Clearly Composite

Clearly Composite - Or Not?

When is there a composite supply for VAT purposes, asks SYLVIA ELWES LLB(Hons), FTII, barrister.

For VAT purposes there is a distinction between a multiple supply, where in a single transaction there is the supply of a number of separable goods and services, and a composite supply, where there is more than one constituent element in a transaction, some of which would be subject to VAT if taxed separately and some not. Here the constituent elements are not separable and their taxability is determined by the nature of the composite supply. It has been stated that 'in the former type of case, each separable supply must be considered as an independent supply for tax purposes, the single consideration being apportioned as appropriate. In the latter type of case, one has to determine the quality of the final compound supply for tax purposes, regardless of its constituent elements' (Hurlingham Club (131)).

Clearly the issue is an important one as it determines the overall amount of VAT that is payable in respect of the transaction and the courts have laid down tests to determine the matter.

No apportionment

In Commissioners of Customs and Excise v MD and RW Jeffs (trading as J & J Joinery) [1995] STC 759, which concerned the supply of goods for making alterations to listed property, the High Court rejected arguments by the Customs that the amount paid for the work should be apportioned between the value of the goods supplied (zero rated) and the value of the joinery supplied off-site in connection with those goods (standard rated).

The court found that they were an intrinsic part of the supply of the goods and took their tax status from that supply. In reality the services were not separable, but were the normal obligations imposed by law on any seller of goods. This was a contract for the sale of goods and the services were no more than 'common or garden obligations which attach in every case to a supply of goods pursuant for example to both the common law and under the relevant section [section 14] of the Sale of Goods Act 1979'.

Mr Justice Ognall reiterated certain principles that have been laid down by the courts in relation to this matter. Firstly, it is a question of law as applied to the facts whether a supply is multiple or composite. Secondly, the question must be answered by the application of common sense to the substance and reality of the matter. Thirdly, in certain cases it may be difficult on a practical level to apportion the consideration between the various elements in a supply and this may indicate that this is rather a composite supply.

Invoicing arrangements

Whether the manner of invoicing and payment is relevant has also been considered by the courts. Commissioners of Customs and Excise v DW and MJ Bushby [1979] STC 8 established that the manner in which supplies are invoiced makes no difference to the nature of the supplies, and in LSA (Full Time Courses) Ltd (1507), the tribunal considered it irrelevant that after a reorganisation of a company providing accountancy courses to students, the supply of tuition and the supply of course materials were included in one invoice for administrative convenience. Nor was it relevant that both the tuition and course materials were compulsory for students. There was nothing in the reorganisation following the change in policy of the company which transformed what had been two different types of supply into a single composite supply. The course materials continued to be zero rated as they were not 'part and parcel' of the supply of tuition.

Lord Donaldson in the Court of Appeal in British Airways v Commissioners of Customs and Excise [1990] STC 643 drew a distinction between the purchase of an airline ticket which included the price of catering for which the customer pays nothing in addition, and that of a train ticket which included only the price of transportation where the passenger can in transit decide whether to use the catering services. In the latter case only are the catering services distinct and separate.

While individual payments for goods and services probably rule out a composite supply, a single payment for a number of services does not necessarily mean a composite supply.

In Card Protection Plan v Commissioners of Customs and Excise (Case C-349/96) [1999] STC 270, the European Court of Justice held that a single price charged suggested that there was a composite supply, but was not conclusive evidence. Where the circumstances indicated that the customer intended to purchase two distinct services, then the single price would have to be apportioned. The court referred to the significance of the 'intention of the customer'. But what is the intention of the customer? When he pays his money he presumably knows that he will be getting different types of services and so the question must be posed whether knowledge is akin to intention.

Customers' intention

One line of cases suggests that the nature of the transaction is determined by the state of mind of the customer. In other words, the court must examine his reasons for spending his money to determine the tax status of the transaction. The number of payments made is not relevant according to this test.

In Mander Laundries (31), the proprietor of a launderette argued that the money he received from operating his shop should be apportioned between the standard rated laundering facilities and the zero-rated supply of water, gas and electricity. The tribunal rejected this argument. A customer going into the launderette with a pile of dirty washing had in mind to depart with a parcel of clean clothes. The provision of water, gas and electricity were an integral part of the deal. Thus it was a composite supply for VAT purposes.

In Commissioners of Customs and Excise v The Automobile Association [1974] STC 192, the issue was whether a member of the Automobile Association was subject to standard rate VAT on his subscription. The High Court considered that the customer's motive in spending his money was relevant. In substance and reality, the subscription was paid not just for the right of membership but for all the benefits to which a member was entitled. So the subscription was apportioned as it was paid for a package of individual benefits some of which were subject to VAT at the standard rate and some at the zero rate.

Other cases, however, show that the motive or intention of the person receiving the goods or services is not relevant. For instance, in British Railways Board v Commissioners of Customs and Excise [1977] STC 221, the Court of Appeal had to consider whether the purchase of identity cards by students to enable them to buy cheap rail tickets at a later time was a zero-rated supply as the purchase of transport by rail, or was a standard-rated supply as an option to buy cheap tickets in the future.

Lord Justice Browne said that neither the motive nor the intention of the person receiving the service was relevant, nor was the motive or intention of the person supplying the service. The transaction had to be looked at objectively. There were two distinct supplies that had not been made contemporaneously and distinct considerations had been respectively paid for these supplies. The court looked at the end result objectively and said there was one composite supply of transport by rail which should be zero rated. The identity card payments by students were part and parcel of the total payments made by students for travelling on the railway and so took their tax status.

A later tribunal decision in MH Jarmain concerned the VAT status of a leaflet purchased for a coin and stamp fair. The tribunal said it was necessary to answer this question objectively: what did the taxpayer supply for the 20 pence he received? There had been a supply both of the programme and of admission to the fair. The tribunal did not conclude that the cost of the leaflet was de minimis in relation to the cost of admission and so an apportionment had to be made. It was stressed that the personal preferences or interests of the persons who were supplied with the leaflet were irrelevant. The question must be decided objectively and without regard to the motives of either party.

Incidental or integral?

Tests such as whether the individual supply is 'incidental to' or 'an integral part of' the overall supply have been laid down. Words such as 'ancillary', 'part and parcel' and 'subordinate' have also been used.

For instance, in Commissioners of Customs and Excise v United Biscuits (UK) Ltd [1992] STC 325 the issue was whether a biscuit tin was to be subject to VAT at the standard rate as a separate supply or whether it was to take on the zero rate at which the biscuits inside it were charged. The Scottish Court of Session said that the correct test was whether the supply of decorative tins was incidental to, or an integral part of, the supply of biscuits. These were different descriptions of the same test. Here the tin was not so elaborate or decorative to qualify as a container in its own right. It was integral to the biscuits as it was a container in which they were packaged, it enabled the biscuits to be sold to the quality market, and it prolonged their shelf life. It also kept them in a better condition once the consumption of the biscuits had begun.

By way of contrast, in Commissioners of Customs and Excise v British Telecommunications Ltd [1998] STC 544, the Court of Appeal accepted that the delivery of cars from the manufacturer was a separable supply distinct from the supply of the cars themselves. The taxpayer was under no obligation to have the cars delivered from the manufacturer and the fact that there was a term in the contract that a particular manufacturer should deliver the cars ordered from him did not transform two supplies into one composite one. Unfortunately for the company, Customs were successful with an appeal to the House of Lords where it was held that what the company wanted was a delivered car and it was artificial to split up the supply of the car and the delivery of it. This was especially so as property in the cars remained with the manufacturer until delivery was completed.

Airlines disputes

There have been various decisions involving supplies by airlines. In Virgin Atlantic Airways Ltd v Commissioners of Customs and Excise [1995] STC 341, the issue was whether the inclusion of a limousine transport to and from home on a first class ticket was a separable supply. The High Court found that the parties made one indivisible contract for transport from home to their final destination. While the limousine service was physically separate from the flight it was not economically dissociable from the price paid for the package offered by the airlines. It was therefore unrealistic to split the provision of the limousine service from the flight itself.

In an earlier case, British Airways plc v Commissioners of Customs and Excise [1990] STC 643, the airline operated the business of transporting passengers and freight (zero rated as the provision of transport services) and also provided in-flight catering for many domestic flights. This supply would normally be standard rated outside the context of airline provision, but the airline contended that the catering formed part of the supply of transport and that therefore it should be zero rated.

The tribunal found that the ticket price had to be apportioned between the transport and the catering as this was not a composite supply. One of the reasons for its decision was that the catering was not a necessary part of the transportation. It was only introduced on flights because of similar provision by other airlines and British Airways had to compete. The necessity test to determine a composite supply was rejected by the Court of Appeal, where Lord Justice Stuart-Smith pointed out that 'while something that is necessary for the supply will almost certainly be a necessary part of it, the converse does not follow'.

Thus, a supply may be integral to another supply and therefore be a composite supply, yet not be necessary to it.

How important is motive?

The tribunal had also said that the state of mind of the customer buying the product was decisive. Whether it was a composite supply depended on what he intended to purchase when he bought his ticket. This too was rejected as a test of a composite supply by Mr Justice Otto in the High Court. The motives and intentions of both the supplier and the customer were not relevant in determining a composite supply. It had to be determined on objective factors.

The Court of Appeal allowed the appeal on the ground that the supply of catering was incidental to, or an integral component to the overall supply of air transport. There were differing grades of air transportation which included in the price of the ticket differing scales of catering, ranging from a cup of coffee and a biscuit to a multi-course dinner.

Commissioners of Customs and Excise v Wellington Private Hospital Ltd [1997] STC 445 concerned whether the supply of drugs in a private health hospital and the supply and fitting of prostheses were an integral part of the exempt supply of health care. The Court of Appeal said that it was necessary to determine whether one element of the transaction was so dominated by another element so as to lose a separate identity as a supply for fiscal purposes. In such a case, the dominant element was the only supply. However, here there was no dominant supply. The supply of the drugs and the prostheses were part of the treatment that were not optional. They had to be supplied to the patient to get better. Thus, these were separate supplies.

Lord Justice Millett found that care and treatment in a hospital involved multiple supplies. In addition, a patient paid separately for the drugs, and the drugs were physically and economically dissociable from other items charged for.

In Commissioners of Customs and Excise v Madgett & Baldwin (trading as Howden Court Hotel) [1998] STC 1189, the issue was whether a hotel proprietor who also organised coach transport for holidaymakers who stayed at the hotel thereby became a travel agent and tour operator for the purposes of the VAT legislation. A single price was paid by the customers for hotel accommodation, a sight-seeing tour and travel to and from the hotel at each end of the stay by coach, the coach services being provided by third parties.

The Advocate-General in his opinion stated that 'the activity of a trader, the object of whose business is not to organise travel or tours, does not change its character if the services associated with the activity remain ancillary'. He then considered what an ancillary service was. Here there were two conditions which had to be fulfilled:

• It had to contribute to the proper performance of the principal service.
• It had to take up a marginal proportion of the package price compared to the principal service.

Moreover, an occasional service is only an ancillary service. In this case, where a hotelier habitually offers his customers services that are outside the tasks traditionally entrusted to hoteliers and which cannot be performed without a substantial effect on the package price, they are principal services.

The European Court of Justice found that an hotelier who, in return for a package price, habitually offers his customers in addition to accommodation, return transport between certain distant pick-up points and the hotel, and a coach excursion during their stay, these transport services being bought in from third parties, was a travel agent.

Potential for abuse

In Commissioners of Customs and Excise v Pilgrims Language Courses Ltd [1999] STC 874, the Court of Appeal said that the packages of educational services were a genuine attempt by Pilgrims Languages Courses Limited to immerse their customers in the English language and therefore there was no abuse for the court to find that the ancillary services should take on the exempt status of the principal service. However, Customs were concerned that a ruling of a composite supply might lead to abuses so that the unscrupulous would sell packages to gain the exemptions from VAT on the ancillary supplies rather than to better enjoy the principal supplies.

Lord Justice Schiemann made it clear in the Court of Appeal that this would not be the case. The judgment of the European Court of Justice in Card Protection Plan enabled the court to determine which services were truly ancillary to, or part of, an exempt supply. Furthermore, Article 13A(2)(b) of the Sixth VAT directive provides:

'The supply of services or goods shall not be granted exemption as provided for in (1)... (I) above if:

This means that the courts may refuse to grant an exemption in such a case of abuse.

If a cohesive, composite package is supplied which is for the purpose of providing educational services, all the services are exempt. This is only the case where the ancillary services are closely connected to the principal service of teaching English as a foreign language. Also, they must not have been provided for an ulterior motive, such as tax avoidance. On the other hand, where the ancillary service is loosely connected to the main supply, and is not a means of better enjoying the principal service but is carried out as an end in itself, then the service is rated according to its own fiscal character.

Whose point of view?

Application of the tests to real situations is difficult. For example, in the case of a college which offers packages to foreign students, as Pilgrims Languages Courses Limited did, the VAT status of a student trip to a cultural event, such as a Shakespeare play, depends on the reason for which the expenditure was entered into by the course provider. If this was an ancillary supply which was given to students to further the principal supply, that is to hear the English language spoken in a different context and idiom, to improve their knowledge of English, it would be VAT exempt. On the other hand, if the course provider included this as part of the package as an end in itself, namely to make additional money, then it would be rated for VAT according to its own fiscal character. It is less clear, however, what the VAT status of such a trip would be if the visit to the play were included as an 'end of course jolly'. This would depend on whose viewpoint the law said had priority. From the point of view of the student, such an event might be regarded as an essential part of the course, without which the course was not complete. It was an ancillary supply which meant a better enjoyment of the principal supply. The view of the course provider, by way of contrast, might be that this was included as an additional way of making money.

In the context of universities, a graduation ceremony might be considered ancillary to the student's course. In the event that the graduation ceremony were found to be a supply ancillary to the supply of education and the supply of refreshments ancillary to the graduation ceremony, it is unclear what the status of the supply of refreshments would be, being a supply ancillary to an ancillary supply.

However, this is not supplied as part of the educational package but is an optional extra. Thus, like the drinks supplied as an optional extra to a rail ticket, it might be rated for VAT. A similar argument would apply to refreshments supplied at the graduation as these too are optional and so not a composite part of the educational package.

This article was written jointly with Richard Clutterbuck MA(Cantab).

Issue: 3799 / Categories: