ROYAL BANK of CANADA TRUST CORPORATION LIMITED Appellant

20520

INPUT TAX – Appellant operated as an Enterprise Zone Property Unit Trust – Appellant claimed VAT as input tax on supplies made after it ceased to make taxable supplies – Appellant contended that the disputed supplies were cost components of its letting business – satisfied on the facts that no direct and immediate link between the disputed supplies and Appellant’s taxable business – in the alternative disputed supplies were costs of issuing the units – no evidence to support alternative argument – in the alternative breached the principle of neutrality – no breach of principle – Appeal dismissed

LONDON TRIBUNAL CENTRE

ROYAL BANK OF CANADA TRUST CORPORATION LIMITED Appellant

(AS TRUSTEE OF THE MATRIX DUDLEY TRUST)

- and -

HER MAJESTY’S REVENUE and CUSTOMSRespondents

Tribunal: MICHAEL TILDESLEY OBE (Chairman)

Sitting in public in London on 15 October 2007

John Watson, Ashurst solicitors, for the Appellant

Andrew McNab, counsel instructed by the Solicitor for HM Revenue & Customs, for the Respondents

DECISION

The Appeal

The Appellant was appealing against an assessment dated 6 October 2006 in the sum of £10,652 plus interest. The assessment related to the tax periods 11/03 (1.9.03 to 30.11.03) to 05/06 (1.3.06 to 31.5.06).
In the decision the term “Appellant” refers to the trust, the Matrix Dudley Trust; Royal Bank of Canada Trust Corporation Limited operated as the Trustee; Matrix-Securities Limited acted as the Sponsor and Trust Manager.

The Dispute

The Appellant was an Enterprise Zone Property Unit Trust (EZPUT) set up to take advantage of enterprise zone allowances now provided for in the Capital Allowances Act 2001. Enterprise Zones were established in 1981 to facilitate and promote privately funded economic regeneration in specific areas of the United Kingdom. Investment in the zones carried a number of incentives, one of which was a capital allowance of 100 per cent for the construction expenditure of a new commercial building.
On 10 March 1994 Royal Bank of Canada Trust Corporation and Matrix Securities Limited entered into a trust deed for the Matrix Dudley Trust. On 11 March 1994 Matrix Securities Limited issued an information memorandum offering £5,460,000 of units. The closing date for applications was 28 March 1994 and the Trust closed on or about that date
On 5 April 1994 the Appellant acquired the freehold of a retail warehouse development in Dudley, West Midlands with the proceeds from the sale of units. The trust property was leased back to the vendor for 25 years. The vendor constructed the retail warehouses. Until 2003 the Appellant received rental income from the tenants of the retail warehouses. VAT was charged on those rents. On 21 May 2003 the Appellant effectively disposed of the property by means of the grant of a long lease, 999 years, for a premium of £7,055,000 plus VAT. On 23 May 2003 the majority of the sale proceeds were distributed to unit-holders. The distribution net of costs was £1,204.86 per £1,000 unit. The Appellant retained a residual and valueless freehold interest to the property which the Appellant intended to retain until 2021 to avoid the risk of a balancing charge on the premium. Since the grant of the long lease in 2003 the Appellant made no taxable supplies. The only income received by the Appellant was bank interest on retained funds.
The disputed issue in this Appeal was whether the Appellant was entitled to recover VAT on supplies made to it after 23 May 2003 when it distributed the sale proceeds to the unit holders. The Appellant submitted three separate arguments supporting its proposition that it was entitled to recover the VAT as input tax which were:

(1)The cost of the supplies after 23 May 2006 was a cost of the Appellant’s business of letting an enterprise zone property as an EZPUT.

(2) The Appellant’s retention of the reversionary interest was an inevitable cost of having financed its business through the issue of units to tax based investors. Accordingly the cost of retaining the reversion was attributable to the raising of that finance and to the actual taxable supplies made in consequence of it.

(3)The Respondents’ refusal of the Appellant’s claim for input tax breached the principle of neutrality which was the foundation of Value Added Tax.

The Respondents contended that the Appellant was not entitled to deduct as input tax VAT that was paid on services that were bought and consumed after it ceased to make taxable supplies. The Respondents submitted that the costs related to a new and distinct activity. They were not cost components of the Appellant’s business of letting an enterprise zone property as an EZPUT. The Respondents considered that the Appellant’s second and third arguments were essentially indistinguishable from its first argument.
The Respondents conceded that the assessment should be reduced by £142.66 which related to an invoice for a supply made before 23 May 2003.

The Evidence

I received in evidence a witness statement of Paul Jonathan Nicholls, a director of Matrix Property Management, which through one of its subsidiaries managed the Appellant’s EZPUT. The Respondents did not object to the contents of Mr Nicholls’ witness statement. The Appellant submitted bundles of documents which were agreed with the Respondents.

The Facts

There was no substantive dispute on the facts between the parties. The background facts are given in paragraphs 3 – 5.
EZPUTs enjoyed two particular tax advantages, 100 per cent capital allowances on the expenditure by the EZPUT on commercial buildings, and a tax deduction for interest on money borrowed to acquire units against a unit holder’s share of rental income. The EZPUT also represented an investment in the underlying property. In appraising that investment investors would take into account the prospect of and the likely taxation of the capital sum when the property was realised.
At the time of the Appellant’s EZPUT the Inland Revenue (PR dated 25 February 1994) tightened up on the capital allowance regime for EZPUTs, in particular the conditions for imposing a balancing charge ( a claw back of the tax relief given by the capital allowances) on the capital sum received from the realisation of the property.
The Information Memorandum offering the units for investment in the Appellant’s EZPUT dated 11 March 1994 explained the tax advantages that would accrue to an investor by reason of his subscription. At the end of page 24 the Memorandum sets out the position on balancing charges:

(1)A balancing charge might occur if the property was sold within 25 years of its first commercial use.

(2)If, however, the Appellant disposed of a lesser interest, a balancing charge would only arise if that lesser interest was granted within seven years of acquisition.

On 16 April 2003 the Appellant held an Extraordinary General Meeting of investors (EGM) which approved a resolution authorising the Appellant to sell the property. The Notice for the EGM explained that the Appellant would retain the reversion in the property following its sale by the grant of a 999 year leasehold interest (the lesser interest) so as to avoid the imposition of a balancing charge on the premium received for the lesser interest. In those circumstances it would be necessary for the Appellant to continue in existence for 15 years ( the end of the 25 year period from the date the buildings were first brought into use) which would have an ongoing cost estimated to be £37,500 comprising of £2,500 plus VAT per annum for management fees. The Notice stated that the ongoing management fee would be deducted from the sale proceeds before any capital distribution was made to investors.
Mr Nicholls stated that he had been advised that the EGM Notice was inaccurate in specifying that the reversion in the property had to be retained by the Appellant for a period of 25 years from the date the building was first brought into use. Mr Nicholls explained that the correct position was that there would be no balancing charge on the premium for the 999 year lease provided the sale of the reversionary interest within the 25 year period was an entirely separate transaction from the sale of the 999 year lease. In those circumstances the balancing charge would be on the sale value of the reversion, which Mr Nicholls described as valueless. Mr Nicholls, however emphasised that EZPUTS were generally advised to retain the valueless reversionary interest for a considerable time to eliminate the risk that the realisation of the reversion and the grant of the lesser interest would be regarded as a single transaction.
On 23 May 2003 the Appellant informed the unit-holders that the sale of the property took place on 22 May 2003 with a sale value of £7,055,500. Following the sale the Appellant distributed the capital proceeds less costs and the remaining rent income to the unit-holders. The costs retained by the Appellant from the proceeds included sums for anticipated tax liabilities and for the management of the trust post 22 May 2003 to 2021. The management fees comprised £43,000 plus VAT for the trustee’s fees and £40,000 plus VAT for the registrar’s and manager’s fees. The trustee’s fees up to 2021 have been invoiced to the Appellant. The registrar’s fees and manager’s fees have been invoiced to 31 December 2005 and 30 November 2005.
The disputed part of the assessment raised on 20 September 2006 related to the VAT credit on the fee invoices from the trustee, registrar, manager and auditor for supplies made to the Appellant after the grant of the 999 year lease. The Appellant made no taxable supplies following the grant of the lease, the sole source of income during this period was bank interest. The Appellant’s VAT registration was cancelled with effect from 16 October 2006.

Reasons for Decision

First Argument: The expenses incurred after the grant of the long lease were a cost of the Appellant’s business of letting an enterprise zone property as an EZPUT.

The Parties’ Representations

The Appellant contended that the expenses were a cost of its business of letting an enterprise zone property because:

(1)The retention of the reversion in the property and the incurring of consequential costs were part of the Appellant’s economic activity as defined in Article 4(2) of the Sixth Directive so that the Appellant remained a taxable person for the purpose of that directive.

(2)The costs were an overhead of the Appellant’s business so that there was a direct and immediate link with the immediate activity.

(3)There were no fraudulent or abusive circumstances.

(4)Any interest received on the cash retained was incidental to the making of the taxable supplies within the meaning of Article 19 of the Sixth Directive and so fell to be ignored.

(5) Thus the VAT on the expenses was recoverable by the Appellant as input tax.

The Respondents submitted that the expenses were not cost components of the Appellant’s business of letting an enterprise zone property. The expenses were for supplies of services received after it ceased to make taxable supplies.
The Respondents constructed its case from the following principles governing deductibility of VAT as derived from the case law:

(1)The deduction system is designed to relieve the trader entirely of the burden of the VAT payable in the course of all his economic activities provided that such activities are themselves, in principle, subject to VAT (the neutrality principle).

(2)There must be a clear nexus between the expenditure and the business itself.

(3)The expenditure must have a direct and immediate link with the taxable transactions of the business. The test of direct and immediate link is an objective one, the ultimate aim pursued by the taxable person is irrelevant.

(4)In principle the existence of a direct and immediate link between a particular input transaction (expenditure) and a particular output transaction (taxable supply of the business) is a necessary pre-condition for the deduction of VAT incurred on the input transaction.

(5) The costs of the input transaction form part of the cost components of the output transaction. Thus the costs must generally have arisen before the making of the output transaction.

(6) There is in general no direct and immediate link between expenditure on services obtained in consequence of an output transaction since the expenditure is not incurred as part of the cost components of the output transaction.

(7) An exception to the general principle that the right to deduct depends upon a direct and immediate link is where the costs form part of the taxable person’s overheads, and as such are, in principle, cost components of the products of business as a whole.

(8)A further exception to the general principle is that the right to deduct may remain where costs have been incurred in contemplation of making taxable supplies but the economic activity envisaged does not give rise to taxed transactions or the taxable person is unable to use the goods or services acquired by reason of circumstances beyond his control.

(9)A final exception is that the right to deduct may remain on costs incurred in relation to closing down the business even though no further taxable outputs are made.

The Respondents submitted that the supplies made to the Appellant after it ceased to make taxable supplies did not fall within one of the exceptions outlined above. The costs incurred on the disputed supplies related to a new activity of managing the reversion which was distinct from the Appellant’s business of letting an enterprise zone property. They were cost components of the new activity. They were not overheads of the letting business. Further the costs did not constitute expenditure for terminating the business.
There was broad agreement between the parties on the facts and the legal principles governing the deduction of VAT as input tax. The Appellant objected to the Respondents’ construction of exceptions. In the Appellant’s view the exceptions cited by the Respondents were elaborations of what constituted a cost component. The costs incurred were either cost components or not.
The essential differences between them turned on the application of the principles established in I/S Fini H v Skatterministeriet (Case C – 32/03)[2005] STC 903 and their interpretation of the status of the trust after the grant of the long lease.
The material facts of Fini H were that

(1)Fini H was a limited partnership created in 1989 with the object of running a restaurant.

(2)In order to carry out that activity, Fini H leased premises from 20 May 1988. The lease was for a term of 10 years and could be terminated only with effect from 30 September 1998.

(3)Fini H closed the restaurant at the end of 1993. Replacement tenants could not be found and the premises remained unused. Fini H sought to terminate the lease, but the landlord refused consent.

(4)From the end of 1993 to 1998 Fini H remained registered for VAT even though it no longer carried on the restaurant business. It continued to deduct the input tax paid on the rent and related supplies in relation to the lease.

The Court of Justice decided that Fini H was entitled to deduct the VAT paid on the rent and related supplies after it ceased making taxable supplies because there was a direct and immediate link between the payments made and its economic activity as a restaurant. In arriving at its decision the Court of Justice reaffirmed the principle established in Abbey National PLC v CEC (CaseC-408/98)[2001]STC 297 that VAT on costs incurred in relation to closing down the business must remain deductible even though no further taxable outputs were made. Such costs form part of the general overheads of the complete business from inception to termination and thus have a direct and immediate link with the output transactions of the business.
The Court of Justice considered that the payments made by Fini H were directly and immediately linked to the restaurant business because:

“In the main case, Fini H’s obligation owing to a non-termination clause in the lease, to continue paying business rent and charges on a property which it had leased for the purpose of carrying on a restaurant business until the normal expiry of the lease could, in principle, be regarded as being directly and immediately linked to the restaurant business”.

“Since Fini H entered into the lease in order to have the premises necessary for carrying on its restaurant business and given that the premises were actually used for that business, it must be conceded that the partnership’s obligation to continue paying the rent and other charges after it had ceased that business was a direct consequence of the carrying on of that business” (paragraphs 27 & 28).

The Fini H decision highlighted the difference between the parties on their respective interpretations of the status of the trust after the grant of the long leasehold interest. The Appellant maintained that the retention of the trust was part of the bargain struck with the unit-holders regarding the grant of the long lease in the property. According to the Appellant, the unit holders held the whip hand and would not have agreed to the grant unless the Appellant retained the reversion so as to protect them from balancing charges on the premium received for the grant of the long lease.