20355

Input Tax – attribution – company making exempt taxable and foreign supplies – partial exemption special method – voluntary disclosure – method in form of a written direction – interpretation – whether interpretation subject to an overriding consideration of a “fair and reasonable recovery” – No – whether the agreed method stands until altered – Yes – whether repayment due – Yes. VAT Regulations 1995; 101-3 VAT (Input Tax) (Specified Supplies) Order 1999.

EDINBURGH TRIBUNAL CENTRE

STANDARD LIFE ASSURANCE COMPANYAppellant(s)

- and -

THE COMMISSIONERS FOR
HER MAJESTY’S REVENUE & CUSTOMS Respondents

Tribunal: (Chairman): T Gordon Coutts, QC

(Members): James D Crerar, WS., NP

R L H Crawford, BA., CA., CTA

Sitting in Edinburgh on Tuesday 28 and Wednesday 29 August 2007

for the Appellant(s)Colin Tyre, QC

for the RespondentsIain Artis, Advocate

© CROWN COPYRIGHT 2007.

1

DECISION

Introductory

In this matter the Tribunal heard evidence led by the Appellant from Neil Alexander Gilbert employed as their Tax Manager between 1997 and 2004 and Martin John Hall their Group Vat Manager since August 2004. The Respondents led evidence from their officers Callum Stewart Melville who was the Higher Officer employed at the large business service in Edinburgh. From about June 2000 to February 2004 he was the lead higher officer for the Appellant dealing with its Vat matters. There was also evidence led from Christopher David Roberts the Respondents National Business Manager from 1April 2002 to 7 March 2006 and as such was the recipient of the responsibility for the Vat matters of the Appellant in mid-2004. The Tribunal was also referred to a witness statement by Stewart Ian Grant a senior officer who at the relevant time was a tax specialist full-time in the partial exemption unit of expertise. He conducted a reconsideration said to be independent, of the Commissioners decision with which we are concerned in March 2006. Mr Tyre did not consider that it would be necessary for him to give oral evidence or be cross-examined on his statement.

The Tribunal was also provided with an Agreed Statement of Facts. There were no issues of credibility arising. A considerable volume of correspondence was produced, detailing the background to the dispute, the history of the Appellants partial exemption special methods and the varying contentions of the parties.

The Appellant’s main activities are the provision of assurance, insurance and banking services. It also provides investment services and has a portfolio of investment properties. There are also other activities, some taxable and some exempt.

The appeal concerns the refusal of two voluntary disclosures submitted by the Appellant on 2 November 2005 and 9 February 2006 for £2,545,450 and £10,313,234 respectively. The question in issue between the parties concerns the attribution of input tax to foreign and specified supplies pursuant to an agreement between the parties. The agreement in issue was set out in the Respondents’ letter dated 4April 2001. That letter also gives approval to the adoption by the Appellant of a partial exemption special method (“PESM”) in terms of regulation 102 of the VAT Regulations 1995.

Question for the Tribunal

The Tribunal considered that the question for them was the interpretation of the Partial Exemption Special Method (PESM) agreed and directed in the Respondents said letter dated 4 April 2001. The question involves consideration of the form of the appeal which is directed against the Respondents’ rejection of two voluntary disclosures submitted by the Appellant on 2 November 2005 and 9February 2006 respectively, covering periods of account from period 11/2 to 9/05. The voluntary disclosures consist of applications for recovery of input tax which had previously been categorised as wholly attributable to exempt supplies but which the Appellant now considers ought to have been categorised as attributable partly to exempt supplies and partly to “foreign and specified” supplies.

The Voluntary Disclosures

The disputed voluntary disclosures are made up principally of residual input tax on costs incurred in the marketing, establishing and ongoing servicing of supplies of life insurance, pensions and related products and services by the Appellant’s UK Life & Pensions business, plus savings products and related financial services supplied by Standard Life Bank (“the relevant supplies”). The relevant supplies include supplies to non-EU residents. The relevant supplies thus include specified supplies in terms of the VAT (Input Tax) (Specified Supplies) Order 1999, SI 1999/3121. There are no material supplies in issue save for exempt supplies and these specified supplies. By reason of the inclusion of specified supplies, the voluntary disclosures treat the relevant supplies as partly exempt and seek recovery of the residual input tax attributable to them at the rate prescribed by step 6 of the PESM.

Background to the 4 April 2001 Agreement

The Appellant had operated various PESMs with the express approval of the Respondents since at least 1987. On 8 November 1987 the Respondents gave approval to a special method in the terms set out in a letter produced to the Tribunal (the “1987 Method”). An adjustment of that method was approved on or about 13December 1990 with effect from 1 April 1990 to impose a cap on the VAT recovery rate for the “Grey area” of 24.63%. “Grey area” is more fully discussed below. On 16 May 1998 the Respondents gave approval in the terms set out in a letter produced to a substitute method (“the 1998 Method”). That method retained the cap.

On 24 November 2000, the Appellant sought approval for a revised method in the terms set out in a letter produced, with a view, inter alia, to removing the cap. On 7February 2001, the Appellant restated its proposals in the terms set out in a letter which was accompanied by demonstrative calculations. The Respondents responded in terms of their letter of 12 February 2001 to which the Appellant replied on 22 February with an amended proposal. That amended proposal formed the basis, with one adjustment, of the method approved on 4 April 2001.

The letter of 4 April 2001

In view of the importance of the whole terms of this letter from the Respondents all the relevant portions of it are reproduced.

“Duration of Method

You must use this method to calculate your recoverable input tax with effect from 16 February 2000 and you must use it until such times as the Commissioners approve or direct the termination of its use. The approval is given in the context of your current business structure and trading patterns. If there are any changes in these trading or business patterns and structures or the VAT group membership to such an extent that the agreed method no longer gives a fair and reasonable recovery of input tax, you should inform this office in writing immediately.

Taxable Supplies

The definition of “taxable supplies” for the purposes of this method are:

  1. any supply of goods or services made in the UK (including the Isle of Man) other than an exempt supply unless that exempt supply is specified within an order made under the Value Added Tax Act 1994 s26(2)(c);
  2. any supply made outside the EC specified in an order under the Value Added Tax Act 1994 s26(2)(c) which would be exempt if made inside the UK;
  3. any supply made outside the UK that would be a taxable supply if made within the UK;
  4. any exempt supply which has been subject to a waiver exemption under the Value Added Tax Act 1994 Schedule 10(2).

Exempt Supplies

The definition of “exempt supplies” for the purposes of this method are:

  1. any supply of goods or services made in the UK (including the Isle of Man) which is exempt from VAT by virtue of the Value Added Tax Act 1994 Schedule 9 (as amended) (or equivalent provision of the 1983 Act) unless that exempt supply is specified within an order made under the Value Added Tax Act 1994 s26(2)(c);
  2. any supply made outside the UK but within the EC that would be exempt if made within the UK;
  3. any supply made outside the EC not specified in an order under the Value Added Tax Act 1994 s26(2)(c) which would be exempt if made inside the UK.

Recoverable Input Tax

You are to calculate your deductible input tax for each partial exemption year with effect from the year commencing 16 February 2000 on the following basis:

  1. Identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in making taxable supplies. This includes those supplies which are outwith the scope of VAT but which attract the right to input tax deduction. The input tax thereon is recoverable.
  2. Identify all supplies, acquisitions and imports you receive which are used, or to be used, in whole by you exclusively in making exempt supplies or in any activity other than the making of taxable supplies. The input tax thereon is not recoverable.
  3. Input tax incurred on Systems will be attributed using your internal Systems costs allocation analysis to the Investment, Property, Grey Area and Disallowed sectors and recovered according to the residual recovery rates of those sectors.
  4. Input tax relating to the Investment Department which has not been attributed under 1 to 3 above should be apportioned and the recoverable proportion determined by applying the following calculation to determine the recoverable percentage:

Taxable supplies of the Investment Department X 100

Total supplies of the Investment Department

  1. Input tax relating to the Property Department which has not been attributed under steps 1 to 3 above should be apportioned by applying the following calculation to determine the recoverable percentage:

Input tax attributed to taxable supplies of the Property Department x 100

Total input tax attributed to the Property Department (excluding non-deductible input tax such as motor cars and business entertainment)

  1. The balance of input tax which has not been attributed to either 1 to 5 above should be apportioned by applying the following calculation to determine the recoverable percentage:

Input tax attributed, directly or indirectly to taxable supplies X 100

Total input Tax (excluding non-deductible input tax such as motor cars and business entertainment)

This will be applied to the Grey Area, Lothian Road, 1 George Street and Staff Ratio within the Input VAT Expenses area.

All the above ratios are to be expressed as a percentage calculated to the nearest 2 (two) decimal places without rounding up.

Exclusions

In calculating the proportions at paragraph 4, 5 and 6 above, you should exclude from the numerator and denominator the value of all distorting supplies in the following categories:

  • Supplies made from branches situated outside the UK.
  • Supplies of capital goods you have used for the purpose of the business.
  • Incidental real estate supplies.
  • Self supplies.
  • Incidental financial supplies.
  • The value of any imported service.
  • The selling price of any car used in the business unless it is sold for a profit. If so, the difference between the buying and selling price should be included.
  • The value of any goods and services not supplied by way of business.
  • The value of any supply of any goods sold on in the same state in connection with a supply of finance.
  • Supplies by way of a transfer of a going concern(s) (“TOGC”).
  • Supplies between companies in the VAT group”.

The Law applicable to such an agreement

1.European Community Law

Article 17 of the EC Sixth VAT Directive (“the Sixth Directive”) provides the right to deduct input VAT. The entitlement is in respect of input VAT on expenditure used for: (1) taxable transactions; (2) economic activities carried out in another country which would be taxable if made in the taxable person’s country; and (3) certain exempt supplies to customers established outside the Community (articles 17(2)(a) and (3)(a) and (c)). Article 17(5) goes on to provide that where expenditure is used partly for deductible transactions, it may be deducted in part.

Article 17(5) begins:

“(5) As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which [VAT] is deductible, and for transactions in respect of which [VAT] is not deductible, only such proportion of the [VAT] shall be deductible as is attributable to the former transactions.

This proportion shall be determined, in accordance with Article 19, for all the transactions carried out by the taxable person.”

Article 19 entitled “Calculation of the deductible proportion”, in relevant parts reads as follows:

“1. The proportion deductible under the first sub-paragraph of Article 17(5) shall be made up of a fraction having:

as numerator, the total amount, exclusive of [VAT], of turnover per year attributable to transactions in respect of which [VAT] is deductible under Article 17(2) and (3),

as denominator, the total amount, exclusive of [VAT], of turnover per year attributable to transactions included in the numerator and to transactions in respect of which [VAT] is not deductible.”.

Article 17(5) continues at the third sub-paragraph:

“However, the Member States may:

(a)authorise the taxable person to determine a proportion for each section of his business.;

and it states

(c)authorise or compel the taxable person to make the deduction on the basis of the use of all or part of the goods and services;”

Case law makes it clear that the entitlement to deduct arises where there is a direct and immediate link between the expenditure and output transactions in respect of which VAT is deductible. This is intended to relieve a trader entirely of the burden of VAT where the expenditure is for activities which are themselves subject to VAT or so treated (the “neutrality” principle). It is for the national court to apply the direct and immediate link to the facts and surrounding circumstances of each case: see e.g. Midland Bank plc v CCE (Case C-98/98) [2000] STC 501; BUPA Purchasing Limited and others v CCE [2003] STC 1203 (“BUPA”) and CCE v Southern Primary Housing Association Limited [2004] STC 209.

Relying on art. 17(5)(c), the UK introduced sections 24(1) and 26(2) of the 1994 Act. The former subsection defines “input tax” as including the Vat on certain specified goods or services “used or to be used for the purpose of any business carried on or to be carried on.”; while section 26(3) empowers the Commissioners to make regulations “for securing a fair and reasonable attribution of input tax to supplies within section 26(2)”. The relevant regulations are Part XIV of the Value Added Tax Regulations 1995.

  1. The Regulations

Regulation 101 provides the standard method of calculation. Key features of that method are: (1) the attribution to taxable supplies of input tax on such goods and services as are used exclusively for taxable supplies (recovered in full): and (2) the attribution (and disallowance) of input tax on such goods and services are used exclusively for exempt supplies. This is generally described as the principle of “direct attribution”. Non-attributable input tax i.e. VAT on expenditure used indiscriminately for all transactions of the taxable person (usually called “residual input tax”), is recoverable in part. In the standard method this calculation is made using a formula based on the value of outputs: regulation 101(1)(d). That sub-paragraph reads:

“(d) there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies as beaRs the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period”. (emphasis added)

Regulation 103 provides for the attribution of input tax to out-of-country supplies. Subject to exceptions not relevant in the instant case, this regulation directs that input tax:

“used or to be used . in whole or in part in making . [out-of-country supplies] . shall be attributed to taxable supplies to the extent that the goods or services are so used or to be used expressed as a proportion of the whole use or intended use”

“Use” is not defined.

3.The LIPA case

The interaction of regulations 101 and 103 was clarified by the House of Lords in C.C.E.V Liverpool Institute of Performing Arts [2001] STC 891 The Institute (“LIPA”) made taxable and exempt supplies within the UK. It also made out-of-country supplies in the form of advertising services supplied to a German company. LIPA operated the standard method which required non-attributable input tax to be recovered according to a formula based on the ratio of the values of taxable to total outputs. The issue was whether the value of out-of-country supplies should be used in the numerator and denominator of the formula. The Court of Appeal considered that “taxable supplies” in what is now regulation 101 excluded foreign supplies, and that “all supplies” in regulation 101 included taxable supplies and exempt supplies but did not include foreign supplies. The court held that new regulation 103 was intended to constitute a separate regime from new regulation 101 for foreign and other specified supplies. The taxpayer’s appeal to the House of Lords was dismissed, their Lordships holding that art 17(5) coupled with art. 19 of the Sixth Directive did not insist on a value based approach to the apportionment of residual input tax. Member States were entitled to require that deduction be made on the basis of the use of all or part of the goods or services.

4.Special methods

Regulation 102(1) provides (with certain exceptions not relevant to the instant case) that:

“Subject to regulation 103, the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101 .”

This is referred to as a “special method”. Most special methods require direct attribution of input tax to the greatest extent possible: in effect they repeat regulation 101(1)(a) to (c). The Method is so framed. Where special methods differ from the standard method is in relation to non-attributable input VAT. It is common to find “sectorisation” i.e. where non-attributable input is allocated, on one or more bases, to separate sectors within the business. Calculation of the deductible proportion within each sector is then on a basis such as a value of outputs ratio, transaction count, use, or sometimes a combination of factors. It may be so framed that, in a value of outputs calculation, certain output values are included and others excluded. In essence, therefore, a special method is directed primarily at allocating and apportioning non-attributable input VAT.