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Cite as: [2008] UKVAT V20731

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The Wellcome Trust v Revenue & Customs [2008] UKVAT V20731 (03 July 2008)

20731

VALUE ADDED TAX – Input tax – Building acquired in 1998 by taxable person for private use and business and exempt use – Input tax re purchase claimed in 2003 – Whether claim valid under Regulation 109 of the VAT Regulations 1995 (SI 1995/2518) – Yes in part – Whether Appellant entitled to rely on Lennartz – Whether HMRC's attitude to Lennartz claims at time made it excessively difficult for Appellant to make a claim – Whether Appellant's claim under Regulation 29 of the VAT Regulations 1995 properly capped – Whether principle of effectiveness breached

LONDON TRIBUNAL CENTRE

THE WELLCOME TRUST Appellant

and –

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE & CUSTOMS Respondents

Tribunal: MISS J C GORT (Chairman)

MISS S WONG CHONG FRICS

Sitting in public in London on 16, 17 and 18 April 2007 and 29 and 30 April 2008

Mr Andrew Young of counsel, instructed by SOC VAT Consultants, for the Appellant

Ms Shaheen Rahman of counsel, instructed by the solicitor's office, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

This is an appeal against a decision of the Commissioners contained in a letter dated 8 August 2005 refusing credit to input tax, under Rule 109 of the VAT Regulations 1995 but allowing it subject to capping under Rule 29..

The main issues in the appeal are:

Whether capping provisions were wrongly applied by the Commissioners in respect of a claim brought under VAT Regulation 29.

Whether the Wellcome Trust ("Wellcome") are entitled to claim the input tax under regulation 109 of the VAT Regulations 1995 (SI 1995/2518).

Whether Wellcome is able to claim its input tax using the "Lennartz" mechanism.

The Background

Wellcome was registered for the purposes of VAT with effect from 1 January 2000 at 215 Euston Road, London. Its main business activity is that of a medical research charity. It has a large property portfolio of both domestic and commercial property. It undertakes pure research with the intention of benefiting humans and animals and it receives royalties from the outcome of that research. It sells CD ROMs on the history of medicine and has the largest medical library in the UK.

On 2 June 1998 Wellcome purchased premises known as Babcock House for £16m plus VAT. By way of a letter dated 17 June 1998 Wellcome waived exemption to tax under Schedule 10, paragraph 2 of the VAT Act 1994 ("the Act") in respect of Babcock House, whose address was given as 140 Gower Street/209 Euston Road, London. Wellcome exercised the option to tax the building. No input tax was claimed on the purchase price at the time. The purpose of the purchase of Babcock House is a matter which the Tribunal will have to determine.

The purchase of Babcock House consisted of the leasehold interest at a cost of £14,100,000 and the freehold interest for £4,700,000, both inclusive of VAT.

Babcock House had previously been occupied by the security services. At the material time the existence of the security services and their location was not publicly acknowledged. As a consequence the paperwork relating to Babcock House bears different names and addresses, including 140 Gower Street, 215 Euston Road and 209 Euston Road.

At or around June 1998 Wellcome conducted an internal review of its property holdings and its long-term need in respect of office accommodation. Plans by Wellcome regarding the use of Babcock House were modified when an adjacent building known as Unity House became available. These plans were considered by the Board of Governors in October 1998.

At or around February 1999 the demolition of Babcock House commenced. At or around November 1999 Wellcome acquired Unity House at a cost of £18m and no VAT. Unity House was demolished at a date commencing around April 2001. At or around July 2004 a new building which became the annexe to 183 (later to be known as 215) Euston Road was completed. The construction of this building was commenced at or around April 2001. The demolition of Unity House overlapped the construction of 183 Euston Road. Prior to the purchase of Babcock House Wellcome had purchased 210 Euston Road which was linked via a tunnel to 183 Euston Road. It had waived the exemption in respect of that building. Babcock House and Unity House were both demolished and replaced with a new construction, which was attached to 183 Euston Road. The option to tax in respect of 210 Euston Road applied. The new construction was a charity annexe to 183 Euston Road and the construction service relating to it was zero-rated.

By a letter dated 31 July 2002 Wellcome notified the Commissioners of the financial structure they intended to apply to the annexe. Considerable correspondence took place between John Hemming, the tax manager of Wellcome, and the Commissioners. A meeting took place, following which, on 10 January 2003 by a letter Wellcome for the first time formally indicated that it was to request a repayment of input tax from the Commissioners. The claim related to the VAT incurred on the purchase of Babcock House together with the VAT incurred in respect of construction-related costs, professional fees and site works concerning the development of the annexe to the extent that such supplies were not zero-rated. A formal claim for repayment by Wellcome followed on 14 February 2003 in the sum of £4,398,651.31.

After further considerable correspondence between the parties Wellcome maintained its claim and asserted that in any event, VAT incurred since 1 January 2000 totalling £1,121,047.06 fell within the 3-year cap and was therefore repayable. The remainder of the claim was repayable under regulation 109. On 26 June 2003 Wellcome stated inter alia:

(a) The original attribution of input tax incurred by the Appellant was partly to intended non-business activities and partly to intended exempt and taxable business activities.

(b) The decision to enter into the lease and lease back arrangement evolved over a period of time, however the final form of decision made by the Trust to go ahead with the transaction was made in October 2002 as demonstrated by the Governors' meeting minutes.

(c) The actual lease and lease back arrangement was entered into on 1 April 2003.

(d) Initial investment purpose encompassed intended non-business, exempt and taxable supplies.

(e) The change of intention to make the zero-rated grant was formalised in October 2002 when the Governors agreed to proceed with the transaction subject to the receipt of relevant clearances from HMRC.

By way of a reply dated 24 October 2003, HMRC stated:

"As discussed I can confirm that the part of the claim that related to change of intention from non-business to business cannot be accepted. A person could only treat VAT he incurs on supplies of goods or services as input tax if at the time it is incurred he intends that the goods or services are to be used for the purposes of his business. If the supplies are required wholly for purposes other than those of his business he has no right to deduct VAT incurred as input tax even if they are subsequently put to business use."

Initially HMRC would not accept that Wellcome had made part of its claim under regulation 29, but after further representations it made the ruling subject of this appeal by which they accepted the claim under regulation 29 but rejected the claim under regulation 109. On 26 September 2005 HMRC paid £1,051,818 as a consequence of that decision.

The legislation

The Sixth VAT Directive provides:

"Article 17

Origin and scope of the right to deduct

(1) The right to deduct shall arise at the time that the deductible tax became chargeable.

(2) Insofar as the goods 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 repay:

(a) Value Added Tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person;

(b) Value Added Tax due or paid in respect of imported goods;

(c) Value Added Tax due under Articles 5(7)(a) and 6(3)."

"Article 18

Rules governing the exercise of the right to deduct

(1) To exercise his right of deduction a taxable person must:

(a) in respect of deductions pursuant to Article 17(2)(a) hold an invoice drawn up in accordance with Article 22(3);

(b) in respect of deductions pursuant to Article 17(2)(b), hold an import document specifying him as consignee or importer, and stating or permitting calculation of the amount of the tax due;

(c) in respect of deductions pursuant to Article 17(2)( c) comply with the formalities established by each Member State;

(d) when he is required to pay the tax as a customer or purchaser where Article 2(1) applies, comply with the formalities laid down by each Member State;

(2) The taxable person shall effect the deduction by subtracting from the total amount of tax due for a given tax period the total amount of the tax in respect of which during the same period, the right to deduct has arisen and can be exercised under the provisions of paragraph 1 […].

(3) Member States shall determine the conditions and procedures whereby a taxable person may be authorised to make a deduction which he has not made in accordance with the provisions of paragraphs (1) and (2)."

"Article 20

Adjustments of deductions

(1) The initial deduction shall be adjusted according to the procedures laid down by Member States, in particular:

(a) where the deduction was higher or lower than that to which the taxable person was entitled;

(b) where after the return is made some change occurs in the factors used to determine the amount to be deducted, in particular where purchases are cancelled or price deductions are obtained; however, adjustment shall not be made in cases of transactions remaining totally or partially unpaid and of destruction, loss or theft of property duly proved or confirmed, nor in the case of applications for the purpose of making gifts of small value and giving samples specified in Article 5(6). However, Member States may require adjustment in cases of transactions remaining totally or partially unpaid and of theft."

(2) In the case of capital goods, adjustments shall be spread over five years including that in which the goods were acquired or manufactured …

In the case of immovable property acquired as capital goods,, the adjustment period may be extended up to 20 years.

Regulation 109(1) of the VAT Regulations 1995 (SI 1995/2518) ("the Regulations") provides:

"Where a taxable person has incurred an amount of input tax which has not been attributed to taxable supplies because he intended to use the goods or services in making either –

(a) exempt supplies, or

(b) both taxable and exempt supplies,

and during a period of 6 years commencing on the first day of the prescribed accounting period in which the attribution was determined and before that intention is fulfilled, he uses or forms an intention to use the goods or services concerned in making taxable supplies or, in the case of an attribution within sub-paragraph (a) above, in making both taxable and exempt supplies."

Regulation 109(2) of the Regulations provides as follows:

"Subject to regulation 110 and where this regulation applies, the Commissioners shall, on receipt of an application made by the taxable person in such form and manner and containing such particulars as they may direct, pay to him an amount equal to the input tax which has become attributable to taxable supplies in accordance with the method which he was required to use when the input tax was first attributed."

Regulation 29(1A) of the Regulations provides as follows:

"The Commissioners shall not allow or direct a person to make any claim for deduction of input tax in terms such that the deduction would fall to be claimed more than 3 years after the date by which the return for the prescribed accounting period in which the VAT became chargeable is required to be made."

The Tribunal was referred to the following authorities:

Fleming (trading as Bodycraft) v HMRC [2006] EWCA Civ 70

Marks & Spencer Plc v Commissioners of Customs and Excise [2003] EWCA Civ 1448

Condé Nast Publications Ltd v Commissioners of Customs and Excise [2006] EWCA Civ 976

Lennartz v Finanzamt München III [1995] STC 514

P. Charles, T.S. Charles-Tijmens v Staatssecretaris van Financiën Case C-434/03

Wolfgang Seeling v Finanzamt Starnberg Case C-269/00

Waterschap Zeeuws Vlaanderen v Staatssecretaris van Financiën Case C-378/02

Royal and Sun Alliance Insurance Group Plc v Commissioners of Customs and Excise [2003] UKHL 29

Uudenkaupungin Kaupunki Case C-184/04

Walker-Fox v Secretary of State for Works and Pensions [2005] EWCA Civ 1441

Local Authorities Mutual Investment Trust v Commissioners of Customs and Excise [2003] EWHC 2766

The evidence

Agreed bundle of documents were produced and witness statements on behalf of Wellcome were provided from John Hemming of Wellcome, Martin Scammel, a partner in Ernst & Young LLP, and James Miller, a partner in the Real Estate Group of the firm CMS Cameron McKenna LLP. Mr Hemming and Mr Scammel gave oral evidence to the Tribunal, Mr Miller's statement was read. There were witness statements from Simon Lewis, Graham Burgess and Linda O'Sullivan on behalf of HMRC, all three gave oral evidence to the Tribunal.

An issue of fundamental importance in this case is what was the intention of Wellcome at the time it purchased Babcock House as to its use, the evidence as to this is not entirely clear. The first relevant document is a minute of a meeting of the Wellcome Board of Governors ("the Governors") which is dated 28 January 1998, however it is headed "Agenda Item No.13(b) February 1998". In that document it states inter alia that the Wellcome building (183 (later 215) Euston Road and 210 Euston Road) "will soon be reasonably filled to capacity". With reference to Babcock House it is said: "This will be put up for sale in March and the agency expect any buyer would want to undertake major refurbishment or a rebuild. The agent envisaged residential, hotel or office use in the future. …" There are various references to other possible buildings in the area which are said to present a range of possible extra space. This document is evidence both that Wellcome was considering using Babcock House to provide extra space for its own use, but also as a possible investment.

A document dated 28 May 1998 is a discussion paper for the Governors in June 1998. It says: "Purchase of Babcock (to be renamed, no doubt) should be completed by 4 June 1998. This transforms our space planning opportunities. … A fantasy which might become reality is that the RMP Union's Unity House, between the Wellcome building and Babcock House, becomes available. Subject to the case being made by the library, Unity House might be redeveloped as the bookstore."

A further document is entitled "Babcock House" and sub-titled "A substantial refurbishment/redevelopment opportunity" and is the cover of a report for the Governors relating to the purchase of Babcock House. Under "introduction" there is a paragraph which states: "The purchase was initially proposed as a commercial investment for development purposes but with the option for the Wellcome Trust to occupy in the future. The emphasis changed to owner-occupation during the course of appraising the property due to a significant anticipated increase in staff numbers and a strategic review of the Wellcome Trust's space requirement." The document is dated 1 June 1998, and the purchase invoice of Babcock House is dated 2 June 1998.

Another relevant document in respect of Wellcome's intention at the time is dated 10 June 1998 and is a confidential annex to the 26 May 1998 Board of Management meeting. It refers to the purchase of a large property in the Euston Road, which "could conceivably house 500 people" would be completed the next day. It continues: "the strategy being contemplated is that this property could house science funding and supporting areas, leaving the Wellcome building as the 'public' building." Towards the end of the minute it is stated: "It was speculated that if ever Unity House in its entirety came onto the market, this could prove an attractive option when considering the Trust's future accommodation requirements."

There are two purchase invoices in respect of Babcock House, one is consideration for the sale of the leasehold interest in the sum of £12m with VAT at £2,100,000, and one for the sale of the freehold interest in the sum of £4m with VAT at £700,000. The invoices are dated 2 June 1998 and are made out to the Wellcome Trust Ltd. The Wellcome Trust Ltd is the Trustee of Wellcome, which is a registered charity spending £500,000,000 each year on medical research.

By a letter dated 13 August 1999 Wellcome informed the Commissioners of the financing structure it was considering. In respect of areas used for third party lettings and mainly taxable business use it said: "VAT incurred on the construction of these areas will therefore be fully recoverable by the Trust". Wellcome contend that this is claim for recovery, albeit an unliquidated one, and rely on Regulation 29(3) for the proposition that Wellcome should have been entitled to take the return date for limitation purposes as the next but one following the period in which the VAT became chargeable.

Mr Hemming did not join Wellcome until April 2002, he was therefore unable to give direct evidence as to what the Governors' intentions were at the relevant time with regard to the purchase of Babcock House. However in his witness statement he refers to reviewing the files and documents for the period held by Wellcome before he joined them, and from talking to people who were involved at the time he was able to establish that Babcock House was originally identified as an investment opportunity by the Trust's investment division and the purchase negotiations proceeded on that basis. The building was purchased with vacant possession. He was aware that at the same time Wellcome was considering its office accommodation needs based on anticipated staff levels up to 2008 and Babcock House was identified as a possible solution to Wellcome's accommodation requirements, but there was no decision as to which employees might occupy it, i.e. as to whether they would be involved in the business, the exempt or the non-business areas. He further referred to an e-mail from a Mr Paul Clarke of Wellcome's investment division which was dated 3 June 1998 and stated: "The intention at the time of negotiation and purchase was that it would be redeveloped by investment for the medium term but that longer term it may be required for the Trust's own occupation. At present the building is VAT-able and it is important that for the present this election remains in place because if the building is redeveloped and re-let I wish to recoup the VAT on construction etc". This is the only evidence which relates directly to the intention at the relevant time.

It was Mr Hemming's opinion that the original intention was that Babcock House would be used for some business purpose and, therefore, if there had been provision for the Lennartz mechanism to be applied, Wellcome would have claimed all the input VAT incurred upon acquisition and made the appropriate adjustments for non-business use once it had been established. It was also his opinion that HMRC's policy at the time did not allow Lennartz to be applied to services, and therefore Wellcome's advisers, Ernst & Young, had advised that such a claim would be difficult. Mr Hemming referred to various business briefs released by HMRC between 1992 and 2003, and to the change of guidance in those briefs.

By a news release dated 6 January 1992 HMRC, in respect of the case of Lennartz v Finanzamt München 3, Case C-97/90, referred to the Court ruling that a taxable person had a right to total and immediate input tax deduction on goods (not services) which are used partly for business and partly for private purposes. In Business Brief 22/2003 HMRC again refer to the Lennartz mechanism and again repeated its view that the implication of Lennartz was that the ruling did not apply to services. However, the Business Brief also refers to the case of Wolfgang Seeling Case C-269/00, in which the Court accepted that VAT on construction services that result in the construction of a building can be dealt with under the Lennartz mechanism. In the present case there was an issue between the parties as to whether the Lennartz mechanism was applicable to the circumstances of Wellcome, and if so whether its use was considered by Wellcome, and furthermore whether, as was submitted on behalf of Wellcome, the Commissioners were unwilling to allow taxpayers to use the Lennartz mechanism at that time.

Prior to Mr Hemming's joining Wellcome, Unity House had been purchased and there had been correspondence with HMRC about the financing structure that the Trust was considering and eventually adopted. In 2000 the construction project had been considered by HMRC to be an annexe used for a relevant charitable purpose and therefore qualified for zero-rating although any business activity was restricted to less than 10% of total usage. The head count method for calculating usage was agreed with HMRC and confirmed in a letter from Linda O'Sullivan dated 14 December 2000.

When Mr Hemming first joined Wellcome he had written to HMRC requesting VAT clearance for the funding structure proposed. A meeting was set up with Ernst & Young and Miss O'Sullivan of HMRC brought with her Mr Burgess, whom Mr Hemming understood to be a property expert. The meeting took place on 14 October 2002 but no opinion was given in respect of Wellcome's arrangements, although confirmation of the VAT analysis was given by HMRC on 23 October 2002. On 10 January 2003 Wellcome made an unliquidated claim in respect of input tax attributable to the development. It lodged a liquidated claim on 14 February 2003.

In 2007 there were moves by the Government and HMRC to mitigate the effect of Lennartz. In the 2007 Budget Note it was recognised that it would be necessary to repeal the legislation that had been introduced in 2003 which was designed to prevent Lennartz accounting in respect of land and buildings. This followed the decision of the European Court of Justice in the case of P Charles, T. S. Charles-Tijmens which prevented EU Member States from legislating against the use of Lennartz accounting. Various measures were set out. Draft regulations were then sent out to various interested parties and comments were invited. This letter was sent out on 30 May 2007. By Revenue & Customs Brief 56/07 it was announced that there would be a delay in the implementation of the new 'Lennartz accounting' regulations. By Revenue & Customs Brief 68/07 it was announced that they would be implemented as from 14 November 2007. Guidance on the Lennartz accounting regulations was issued in November 2007, and the regulations were laid on 30 October 2007. The regulations are lengthy.

Wellcome had agreed a partial exemption method with HMRC on 8 March 2002, which was used with effect from 1 January 2000, the same method has been used since. It was Mr Hemming's clear oral evidence that the intended use of Babcock House at the time of purchase was for a mixed use, the business activities proposed would include exempt and taxable activities, there was a possibility of non-business use, but Wellcome would try to minimise its non-business activity. It was also his evidence that at the time Babcock House was acquired it was not possible for Wellcome to determine exactly how the building would be used. It was known that there would be excess space over and above any requirement to accommodate staff. The partial exemption method was not considered for use in respect of Babcock House because nothing would give the appropriate attribution in terms of the proportion of use .

The original intention with Unity House had been to build a 17-storey building, however planning permission was refused and in the end planning permission was given for a 9-storey building which became fully occupied by Wellcome's staff. Even when Unity House was purchased, there was still no certainty as to what would be done with Babcock House. The ruling on the annexe imposed a restriction on Wellcome's activities. Until the zero-rating ruling in respect of the annexe was made, it was not known how to allocate the input VAT on Babcock House. Once the lease and lease back arrangement was set up, and the supply became zero-rated not exempt, there was then an intention to make a 100% taxable supply. It was only when this arrangement was signed in April 2003 that it was possible to reach a basis for appropriate attribution. It was disputed by Mr Hemming that Wellcome had ever contemplated exempt lettings, as had been referred to by the Commissioners in a letter from Simon Lewis dated 19 May 2003 to Wellcome.

It was Mr Hemming's understanding at the time he joined Wellcome in 2002 that the Lennartz mechanism could not be used for services, but could be used for goods, he believed that Lennartz was not well understood at the time and there were still issues with regard to how it worked with partial exemption. None of the correspondence between Mr Hemming and the Commissioners before 2005 makes reference to the Lennartz mechanism. Mr Hemming's explanation for this was that he was aware of Ernst & Young's advice that it was difficult to apply and he also had been advised that it was possible to claim under either regulation 109 or 29 which was the action he eventually took. The complications that Mr Hemming saw arising out of the Lennartz case were in keeping the records of expenditure, the monitoring of use, the allocation of business/non-business use and how to deal with that within a capital goods scheme and partial exemption. The first written reference by Mr Hemming to Lennartz is in a letter dated 15 April 2005 sent to Simon Lewis at HMRC following a meeting. Mr Hemming wrote:

"This Business Brief [22/2003], which was issued in November 2003, outlines the Commissioners' change in policy on the treatment of certain services supplied to a business and used for both business and non-business purposes. In particular, Customs now accept that the Lennartz mechanism can be applied to construction services incurred before 9 April 2003. It appears to us that this mechanism could have been applied to the Trust's circumstances."

He continues in the same letter:

"If regulation 109 is not applied, the Trust is effectively left in a position where it has incurred input tax that is directly attributable to a taxable supply, but is nevertheless not reclaimed. This is contrary to basic VAT legislation."

Mr Lewis replied by letter dated 8 August 2005 (the decision letter) and, having referred to Lennartz, states that there is no mechanism within VAT for circumstances where VAT had been attributed at the outset to a non-business use and subsequently those goods or services are put to a business use, and he therefore rejected the regulation 109 claim. In evidence Mr Hemming gave it as his opinion that Wellcome would have made a Lennartz claim if it could because of its need for cash flow, but it had not made a claim at the time because it did not believe it could make a successful claim in regard to services, and whilst it would have been possible to make a claim with regard to goods, it would have been difficult to administer. Mr Hemming appears to have misunderstood that any claim by Wellcome would have been a claim for goods.

Martin Scammel had left Ernst & Young LLP and at the time of the hearing was head of the indirect tax department at Eversheds LLP. Mr Scammel had advised Wellcome on the possibility of making a Lennartz claim not long after Wellcome acquired Babcock House. Ernst & Young had been involved in the aftermath of the purchase and the possibility of using the site to construct a new building. Mr Scammel was aware of a general pattern of HMRC putting obstacles in the way of people making Lennartz claims, especially for property-related expenditure, and that at that time the mechanism was little used. One obstacle he foresaw in the way of making a Lennartz claim was that he believed that HMRC had taken the view that such a claim must be made immediately, and that HMRC would have had to have known in June 1998 the intended use of the building as between business and non-business. Furthermore HMRC did not accept the use of the Lennartz mechanism for services until 2003, and in 1998 it was not clear that it applied to buildings at all. Whilst he accepted that the grant of a major interest in property was treated as a supply of goods, that was not the same thing as it being goods, and he would not have expected HMRC to admit the claim for that reason alone. Wellcome did not wish to be confrontational and it was considered that the use of Lennartz was confrontational and the fact that HMRC used its anti-avoidance unit for Lennartz claims supported that view. Furthermore there was nothing in the guidance from HMRC as to the relationship between Lennartz and partial exemption at the time.

On behalf of the Commissioners Linda O'Sullivan, who had been in correspondence with John Harrison, Wellcome's chief accountant, from 1999 until 2001 gave evidence that she was not aware of any discussion about Lennartz in the context of Wellcome. At the time she was a charities expert who dealt with Wellcome. She had never personally dealt with a Lennartz claim, but if she been confronted by one, she would have referred it to the policy unit.

Graham Burgess' evidence was that after the meeting with Wellcome in October 2002 he was content that there was not a tax avoidance issue, and at the time of the meeting he was not aware that Lennartz was involved. He was aware that HMRC had tried to restrict the use of Lennartz and had removed the possibility of using it for construction services, although it had later been found out that that restriction was ultra vires, however between 1998 and 2003 Wellcome could have used the Lennartz mechanism. In the course of his evidence he acknowledged on behalf of the Commissioners that they had publicly indicated that they had not welcomed the case of Lennartz.

Mr Lewis of the Commissioners who had initially refused Wellcome's claim, did not remember anyone on behalf of Wellcome raising the fact that they had been confused by HMRC's policy with regard to Lennartz. On 15 March 2005 a meeting had taken place between Mr Lewis and Graham Burgess of the Commissioners and Mr Hemming, Mr Steven Grover and Mr Socrates Socratous (tax advisor) on behalf of Wellcome, to discuss Wellcome's claim. At that meeting for the first time the Lennartz point was raised by reference to Business Brief 22/03 which was issued following the decision in the case of Wolfgang Seeling. Mr Lewis invited submissions to be made on this point and Mr Hemming's letter of 15 April 2005 which is set out in part at paragraph 29 above was the response. As a consequence of this letter, and following consultation, Mr Lewis allowed the claim under regulation 29 insofar as it related to supplies of services which related to business use and were within the statutory three-year time limit. He did not allow the regulation 109 claim on the grounds that the change was from non-business use to business use.

The Respondents' case

The Respondents' case was that the establishment of the right to deduct input tax arose under article 17 of the Sixth Directive, and was conditional upon the VAT having been used for the purposes of taxable transactions by a taxable person, a taxable person being defined at 4(1) as a person who carries out an economic activity. The initial deduction of business VAT, as opposed to the right to deduct, is dependent upon the extent to which the business VAT is used to make taxable as opposed to exempt supplies. Article 17 was implemented into domestic law and is contained at section 24 to 26 of the Value Added Tax Act.

The right to deduct input tax is dealt with in article 18 of the Sixth Directive which provides that procedures are to be set by Member States. Such procedures include the setting of a cap or limitation period for the making of claims for input tax. The UK set a cap under regulation 29(1A) of the VAT Regulations 1995. There were challenges to that cap in the cases of Fleming (t/a Bodycraft) v HMRC and Condé Nast Publications Ltd v HMRC [2008] UK HL. It was considered that those cases were irrelevant since the present appeal was about the right to deduct under article 17, not the exercise of that right under article 18. Wellcome's argument that there was a 6-year cap contained in regulation 109 was considered misconceived in that the time period in regulation 109 relates to the right to adjust the deduction and there was therefore no regulatory overlap as alleged by Wellcome.

The Tribunal was referred to the case of Royal and Sun Alliance Insurance Group Plc v HMRC [2003] UK HL 29 for the proposition that regulation 109 applies where a taxable person has incurred an amount of input tax which he has not attributed to taxable supplies because he intended to use the goods or services in making exempt supplies. Accordingly, the adjustment that is permitted by regulation 109 is an adjustment between taxable business use and exempt business use. It is not a mechanism by which Wellcome can seek to alter its initial right to deduct which is determined only by the capacity in which it was acting at the time that the tax became chargeable.

The Respondents relied on a letter dated 26 June 2003 written by Wellcome to HMRC stating that:

"(i) The original attribution of the input tax incurred by Wellcome Trust … was partly to intended non-business activities and partly to intended exempt and taxable business activities …

"The initial attribution was therefore to intended non-business supplies and exempt and taxable business supplies …"

HMRC considered that the change of intention from non-business to business use could not be accepted as a valid reason for allowing a claim for input tax and initially refused the claim under regulation 109 in its entirety.

The Tribunal was referred to the case of Waterschap Zeews Vlaanderenm v Staatssecretaris van Financien Case C-378/02 a case where a Dutch water authority which had constructed sewage works as an Article 4(5) body (and thus was entitled to no initial deduction on construction) was seeking to recover input tax because it later opted to tax the sale of the works. It sought to equate itself with a private person acquiring goods for exempt purposes, but Advocate General Jacobs considered that the correct analogy was with a taxable person acquiring goods for private use. The court agreed with this, stating:

"Contrary to the argument of Waterschap Zeews Vlaanderenm, such a body cannot be equated to a non-taxable person carrying out some taxable activities and other exempt activities. As was stated above the capacity in which the person acts is the precise factor and that is assessed at the time of acquisition by that body of the goods concerned." (Paragraph 41)

It was submitted on behalf of HMRC that the subsequent change of intention to business use when Wellcome made the zero-rated supply to the bank in 2002 had no bearing upon the capacity in which Wellcome acted at the time of the acquisition in 1998. Regulation 109 applies only where input tax requires adjustment because there has been a change of intention from exempt to taxable use or from both taxable and exempt to fully taxable use. However it was conceded by Ms Rahman at the hearing that the regulation 109 mechanism would be available to Wellcome in respect of such proportion of the purchase price of Babcock House as could be identified as relating to taxable and exempt supplies subject to Wellcome providing appropriate evidence, there not having to date been any evidence provided which would enable the quantification of any adjustments which had been made in respect of those supplies which changed from exempt to taxable.

With regard to regulation 29, it was accepted by HMRC that upon the purchase of Babcock House in 1998 it was Wellcome's intention to use the building for the purposes of mixed business and non-business. In those circumstances it could have allocated all related expenditure to non-business use, or it could have apportioned the VAT incurred and treated only the business proportion as input tax. Alternatively it could have treated all the VAT as input tax, claimable subject to its partial exemption method and accounted for output tax on non-business use (in accordance with the Lennartz approach). The Appellant however had failed to make any decision about allocation at the relevant time.

The Appellant's entitlement to recover any input tax at the date of the claim on 14 February 2003 was subject to regulation 29(1A), the capping rule. Wellcome had been permitted to recover input tax in respect of construction services, subject to the 3-year cap. With regard to Wellcome's claim that the 3-year cap should not be applied because it was excessively difficult for it to comply with the requirement to make the claim within three years of incurring the input tax because of a change in HMRC's policy in respect of Lennartz's claims, in particular its change with regard to whether a claim could be made in respect of supplies of services, this was rejected by HMRC. It was submitted that, whilst the policy in relation to the application of Lennartz to supplies of services did change, this had no bearing upon the Babcock House claim, because that was a supply of goods. It was accepted by HMRC at the time of the Babcock House acquisition that any purchase of capital goods was a supply of goods and could be subject to the Lennartz approach. It was not accepted that there was any basis for Wellcome's claim that it was considering using such an approach but was deflected from doing so because of the Commissioners' stated policy at the time.

The Commissioners relied upon Wellcome's subsequent declaration that the intended business use was less than 10%, thereby enabling it to take advantage of the concession whereby charities obtained zero-rating for business use. It was suggested that this was the maximum amount of intended business use ab initio. Were any argument to be advanced at this stage by Wellcome that it was entitled to reclaim in respect of that less than 10% business use, it would be met by the argument that any such claim was now capped under regulation 29.

The Appellant's case

It was Wellcome's case that it has a prima facie right to recover the input tax incurred in respect of Babcock House when it was purchased in 1998. Although the subsequent demolition of Babcock House destroyed its initial option to tax, the whole development site itself was opted to tax and it was submitted that this provided evidence of an intention to use the site for taxable purposes, albeit that there was a variation of the original intended use.

Mr Young submitted that one ground for Wellcome's claim to entitlement to repayment is that the 3-year capping provisions can only apply if they are expressly incorporated into the mechanism designed for repayment: the claim not being made under section 80 of the VAT Act 1994, the capping provisions under that section are inapplicable. The Tribunal was referred to the cases of Condé Nast per Chadwick LJ at paragraphs 26 and 56. We were also referred to the case of Fleming at paragraph 14 onwards and Marks & Spencer at paragraph 38. Mr Young submitted that it was a question of law as to which mechanism, regulation 29, regulation 109 or the Lennartz mechanism applies. Prior to October 2003 HMRC had treated all repayment claims as coming under section 80 of the VAT Act, and the courts had identified a number of claims in respect of unclaimed input tax which had in fact been brought under regulation 29 and, in the case of Royal and Sun Alliance Insurance Group, as arising under regulation 109. Wellcome contended that it was entitled to recover under the most favourable régime, and a claim based on the Lennartz mechanism could fall under either regulation 29 or regulation 109 or give rise to a free standing, as yet uncapped claim, being one which is given direct effect under community law.

The basis for Wellcome's claim that it falls within regulation 109 is as follows:

(i) It is a taxable person and has been such throughout.

(ii) It incurred an amount of input tax, which had not been attributed to taxable supplies at the time of their receipt.

(iii) It intended to make both taxable and exempt supplies.

(iv) Before the intention to make both taxable and exempt supplies was fulfilled it both used, and formed an intention to use, its supplies in making taxable supplies.

(v) On receipt of three supplies of land (the freehold of Babcock House on 2 June 1998, the leasehold interest in Babcock House on 2 June 1998 and the freehold of Unity House in November 1999) it developed the land and its option to tax applied from the onset.

(vi) Under VATA Schedule 10(2)(b) the option is disapplied when applied to a Relevant Charitable Purpose other than as an office.

(vii) At the time of the receipt of the input supply it intended to make business, non-business and exempt supplies.

(viii) It did not make any supplies of any kind prior to its making a supply of a zero-rated grant to HSBC, the lease being signed on 1 April 2003.

(ix) All supplies made by Wellcome were fully taxable, none was exempt or non-business. There was therefore a change of intention which occurred during a period of six years commencing on the first day of the prescribed accounting period.

With regard to regulation 29, Wellcome observed that it was unable to ascertain the exact amount of input tax to be deducted until 14 December 2002. On that date HMRC accepted that the annexe would be used for less than 10% business activity. Until 26 October 2002 when HMRC ruled that a part of the development would qualify as an annexe for the purposes of Note 16 of Group 5 of Schedule 8 of VAT Act 1994, it could have considered taxable use of the buildings in the course of supplies made to third parties as against mixed use by it, that is business, non-business and exempt. Consequently Wellcome provided estimated returns which were estimated on the basis of the partial exemption method in place.

Alternatively Wellcome submits that it could have relied on the Lennartz mechanism but was precluded from doing so by the Commissioners' policy in respect of Lennartz. It was submitted that HMRC would not allow recovery of input tax in respect of services and it was not until the ECJ decision in the case of P Charles in 2005 that in their Business Brief of 9 August 2005 HMRC accepted the application of Lennartz to all services.

In relation to Lennartz it was submitted that the case was authority for the proposition that if a taxable person acquires capital goods as a taxable person, that person has an immediate right to deduct the input tax in its entirety. Thus each time Wellcome received a supply which was attributable to the development it was entitled to deduct input tax. The fact that the supplies may not have been used entirely for a taxable activity did not displace its right to deduct. Immediate use was not a prerequisite which is expressed in the decision: see paragraph 14 of the ECJ judgment where the court, with reference to the case of Rompelman (Case 268/83) said:

"It follows from that judgment that a person who acquires goods for the purposes of an economic activity within the meaning of Article 4 does so as a taxable person, even if the goods are not used immediately for such economic activities."

Whilst a Member State can seek derogation under the procedure set out under article 27, the UK had not sought derogation. The ECJ had ruled that a rule or administrative practice imposing a general restriction on the right to deduct in cases where there is limited, but nonetheless genuine, business use constitutes derogation from article 17 and is valid only if properly approved. Therefore Wellcome had a right to deduct all of the disputed input tax as and when it became chargeable. In Wellcome's view the claim filed by it on 14 February 2003 met the Lennartz criteria and should be treated accordingly. Although there is an immediate right of deduction, nothing in the decision of Lennartz prevents a later claim being made.

Mr Young submitted that HMRC did not properly implement Lennartz and the evidence indicated that its administrative practice in respect of Lennartz made any such claims difficult. In Wellcome's submission such claims were impossibly difficult to achieve successfully, and the administrative practices breached the principle of effectiveness.

The Tribunal was referred to the case of Uudenkaupungin Kaupunki v Lounais-Suomen for guidance concerning the right to deduct in respect of immoveable property in circumstances where the first use was not attributable to a taxable activity. It was submitted that all taxable person should be allowed to adjust their VAT deduction where VAT is initially irrecoverable but, as a result of a change in activity (including voluntary change such as exercising the option to tax), all or part of it becomes a cost component of a taxable supply. Where a Member State makes provision for the option to tax to be exercised, it is a corollary that the taxpayer exercising the option to tax must be allowed a right to adjust the deduction of input tax.

It was further submitted by Mr Young that it was implicit both from the wording of article 20 and the decision in Lennartz that, since the adjustment period for capital goods is five years and in the case of immoveable property twenty years, a claim for deduction after the tax becomes chargeable was not to be rejected and any short limitation period should be disapplied as breaching the principle of effectiveness.

Mr Young invited the Tribunal to conclude from Lennartz that the language used in both the question and the decision of the court hold similarities to the wording of Regulation 109, and therefore to conclude that the appeal should succeed. In the event that the Tribunal finds that neither Regulation 109 or 29 satisfies Lennartz, then it should find that Wellcome is entitled to rely on the on-capped direct effect of Community Law, and the appeal should succeed.

Reasons for decision

On the basis of the above facts we find that, whilst there was, prior to 2 June 1998, an intention by Wellcome to use Babcock House as an investment vehicle, as per Paul Clarke's e-mail, by 2 June that intention had changed because of Wellcome's need for increased office accommodation. For the purposes of Regulation 109 it is Wellcome's intention as at 2 June 1998 that has to be considered, and not the date on which there was a later change of intention. We find that the intention as at 2 June 1998 was for Wellcome to use Babcock House to meet its own needs for more office space, and therefore the use would be a mixture of non-business, business and exempt, there being no direct evidence as to the proportions of such use. In the letter of 26 June 2003 sent by Wellcome to the Commissioners it is said: "The original attribution of the input incurred by the Appellant was partly to intended non-business activities …", and therefore to the extent that such activities were non-business, Wellcome is unable to rely on Regulation 109 which relates only to an initial intention to use the goods or services for exempt or a mix of taxable and exempt supplies. Although in the decision letter of 8 August 2005 the Commissioners rejected the claim under Regulation 109, it was indicated at the hearing that such a claim would be allowed in respect of the 10% of the purchase price which they accept related to taxable activities, provided Wellcome were able to supply them with the relevant evidence, which had not previously been produced (see para. 39). We consider that Wellcome was entitled in 2003 when it made its claim to recover input tax under Regulation 109, to recover input tax in respect of the proportion of its supplies that initially were attributed to exempt supplies but which subsequently became taxable supplies, albeit it had never specifically identified which were those supplies.

With regard to Wellcome's claim that it should have been allowed to use the Lennartz mechanism to make a claim at the time of the purchase, but was unable to do so because the Commissioners had wrongly interpreted Lennartz as applying only to goods and not to services, we do not accept that argument. There was no attempt to claim the input tax on the purchase before 2003 and no approach by Wellcome to the Commissioners in respect of Lennartz until the letter from Mr Hemming on 15 April 2005 which referred to the Business Brief 22/2003, but did not specifically ask for the Lennartz mechanism to be applied, saying only it 'could have been' applied. Whilst it was Mr Hemming's opinion that, if it were possible, the Lennartz mechanism would have been used because it would have been beneficial to Wellcome's cashflow, the extent of the advice received from Ernst & Young was that such a claim "would be difficult". This is not the same thing as saying that such a claim was impossible or even uncertain. It was accepted by Simon Lewis in his letter of 5 August 2005 that Wellcome would have been able to make a Lennartz claim in June 1998 but he pointed out that the mechanism could not retrospectively be invoked. There was no acknowledgment by the Commissioners that they would not have allowed a Lennartz claim in 1998. We will deal further with that letter below.

With regard to the fact that the Commissioners had, wrongly, at the relevant time believed that the Lennartz mechanism could only be applied in respect of goods, Wellcome's claim was in fact in respect of goods and therefore that in itself was not a reason for not claiming the input tax at the time of the purchase, or at any time within the following five years. We do not accept Mr Young's argument that paragraph 26 of the judgment in Lennartz is authority for the proposition that in Wellcome's circumstances the use of capital goods is to be treated as a supply of services for consideration. At paragraph 26 it is said as follows:

"In reply to the national courts' question, it must be emphasised in the first place that, pursuant to Article 6 of the Sixth Directive, the use of capital goods for the private use of a taxable person or for purposes other than those of his business, where the VAT on such goods is wholly or partly deductible, is treated as a supply of services for consideration. It is apparent from the combined provisions of Article 6(2)(a) and of Article 11A(1)(c) that, where a taxable person acquires goods which he employs partly for private use, he is deemed to effect for consideration a supply of services taxed on the basis of the cost of providing the services."

The above does not change the fact that Wellcome's original purchase was one of goods. If we are wrong as to this, Wellcome could nonetheless have challenged the Commissioners' decision not to apply Lennartz to services, but they did not do so. In our opinion a decision was taken by or on behalf of Wellcome not to use the Lennartz mechanism, and indeed there are good reasons why such a decision might have been taken, in particular at the time there was no partial exemption method in place and it would have been complicated for Wellcome to calculate the annual adjustments it would have been required to make under Article 20. There is no mention in the notice of appeal of the Respondents' policy at the time making a Lennartz claim impossible or difficult which would be surprising if this was genuinely a reason for not having made an earlier claim. A further reason for not accepting the suggestion that it was the Commissioners' attitude to the use of the Lennartz mechanism that prevented Wellcome from making a Lennartz claim is contained in the letter from Mr Hemming of 15 April 2005 to Simon Lewis of the Commissioners in which he says:

"At no stage did the Trust reclaim any input tax incurred in respect of this project including the VAT incurred on the purchase of Babcock House. The reasons for this are unclear, but it is probable that any claim for input tax was delayed until there was some certainty regarding (1) the building design, which would dictate the use it might be put to, e.g the sub-letting excess space, and (2) agreement reached with the Commissioners."

There is no reference here to Lennartz. On all the evidence it appears that Wellcome attempted post hoc to rationalize its failure to claim the input tax at the outset. For all these reasons we do not accept the argument raised at the hearing that it was because it was either virtually impossible or excessively difficult for Wellcome to make a Lennartz claim at the time, had it been minded so to do, that it failed so to do.

We do not accept Wellcome's submission that Lennartz gives rise to directly effective rights which are not reflected in the UK legislation. Sections 24 to 26 of the VAT Act 1994 fully implement the right to deduct, Lennartz merely describes the situation in which someone with mixed non-business and business use can attribute the whole of the VAT to business so long as he accounts for output tax on non-business use.

It was submitted by Ms Rahman that the VAT paid by Wellcome on its purchase of Babcock House was not input tax insofar as it related to non-business use and therefore the Lennartz mechanism could not be used to recover it, we do not accept that argument. In the case of Lennartz Mr Lennartz himself, who was registered for VAT purposes, had in 1985 purchased a car initially for his own private use but with some 8% business use. In 1986, having bought a tax consultancy, he brought the car into the business and claimed an input tax deduction in respect of the car amounting to the VAT paid on its acquisition. The European Court ruled that he was entitled to reclaim the full amount of the input tax paid on the purchase of the car but had to account for output tax in the subsequent periods in respect of the non-business use in accordance with Article 20. The fact that there was a delay of one year between the purchase of the car and his bringing the car into the consultancy business and claiming an input tax deduction in respect of it did not prevent him from being entitled to that deduction. As was said by Advocate General Jacobs at paragraph 39 of Lennartz: "… adjustments to the initial deduction may be made under Art. 20(2) only where capital goods were allocated to the business at the time of acquisition provided that that condition is fulfilled, adjustments may be made even if there was no immediate use of the goods for taxable or exempt transactions", which is the situation in the present case.

We have already dealt with Wellcome's intention at the time it acquired Babcock House, which is such that it could have made a Lennartz claim at the time of acquisition, but did not do so. In Lennartz Advocate General Jacobs continued by saying that, whilst the Sixth Directive does not specify a period within which the goods should actually be used for making business supplies, a failure to use the goods for making such supplies immediately or within a reasonable period of their acquisition may, depending on the circumstances and, in particular, the nature of the goods in question, be taken into account by the tax authorities in determining whether a person acquires the goods as a taxable person, and hence whether an initial deduction maybe made under Art. 17. The European Court held that it followed from the judgment in the case of Rompelman that a person who acquires goods for the purposes of an economic activity within the meaning of Art. 4 does so as a taxable person, even if the goods are not used immediately for such economic activities. As to the question of the criteria to be used in determining whether a person acquires goods in his capacity as a taxable person where they are not allocated immediately to his economic activities, the court at paragraph 20 said:

"The answer to that question depends on an assessment of all the relevant circumstances, inter alia, the nature of the goods concerned and the period which elapsed between their acquisition and their use for the taxable person's economic activities. However, the adjustment periods provided for in Art. 20(2) of the Sixth Directive do not as such have any bearing on the question whether the goods are acquired for the purposes of those economic activities."

In the present case Wellcome did acquire Babcock House with the intention of using some part of it for business purposes. It was not in a position to calculate the exact proportion or the precise way in which it would be used until it had completed its purchase of Unity House and its negotiations with the Commissioners. It was a matter for the Commissioners to consider whether or not the delay in using the goods for taxable or exempt transactions was such as to bar the claim, however that was not the basis on which they decided not to allow a Lennartz claim. Mr Lewis, in his refusal letter of 8 August 2005 said:

"You raised the matter of BB22/2003 being relevant to your case. I cannot see how this can apply to the purchase of Babcock House, as the Lennartz approach has always applied to goods and there has never been any suggestion that "WT [Wellcome Trust] …" in any way chose to use the Lennartz mechanism back in June 1998 and it cannot be retrospectively invoked. BB22/03 did, however, provide that where VAT was being incurred on pre 9 April 2003 construction services, taxpayers could make claims for full input tax deduction on those services, subject, of course, to capping. WT could not have made claims under this business brief before 9 April 2003 because it was not issued until November 2003."

This seems to us to show a misunderstanding of the ruling in Lennartz. The obligation in Lennartz is for there to be an intended business use at the time of acquisition, the claim for recovery of the whole of the input tax on the acquisition does not have to be made at the time of acquisition, as was stated by Advocate General Jacobs, and as appears from the facts themselves in Lennartz. At the time Wellcome made its claim in 2003 for the whole input tax on the purchase of Babcock House it was in principle entitled to that deduction subject only to a consideration of whether there had been too long a time lapse, and whether the regulations were adequate in these circumstances. The misunderstanding evinced in Mr Lewis' letter of 8 August 2005 and his failure to consider whether the claim made by Wellcome was made within a reasonable period, raises the theoretical question of whether the decision is thereby invalidated, but this was not an issue addressed by Mr Young and we do not intend to deal further with it, save to say that it appears that there would in any event be no advantage to Wellcome in the matter being referred back to the Commissioners on that point, given our findings set out below in relation to Regulation 29.

We find that Wellcome would have been entitled to deduction of its input tax in relation to the purchase of Babcock House had a claim been made on time, but that no claim was made by Wellcome inside the three year time limit which exists in respect of claims under Regulation 29. Three questions therefore arise, namely was Regulation 29 the applicable regulation in these circumstances, if not did Wellcome have an uncapped directly effective right to deduct?, and if it is, what is the effect of the undoubted difficulties that Wellcome had in making such a claim within the three year cap? In our judgment Regulation 29 did allow Wellcome to make a claim, and, had they made such a claim within three years of the purchase of Babcock House, the Commissioners would have been obliged, because of the ruling in Lennartz, to have allowed the full amount of the claim including the amount which related to non-business use. If they had not allowed it, it would have been open to Wellcome to have appealed that decision, on the basis that the United Kingdom were denying its right under European law to make such a claim. The issue of whether Wellcome has a freestanding right to assert a claim does not arise because, in our judgment it was not prevented from asserting its rights. The requirement of certainty requires that a claim must be made within a reasonable period, and the three year period contained in Regulation 29 has long been recognised as providing sufficient period. By John Harrison's letter of 13 August 1999, the letter which Mr Young suggested was itself a claim, albeit an unliquidated one for recovery of input tax, Wellcome wrote to the Commissioners "VAT incurred on the construction of these areas will therefore be fully recoverable by the Trust." There was nothing to prevent Wellcome from putting in an unliquidated claim at that stage, but it did not do so The above assertion is not a claim. We therefore find that Wellcome were not prevented from making a claim for input tax within three years and that they would have been entitled to full recovery of the input tax on Babcock House had they made a claim within that period. However, Wellcome failed to do so and to that extent this appeal must fail. Nonetheless, as stated above, the appeal succeeds to the extent that we find, and the Commissioners acknowledge that, some recovery is possible under Regulation 109, but the amount of such a claim needs to be clarified by Wellcome. Insofar as there is a claim for interest in respect of the Regulation 29 claim which was met by the Commissioners, that is a matter on which we have had no evidence and heard no specific argument.

The Respondents did not ask for costs in this appeal, Mr Young reserved his position with regard to the issue of costs. We grant liberty to apply with regard to the issue of costs and with regard to interest.

MISS J C GORT

CHAIRMAN

RELEASED: 3 July 2008

LON 2005/0942