United Kingdom VAT & Duties Tribunals Decisions

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URL: http://www.bailii.org/uk/cases/UKVAT/2008/V20870.html
Cite as: [2008] UKVAT V20870, [2008] V & DR 558, [2008] STI 2800

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Vision Express (UK) Ltd v Revenue & Customs [2008] UKVAT V20870 (14 November 2008)

20870

VALUE ADDED TAX ... partial exemption — retail opticians using floor-space based special method — override notice served — whether notice properly served — whether PESM achieved fair result — no — whether override notice sufficiently precise —VAT Regulations 1995, regs 99, 101, 102. 102A, 102B — override notice properly served and valid — appeal dismissed

MANCHESTER TRIBUNAL CENTRE

VISION EXPRESS (UK) LIMITED Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS Respondents

Tribunal: Colin Bishopp (Chairman)

Arthur Brown FCA

Sitting in public in Manchester on 26 February to 2 March 2007 and 19 to 23 May 2008

Roderick Cordara QC and Mitchell Moss, counsel, instructed by Dorsey & Whitney, for the Appellant

Owain Thomas, counsel, instructed by the Solicitor and General Counsel for HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2008


 


DECISION

Introduction

1. The Appellant, Vision Express (UK) Limited ("VEUK") operates a well-known chain of retail opticians' shops. Like others engaged in the same business, it makes supplies of goods and services, some standard-rated and some exempt, and it is correspondingly a partially-exempt trader. It has agreed with the Commissioners on methods of calculating its output tax liability and its recoverable input tax. Although we shall need to touch on the calculation of VEUK's output tax, the issues in this appeal relate to its input tax recovery. In 2001 VEUK agreed a method for making that calculation—a partial exemption special method, or PESM—which replaced an earlier method. However, the Commissioners soon became dissatisfied with the PESM and on 22 March 2005 they served an override notice. It did not formally prohibit use of the PESM, but its practical effect was much the same. The override notice affects VEUK's input tax recovery from 1 April 2005. The first of VEUK's appeals before us is against that override notice. The second is against an assessment dated 1 February 2007 designed to recover input tax in the aggregate amount of £4,119,103 for which VEUK claimed credit after service of the override notice and which, the Commissioners say, exceeded the amount properly recoverable. We are required to decide only issues of principle in relation to the assessment.
2. VEUK's PESM is intended to meet the requirements of section 26 of the Value Added Tax Act 1994 and regulation 101 of the Value Added Tax Regulations 1995 (SI 1995/2518). The general rule, prescribed by regulation 101(2), is that the input tax incurred by a trader in obtaining goods and services is to be attributed, as far as possible, to his taxable and exempt supplies by reference to the use made by him of the goods and services in making those supplies. So much of that input tax as is wholly attributable to the making of taxable supplies is recoverable, while so much as is wholly attributable to the making of exempt supplies is not. What remains, that is the input tax which cannot be fully attributed to taxable or exempt supplies, referred to as "residual input tax", is attributed to the trader's taxable and exempt supplies in the same proportions as the values of his taxable and exempt supplies bear to the total value of his supplies. In other words, where it is not possible to attribute by reference to use, values are used as a proxy, reflecting the requirements of article 19(1) of the Sixth VAT Directive (77/388/EEC), the European legislation in force at the relevant time—the corresponding provision in the current legislation is to be found at article 174(1) of the Common System Directive (2006/112/EEC). The general rule represents the "standard method".
3. It is recognised that attribution by proxy will not achieve the same level of accuracy as direct attribution, and to a limited extent inaccuracy is tolerated, although an annual adjustment, designed to redress as much as possible of the inaccuracy, is usually a requirement of the standard method: see regulation 107. The overriding objective, when some inaccuracy is inescapable, is that the apportionment must achieve a fair and reasonable result.
4. For some partially-exempt traders attribution by a values-based proxy is not appropriate, because it does not achieve a fair and reasonable result, or because it is impossible or excessively difficult to apply. VEUK maintains that the standard method and its values-based proxy are not appropriate in its case because the result of its use would be neither fair nor reasonable. The Commissioners accept that proposition, because they recognise that supplies VEUK makes to a related joint venture company cannot properly be accommodated by it; but, without advancing a positive case to that effect in this appeal, they incline to the view that it would be appropriate to VEUK's retail trade if that could be considered in isolation.
5. Regulation 102 permits the Commissioners to direct that a trader use a special method or, as in this case, to agree with that trader upon its use of a special method. The regulation, so far as relevant to this appeal and as it was in force at the material time, read as follows:

"(1) … the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 …

(3) A taxable person using a method as approved or directed to be used by the Commissioners under paragraph (1) above shall continue to use that method unless the Commissioners approve or direct the termination of its use.

(4) Any direction under paragraph (1) or (3) above shall take effect from the date upon which the Commissioners give such direction or from such later date as they may specify."

6. VEUK's method was agreed in accordance with paragraph (1). The Commissioners did not terminate its use, as paragraph (3) of the regulation permits, but served an override notice in accordance with, or purported accordance with, regulation 102A, which is set out below. The first issue we must decide is whether the agreed PESM was capable of achieving a fair and reasonable result. If it was, we must next decide whether VEUK has operated the method in a manner which does not in fact achieve such a result. Third, we must decide whether, in the light of our conclusions about the first two issues, the Commissioners were correct, as a matter of fact and law, to issue the override notice. Fourth, we must decide whether the override notice, assuming it was justified, is valid; VEUK's position is that it fails because it does not indicate what VEUK must do in order to comply with it. Last, we must decide whether the assessment which is the subject of VEUK's second appeal was properly made.
7. VEUK's principal argument was that the PESM did in fact lead to a fair and reasonable result. It had been carefully devised, and remained appropriate to VEUK's business, the nature of which had remained constant. Though resistant to a change in the method itself, VEUK was a little more receptive to criticism of the manner of its application, that is, it was prepared to consider adjustments if it could be shown that, in practice, its use had led to a result which was inaccurate to a significant extent. It also argued that the PESM itself prescribed the condition for its revocation, namely that it "should remain in place until such time as there is any change in the liability of the goods and services supplied", a condition which was not satisfied, and that, in consequence, the service of an override notice was not only unjustified, but a course which was not open to the Commissioners. Lastly, it argued that even if the Commissioners were permitted to serve a notice and justified in doing so, the notice they had served was bad in that it lacked certainty, by giving no guidance on a method the Commissioners would find acceptable.
8. The Commissioners' case, in summary, is that the override notice was validly made because it had become apparent, even in the short time between the adoption of the PESM and the service of the notice, that the PESM did not achieve a fair and reasonable result (in that it enabled VEUK to recover more than a proper proportion of the input tax it incurred) and that the necessary conditions for the service of an override notice were satisfied. They accept that it is implicit in their argument that the PESM could never achieve a fair and reasonable result and that they should not have agreed it. The override notice did not direct the use of another PESM, or the standard method, but did require VEUK to calculate its recoverable input tax in a manner which fairly and reasonably reflected the use of the costs incurred by VEUK in making taxable and exempt supplies. But in doing so, it obliged VEUK to do no more than comply with the essential requirement that it should recover no more input tax than was attributable to its taxable supplies, and there was no ambiguity or want of certainty about the requirement as VEUK complains.
9. If we find that the PESM properly reflects, or is capable of properly reflecting, VEUK's use of the goods and services, it follows that the first of the appeals must be allowed since the override notice could not have been validly issued. The assessment may survive, at least in part, if we find that the method is sound but that it has been incorrectly applied; it does not necessarily follow from an incorrect application that the assessment is right since it depends on a number of assumptions which the Commissioners have made, not all of which are accepted by VEUK to be correct. We are not, however, required to reach a conclusion about the correct amount of tax; instead, we are asked to make findings to assist the parties in an endeavour to agree between themselves on the approach to be adopted and on the tax, if any, which may be due. If we are satisfied that both the method and its application are appropriate the assessment must be discharged.
10. The parties were agreed—and it is now well-established although there were previously some differences of view—that the tribunal has a full appellate jurisdiction in respect of the validity of the override notice: see Banbury Visionplus Ltd v HMRC [2006] STC 1568 at [39] to [52]. That is, we are not limited to deciding whether the Commissioners could reasonably have concluded that the PESM was flawed and that an override notice was appropriate, but may decide those matters for ourselves. There has never been any doubt that the tribunal has a full jurisdiction in relation to assessments. If we determine that the Commissioners were justified in serving the override notice, and dismiss the first appeal, we are asked to indicate our views about a suitable replacement method, though it is equally well-established that we have no jurisdiction to impose one.
11. VEUK was represented at the hearing by Roderick Cordara QC, leading Mitchell Moss, and the Commissioners by Owain Thomas of counsel. We heard evidence from Michael Flint, VEUK's property manager, Sarah Jutsum, its taxation manager, Glenn Tomison, an expert witness called by VEUK to give evidence about practices in the retail optical trade, Susan Bowman, the HMRC officer responsible for the decisions the subject of the appeal, Alfonsas Pernavas, an officer who was also involved in the making of the decisions, and Professor Mohammed Jalie, an expert on opticians' practices called by the Commissioners. We had the benefit of a visit to one of VEUK's stores, at the Trafford Centre in Manchester, where we were able to see for ourselves the manner in which VEUK conducts its business, and we had copies of all the relevant documents.

Opticians' supplies and their tax treatment

12. A succinct description of a retail optician's supply to his customer was given by McCullough J in Customs and Excise Commissioners v Leightons Ltd [1995] STC 458 at 461:

"It is agreed that the stages in the sale of a pair of corrective spectacles can be summarised as follows. (i) The patient is first seen by a dispensing optician who examines the patient's existing spectacles (if any), prepares a record card and decides on the appropriate next step. (ii) Usually the patient has his eyes tested by an ophthalmologist (who is a registered medical practitioner) or an ophthalmic optician who writes out a prescription. (iii) The patient takes the prescription to the dispensing optician who then or later may discuss matters with the prescriber. (iv) The dispensing optician takes detailed measurements of the patient's eyes and other features and prepares detailed notes. (v) The dispensing optician advises the patient on the options available in respect of lenses and frames. (vi) The dispensing optician draws up a specification for the lenses and frames from the measurements which he has taken. (vii) The specification is sent to a laboratory which produces the lenses and frames to specification. (viii) When the spectacles are returned the dispensing optician will check whether they conform to the specifications sent. (ix) And finally the dispensing optician will fit the spectacles with the patient and make any minor modifications required."

13. Time has moved on, and computers have taken over some of the functions the judge described, but the overall process is still much the same. There are differences of approach from one optician to another; one such is described in detail in the tribunal's decision in Banbury Visionplus Limited and others v HMRC (2005, Decision 19266) at paragraphs 23 to 30. VEUK's method, to which we shall come shortly, is not identical but the essential features described in Leightons are all present.
14. Those features include supplies of services—eye tests and the dispensing process—and of goods, that is dispensed spectacles and contact lenses. Retail opticians such as VEUK also supply other goods, such as non-prescription sunglasses, neck chains, cleaning materials and other accessories. Eye tests have always been regarded as exempt supplies, while sales of sunglasses and accessories have always been regarded as standard-rated. There was, however, some doubt about the correct treatment of the supply of dispensed spectacles and contact lenses. Until 1988, the whole supply was treated in the United Kingdom as exempt. As VEUK supplied (as the law was understood at the time) both exempt and taxable goods, as well as exempt eye tests, it was a partially exempt trader, and it had agreed a PESM with the Commissioners, though we understand that PESM differed little from the standard method.
15. In EC Commission v United Kingdom (Case 353/85) [1988] STC 251 the Court of Justice determined that the United Kingdom's treatment of opticians' supplies, hitherto, was wrong: article 13A(1)(c) of the Sixth VAT Directive (77/388/EEC), it decided, made it mandatory to exempt the provision of medical care (which description includes eye tests and the supply of dispensing services) but it did not extend to the supply of related goods, that is the spectacles and contact lenses themselves. The Commissioners thereafter formed the view that, while the services of ophthalmic opticians undertaking eye tests constituted exempt supplies, dispensing opticians made a single, standard-rated, supply of goods to which the dispensing service was merely ancillary. VEUK agreed a new PESM with the Commissioners in order to reflect the revised treatment of its supplies; it, too, was very similar to the standard method.
16. However, in Leightons, to which we have referred above, McCullough J concluded that the Commissioners' new approach was also incorrect: dispensing opticians selling prescription spectacles and contact lenses, he decided, make two separate supplies, of goods and of dispensing services, standard-rated and exempt respectively. The frames and the lenses are taxable goods, even though the lens is the means by which the patient benefits from the prescription, and the manufacture of a lens to a prescription is regarded as part of the taxable supply of the lens, rather than part of the dispensing process.
17. The decision in Leightons has been the subject of some criticism and, had it been decided after the judgments of the Court of Justice in Card Protection Plan Ltd v Customs and Excise Commissioners (Case C-349/96) [1999] STC 270 and of the House of Lords in Customs and Excise Commissioners v British Telecommunications plc [1999] STC 758 its outcome might have been different, though in our view the decision merely reflected the observation by the Court of Justice in EC Commission v United Kingdom, at paragraph 33 of its judgment, that "the supply of medicines and other goods, such as corrective spectacles prescribed by a doctor or by other authorised persons, is physically and economically dissociable from the provision of the service" [of dispensing]. The decision in Leightons has remained good law but it has led to many differences of view between retail opticians and the Commissioners and to several appeals to this tribunal.
18. The first consequence, relevant for present purposes, of the decision in Leightons is that an optician who supplies dispensed spectacles and contact lenses must devise a method of apportioning his charge between the exempt service and the taxable goods. He may do so by identifying them separately on his invoice or, as VEUK does, he may charge a single price, a course acceptable to most customers as they are indifferent to the composition of the charge. It is recognised by VEUK and by the Commissioners that the taxable and exempt proportions of the charges for spectacles and for contact lenses differ, and the agreed method for the calculation of VEUK's output tax liabilities reflects that difference (as well as other factors). Although, we learnt, the Commissioners have misgivings about them, the apportionments were not in issue before us. The calculation is, however, a feature of VEUK's PESM. The second significant consequence of the decision in Leightons was that VEUK needed to negotiate a new PESM, since the existing method reflected an understanding of the law which was no longer sound. Agreement on a new method was reached, after what were evidently lengthy discussions, in June 1998.
19. However, between early 1998 and early 1999 VEUK made changes to the manner in which it conducted a joint venture business in which it participated, and it became necessary in consequence to negotiate yet another PESM—indeed, the nature of the change was such that the Commissioners withdrew their approval of the method agreed in June 1998 with effect from 1 April 1999. It was decided at the outset of the negotiations that the new PESM which resulted would be applied from the cessation of the method it was to replace. The PESM which was ultimately agreed is the one in issue in this appeal.

The disputed PESM and the override notice

20. Discussions about the new PESM began in early 1999, before Miss Jutsum joined VEUK. She took over the negotiations on her arrival in September 1999; they were conducted on the Commissioners' behalf by the officer who was at that time responsible for VEUK's affairs, John Beresford. Mr Beresford, from whom we had no evidence, was not a specialist PESM officer, but it appears he took advice from a specialist as the negotiations proceeded. Miss Jutsum emphasised the length of the negotiations, which extended over 17 meetings and led to a considerable amount of correspondence. This was not, she said, a hastily agreed method; it had involved a great deal of thought and work on both sides. Mr Beresford, who was already familiar with VEUK's trading methods, had made two visits to a typical store and knew how it was laid out before agreeing to the use of floor areas as a means of apportioning some of the residual input tax. Miss Jutsum had not agreed with Mr Beresford in every respect and had, she said, made some concessions in order to achieve finality. She believed, however, that when agreement was eventually reached in March 2001 it fully met the concerns of both sides and that the new method would achieve a result which was reasonable and fair. Partly because of the passage of time it was agreed, despite the revocation of its approval and the initial understanding that it would take effect from April 1999, that the former method would be used until March 2000, and that the new method would be adopted from 1 April 2000.
21. The PESM which Miss Jutsum and Mr Beresford agreed is very complicated, though it is, fortunately, possible to summarise most of it for the purposes of this appeal. It has five steps, within each of which a number of calculations must be made. The Commissioners' reasons for serving the override notice focus on the perceived inadequacies, or distortive effect, of steps two and three; they do not attack the other three.
22. The first step requires the identification of as much input tax as can be directly attributed to taxable and exempt supplies, and the segregation of the remainder, the residual input tax, into five categories of expenditure: rents and service charges; other expenses relating to retail stores; support office expenses and corporate overheads; expenses which cannot be directly related to any of those categories; and management charges. Why the fourth and fifth of those categories appear in that order was not explained.
23. The second step requires the identification of those areas of the stores, by reference to what was agreed between Miss Jutsum and Mr Beresford to be a representative sample of six, which are used respectively for taxable, exempt and mixed purposes, and allocating a weighted value to each such area, the weighting being determined by the zoned rental value. We shall deal with the zoning of rental values in more detail shortly. The recoverable proportion of the residual input tax incurred on rents and service charges (the second of the categories identified at step one) is calculated by multiplying it by the zoned weighted area used for taxable purposes and then dividing it by the aggregate of the zoned weighted areas used for taxable and exempt purposes.
24. Step three is applied to the residual input tax incurred on other store expenditure, and is identical to step two save that zoning is left out of account.
25. Step four deals with the remaining three categories of expenditure identified at step one, and uses two calculations, one based on a staff head-count and the other on turnover. It is in this step that the apportionment of VEUK's charges to its customers to which we have referred is taken into account but, as this part of the PESM is not the subject of a specific challenge, we shall not describe the calculations further.
26. Step five draws the results of the preceding steps together in order to determine VEUK's overall percentage of recoverable residual input tax. Save that it uses data whose validity, or appropriateness, is challenged, that step, too, is not controversial.
27. The PESM concludes with one further contentious provision. It is that each year's recoverable residual input tax is to be calculated by reference to the preceding calendar year's figures—that is, the recoverable input tax for the year 1 April 2001 to 31 March 2002 was to be calculated by using the figures for the calendar year 2000, and so on. The calculation was not merely provisional, but final, since the PESM made no provision for an annual adjustment in the light of the actual figures for the year. (In fact, the agreement stated that for the year to March 2001 the figures for the calendar year 1999 were to be used, while the recoverable proportion in every year thereafter was to be determined by reference to the figures for the calendar year 2000. The parties agreed that this was a drafting error; it was intended on both sides that the figures to be used should move on year by year.)
28. Once they had concluded that the PESM did not lead to a fair and reasonable result the Commissioners could have issued a direction terminating its use in accordance with regulation 102(3), but the impediment to their adopting that course is that, since no replacement special method had been agreed and they did not feel able to direct a method, as regulation 102(2) allows, VEUK would have been forced to use the standard method, which the Commissioners were also not satisfied was appropriate. Instead they used the power conferred on them by regulation 102A. That regulation, as it was in force at the material time, was in these terms:

"(1) Where a taxable person—

(a) is for the time being using a method approved or directed under regulation 102, and

(b) that method does not fairly and reasonably represent the extent to which goods or services are used by him or are to be used by him in making taxable supplies,

the Commissioners may serve on him a notice to that effect, setting out their reasons in support of that notification and stating the effect of the notice.

(2) The effect of a notice served under this regulation is that regulation 102B shall apply to the person served with the notice in relation to—

(a) prescribed accounting periods commencing on or after the date of the notice or such later date as may be specified in the notice, and

(b) longer periods to the extent of that part of the longer period falling on or after the date of the notice or such later date as may be specified in the notice."

29. "Longer periods" are used for making the annual adjustments usually required by regulation 107, to which we have already referred. They are not directly relevant in this case. The consequence of an override notice, as regulation 102A(2) indicates, is that regulation 102B applies to the trader; that regulation reads:

"(1) Where this regulation applies, a taxable person shall calculate the difference between—

(a) the attribution made by him in any prescribed accounting period or longer period, and

(b) an attribution which represents the extent to which the goods or services are used by him or are to be used by him in making taxable supplies,

and account for the difference on the return for that prescribed accounting period or on the return on which that longer period adjustment is required to be made, except where the Commissioners allow another return to be used for this purpose.

(2) This regulation shall apply from the date prescribed under regulation 102A(2) …, unless or until the method referred to in regulation 102A(1)(a) … is terminated under regulation 102(3)."

30. As regulation 102A(1) requires, the Commissioners set out their reasons in an annex to the notice. There were three. The first (in the order in which they were set out) related to step three of the PESM, and attacked the use of floor areas as a factor. It was asserted that areas identified for the purpose of the method as used for the making of taxable supplies were in fact used for making both taxable and exempt supplies; that, even if VEUK's assessment of the use of the floor areas was correct, as much as 46 per cent was used for mixed supplies and there was no evidence that the proportions of that use derived by the application of step three reflected the actual proportions; and that there was little relationship between some of the supplies whose costs were dealt with by step three and the floor areas. In the second reason the Commissioners attacked the use in step two of weighting by reference to zoning, contending that such weighting was irrelevant to the use of different areas of a shop for which a single rent, however it was calculated, was paid. In their third reason they contended that the use of one year's figures for the apportionment of the input tax incurred in the following year could not be justified; recovery, they said, should be determined by contemporaneous figures. VEUK does not accept the validity of any of those criticisms.
31. Although other factors play a part in the PESM, it is, in essence, a floor area-based method. Miss Jutsum told us she had become convinced that the Commissioners had decided that floor area-based methods were not appropriate, as a matter of principle, for retailers, or at least retail opticians, and that their approach to VEUK's PESM was coloured, if not driven, by that view. They had, she believed, rejected her arguments, regardless of their merits, because they were not consistent with the fixed objective, as she perceived it, of eliminating the use of such methods by optical retailers. Miss Jutsum evidently felt strongly about the matter, and we think it appropriate we should deal with it at this stage.
32. Mrs Bowman, who was ultimately responsible for the override notice, accepted that she thought that any floor area-based method would be quite unsuitable in VEUK's case, but denied that she was hostile in principle to the use of such methods in the retail trade. Though it was quite clear that Mrs Bowman formed the view at an early stage that it would be necessary to prevent a significant loss of revenue by VEUK's continuing use of what she perceived to be a fundamentally flawed method, we accept her evidence that she was willing to consider alternatives, even if acceptable alternatives were unlikely to include a floor area-based method. We add that we are satisfied that she was right in her view that it was not possible to direct the use of a different PESM, or the standard method, since she did not know enough about the business. It has also to be said that Miss Jutsum was firmly, even dogmatically, resistant to any criticism of the PESM and to the consideration of any possible replacement of it, though we can understand that, having spent so much time negotiating it, she was very disappointed to find that its whole basis was challenged.

VEUK's stores

33. The Trafford Park store we visited has a regular, rectangular shape and it was clear to us, with little explanation, how each part of it was used. The plans of several others of VEUK's stores which were produced at the hearing (including the plans of the representative stores used for the PESM) show that their layout is not uniform—there are differences of size and shape and, correspondingly, the various features which are common to the stores are distributed differently within them. However, they are all laid out in a way which reflects VEUK's preferred trading method.
34. The window displays visible from the exterior of the Trafford Park store, which we take to be typical in this respect of all the stores, advertise the ophthalmic services VEUK offers, as well as the range of goods which may be bought, and any special prices or offers which are currently available. As one might expect, they are designed to encourage passers-by to enter the store.
35. Internally, each store has five basic sections, in some occupying a single unbroken expanse of floor space, in others occupying two or more areas separated by other sections. The first and, as the plans indicated, the largest single area, accessed immediately from the entrance and (since we understand the doors are usually left open during trading hours) readily visible from the exterior, is the area in which spectacle frames and other goods are displayed and around which customers may walk freely. The second contains the desks and chairs from which the dispensing process—measuring customers' facial features, discussing the suitability of frames for a customer's prescribed lenses and the fitting of the finished spectacles—is undertaken. Third are the rooms in which eye tests are carried out; these include not only the ophthalmic opticians' rooms but also those in which equipment for checking the condition of the customers' eyes is located. In most stores contact lenses are dispensed from a specially designated room in this area. Customers are instructed in the room, away from public view, in the insertion and removal of their lenses. Chairs are also provided near the examination rooms, but in an open part of the store, for customers who are waiting for an eye test. The fourth area, usually a prominent feature of the store, is the laboratory in which the lenses are manufactured and inserted into the customers' chosen frames: for most prescriptions VEUK offers a one-hour manufacturing service, and in many stores, including that at the Trafford Centre, customers may look into (though they may not enter) the laboratory and watch the process. The fifth section contains those areas which are not accessible by the public, consisting of staff and storage rooms.
36. The display areas are laid out with generous space, to allow customers to circulate freely, though they may be intercepted by sales staff as they do so. At the Trafford Centre, which we take to be typical, the area is well lit and laid out attractively. The dispensing desks, quite small and typically with a chair for the dispensing optician on one side and two chairs for a customer and a companion on the other, are in most cases set within the display areas. The eye test rooms and the contact lens dispensing and instruction rooms are usually at the rear of the store, as are the staff and storage rooms, though some of those rooms may be on an upper floor or in a basement. The position of the manufacturing section varies; in the Trafford Centre store it is set in the centre of the display area, is rectangular in shape and has a row of dispensing desks along one of its longer sides, and various display cabinets along the other. In that store the display area completely encircles the laboratory and the dispensing desks, but the plans show that in other stores, the laboratory or the dispensing desks are at one side of the store. Each store has a reception desk near the entrance, and some have another near the rear where customers seeking eye tests are greeted.
37. VEUK's position is that the display area is used exclusively for taxable purposes, that is the sale of frames and other goods, save for a small notional part, referred to as the "doormat adjustment", designed to reflect the fact that customers seeking a sight test or to benefit from the dispensing service must walk through this section in order to reach the examination rooms or the dispensing desks. VEUK's position is reflected in the PESM: that notional part of the display area is marked on the plans as an area used for making mixed, taxable and exempt, supplies. The laboratory is treated as an area from which exclusively taxable supplies are made. The examination rooms are regarded as areas from which only exempt supplies are made. The contact lens instruction rooms are designated as mixed supply areas, since, although they are used for the exempt processes of advising and instructing customers, the taxable sale of contact lenses also takes place in them. The part of the store in which the second reception desk and the chairs on which customers may sit while waiting for eye tests or for instruction in the use of contact lenses is treated as used for making mixed supplies. The storage and staff rooms are also considered to be of mixed use, and therefore residual, although, it seemed to us, the storage rooms are necessarily used primarily for the storage of goods which will form the subject of taxable supplies.
38. Some of the staff employed within each store (particularly the ophthalmic opticians) make predominantly or exclusively exempt supplies, while others (mainly the laboratory staff) make predominantly or exclusively taxable supplies and the remainder mixed supplies, by dispensing prescriptions and at the same time selling frames and lenses. There are, we understand, no staff who undertake only dispensing.

The calculation of store rents

39. The determination of rents for retail premises, and in particular the use of zoning, was the subject of Mr Flint's evidence, much of which was unchallenged. It is, he says, the common practice to calculate the rent of a shop by valuing first the front portion of the interior, which is known as "Zone A". The rental value of the portions further removed from the front, successively known as "Zone B", "Zone C" and so on, are arrived at by dividing the rental value of the preceding zone by 2 (occasionally a different divisor is used, but the divisor is not a relevant consideration here). The value of each portion is ascertained "in terms of Zone A", since once the rental value of Zone A is determined, the rental value of every other portion can be determined by reference to it. In England and Wales each zone is normally twenty feet deep; in Scotland and some parts of London the usual depth is thirty feet. Zoning is not rigid, in as much as adjustments may be made for awkward shapes, obstructions such as pillars, and other similar features. The system has the consequence that, other things being equal, the rent of a wide but shallow shop will be greater than that of a deep but narrow shop of the same surface area. We accept Mr Flint's evidence that the calculation of rents by this method is normal practice, and that VEUK's rents have been calculated by means of it.
40. VEUK's position is that zoning is not merely a convenient means of calculation, but a reflection of the reality, that is that the front part of a retail store is more valuable, and its cost, the value of the rent actually paid for it, correspondingly higher. It is true that a tenant cannot take the front of a shop without the back, or vice versa, and that a single rent is charged for the whole, but those are inevitable consequences of the fact that landlords rent only whole shops. Opticians such as VEUK need premises with an attractive (and relatively expensive) frontage, to encourage customers who are likely to make purchases of standard-rated goods, but are able to use the cheaper rear part of the store to accommodate the examination rooms from which exempt supplies are made, and the staff areas. It is, VEUK argues, reasonable that the PESM should reflect the differential costs of the floor areas. It would necessarily do so if VEUK were to undertake eye tests in inexpensive premises, and sales in separate, more expensive premises, and there was no difference of principle even though, in the event, both activities took place in the same store.
41. The Commissioners' argument is that zoning is no more than an essentially arbitrary method of calculating the rent for a whole shop, and should not be elevated into something else. Mr Flint's evidence does not support the proposition that VEUK, or any other shop tenant, pays more for one part of a shop than another. The front part of the shop is not available without the back, nor the back without the front. The fact that the examination rooms are located at the back does not make the floor space they occupy cheaper, since VEUK has to pay for the front of the shop in order to secure the rear. The only realistic view is that the rent, whatever the method of its calculation, is paid at a uniform rate for the whole of the space.
42. We can conveniently deal with this issue now. The use of a zoning factor in a retail optician's PESM was considered in Optika Limited v Customs and Excise Commissioners (2004, Decision 18627). The tribunal concluded (at paragraph 143) that it was inappropriate since, as the Commissioners argued before us, zoning was no more than a method of calculating the rent, which was expressed as a single amount for the whole premises; it could not be concluded that there were separate rents for separate zones. The same reasoning was adopted by the tribunal in Banbury Visionplus, but it added the observation that, while zoning was a tool for valuing the rent of comparable premises with different frontages, other factors, particularly location, also affected the rent of shop premises. That finding was not challenged on appeal to the High Court (see [2006] STC 1568).
43. In our view those tribunals came to the right conclusion, and for the right reason. We think, however, that the introduction into a retailer's PESM of an adjustment by reference to zoning is inappropriate on another, additional, ground. A trader such as VEUK, though it carries on different activities in different parts of the store, is nevertheless carrying on a single business, each part of which is dependent on every other. The core of the business is the sale of dispensed spectacles and contact lenses. While it is true that parts of the process are carried out at the front, and other parts at the rear, of the store, the reality is that virtually all of the store is used, in one way or another, for the core business. If VEUK were able to segregate its core business and undertake those parts which give rise to exempt supplies in less expensive premises, while undertaking those which result in taxable supplies in other, dearer, premises there might be merit in its argument. The fact is, however, that it does not, and in practical terms cannot, segregate its business in that way. It requires the whole of the store in order to carry on every part of its chosen business, and it follows that the rent cannot be said to weigh more heavily on one aspect of the business than another.

The use of the stores

44. We heard a good deal of evidence about the manner in which the stores are used, and in particular about the progression of a typical customer, to whom an eye test, a prescription and dispensed spectacles or contact lenses are supplied. We had also the evidence of Mr Tomison and Professor Jalie about the dividing line between dispensing properly so-called and the selling of frames and lenses. There was a large measure of agreement between them on some points, and disagreement on others. Without intending any disrespect to them, we are bound to say we concluded that their evidence was of limited help save in one respect to which we shall return, and we do not intend to set out the detail of it.
45. We find—and this will largely be common experience—that VEUK's customers enter the stores either because they have already decided to do so (since they are existing customers or are responding to personal recommendation or advertising), or because they are persuaded to do so by the material displayed in the store window. A customer, or potential customer, in the latter category would, naturally, be more likely than one in the former to enter the store, browse for a few minutes and leave without becoming the recipient of any kind of supply, but there is otherwise no material difference between customers who enter for one reason rather than another. Customers may, of course, require only a standard-rated supply of, say, sunglasses, but the majority, as we understood the evidence, are those who come in for an eye test leading, if appropriate, to a prescription, and thereafter the supply of dispensed spectacles or contact lenses. Some may have a prescription provided elsewhere; and some may obtain a prescription from VEUK but arrange for it to be dispensed elsewhere, though we understand that (eye tests being undertaken at a loss) VEUK does its best to ensure that all the prescriptions it gives are dispensed in the store. Indeed, it has a "handover" routine, by which the ophthalmic optician, having handed a prescription to a customer, introduces him immediately to a member of the dispensing staff.
46. The typical customer must follow a number of steps: making an appointment for an eye test if no ophthalmic optician is immediately available, undergoing the eye test, choosing a suitable frame, deciding, with the ophthalmic or dispensing optician, or both, on a suitable type of lens and having the lenses made, fitted in the frame and, finally, having the frame adjusted in order that the lenses are correctly positioned in relation to his eyes. For reasons of privacy and practicality, the eye tests are carried out in closed rooms. Appointments for eye tests are made by a customer standing at or close to a reception desk (if he has not telephoned), and the lenses are made—by cutting, grinding, polishing and tinting blanks—in the laboratory. There is otherwise no demarcation of the areas in which the remaining steps are carried out. That is of importance in relation to what we have described as the "display area", that is the part of the store to which customers have free access, and in which frames and other goods are displayed. Usually frames intended for dispensed spectacles and sunglasses are displayed on racks fixed to the walls of the display area, while other goods are displayed on stands placed on the floor.
47. The floor space allocation used for the PESM is reflected in the colouring of the plans of the representative stores. That colouring identifies the eye test rooms (including those in which the condition of customers' eyes is checked) as the only areas from which exclusively exempt supplies are made. The dispensing desks, reception desk and "doormat adjustment" are shown as areas from which mixed retail supplies are made. It is conspicuous that the dispensing desks and reception desk, as they are shown on the plans, are confined to their "footprints", with no allowance for access, for the fact that customers stand by the reception desks, or for the moving of the chairs away from the dispensing desks as customers sit down. The remainder of the display area, including the area where chairs are provide for those who are waiting for, perhaps, the mixed supply of dispensed spectacles, is shown as one from which exclusively taxable supplies are made (as is the laboratory). In other words, the plans show what appeared to us to be the smallest possible mixed use areas, and then allocate the remainder of the display area to exclusively taxable supplies. This approach has the consequence that in some cases a narrow strip, only inches wide, between the chairs adjoining two dispensing desks is treated as used for the making of exclusively taxable supplies when it is in our view quite clear that it would be used only by those intending to sit at a dispensing desk.
48. All the remaining parts of the store to which customers have access—the area set aside for waiting for eye tests or instruction in inserting contact lenses and the room used for that instruction—are treated as used for making mixed supplies, as is the entirety of the area accessible only to staff.
49. VEUK's position is that the allocation by the PESM of the various areas of the store to exempt, taxable and mixed uses reflects the way the stores are used in practice. The Commissioners contend that the allocation of the display area, save for the limited parts we have mentioned, to taxable purposes is inappropriate since, although the frames displayed within that area will form the subject of a taxable supply, the area is not used exclusively for selling frames, but also for the dispensing process. They are critical too of the fact that one result of the application of the method is that a very high proportion of the store is said to be devoted to mixed, or residual, use; a floor area-based method, they say, should be used only when a high proportion of the aggregate floor area can be directly attributed to taxable or exempt supplies.
50. It was apparent from the evidence we heard from Mr Tomison and Professor Jalie, and from our own observations, that the line between selling and dispensing is not easy to draw, and that much depends on the customer. That conclusion was reinforced by the lists of references to the evidence which the parties produced after the hearing which, in our view, made it clear that an attempt to draw such a line is almost impossible. Some customers, unaided, might choose a frame suitable both cosmetically and for the prescribed lens; others, particularly those with complicated or strong prescriptions, might need a good deal of advice, some of it of a cosmetic nature and some properly regarded as dispensing. Although, we were told, most frames can accommodate lenses to a moderate prescription without difficulty, some frames lend themselves only to particular types of lens, and some prescriptions require thick lenses which can be accommodated in a cosmetically satisfactory manner in some frames but not in others. That is particularly so when a customer's prescription for one eye is significantly different from the prescription for the other. Customers' choices are driven not only by the prescription and taste but by budget; and advice may often be needed about the coating or tinting of lenses. From time to time ophthalmic opticians are called on to give advice about the dispensing of a prescription.
51. What can be said with certainty is that it is not possible to identify the areas of the stores which are used for exempt, taxable and mixed purposes with the precision adopted by the PESM. It is apparent from what we have already said that a member of VEUK's staff engaged in selling a frame into which dispensed lenses are to be fitted is, throughout the process, simultaneously selling taxable goods and making an exempt supply of dispensing services. The two are inextricably mixed in that the one is of no value without the other. We find it impossible to conclude that, when the customer is in the display area but not at a dispensing desk, the dispenser is making a wholly taxable supply of a frame, but when the customer sits at the dispensing desk the dispenser is making a mixed supply. The emphasis may be on the sale or the dispensing respectively, but the abrupt switch from one activity to the other which the PESM assumes is not present. It is unrealistic to conclude, as the PESM implies, that when the customer is standing in one spot he is receiving an exclusively taxable supply, but if he sits down two feet to the side he is receiving a mixed supply, even though he is continuing the same conversation with the same salesperson.
52. In addition, it seems to us that, regardless of that criticism, the PESM goes about identifying the floor areas in the wrong way. It was apparent to us that the exempt areas had been identified first, followed by the mixed areas, and that everything which remained had been treated as a taxable area. The proper course in our view would be to do as the legislation requires, that is identify those areas which can be directly attributed to the making of taxable and exempt supplies respectively first, allocating the remainder to mixed supplies. Even the approach adopted by VEUK leads to mixed areas constituting 46 per cent of the whole, a feature on which the Commissioners relied in the first of their reasons for serving the override notice. Though one cannot say dogmatically that mixed use of about half the available area would be fatal to a floor area-based PESM, such a high proportion must call into question the reliability of the calculations based on it. The smaller the proportion of the floor area which can be directly attributed, the greater must inevitably be the margin for error. If the approach we consider proper were adopted the residual area would, we think, be much greater even than it is.
53. It may be that a floor area-based PESM is suitable for some retail opticians' businesses, and even that one could be devised which is suitable in VEUK's case, though we are doubtful since in our view VEUK's chosen method of doing business, in open-plan stores, has by its nature the result that only a modest part of each store can properly be regarded as used for exclusively taxable or exclusively exempt supplies. It is certainly clear to us that the PESM we must consider is unsuitable. A number of criticisms of detail were made—the occasional seeking of advice from ophthalmic opticians on matters which might properly be regarded as relevant to the sale of a frame, and the placing in some stores of focimeters (devices which check the characteristics of a lens, and which are used for that purpose by dispensers before spectacles are handed to the customer) within the laboratories, which we think might be considered de minimis. Much more important is the treatment of the display area, in its attribution to taxable use when, as we have indicated, the area is in reality used almost entirely for mixed purposes. It is, of course, possible to sell a frame without dispensed lenses, though it was clear that VEUK seldom does so. In those few instances, and in cases when a customer requires non-prescription sunglasses or accessories, the display area is used for the making of a wholly taxable supply. In every other case it is used for the purpose of making both exempt and taxable supplies. If the display area were attributed, as it should be, to mixed uses the only remaining area of exclusively taxable use would be the laboratory.

The use of previous years' figures

54. There are two obvious advantages to a trader if he is able to use figures for an earlier year for the purposes of his PESM. The first is that he has ample time to verify them, and the second that they remain constant, and his input tax recovery correspondingly predictable, throughout the year for which the figures are used. The Commissioners' case is that while the use of an earlier year's figures is acceptable provisionally, the end result must nevertheless reflect the use of the input tax during the year in which it was incurred, hence the normal requirement of the standard method of an annual adjustment when provisional figures have been used. Miss Jutsum did not explain why she thought it appropriate to use the previous year's figures without adjustment, merely contending that there was little variation in the figures from one year to the next, and that this feature of the PESM was therefore not distortive.
55. We are willing to accept that, as a matter of fact, the figures did not vary much from year to year—the Commissioners adduced no evidence to the contrary—but we are not persuaded that the absence, in practice, of significant variation answers the Commissioners' objection to this feature of the PESM. They are right to argue that, as a matter of principle, the proportion of the input tax which is recovered should be the amount incurred on supplies which have been used in the making of taxable supplies. The use of figures removed by a year or, in this case, 15 months, without any provision for adjustment in the light of differences from year to year, or changes in the business, is inconsistent with that principle. If Miss Jutsum is right, and there is little year-on-year variation, it would be simple to make an annual adjustment. That fact alone makes it difficult to understand why there is no provision for one.

The suitability of the PESM

56. For all those reasons we have concluded that the PESM was not appropriate, and that it does not produce a fair and reasonable result. Indeed, we are satisfied that the combination of the method itself and the manner in which it has been implemented, by the allocation of floor areas to various supposed uses, will inevitably result in the over-recovery by VEUK of input tax credits. It is entirely understandable that the proportion which a partially-exempt trader's taxable outputs bears to the whole will not correspond exactly with the proportion of its input tax which the same trader may properly recover, since, as in this case, wages are likely to bear more heavily on exempt than on taxable supplies. We agree with Mrs Bowman, however, that it defies logic that while it is a consequence of the PESM that the staff areas are treated as used to the extent of 93 per cent for making taxable supplies, VEUK's output tax calculation assumes that 91 per cent of the stores staff wages are used in the making of exempt supplies. Overall, VEUK claims that about 35 per cent of its supplies from its stores are taxable, yet it has recovered 88 per cent of the input tax attributable to stores expenditure by use of the PESM. These are not the modest differences which might be expected; they are so large that they call into question the reasonableness of the calculations from which they are derived. We express no view about the output tax calculation, which is not in issue before us, but we have no doubt that the PESM, as the Commissioners contend, has resulted in over-recovery by VEUK of input tax.
57. We conclude, therefore, that the Commissioners were right to take steps to ensure that VEUK's recovery of input tax more closely reflected its use of the inputs.

The validity of the override notice

58. Mr Cordara raised two points: the provision in the PESM that it was to remain in effect until there was a change in the business, and the lack of precision in the notice, in that it gave VEUK no indication of what the Commissioners required it to do.
59. He did not pursue the first issue with vigour, and we consider he was right not to do so, since it seems to us to be bound to fail. It is true that the overall effect of an override notice is to force the trader to claim credit for the input tax he has incurred in a different way, but examination of regulations 102A and 102B shows that a notice served in accordance with regulation 102A does not preclude use of the PESM to which it relates, but requires the trader concerned to make an additional, separate, calculation of the difference between the amount recoverable by use of the method, and the amount properly recoverable, and to account for that difference. Accordingly, far from requiring him to cease using the PESM, an override notice obliges him to continue to do so, albeit the consequence of his having to make the additional calculation may be indistinguishable, in a practical sense, from abandonment of the special method.
60. The question of uncertainty or ambiguity in a direction by the Commissioners that a special method be used was considered by the Court of Session in Kwik-Fit (GB) Ltd v Customs and Excise Commissioners [1998] STC 159. The appellant in that case argued successfully that the direction was not fair and reasonable (and should consequently be set aside) because its ambiguity meant it was open to differing interpretations. An override notice served in accordance with regulation 102A is not the same as a direction made pursuant to regulation 102, requiring a trader to use a special method, but there is an obvious analogy. We agree with Mr Cordara's proposition that if we find ambiguity in the override notice, the decision in Kwik-Fit obliges us to set it aside.
61. We are not, however, persuaded that there is any ambiguity in the notice. It requires VEUK to do exactly what regulation 102B demands, and in doing so it adopts the wording of that regulation. It may be that VEUK does not know how to go about calculating "an attribution which represents the extent to which the goods or services are used by [it] or are to be used by [it] in making taxable supplies", but that is not a consequence of any ambiguity in the notice. Rather, it is a consequence of the manner in which VEUK conducts its business. We reject Mr Cordara's argument that there is any ambiguity in the notice.
62. We also find nothing in the argument that the Commissioners should have told VEUK what method would be acceptable to them. Such an indication would have amounted, in substance if not in form, to a direction to use a special method, a course which the Commissioners considered (as we have indicated, in our view correctly) was not open to them. The greater difficulty with the argument is that regulation 102A prescribes that a trader in receipt of an override notice must comply with regulation 102B. That regulation tells the trader what he is to do (namely, to comply with the general law by claiming credit for the correct amount of input tax), and not how he is to do it. We do not understand how it can be said that the Commissioners are required to fill the gap by themselves instructing the trader how to comply with the law.
63. It accordingly follows that the appeal against the override notice must fail.
64. We must also dismiss the appeal against the assessment, in principle, since it is implicit in our earlier conclusions and in our rejection of the appeal against the override notice that there was some difference between the input tax for which VEUK claimed credit, and the credit to which it was entitled. As we heard little evidence about the detail of the assessment, we give the parties permission to apply for a further hearing (not necessarily before an identically constituted tribunal) for the amount of the assessment to be determined if they are unable to reach agreement.
65. We also give the parties permission to seek directions in respect of costs.
66. Lastly, as the parties requested, we express our views about what might be a suitable method, in the light of the evidence we heard. That evidence extended only to the use of the retail stores; we are aware that VEUK makes other supplies of which any PESM must take account but we heard insufficient about them to express any view which does so.
67. We have already indicated that we think it unlikely that a floor area-based method could ever be suitable. We heard some evidence about the calculations, referred to as a "full cost apportionment", VEUK makes in order to determine the taxable and exempt proportions of the charge it makes for dispensed spectacles and the slightly different calculation it makes in respect of contact lenses. We are aware that the Commissioners have misgivings about the calculations, but as we understood the matter, their misgivings relate to the details of the calculation, rather than to the principle. The more we heard evidence on the matter, the more it seemed to us clear that a method which satisfactorily calculates VEUK's output tax liabilities is as likely, perhaps with adjustment for special factors, to represent a suitable method for calculating the input tax for which it is entitled to credit. We did not understand how an expense which is a cost component of a mixed supply must be treated in one way when calculating the output tax liability, and in another when calculating the input tax credit. In short, it appeared to us that the Commissioners were right to conclude that, in relation to the retail business taken alone, the standard method, perhaps with some small adjustment, was appropriate.

COLIN BISHOPP

CHAIRMAN
Release Date: 14 November 2008

MAN/05/0262 & MAN/07/0147