The Direct Link - Input tax allowed in Royal and Sun Alliance Group v Commissioners of Customs and Excise.

Input tax allowed in Royal and Sun Alliance Group v Commissioners of Customs and Excise; VAT was not deductible where it was paid on professional fees relating to a share issue in Trinity Mirror plc (formerly Mirror Group Newspapers Ltd) v Commissioners of Customs and Excise.

The Direct Link

The High Court ruled that input tax should be allowed in Royal and Sun Alliance Group v Commissioners of Customs and Excise.

The taxpayer company leased five properties and, after a vacant period, elected to waive exemption on the properties. It claimed repayment of input tax incurred on payment of the superior rent in the vacant period, on the ground that it had subsequently the intention of making taxable supplies by way of subleases. In the High Court, it was ruled that the claim should be allowed as the input tax was a cost component of future taxable supplies, and also there was a direct and immediate link between the company maintaining the superior leases and the company granting sub-leases out of the superior leases.

Background

Royal and Sun Alliance was the tenant of five properties whose rents were subject to VAT. In the early 1990s, the company stopped using the properties, and tried unsuccessfully to sublet them. So, from 21 November 1995, Royal and Sun Alliance elected to waive exemption from VAT in relation to all the properties. It claimed a repayment of the input tax suffered on the rents of the properties for the various periods when it no longer occupied the properties, and ended with the elections to waive exemption under regulation 109 of the Value Added Tax Regulations 1995.

Regulation 109 provides for a repayment of input tax where a taxable person incurred input tax which had not been attributed to taxable supplies because he intended to use the goods or services in making exempt supplies and during a prescribed period before that intention was fulfilled he used or formed an intention to use the goods or services in making taxable supplies.

Customs refused the company's claim, so Royal and Sun Alliance appealed. The tribunal dismissed the appeal stating that there was no direct and immediate link between supplies made to the company and supplies made by it. So the company appealed to the High Court.

(Malcolm Gammie for the company; Peter Mantle for Commissioners of Customs and Excise.)

Judgment in Chancery Division

Mr Justice Park began by saying that the case was 'conceptual and difficult'. He then provided a helpful summary of the effect of VAT on lettings, and explained the election to waive exemption.

Royal and Sun Alliance said that Regulation 109 applied for the following reasons:

• it incurred input tax in the vacant unelected periods when it paid taxable rents to its landlords;
• it did not at that time attribute the input tax to taxable supplies because it intended to use the input tax in making exempt supplies;
• it failed to find any suitable subtenants within six years, i.e., the company did not fulfil its intention to make exempt supplies;
• within the six years, the company resolved to make irrevocable elections to tax any future supplies it made of the properties;
• once Royal and Sun Alliance made the election, the input tax which it had been paying during the period when the properties lay vacant became attributable to taxable supplies within the meaning of Regulation 109(2);
• the company made the appropriate application to Customs.

The judge said that the critical reason was the fourth one, i.e., Royal and Sun Alliance formed an intention to use the inputs in making taxable supplies, and manifested this by making the election to tax rents from sub-lettings. He said that this was clearly correct, but that it required careful examination. It was true that Royal and Sun Alliance intended to grant subleases of the properties, and that it took measures to ensure that future sub-lettings would be taxable supplies, rather than exempt supplies. However, the question had to be asked if this was the same as an intention to use the inputs, for which the company had been paying input tax during the vacant unelected periods, in making taxable supplies. The judge decided that it was.

Regulation 109 adopted the concept of a taxable person using past inputs in making future taxable supplies, and this had to be applied having regard to general principles of European Community law. The first principle concerned the cost components of a supply made by a taxable person. Article 2 of the First Council Directive (67/227/EEC) states 'on each transaction, VAT … shall be chargeable after deduction of the amount of VAT borne directly by the various cost components'.

Royal and Sun Alliance paid the rents due during the vacant unelected periods, and in Mr Justice Park's view these rents were cost components of the taxable supplies later made by Royal and Sun Alliance by granting subleases to outside sublessees. He said that the rents were cost components because, in paying them, the company complied with its obligations to its landlords. Therefore it could grant subleases when it found suitable tenants. He continued that because the inputs were cost components of the company's future supplies, when it made those future supplies, it would use the inputs in making the supplies.

The judge then moved on to the second general principle of European Community law, the direct and immediate link. If the input tax borne on an input paid for by a taxable person is to be deducted or recoverable by the person, there must be a direct and immediate link between the input and the person's actual or intended outputs. Royal and Sun Alliance accepted that for it to use the inputs in making future taxable supplies, there would have to be a direct and immediate link between the inputs and the future supplies. The judge accepted that such a link existed between the inputs, i.e., the superior leases obtained and maintained by the company, and Royal and Sun Alliance granting the subleases out of the superior leases.

Mr Justice Park also considered Customs' contention that the inputs were consumed or exhausted so that by the time that Royal and Sun Alliance exercised the option to tax rents received from future supplies of the properties, the inputs could no longer be used in making any supplies of its own. Customs argued that the inputs were used up in the company's unsuccessful efforts to make exempt sublettings during the period the properties lay empty. The judge disagreed, saying that if the company failed to sublet the properties, how could the inputs be consumed. Alternatively, Customs said that the inputs were transient and no longer existed by the time the company formed its intention to opt to tax. However, the judge dismissed this, saying that for that argument to succeed inputs could only be linked with outputs made in the same quarter and which lasted for the same quarter, and this as a matter of general principle or by virtue of the deeming provisions was a correct analysis of the case. It was not right to say that a landlord kept making new supplies lasting only one quarter to say a tenant granted a 21-year lease. The grant of a lease was one transaction, and the lease a single asset of the tenant.

The fact that Customs accepted that any future payments of superior rents made to the landlords would be recoverable by Royal and Sun Alliance, was in the judge's view tacit acceptance that this applied to past rent payments.

Royal and Sun Alliance was entitled to recover the input tax, and its appeal succeeded.

Decision for the taxpayer company

(Reported at [2000] STC 933.)

Commentary by Allison Plager

The important point for taxpayers in this case is that the judge recognised the company's intention to make supplies before it had made an election to waive exemption. He acknowledged that the company had attempted to sublet the properties and incurred input tax on the rent it had had to pay on those properties in that attempt. It did not matter that the election to waive exemption was made after the event. Other taxpayers in a similar position may find that they too can successfully obtain a repayment of input tax.

However, as an aside, regardless of the outcome, Mr Justice Park's decision presents a clear and easily comprehensible analysis of the subject. It is a pleasure to see the skills of the former doyen of the Tax Bar now in operation from the Bench.

Mirror Shares

The Court of Appeal confirmed that VAT was not deductible where it was paid on professional fees relating to a share issue in Trinity Mirror plc (formerly Mirror Group Newspapers Ltd) v Commissioners of Customs and Excise.

The taxpayer company issued shares to raise finance for the business. Residents and non-residents of the European Union were able to subscribe. The company claimed VAT in respect of professional fees incurred with the issue of shares. Customs refused on the grounds that the issue of shares was an exempt supply and that input tax was therefore not recoverable, except in respect of the proportion relating to the shares sold to non-European Union residents. The Court of Appeal ruled that the issue in the United Kingdom by a taxable person of its own shares in order to finance expansion of its business was an exempt supply of services.

Background

In May 1991, Mirror Group made an issue of shares in order to raise finance so that the business could be expanded. Shares were issued to European Union and non-European Union residents. The company incurred VAT in respect of professional fees relating to the share issue, and later tried to recover the VAT incurred as input tax on its general overheads.

Customs said that the share issue was an exempt supply of services, as the input tax incurred by the company was not recoverable as it related entirely to the exempt supply. However, under Article 17(3)(c) of the Sixth Directive, the company was allowed to claim the input tax which related to the proportion of fees in respect of the issue of shares to non-European Union residents.

The company appealed to the tribunal which upheld Customs' decision. On further appeal to the High Court, Mr Justice Lightman also agreed with Customs.

(David Milne QC and Greg Sinfield for the taxpayer company; Melanie Hall for Customs.)

Judgment in the Court of Appeal

Lord Justice Chadwick first explained that the tribunal had agreed with Customs that the issue in the United Kingdom by a taxable person of its own shares in order to finance the expansion of its business constituted a supply of services for the purposes of the VAT Act 1994. The High Court had upheld this, but leave to appeal to the Court of Appeal had been given as the question was of 'some general importance'.

He went through the six characteristics which had been agreed in the High Court as being necessary for a share issue to constitute a supply of services within Article 6 of the Sixth Directive:

• it had to be done for a consideration;
• the action must not be capable of being defined as a supply of goods;
• what was done had to be capable of being used by the recipient;
• the benefit provided had to be capable of being regarded as a cost component of the activity of another person in the commercial chain;
• it had to constitute a transaction;
• it had to be done by the person said to have made the supply.

The judge then said that the issue in the appeal was whether, in addition, a necessary additional characteristic was that the consideration for the supply had to be part of the supplier's turnover. The company submitted that VAT was a tax on turnover, and cited observations made by the Advocate General in H J Glawe Spiel und Unterhaltungsgerate Aufstellungsgesellschaft mbH & Co KG v Finanzamt Hamburg-Barmbek-Uhlenhorst (Case C-38/93) [1994] STC 543 in support. The judge said that the observations had to be read in context: the case equated 'the actual turnover which a trader earns from his supplies of goods and services' with 'everything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser, the customer or a third party for such supplies'. It did not support the argument that turnover had to bear some meaning which excluded consideration received by a company on the issue of its own shares; so that the consideration received by a company on the issue of its own shares could not be consideration obtained for a supply of services.

Referring to another case, Commissioners of Customs and Excise v Plantiflor Ltd [2000] STC 137, which the company also cited in support, Lord Justice Chadwick said that whatever support it offered was overturned by Lord Justice Ward's observation that turnover equated with 'whatever is available for profit, for meeting overheads and for discharging the cost-components of the supply'. He could see no reason why that test was not met by the receipts of the share issue.

Overall, the judge said that turnover, in the context of VAT, was a 'convenient label' with which to describe 'everything which constitutes the consideration which has been or is to be obtained by the supplier from the purchaser, the customer, or a third party for … supplies [of goods and services]' (Article 11A(1) of the Sixth Directive). The correct question to ask was whether, in the light of the definitions in the Sixth Directive and the VAT Act 1994, 'something done' was, or was to be treated, as the supply of goods or services. If it was, then the consideration could be described as part of his turnover. However, to suggest that turnover has some 'autonomous meaning … independent of the VAT legislation', and to argue that because the consideration did not fit with that meaning it followed that what had been done was not a supply of goods or services was 'to invert that approach' and likely to lead to error.

Looking at BLP Group plc v Commissioners of Customs and Excise [1995] STC 424, Lord Justice Chadwick said that the European Court of Justice in that case pointed out that a borrower who accepts a loan upon terms as to the payment of interest could not be said to be making a supply to anyone. It was impossible to treat that proposition as the foundation for the proposition that a company which issued its own shares was not so doing as the supplier of those shares.

Lord Justice Chadwick then turned to the suggestion that the question whether the issue by a taxable person of its own shares to subscribers was a supply of services within Articles 2 and 6 of the Sixth Directive should be referred to the European Court of Justice. He believed it to be unnecessary, agreeing with the tribunal and the High Court judge that there was no real doubt has to how the question should be answered.

In Lord Justice Chadwick's view, the tribunal and Mr Justice Lightman were right to say that the issue by a taxable person of its own shares was an exempt supply. The company's appeal was therefore dismissed; both Mr Justice Wright and Lord Justice Pill agreed.

Decision for Customs

(Reported at [2001] STC 192.)

Categories: