United Kingdom VAT & Duties Tribunals Decisions

20752

VAT – INPUT TAX – Charity applying method apportioning VAT to business purposes – Church of England Children's Society decision permitted the Appellant to recover part of VAT incurred on unrestricted fundraising expenditure – Appellant submitted a claim for input tax contending that the Church of England Children's Society decision re-defined the apportionment method and that the Respondents were bound contractually to apply the method – Respondents submitted no contract required to assess the claim in accordance with statute – whether binding agreement re apportionment method – No – the Appellant's claim for input tax new which the Respondents required to consider afresh – Appellant failed to discharge evidential burden on whether its claim attributable to business purpose – Appeal dismissed

LONDON TRIBUNAL CENTRE

OXFAM Appellant

- and -

HER MAJESTY'S REVENUE and CUSTOMS Respondents

Tribunal: MICHAEL TILDESLEY OBE (Chairman)

MOHAMMAD HOSSAIN FCA (Member)

Sitting in public in London on 12 and 13 May 2008

David Milne QC and Richard Vallat counsel instructed by Saffery Champness, Chartered Accountants for the Appellant

Sarah Moore counsel instructed by the Solicitor's office of HM Revenue & Customs, for the Respondents

© CROWN COPYRIGHT 2008


 


DECISION

The Appeal

1. The Appellant was appealing against the Respondents' decision of 10 January 2007 refusing the Appellant's claim for a repayment of VAT. The repayment claim was made on 17 March 2006 and related to the period 1 August 1997 to 30 September 2005. The original amount claimed was £5,448,658.38 of which the Respondents have repaid £2,548,590.21.^[1]

The Dispute

2. The Appellant engaged the services of professional fundraisers to procure regular donations from members of the public, usually by approaching them in the street. The Appellant's claim related to the VAT incurred on the fees of professional fundraisers (also referred to as unrestricted fundraising expenditure). Prior to the High Court decision in Church of England Children's Society v Commissioners of Revenue and Customs [2005] STC 1644, the perceived wisdom was that donations received constituted non-business income with the result that the VAT incurred on fees of professional fundraisers was irrecoverable as it did not count as input tax.
3. The High Court decided in Church of England Children's Society at paragraphs 28-29 that

(1) Receipt of unrestricted voluntary donations was not a supply for VAT purposes and the income was therefore outside the scope of VAT.

(2) However, since the unrestricted voluntary income from donations was, by its nature, available to fund all the Society's activities, some of which were business activities for VAT purposes, the VAT incurred on unrestricted fundraising expenditure was recoverable by the Society in part.

4. Following the Church of England Children's Society decision the Appellant sought to recover a proportion of the VAT incurred on the fees of professional fundraisers for the period 1 August 1997 to 30 September 2005 in two ways. First, the VAT on professional fundraisers' costs increased the amount of VAT which was subject to an apportionment between business and non-business activities. Second the Appellant contended that the application of the formula agreed between the parties in October 2000 which determined the apportionment percentage for business and non-business activities enhanced the amount of VAT that could be recovered as input tax. The Respondents conceded that the Appellant was entitled to recover that part of the VAT represented by the increased amount available for apportionment (the first way) which accounted for a substantial portion of the subsequent repayment of £2,548,590.21. The dispute between the parties concerned the application of the October 2000 formula for determining the apportionment percentage (hereinafter referred to as the Approved Method).
5. The apportionment percentage was calculated under the Approved Method by dividing the Appellant's VAT exclusive expenditure on its business activities by the total of its VAT exclusive expenditure on its business and non business activities. According to the Appellant the effect of the decision in Church of England Children's Society was that the denominator of non business expenditure no longer included the expenditure on professional fundraisers, in which case the apportionment percentage increased from about 75 per cent to 85 per cent. The Appellant submitted that the Respondents were bound by the Approved Method in respect of VAT repayment claims for the period 1 August 1997 to 30 September 2005. The Appellant accepted that the Respondents were entitled to amend the Approved Method but only in respect of prospective repayment claims from the date they indicated their intention to amend which was on 30 May 2006. The Respondents countered that the dispute was not strictly speaking the effect of the decision in Church of England Children's Society but whether the Respondents were bound by the Approved Method. In their view they were a public body with statutory functions. They were only permitted to allow VAT claims on returns or voluntary disclosures insomuch as were referable to the Appellant's business purposes. The Respondents submitted that they were not bound by the Approved Method because it allowed the Appellant to recover a level of input tax that was not envisaged when they agreed the Approved Method and one which was not fair or reasonable with reference to the Appellant's business activities. In short the Approved Method would act as an unlawful fetter on the Respondents' statutory functions.
6. The issues for determination as expressed by the Respondents in the alternative were that:

(1) Whether the Approved Method constituted a binding contract?

(2) If yes to question (1), whether the contract was subject to an implied term that it would not apply if subsequent legal developments significantly changed the basis upon which the agreement was made.

(3) If no to question (2), the Approved Method was unlawful and ultra vires.

The Evidence

7. We heard evidence from Mr Tim Childs, Tax and Treasury Manager, and Mr Russell Moore, a partner of Saffery Champness, Chartered Accountants for the Appellant.
8. Mr Childs gave evidence on the Appellant's activities and the circumstances surrounding the Approved Method. Mr Moore testified on the chronology and details of the Appellant's claims, and the wider picture following the release of the Church of England Children's Society decision.
9. Mr Howard John Higgins, Higher Officer, gave evidence for the Respondents. He was the Officer who dealt with the Appellant's claim.
10. The parties produced an agreed statement of facts and bundle of documents, which were admitted into evidence.

Agreed Facts

11. The Appellant was a registered charity (registered number - 202918) and private company limited by guarantee (registered number - 612172). It was a member of Oxfam International, a separate legal entity registered in the Netherlands as a charitable foundation. Oxfam International coordinated the joint activities of the Appellant and eleven other affiliated international agencies, each separately constituted under the appropriate national regulations.
12. The Appellant was registered for VAT as part of a group registration with Oxfam Activities Ltd ("Oxfam Activities"), the Appellant's wholly owned trading subsidiary.
13. The Appellant was deemed for VAT purposes to have income from non-business activities and business income which was taxable at the standard and zero-rate, as well as income which was exempt from VAT.
14. This Appeal related to the Respondents' decision contained in a letter dated 10 January 2007 to amend the terms of a business/non-business apportionment method (the Approved Method) agreed between the parties by letter dated 17 October 2000 in relation to the recovery of VAT incurred by Appellant on the costs incurred in securing unrestricted charitable donations (Unrestricted Fundraising Expenditure).
15. The Appellant's main sources of income consisted of:

(1) Voluntary income comprising public donations, appeals, fundraising events, legacies, DEC appeals, UK government grants and donated goods and services;

(2) Trading activities, comprising the sale of donated goods through its shops;

(3) Investment income; and

(4) Income from charitable activities (income from government and public authorities and primary purpose trading).

16. Where the Appellant incurred VAT on supplies made to it for business purposes ("input tax": section 24 VAT Act 1994) it can claim credit for all or part of it under sections 25 and 26 VAT Act 1994. The Appellant can claim credit for all the input tax attributable exclusively to taxable supplies, none of the input tax attributable exclusively to exempt supplies, and part of the input tax attributable to both taxable and exempt supplies (residual input tax). The rate of recovery of residual input tax was determined by application of either a standard or special method, as determined under regulations 99-111 of the VAT Regulations 1995. The Appellant had approval for the use of a partial exemption special method by letter dated 17^th October 2000 (in a separate letter from that agreeing the Approved Method).
17. Before assessing what input tax can be recovered, the Appellant must establish how much of the VAT incurred was input tax at all, and must therefore apportion it between business and non-business expenditure. If the VAT was incurred wholly on business (or non-business) expenditure, the position was straightforward: VAT incurred wholly on business expenditure was input tax, while VAT incurred wholly on non-business expenditure was not input tax. Where the VAT was incurred on expenditure which was neither wholly business expenditure, nor wholly non-business expenditure (residual VAT), it must be apportioned to determine what VAT was input tax (section 24 (5) VAT Act 1994). There were no regulations specifying a standard method or governing the agreement of a special method for determining what VAT was input tax as there were for determining what input tax was recoverable. The method used by the Appellant for the apportionment of residual VAT between business and non-business use (to determine how much was input tax) was the Approved Method.
18. The Approved Method was agreed by the Respondents in their letter to the Appellant of 17 October 2000. The Approved Method proceeded in three stages:

(1) The Appellant shall identify all supplies, acquisitions and imports [the Appellant] received which were used, or to be used, in whole by [the Appellant] exclusively in the course or furtherance of the [Appellant's] business activities [Appellant's "business expenditure" or "BE"]. The VAT thereon was input tax.

(2) The Appellant shall identify all supplies, acquisitions and imports [the Appellant] received which were used, or to be used, in whole by [the Appellant] exclusively in carrying out any activity other than the making of taxable and/or exempt supplies [Appellant's "non-business expenditure" or "non BE"]. The VAT thereon was not input tax and was not recoverable.

(3) The Appellant shall determine how much of any remaining, non-attributable VAT shall be treated as input tax according to the following formula":

The value (excl VAT) of expenditure incurred exclusively in the course or furtherance of [the Appellant's] business activities

__________________________________________________________

The value (excl VAT) of expenditure incurred exclusively in the course or furtherance of [the Appellant's] business activities

+

The value (excl VAT) of expenditure incurred exclusively in the course or furtherance of [the Appellant's] non-business activities

19. In short, the formula (the Approved Method Formula") applicable in relation to the residual VAT amounted to:
BE ___________
BE + Non BE
20. The Approved Method Formula was used to produce a ratio expressed as a percentage calculated to the nearest two decimal places. The total residual VAT was multiplied by this percentage figure in order to determine the amount of residual VAT which was input tax.
21. The Approved Method contained the proviso that

"Should there be any changes in the structure of the business or any changes in the trading patterns to such an extent that the agreed method no longer produced a fair and reasonable calculation of input tax, [the Appellant] should inform [the Respondents] in writing immediately."

22. There has been no such change in the structure of the business or the trading patterns of the Appellant.
23. The issue in this case arose because of a change in the parties' understanding of the law relating to the VAT status of unrestricted fundraising expenditure.
24. Before the decision of the High Court in Church of England Children's Society v Commissioners of Revenue and Customs [2005] EWHC 1692 (Ch), [2005] STC 1644, it was the Respondents' policy that the receipt of voluntary donations by a charity represented non-business income for VAT purposes. As a result:

(1) The income received by a charity from voluntary donations was outside the scope of VAT; and

(2) VAT incurred on the unrestricted fundraising expenditure was not input tax and was therefore wholly irrecoverable.

25. When this approach was applied in relation to the formula of the Approved Method, the result was that the unrestricted fundraising expenditure (which was treated as non-business income) was included in the denominator of the Approved Method formula. The formula, therefore, produced a smaller percentage figure, restricting the recovery of residual VAT incurred by the Appellant, than if it were not included in the fraction.
26. The parties' understanding of the law has altered as a result of Church of England Children's Society, in which Blackburne J held, following the decision of the ECJ in Kretztechnik AG v Finanzamt Linz (Case C-465/03) that ([2005] STC 1644 at paragraphs 28-29):

(1) Receipt of unrestricted voluntary donations was not a supply for VAT purposes and the income was therefore outside the scope of VAT.

(2) However, since the unrestricted voluntary income from donations was, by its nature, available to fund all the Society's activities, some of which were business activities for VAT purposes, the VAT incurred on unrestricted fundraising expenditure was recoverable by the Society in part.

27. The Respondents declined to appeal the decision in Church of England Children's Society, setting out its understanding of the law and its policy following that decision in Business Brief 19/05 in which it noted that

"[W]here a charity which has non-business and business activities incurs VAT on fundraising costs and the funds raised support various activities of the charity, the VAT incurred can only be recoverable input tax to the extent that the funds raised will support taxable business supplies. In practice this means that the VAT incurred on fundraising costs must first be subject to an initial business/non-business apportionment to determine how much of the VAT incurred may be treated as input tax. Then, in circumstances where the charity has exempt business activities, this input tax is further subject to the partial exemption rules.

In some cases, a charity's existing business / non-business apportionment method and partial exemption method will produce a fair and reasonable basis by which input tax can be recovered. However, where this is not the case, HMRC will consider proposals for alternative methods. If exceptional circumstances exist, HMRC may allow alternative methods to be applied retrospectively, provided it is fair and reasonable for the charity as a whole. "

28. The Respondents further stated that

Making claims for repayment of Tax

"Charities that wish to make claims for input tax may do so by making a voluntary disclosure to their local VAT office in accordance with guidance in Notice 700/45 How to correct VAT errors and make adjustments or claims, subject to the time limit in Regulation 29(1A) of the VAT Regulations 1995. This restricts late claims for input tax to three years from the due date of the return for the prescribed accounting period in which the input tax was chargeable."

29. The Appellant made a claim under Regulation 29 VAT Regulations 1995 (hereinafter referred to as the 1995 Regulations) by letter dated 17 March 2006 retrospectively to reclaim VAT incurred on the fees of professional fundraisers in generating voluntary charitable donations (the Claim).
30. For the purposes of the Claim, Oxfam used the Approved Method and proceeded on the basis of its understanding of the decision in Church of England Children's Society. This was that the unrestricted fundraising expenditure was neither expenditure incurred exclusively in the furtherance of the Appellant's business activities, nor expenditure incurred exclusively in the furtherance of its non-business activities. In other words, it was neither business nor non-business expenditure. For this reason, in the Claim, the Appellant excluded the unrestricted fundraising expenditure from the denominator of the Approved Method Formula. As a result, the Approved Method Formula produced a higher percentage figure and an increased amount of residual VAT incurred by the Appellant was deemed to be input tax and therefore recoverable.
31. In letters dated 16 October 2006, 4 September 2006 and the final decision letter of 10 January 2007, the Respondents refused to repay the Claim, on the basis that the Church of England Children's Society had changed the effect of the Approved Method Formula so that it no longer produced a "fair and reasonable" result as regards the Appellant's level of input tax.
32. On 30 May 2006, the Respondents withdrew their approval of the Approved Method and advised the Appellant that a revised method needed to be put in place. The Appellant has not yet put forward a revised method which the Respondents were able to approve.
33. The Respondents' decision to reject the Appellant's retrospective reclaim of VAT was also the subject of a Judicial Review in the High Court. This application for judicial review was currently stayed pending the VAT and Duties Tribunal determination.

The Oral Evidence

34. The Appellant has operated a business/non business apportionment method based on the formula used in the Approved Method since 1 May 1995. Following discussions the parties put the apportionment method on a formal footing with the Approved Method agreed on 17 October 2000. Mr Childs described the discussions in terms of the Appellant making representations and rejecting the Respondents' suggestion to alter their existing method. Mr Childs accepted on behalf of the Appellant that at the time of the agreement it was the understanding of the parties that the fees paid to professional fund raisers fell within the non-business expenditure category. There had been no change in the Appellant's business and its trading patterns since the Approved Method was agreed.
35. The original recovery rate of VAT in respect of the business/non-business apportionment under the Approved Method was in the region of 75 per cent per year. The Appellant's proposed application of the Approved Method following the Church of England Children's Society decision increased the recovery rate to around 85 to 90 per cent. In Mr Higgins' view this did not produce a fair and reasonable rate of recovery, and represented a significant departure from the shared understanding upon which the Approved Method was agreed. Further the Appellant's proposal meant that it would effectively be recovering VAT on services which were used for its non-business activities. Mr Higgins pointed out that the Appellant's financial statements recorded that its trading activities were profitable. This indicated that the expenditure incurred on professional fund raisers generated income for use in the Appellant's aims of overcoming poverty which was a non-business activity. The Appellant's website stated that for every £1 donated, 79 pence was spent on emergency, development and campaigning work, 11 pence was spent on support and running costs and 10 pence was invested to generate future income.
36. Mr Childs accepted the Respondents' evidence of the Appellant's website and its financial statements. Mr Childs, however, considered that the information on the breakdown of every £1 donated was just one way of looking at the Appellant's activities. In reality the funds raised by the Appellant were applied to the totality of its activities, not for selected activities. Further the information on the website did not mention that the Appellant expended considerable resources on the warehousing and export of relief goods which were zero-rated activities for VAT purposes. In any event the Appellant was not putting its case on the basis that the VAT claimed in its voluntary disclosure was attributable to business activities. The Appellant's case was straightforward, namely the Respondents were bound by the terms of the approved method.
37. Mr Moore for the Appellant pointed out that the recovery rate varied each quarter and that the Respondents' reliance on the recovery rate to assess whether the outcome was fair and reasonable was misplaced. In Mr Moore's view it was the methodology for determining the apportionment formula which mattered. The Appellant did not change the methodology underpinning the approved method when calculating the VAT repayment in its voluntary disclosure.
38. The Respondents conceded part of the Appellant's claim relating to the Church of England Children's Society decision. Following the release of the Tribunal decision they repaid the sum of £490,571.27 which had been incurred in the production of newsletters, Oxfam Reports and Oxfam News, sent to individuals signed up to the committed giving scheme. After release of the High Court decision, a meeting took place on 3 May 2006 between representatives of the Charities' Tax Reform Group and the Respondents' Policy Branch. The Respondents agreed that VAT on costs of generating unrestricted funds could be recovered in accordance with the existing business/non business apportionments and partial exemption methods. Thus the Appellant was able to recover some of the VAT incurred on the costs engaging professional fundraisers in the sum of £2,158,000 because they formed part of the residual VAT to which the existing Approved Method was applied.
39. The Respondents believed that they acted fairly to the Appellant in allowing the repayment claim of £2,158,000 which in their view was in line with the Church of England Children's Society decision. They, however, considered that the Appellant's proposed adjustment of the approved method was a step too far. First the Church of England Children's Society decision had no direct bearing upon methods apportioning residual VAT between business and non-business activities. Second Mr Higgins suggested at the Tribunal hearing that in fact the Respondents were applying the Approved Method as agreed which was that expenditure on professional fundraising costs should be included in the non business expenditure denominator.

Correspondence on Apportionment

40. On 25 January 2000 the Respondents wrote to the Appellant requesting a formal agreement addressing the apportionment of VAT between business and non-business activities. Further the Respondents considered that the present informal method of apportionment used by the Appellant did not produce a fair and reasonable result as 50 per cent of the input tax incurred was residual and excluded from the calculation. On 3 March 2000 the Appellant responded indicating that the Respondents had misunderstood the formula which used the value of purchases rather than input tax. The Appellant provided a comparison of the outcome of its present method with that from two other methods of apportionment, staff and floor area, to justify its assertion that the present method produced a fair and reasonable result. These two methods produced rates of recovery of 79.99 and 95.53 per cent respectively compared with 78.56 per cent under the current method.
41. On 23 May 2000 the Respondents indicated that they would be prepared to accede to the existing method of apportionment provided that the bulk of expenditure was either attributed to business and non-business activities.
42. On 17 October 2000 the Respondents wrote agreeing to the existing method by which the Appellant calculated the quantum of VAT treated as input tax subject to the condition that it must be used with effect from 1 May 2000 and until such time as the Respondents terminate its use. Further the approval was given in the context of the Appellant's current business structure and trading patterns.
43. On 17 March 2006 the Appellant submitted a claim for repayment of input tax in the sum of £4,958,078.28 pursuant to regulation 29 of VAT Regulations 1995. The basis of the claim was that the Appellant proposed to treat the costs incurred on the raising of unrestricted funds by way of donations and legacies as an overhead. The Appellant considered that its claim was in accordance with the decision in The Church of England Children's Society and Business Brief 19/05.
44. On 16 October 2006 the Respondents refused the voluntary claim because the Approved Method in place did not envisage the inclusion of fundraising activities as a non-attributable expense. They did not consider the current Approved Method fair and reasonable because it produced a recovery rate well over 50 per cent. This would imply that in real terms over half of the funds were used for business activities which did not sit with the Appellant's own statement of over 85 pence in every £1 goes to fight poverty. Finally they were of the view that removing the unrestricted funds element from the denominator the Appellant would obtain an unfair increase in the recovery rate on previously claimed overhead VAT.

Guidance on Apportionment Methods

45. The Respondents' guidance on the apportionment of tax between business use and non-business use is found at paragraph 5 V1-6 of the Internal Guidance which can be accessed from their website. The Respondents also give advice on apportionment methods in Notice 700 VAT Guide (April 2002) at paragraph 33. The advice does not have the force of law.
46. Paragraph 5.3 of the Internal Guidance states that:

"It is implicit in section 24 of the VAT Act 1994 that traders should directly attribute as much tax as possible to business and non business activities. This should always be done. A business/non-business apportionment should not be seen as an alternative to direct attribution.

Yet it is probable that following a direct attribution there will still be a block of expenditure, which cannot be directly attributed to either category. This non attributable expenditure must be apportioned.

Under section 24(5) VAT Act 1994 the trader is required to apportion tax so that only tax, which relates to their business purposes is treated as input tax"

47. Paragraphs 5.4 and 5.5 state that

"the law does not specify any particular method by which traders must apportion tax incurred. Any method of doing so may be used provided that it results in a fair and reasonable apportionment of the tax bearing in mind the trader's various activities and the purposes for which the expenditure is incurred".

Section 24(5) VAT Act 1994 states that the trader should apportion tax to reflect their business and non-business purposes. Unfortunately defining what a trader's purpose is for an item of expenditure is inherently a subjective question and one in which different people will take different views. Therefore in practice there is likely to be a range of acceptable apportionment figures that can be justified. Officers should only challenge an apportionment if it is completely outside what they perceive to be this range".

48. Paragraph 5.9 deals with agreeing an apportionment method:

Although there is no obligation for traders to seek departmental approval for business/non-business methods, in practice many will do so. Officers should consider all such requests taking account of the following factors:

1) Does the indicator of non-business activity on which the method is based gives a fair and reasonable reflection of the balance of the trader's non business activities. Is the result fair and reasonable?

2) Will the method reflect changes in the extent of the trader's business activities and is the indicator it is based on suitable for this?

3) Is the method over-complicated and prone to error. Can it be easily administered by the trader and monitored by the Department. Simplicity is often best.

If an officer is satisfied that the method is soundly based then approval should be given. However it is important to inform the trader that the method is approved on the basis of the current level of business activity and non-business activities. If these activities change substantially, the method may no longer give an accurate apportionment. The trader's should be required to keep the method under review and to notify Customs if there are significant changes in the nature or level of business/non-business activities.

When agreeing methods – especially complex ones – it is important that officers send a letter to the trader indicating the basis on which they accept the method.

49. Paragraph 5.10 enables a trader to request a retrospective change of a previously agreed method of apportionment. The retrospective change may be approved if the proposed method produces a fair and reasonable result, which was not achieved by the original method.
50. Paragraph 5.12 states that

"As the law does not mention "methods" it is not possible for officers to challenge a method as such but only the proportion of input tax resulting from its application".

51. Mr Higgins on behalf of the Respondents stated that the Approved Method was agreed in order to assist the Appellant. Mr Higgins pointed out that if it had been the case that a subsequent development in case law had reduced the recovery percentage to the Appellant's detriment, then there would be no question of the Respondents relying on the Approved Method to prevent the Appellant from recovering a fair and reasonable rate of recovery. Mr Higgins testified that written agreements of taxpayers' methods of apportionment were fairly common in practice. He accepted that they were agreements which simplified matters for the parties avoiding the need to go through each transaction. Although the guidance was silent on whether the Respondents could revisit the agreed method retrospectively, Mr Higgins believed that they had the power to do so. Mr Higgins also expressed the view that he could not see how it could be said that the Respondents were contractually bound to apply an approved method, if that method permitted recovery of VAT which was not attributable to a trader's business purposes.

The Submissions

The Appellant's Submissions

52. The Appellant proceeded on the basis of its understanding of the decision in Church of England Children's Society and applied the Approved Method to arrive at the amount of VAT claimed in its disclosure of 17 March 2006. The Appellant pointed out that the Approved Method had been in operation since 1^st May 1995, later reduced to writing in 2000 and continued to be used without any complaint from the Respondents until May 2006. Given those facts the Appellant contended it was absurd to suggest that there was no agreement or that the Approved Method was not binding on both parties. In the Appellant's view where a method of apportioning residual VAT between business and non-business activities was agreed, both parties to the agreement were bound to accept the application of the method until such time as approval was withdrawn or the taxpayer applied to vary the method. If an unfair or unreasonable result was reached, the method may be challenged either by the Respondents or by the taxpayer on the basis that it was no longer "fair and reasonable" and a revised method was more appropriate. However, any revised method could take effect only prospectively, not with retrospective effect, which was what the Respondents were attempting to do in this particular case.
53. The Appellant relied on the Court of Appeal decision in GUS Merchandise Corp Ltd v Customs and Excise Commissioners (No 2) [1995] STC 279 (CA) for its proposition that the Respondents were bound by an Approved Method for apportioning residual VAT between business and non-business activities.
54. In GUS Merchandise Corp Ltd the taxpayer companies sold goods by mail order through agents. The companies operated a modified version of retail scheme H with the agreement of the Respondents to calculate their output tax. The scheme was supplemented by an arrangement between the parties whereby the companies' gross takings were reduced by an agreed percentage to reflect the amount of receipts for purchases by agents of the companies who were entitled to a ten per cent discount. The companies discovered that they paid too much output tax under the supplementary arrangement. In those circumstances the companies applied a new percentage for the agents' purchases in their VAT returns and sought to recover the overpayment of VAT in previous years. The Respondents accepted that the companies were able to apply the new percentage but challenged the recovery of previous overpayments. The issue for the Court of Appeal was whether the companies were entitled to resile from the terms of the arrangement. The Court of Appeal held that

"The commissioners had a specific statutory power to adapt any retail scheme by agreement with a retailer, and also had authority under their general powers of care and management to conclude a binding free-standing agreement. Accordingly the issue was simply whether GUS and the commissioners had entered into a binding agreement: a question of fact to be resolved by reference to the correspondence read in context. The correspondence read as a whole evidenced a binding agreement which came into existence when the companies submitted the first return taking advantage of the newly determined percentage figures. The essence of the agreement was that the companies were precluded from altering the agreed basis for calculation within a three year period save with the agreement of the commissioners.

Accordingly the companies were not entitled to resile from the agreements and the appeals would be dismissed".

55. Thus according to the Appellant the analysis of the parties' intentions in this Appeal demonstrated that the Approved Method was essentially a contractual binding arrangement between them until the Respondents withdrew their approval or the Appellant applied to vary it.
56. The Appellant disagreed with the Respondents' principal submission that they were not entitled to contract out of their statutory responsibilities. Although the Respondents have a duty to collect VAT according to the law, they also have a general power of care and management in relation to the tax (paragraph 1 schedule 11 VAT Act 1994) under which they can settle claims and compromise disputes. The Respondents' ability to make agreements in order to meet their statutory responsibilities was an established principle applicable to the whole taxation area. In IRC v National Federation of Self-Employed and Small Businesses Ltd [1981] STC 260 Lord Diplock at 269 stated that

"[The Respondents] are charged by statute with the care, management and collection on behalf of the Crown of [tax]. In the exercise of these functions [the Respondents] have a wide managerial discretion as to the best means of obtaining for the national exchequer from the taxes committed to their charge the highest net return that is practicable having regard to the staff available to them and the cost of collection".

57. More specifically to this Appeal, in GUS Merchandise Corp Ltd the Court of Appeal ruled that the Respondents were entitled under their general powers of care and management to conclude a binding free-standing agreement for the purpose of discharging their statutory responsibility to collect VAT. Moreover, the Respondents in the VAT & Duties Tribunal case of The Labour Party (VAT No. 17034) conceded that they had entered into an agreement dealing both with the apportionment of residual VAT and partial exemption with the intention to create legal relations from which they did not wish to resile. Thus the Respondents' characterisation of the Approved Method as a non-binding mechanism was not supported by the authorities. They suggested that the Respondents were bound by an Approved Method made under their general powers of care and management as they were by one reached pursuant to the 1995 Regulations dealing with retail schemes and partial exemption methods.
58. The Appellant considered that there were no grounds to imply a term in the Approved Method about subsequent legal developments. In its view the agreement was effective as it stood. The method had an express provision dealing with changes in the Appellant's business and trading structure so the absence of a similar caveat dealing with other changes should not be seen as mere oversight. Further the Church of England Children's Society decision did not represent a change in the substantive law but merely revealed what the law should have been.

The Respondents' Submissions

59. The Respondents' starting point was section 24(5) VAT Act 1994 which required the Appellant to apportion the VAT on supplies, acquisitions and importations used for the purposes of its business and for other purposes. Only that VAT as was referable to its business purposes counted as input tax. According to the Respondents, they were bound by the provisions of section 24(5) VAT Act 1994 to refuse the Appellant's retrospective claim if they were satisfied that the repayment related to VAT on supplies which were not used for its business. The Respondents pointed out that the Appellant's sole justification for its claim was that the Respondents were obliged to accept the apportionment formula in the Approved Method despite the fact that it produced a recovery rate for input tax considerably higher than that envisaged when the Respondents agreed the method. In the Respondents' view an increased recovery rate of 84-88 per cent was not fair and reasonable and meant that the Appellant would recover VAT that was not attributable to business purposes.
60. The Respondents considered the Appellant's characterisation of the dispute in contractual terms flawed in that it completely ignored that the Respondents were a public body exercising statutory functions. In the Respondents' view a public body cannot contract out of its statutory duties or by contract fetter itself so as to disable itself from exercising its statutory functions as required by law (see Cory (William) & Son Ltd v London Corporation [1951] 2KB 476 and Maurice Kilby v Basildon DC (2006) HLR 46). Thus the Appellant's insistence that the Respondents were bound by the formula in the Approved Method had the effect of preventing the Respondents from exercising their power to refuse a retrospective repayment claim for VAT when the VAT was not attributable to business purposes in which case the approved method amounted to a unlawful restriction on their statutory powers and would be void. The Respondents accepted that they would be amenable to the process of judicial review if they had been guilty of conduct equivalent to a breach of contract but their actions would be assessed against the public law concepts of abuse of power, unfairness or ultra vires rather than by private law contractual rights ( see In re Preston [1985] 1 AC 835)
61. On the facts of the case the Respondents did not enter into a binding agreement with the Appellant never to exercise their power to assess claims if the input tax claimed under the Approved Method was not in fact fair and reasonable or was significantly different from that that the parties assumed it would be when the arrangement was made. The Respondents agreed to the Approved Method on the basis that it gave a right to recovery of input tax at a particular level and that which was regarded as fair and reasonable, but that the Approved Method would not apply be it prospectively or retrospectively if that turned out not to be the case.
62. The Respondents questioned the relevance of Gus Merchandising Corporation to the facts in this Appeal. The issue in Gus Merchandising Corporation was about whether a tax payer was bound by an agreement with the Respondents in the context of retail schemes. The Court of Appeal did not conceptualise the agreement in private law terms. The word contract was not used in the judgment. The Court of Appeal did not consider whether the Respondents would be bound by the agreement. In R v Customs and Excise Commissioners, ex parte Littlewoods Home Shopping Group [1997] STC 317 Turner J decided that the Respondents were not contractually bound by a retail scheme agreement scheme, even though Gus Merchandising Corporation was cited to the Court.
63. The Respondents considered that the various VAT & Duties Tribunal decisions on partial exemption methods cited by the Appellant had no bearing on the outcome of the Appeal. Partial exemption methods were agreed under a specific statutory scheme which determined the legal consequences of the agreement. The Respondents may be prohibited from resiling a partial exemption method but this was because of their obligations under a specific statutory framework rather than a private law contract. Thus the Tribunal in the Labour Party decision was principally concerned with the legal consequences arising from an agreed partial exemption method. The decision was based solely on the construction of documents with no consideration given to the public law issues arising from the Respondents' statutory functions.
64. The distinction between partial exemption methods and apportionment of VAT between business and non-business activities was highlighted in the High Court decision of Victoria and Albert Museum Trustees v Customs and Excise Commissioners [1996] STC 1016. In that case Tucker J decided that the apportionment formula set out in appendix J of Customs and Excise Notice 700 was expressed in permissive and not mandatory terms save that it must produce a result which was fair and reasonable and been agreed by the local VAT office.
65. The Respondents submitted that if the Tribunal found that the approved method constituted a contract between them and the Appellant, then there was an implied term of the contract that the Respondents would not apply the method if subsequent legal developments significantly changed the basis of the agreement. Any contract entered into by a public body must be compatible with its statutory duties and be considered in the light of the purpose for which the statutory duty was conferred. It followed from the House of Lords decision in Equitable Life Assurance Society v Hyman [2000] 3 WLR 529 that a term can be implied into a contract where its terms conflicted with the statutory responsibilities of public bodies.
66. The Appellant's summary of the Respondents' opposition to its claim that the application of the Approved Method in the light of Church of England Commissioners' decision permitted a higher recovery than they would like entirely missed the point. According to the Respondents it was not a question of a commercial bargain, the issue at stake was whether the higher recovery rate was lawful and compatible with the very purpose for which the statutory duty to apportion tax has been conferred. Thus it was clear from the evidence that the application of the Approved Method resulted in the repayment of VAT not attributable to the Appellant's business purposes, which was incompatible with the Respondents' statutory functions under section 24(5) VAT Act 1994. Accordingly an implied term that the Respondents would not apply the method if subsequent legal developments significantly changed the basis of the agreement was essential to give effect to the reasonable expectations of the parties to the agreement.

Findings of Fact

67. Although the facts of the Appeal were largely agreed there were some areas particularly arising from the oral evidence which required determination by the Tribunal. We make the following findings of fact:

(1) The Appellant was deemed for VAT purposes to have income from "non-business" activities and business income which was taxable at the standard and zero-rate, as well as income which was exempt from VAT.

(2) The Appellant operated a method for apportioning VAT between business and non business activities from May 1995. The Respondents gave formal approval to the method in a letter dated 17 October 2000.

(3) Formal approval was given on the shared understanding of the parties that unrestricted fundraising expenditure should be counted in the value of non-business expenditure, which constituted a denominator in the Approved Method Formula.

(4) The discussions leading to the Approved Method in October 2000 comprised the Appellant justifying its existing method and rejecting the Respondents' suggestions to alter it.

(5) The Appellant's business operations were profitable, and that the Appellant applied over 80 per cent of donations to the relief of poverty, a non-business activity.

(6) The Appellant adduced no evidence that the unrestricted fundraising expenditure upon which its claim for VAT was based was used for the purposes of its business.

(7) The Appellant's claim would enable it to recover about 85 per cent of the VAT incurred on unrestricted fundraising expenditure

(8) The Respondents applied the Approved Method as understood by the parties in October 2000 to the Appellant's claim resulting in a VAT repayment of over £2 million.

Reasons for the Decision

68. The appellate jurisdiction of the Tribunal is limited to determining the amount of any input tax which may be credited to a person (see section 83(c) of the VAT Act 1994). The Tribunal has no specific jurisdiction to deal as such with methods to apportion VAT between business and non-business activities. This contrasts with the Tribunal's jurisdiction to hear appeals against the Respondents' refusal to permit the value of supplies to be determined by a retail scheme, and against the Respondents' decision on the proportion of input tax attributable to taxable supplies in methods of partial exemption (see sections 83(x) and 84(4) of the VAT Act 1994).
69. The parties accepted that the Tribunal had jurisdiction to deal with the disputed issue within its powers to determine the amount of any input tax claim. The Appellant contended that the Respondents were bound by the Approved Method agreed in October 2000, the application of which determined the amount of input tax due. The Respondents disputed that it was obliged to adhere to the Approved Method and that the Appellant's claim for input tax should be decided by the applicable statutory provision which was section 24(5) of the VAT Act 1994.
70. The Appellant relied on the Court of Appeal decision in Gus Merchandising Corporation and several VAT & Duties Tribunal decisions for its proposition that the Respondents are empowered to make agreements with taxpayers binding on both parties for the purpose of discharging their statutory function of collecting taxes. We consider that the correctness of the Appellant's proposition depended upon the statutory context in which the Respondents exercise their functions. We question whether the proposition was applicable to the particular circumstances of this Appeal. The facts of Gus Merchandising Corporation and the Tribunal decisions, involved agreements under retail schemes or special methods of partial exemption. Contrary to the Appellant's submissions we consider that the legal context for agreements on methods of apportioning VAT between business and non-business activities was materially different from that for methods of partial exemption and agreements under the retail scheme.
71. The method of partial exemption apportioning VAT between taxable and exempt supplies is fixed by statute (see section 26 VAT Act 1994 and regulation 101 1995 Regulations). Under regulation 102 of 1995 Regulations the Respondents may approve or direct the taxpayer to use a method other than specified in regulation 101 (a special method). The respective legal rights of the Respondents and the taxpayer under a special method of partial exemption are governed by regulation 102 which effectively binds both parties to the agreed method unless notice is given to terminate it^[2].
72. Likewise the detail for retail schemes is found in statute. The schemes are a simplification measure intended for businesses which cannot reasonably be expected to account for VAT in the normal way. The statutory basis for retail schemes is found in the Sixth directive, paragraph 2(6) schedule 11 VAT Act 1994, regulation 67 of the 1995 Regulations, and Notice 727, (some provisions of which have the force of law). Under the legislative framework the Respondents may permit a retailer to determine the value of his supplies by an agreed method or by any method described in Notice 727. As a general rule the retailer is obliged to use his chosen or agreed method for 12 months. Equally the Respondents' powers to vary the terms of any method or to terminate the retailer's use of the method are defined by the legislation. For example regulation 67(2)(c) of the 1995 Regulations permit the Respondents to adapt any method by agreement with any retailer.
73. There is no equivalent legislative framework for methods apportioning residual VAT between business and non-business activities. Section 24(5) of the VAT Act 1994 simply states that VAT on supplies, acquisitions, and importations shall be apportioned so that only so much as is referable to his business purposes is counted as his input tax. The legislation is silent on how the taxpayer should discharge his responsibility to apportion VAT to business purposes. The Respondents provide advice to taxpayers. about apportioning VAT, which does not have the force of law. The Respondents internal guidance emphasises that it is the taxpayer's responsibility to choose the most appropriate apportionment method. The Respondents' consent is not required for the method chosen, although they will give their approval if requested and in order to be of assistance to the taxpayer. The guidance permits a retrospective change of a previously approved method by a taxpayer, if it did not produce a fair and reasonable result. The guidance clearly states that it is not open to officers to challenge a method of apportionment. They can only contest the proportion of input tax resulting from the application of the method.
74. The case law on apportionment methods consists of one High Court decision, Victoria and Albert Museum Trustees v Customs and Excise Commissioners [1996] STC 1016. Turner J dismissed the Appellant's submission that they were required to operate the method laid down by the Respondents in their Notice finding that Notice 700 Appendix J was expressed in permissive and not mandatory terms. Turner J held that the Appellant could not change its method because it had not made an error within the meaning of regulation 64 of the VAT Regulations 1985. We consider that this decision supports the view that the choice of an approved method is a matter for the taxpayer alone. Further the case is not authority for the proposition that an approved method constituted a binding agreement.
75. The Appellant cited the VAT and Duties Tribunal decision in The Labour Party (Decision Number 17034) in which the Tribunal endorsed the Respondents' concession that there was an agreement with consideration and with the intention to create legal relations. However, that concession was made in the context of a single agreement dealing both with the apportionment of VAT between business and non business activities and a partial exemption method. We find that this decision has no application to the facts of this Appeal.
76. We conclude from our analysis of the legal context of agreements in respect of retail schemes and special methods of partial exemption that they have a statutory footing which defines the mutual obligations of the parties. The Respondents are bound by these agreements because of the legislative framework, and if they choose to renounce the agreements on grounds other than permitted by the legislation they would be in breach of their statutory obligations. There is no corresponding statutory footing for methods of apportioning VAT to business and non-business activities.
77. The Appellant placed weight on the fact that the agreement in Gus Merchandising Corporation was made as a result of the Respondents exercising their care and management powers rather than under the specific authority given to them in the legislation dealing with retail schemes. The Court of Appeal in Gus Merchandising Corporation, however, proceeded on the basis of a concession made by the taxpayers that there was no distinction in the legal consequences of a free-standing agreement from one made under the statutory framework governing retail schemes. In the light of the concession we consider that the Court of Appeal ruling was predicated on there being no conflict between the Respondents' discretionary and statutory powers in respect of retail schemes, which is of significance for the application of Gus Merchandising Corporation to facts of this case.
78. The Appellant asserted that the Approved Method constituted a free-standing agreement binding on both parties, which was made under the Respondents' care and management powers. We consider that the Appellant's submission was founded on two interdependent premises. First, the evidence of the events and documents associated with the Approved Method demonstrated the existence of a contract between the parties. Second, the Respondents had the lawful authority to enter into a binding contract under their care and management powers.
79. The Appellant's case for a contractual relationship between the parties depended more on argument rather than on evidence. The evidence relied upon by the Appellant was not substantial, consisting of the fact that the Approved Method had been used since May 1995 and of the wording in the letter dated 17 October 2000, which recorded that

"[the Respondents] agree to the method used subject to the conditions below and that the Appellant must use this method to calculate its input tax until such time as the Respondents approve or direct the termination of its use".

80. The Court of Appeal in Gus Merchandising Corporation did not find a linguistic approach helpful in deciding the existence of a contract as Steyn LJ stated at page 280:

"I would entirely agree with Mr Goy that the frequent use of the word 'agree' cannot be decisive. The same is of course true of the frequent use of the word 'concession'. I would eschew a purely linguistic approach and pay close attention to the objectives of the parties".

81. We are satisfied that the discussions and documents associated with the Approved Method when looked at as whole followed the approach adopted in the Respondents' internal guidance. The letter of 17 October 2000 referred to the Respondents formalising the existing method by which the Appellant counted VAT as input tax. The condition about changes in the structure of the business replicated the recommendation in the guidance. As stated by Mr Higgins the Respondents' purpose for agreeing to methods was to assist the tax payer. The guidance was clear that it was not open to the Respondents to challenge the method of apportionment.
82. The evidence of Mr Childs about the events in 2000 portrayed a picture of the Appellant justifying its existing method to the Respondents not one of the parties negotiating a contract. The Appellant made representations and rejected the Respondents' suggestion to alter their existing method. Mr Child's description was consistent with the process envisaged in the internal guidance.
83. We find that there was no evidence of intention on the part of the parties to create contractual relations with the Approved Method. There was no meeting of minds. The Appellant continued with its existing method. The Respondents followed the steps laid out in their internal guidance.
84. Our conclusion on the facts is consistent with the legal context for apportionment methods. The legislation does not recognize such methods and places responsibility upon the taxpayer to get it right. The internal guidance stresses that the Respondents have no legal challenge to the method used by the taxpayer. The guidance does not mention the use of care and management powers to secure free-standing agreements on apportionment. Thus on our analysis any purported exercise by the Respondents of care and management powers to enter into contractually binding agreements on an apportionment method would be contrary to their statutory functions and section 24(5) of the VAT Act 1994.
85. In Gus Merchandising Corporation the free-standing agreement secured an outcome which was consistent with the Respondents' statutory functions under the retail scheme. In this respect our position on the parties' principal legal submissions is an amalgam of their views. We accept that the Respondents have a discretion to enter into free-standing agreements to discharge their responsibilities (the Appellant's position) but only insofar as it is consistent with their statutory functions (the Respondents' position). In the case of free-standing agreements on apportionment methods it would be outside the statutory remit of the Officers' involved. We find that the Respondents would not enter into a binding contract dealing with apportionment knowing that it would be outside their legal authority.
86. We conclude from the facts found relating to the making of the Approved Method and from the legal analysis of apportionment methods and care and management powers the Appellant's two interdependent premises lacked substance. We, therefore, hold on the facts and in law the Approved Method as recorded in the letter of 17 October 2000 did not constitute a binding agreement.
87. We consider there is another compelling argument why the Appeal should fail. The Appellant's submissions rested on the factual supposition that the Respondents were seeking to undo retrospectively the Approved Method and on the legal proposition that the Respondents were obliged to apply the Church of England Children's Society decision because it represented what the law had always been.
88. We question whether the Respondents' were in fact going back on the terms of the Approved Method of 17 October 2000. They were not seeking to re-open the Appellant's previous repayment claims calculated in accordance with the Approved Method. The Respondents were in fact handling a new claim for input tax under a voluntary disclosure and regulation 29 of the 1995 Regulations, which required the Respondents to consider the matter afresh in accordance with section 24(5) of the VAT Act 1994. The Respondents dealt with the new repayment claim by applying the Approved Method as understood and agreed by both parties on 17 October 2000. They considered that they were acting fairly, and that the application of the Approved Method with fundraising expenditure in the denominator produced a fair and reasonable result consistent with their powers under section 24(5) VATA 1994. Their inclusion of the value of unrestricted fundraising expenditure in the denominator of the Approved Method Formula was part of the agreed understanding as Mr Childs on behalf of the Appellant acknowledged in his evidence.
89. The Appellant's submission also rested on their interpretation of the Church of England Children's Society decision. The Appellant was effectively saying that the decision by operation of law altered the Approved Method Formula by deleting the value of the fundraising expenditure from the denominator. We consider that the Appellant has exaggerated the scope of the decision. The High Court only went as far as ruling that some of the VAT incurred on unrestricted fundraising expenditure may count as input tax dependent upon whether the expenditure was used for business purposes and for taxable supplies. The decision had no direct effect on the methods used by taxpayers to apportion VAT between business and non-business activities. The Respondents accepted the ratio decidendi of Church of England Children's Society judgement by repaying a substantial proportion of the VAT in a sum in excess of £2 million incurred on fundraising expenditure.
90. On these facts it was the Appellant which was seeking to depart from the Approved Method by deletion of the value of unrestricted funding expenditure from the denominator of the formula. The Respondents' conduct, on the other hand, was one of a responsible public authority mindful of its duties to the Exchequer and at the same time acting fairly to the citizen. This description of the facts encapsulated our principal finding that the dispute was not about contractual rights but of the Appellant seeking to justify a new claim for input tax and the Respondents exercising their statutory functions responsibly.
91. There remains the critical issue of determining the Appeal in accordance with our jurisdiction. The Appellant justified its claim for input tax on the basis that it was calculated in accordance with its understanding of the Approved Method which it said was binding upon the Respondents. The Appellant adduced no other evidence to support its claim for input tax. Despite our finding that the Approved Method did not constitute a binding agreement, we are still required to decide on the merits of the Appellant's claim in accordance with the provisions of section 24(5) of the VAT Act 1994. Essentially the Appellant sought to recover approximately 85 per cent of the VAT incurred on unrestricted fundraising expenditure. The Respondents disputed the figure of 85 per cent, saying that it did not reflect a fair and reasonable attribution of VAT to the Appellant's business purposes. The Respondents supplied evidence of the Appellant's financial accounts and website which indicated that its business operations were profitable, and that the Appellant applied over 80 per cent of donations to the relief of poverty, a non-business activity. Although Mr Childs considered that the information on the breakdown of every £1 donated was just one way of looking at the Appellant's activities, he did not pursue the point. The Appellant did not put its case on the ground that the expenditure and the claimed VAT thereon were attributable to business activities. We are satisfied that the Appellant has failed to discharge its evidential burden on the balance of probabilities that its claim for input tax met the requirements of section 24(5) of the VAT Act 1994.
92. We make no decision on the alternative argument about the implied term which we leave open for the Respondents to argue in the event of an Appeal. We consider the ultra vires argument was incorporated in the Respondents' submissions on whether the Approved Method constituted a binding agreement. We note that the Appellant wished to reserve its position on the question of interest which presumably related to the £2 million already paid, in which case we grant leave to the Appellant to refer this outstanding matter to the Tribunal under the umbrella of this Appeal. Finally the Respondents raised the issue about the start date of the Appellant's claim. We assumed that a decision on this matter was only required if we found against the Respondents. If it also related to the £2 million repayment we again give leave for either party to bring this matter before the Tribunal under the umbrella of this Appeal.

Decision

93. We find that

(1) The Approved Method did not constitute a binding agreement.

(2) The Appellant submitted a new claim for input tax which required the Respondents to deal with it afresh under section 24(5) of the VAT Act 1994. In so doing the Respondents acted fairly and applied the ratio decidendi in the Church of England Children's Society judgement.

(3) The Appellant failed to discharge its evidential burden on the balance of probabilities that its claim for input tax met the requirements of section 24(5) of the VAT Act 1994.

94. We, therefore, dismiss the Appeal, and make no order for costs.

MICHAEL TILDESLEY OBE

CHAIRMAN RELEASE DATE: 30 July 2008

LON/