the attribution of residual input tax to taxable supplies in this period on a provisional basis by applying the partial exemption percentage for the year ending 31 July 2000, i.e. 44.34% to the residual incurred input tax in that period.
Without prejudice to any errors later identified in the partial exemption percentage or the residual input VAT figures used by the University to make its claim, I have determined the correct entitlement for that period by:
(a) establishing the percentage of that residual VAT attributable to business use (using the method set out in appendix A) for year ending 31 July 2000;
(b) applying the percentage at (a) to the residual VAT figure to establish, provisionally, residual VAT used for business purposes;
(c) applying the provision partial exemption percentage to the "business" residual VAT at (b).
As this business percentage is provisional, it needs to be revisited as part of the partial exemption annual adjustment process which for this period would fall in 01/02.
Calculation
| a) | Business income for 2000 (as per University's PE calculation summary) | £117,079,637 |
| b) | 'Active' non-business income (funding non-business activity) | £39,122,000 |
| c) | Business income + Active non-business income (a+b) | £156,201,637 |
| d) | Business percentage (a / c) | 74.95% |
| e) | 01/01 residual input tax used by the University for PE purposes | £1,078,257 |
| f) | Business 'adjustment' to input tax pot (e x d) | £808,159 |
| g) | PE recovery percentage (as per University's PE calculation) | 44.34% |
| h) | Recoverable input tax (f x g) | £358,335 |
| i) | Amount of input tax claimed in 01/01 (e x g) | £478,099 |
| j) | Over claimed input tax (i – h) = amount to be assessed | £119,764 |
Taxable supplies
Taxable and exempt supplies (including T-grant)).
Taxable and exempt supplies plus T-grant
Taxable and exempt supplies plus PFR income (not including T-grant)).
The Relevant Legislative Provisions
"73. Failure to make returns etc
(2) In any case where, for any prescribed accounting period, there has been paid or credited to any person —
(a) as being a repayment or refund of VAT, or
(b) as being due to him as a VAT credit,
an amount which ought not to have been so paid or credited, or which would not have been so paid or credited had the facts been known or been as they later turn out to be, the Commissioners may assess that amount as being VAT due from him for that period and notify it to him accordingly.
…
(6) An assessment under subsection (1), (2) or (3) above of an amount of VAT due for any prescribed accounting period must be made within the time limits provided for in Section 77 and shall not be made after the later of the following—
(a) 2 years after the end of the prescribed accounting period; or
(b) one year after evidence of facts, sufficient in the opinion of the Commissioners to justify the making of the assessment, comes to their knowledge."
"Subject to the following provisions of this section, 'input tax', in relation to taxable person, means the following tax, that is to say —
(a) VAT on the supply to him of any goods or services;
(b) VAT on the acquisition by him from another member State of any goods;
(c) VAT paid or payable by him on the importation of any goods from a place outside the member States being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him."
"The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below."
"Subject to regulation 102 and 103B the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation."
"There shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period."
"Subject to paragraph (2) below and regulations 103, 103A and 103B, the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 …"
"(3) A taxable person using a method as approved or directed to be used by the Commissioners under paragraph (1) above shall continue to use that method unless the Commissioners approve or direct the termination of its use.
(4) Any direction under paragraph (1) or (3) above shall take effect from the date upon which the Commissioners give such direction or from such later date as they may specify."
DAVID DEMACK
CHAIRMAN
Release Date: 22 May 2007
MAN/05/0363
Glossary of Acronyms:
BUFDG British Universities Finance Directors Group
CVCP Committee of Vice Chancellors and Principals
HEFC Higher Education Funding Council of England
PESM Partial Exemption Special Method
PFR Publicly Funded Research
SOP Statement Of Policy
THE SCHEDULE
Calculation of Overassessment in respect of BNB issue
| 2000/01 | ref | 2001/2 T-grant in as business |
T-grant excluded |
2002/3 T-grant in as business |
T-grant excluded |
||
| T grant business income |
44,654,791 117,079,637 |
a b |
48,823 92,217 |
92,217 |
50,939 105,865 |
105,865 |
|
| Total business income | 161, 734,428 | c | a+b | 141,040 | 92,217 | 156,804 | 105,865 |
| Active non-business | 39,122,000 | d | 47,525 | 47,525 | 47,374 | 47,374 | |
| Total income | 200,856,428 | e | c+d | 188,565 | 139,742 | 204,178 | 153,239 |
| Business percentage | 80.52% | f | c/e | 74.80% | 65.99% | 76.80% | 69.08% |
| Total expenses VAT | 1,078,257 | g | 4,433,616 | 4,433,616 | 6,910,899 | 6,910,899 | |
| Business input tax | 868,238 | h | f x g | 3,316,187 | 2,925,771 | 5,307,408 | 4,774,381 |
| Recovery percentage | 44.34% | i | 40.95% | 40.95% | 35.72% | 35.72% | |
| Recoverable input tax | 384,977 | j | h x I | 1,357,979 | 1,198,103 | 1,895,806 | 1,705,409 |
| Input tax claimed | 478,099 | k | 1,815,566 | 1,815,566 | 2,830,013 | 2,830,013 | |
| Over recovery | 93,122 | l | k-j | 457,587 | 617,463 | 934,207 | 1,124,604 |
| Figure assessed by Customs | 119,764 | m | 617,603 | 617,603 | 1,124,583 | 1,124,583 | |
| Over assessment | 26,642 | n | m-l | 160,015 | 140 | 190,376* | 21 |
| Total overassessment | 26,642 160,015 190,376 |
*(rounding error relating to RWB original calc) (caused by single calculation approach |
|||||
| 377,034 |