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England and Wales Court of Appeal (Civil Division) Decisions |
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You are here: BAILII >> Databases >> England and Wales Court of Appeal (Civil Division) Decisions >> Volkswagen Financial Services (UK) Ltd v HM Revenue & Customs [2015] EWCA Civ 832 (28 July 2015) URL: http://www.bailii.org/ew/cases/EWCA/Civ/2015/832.html Cite as: [2015] BVC 32, [2015] EWCA Civ 832, [2015] STI 2533, [2016] STC 417 |
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ON APPEAL FROM THE UPPER TRIBUNAL (TAX AND CHANCERY CHAMBER)
MR JUSTICE VOS AND JUDGE TIMOTHY HERRINGTON
[2012] UKUT 394 (TCC)
Strand, London, WC2A 2LL |
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B e f o r e :
LADY JUSTICE SHARP
and
LADY JUSTICE KING
____________________
| VOLKSWAGEN FINANCIAL SERVICES (UK) LIMITED |
Appellant |
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| - and - |
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| THE COMMISSIONERS FOR HER MAJESTY'S REVENUE AND CUSTOMS |
Respondent |
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Owain Thomas instructed by the General Counsel and Solicitor to HM Revenue and
Customs for the Respondent
Hearing dates : 16 and 17 April 2015
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Crown Copyright ©
Lord Justice Patten :
Introduction
(1) Retail – (i) entering into hire purchase ("HP") agreements with customers in respect of Group Brand vehicles; (ii) entering into leasing agreements with customers in respect of Group Brand vehicles; and (iii) fixed price service and maintenance contracts on Group Brand vehicles;
(2) Wholesale – providing funding to dealers of Group Brand vehicles for the purchase of demonstrator vehicles and stock (new and used cars);
(3) Volkswagen Insurance Services ("VIS") – the arrangement of insurance for owners of Group Brand vehicles and dealers of Group Brand vehicles;
(4) Asset Backed Securitisation ("ABS") – servicing (and reporting on) securitised hire purchase contracts;
(5) Contract Disposals – the disposal of previously leased and/or repossessed Group Brand vehicles; and
(6) Catch All – miscellaneous items, such as the provisions of training programmes or the rental of signage to dealers of Group Brand vehicles.
"The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions which take place in the production and distribution process before the stage at which tax is charged.
On each transaction, value added tax, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components.
The common system of value added tax shall be applied up to and including the retail trade stage."
"(1) … the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.
(2) … In respect of each prescribed accounting period—
…
(b) there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies,
(c) no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies, and
(d) there shall be attributed to taxable supplies such proportion of the residual input tax 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,
(e) the attribution required by subparagraph (d) above may be made on the basis of the extent to which the goods or services are used or to be used by him in making taxable supplies, …"
(i) for Retail, the proportion of recoverable input tax is quantified by reference to the total number of taxable transactions to total transactions; and
(ii) for Wholesale, VIS, ABS and Contract Disposal, the proportion of recoverable residual input tax is quantified by reference to the ratio of taxable income to total income in the sector.
"input tax allocated to this sector is deductible to the extent that it is incurred on goods or services which are used or to be used to make taxable supplies, expressed as a proportion of the whole use or intended use".
The facts
"14. The market or advertised rate of interest is determined by VWFS. It does this by applying a margin for overheads, a profit margin and an allowance for bad debts to its own cost of financing the vehicle. However, the VW brands use a range of incentives to make their cars more attractive to consumers, including discounts and free specification upgrades. The incentives also extend to the finance options, including offers of low or zero rate finance and low deposit requirements. If the VWFS market rate is higher than the VW brands wish to offer to their customers, the brands can subsidise the difference by making subvention payments to VWFS. The brands pay the difference to VWFS up front out of their marketing budgets. The commercial risk of these incentives is therefore borne by the VW brands."
"15. From the evidence we find that the overheads that are the subject of this appeal are built into the interest rate, the option to purchase fee and the acceptance fee. There is no separate fee charged to cover overheads. Overheads do not form part of the cash price for the vehicle, as that merely reflects the price paid by VWFS to the retailer."
The authorities
"16. As the court pointed out in its judgment of 5 May 1982 in case 15/81 (Schul v Inspecteur Der Invoerrechten En Accijnzen, (1982) ECR 1409), a basic element of the vat system is that vat is chargeable on each transaction only after deduction of the amount of the vat borne directly by the cost of the various components of the price of the goods and services and that the deduction procedure is so designed that only taxable persons may deduct the vat already charged on the goods and services from the vat for which they are liable.
…..
19. From the provisions set forth above it may be concluded that the deduction system is meant to relieve the trader entirely of the burden of the vat payable or paid in the course of all his economic activities. The common system of value-added tax therefore ensures that all economic activities, whatever their purpose or results, provided that they are themselves subject to vat, are taxed in a wholly neutral way."
"19. Paragraph 5 lays down the rules applicable to the right to deduct VAT where the VAT relates to goods or services used by the taxable person 'both for transactions covered by paragraphs 2 and 3, in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible'. The use in that provision of the words 'for transactions' shows that to give the right to deduct under para 2, the goods or services in question must have a direct and immediate link with the taxable transactions, and that the ultimate aim pursued by the taxable person is irrelevant in this respect.
…..
25. It is true that an undertaking whose activity is subject to VAT is entitled to deduct the tax on the services supplied by accountants or legal advisers for the taxable person's taxable transactions and that if BLP had decided to take out a bank loan for the purpose of meeting the same requirements, it would have been entitled to deduct the VAT on the accountant's services required for that purpose. However, that is a consequence of the fact that those services, whose costs form part of the undertaking's overheads and hence of the cost components of the products, are used by the taxable person for taxable transactions.
26. In that respect it should be noted that a trader's choice between exempt transactions and taxable transactions may be based on a range of factors, including tax considerations relating to the VAT system. The principle of the neutrality of VAT, as defined in the case law of the court, does not have the scope attributed to it by BLP. That the common system of VAT ensures that all economic activities, whatever their purpose or results, are taxed in a wholly neutral way, presupposes that those activities are themselves subject to VAT (see in particular Rompelman v Minister van Financiën (Case 268/83) [1985] ECR 655 at 664, para 19)."
"30. A consideration of those provisions together shows that the Community legislature, proceeding from an ideal image of 'chains of transactions'—to adopt the neat phrase used at the hearing by the representative of the United Kingdom—intended to attach to each transaction only so much VAT liability as corresponds to the added value accruing in that transaction, so that there is to be deducted from the total amount the tax which has been occasioned by the preceding 'link in the chain' (see, for example, the judgment in EC Commission v France (Case 50/87) [1988] ECR 4797 at 4817, para 16)."
"29. It should be borne in mind that, according to the fundamental principle which underlies the VAT system, and which follows from art 2 of the First and Sixth Directives, VAT applies to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components (see, to this effect, BP Supergas Anonimos Etairia Geniki Emporiki-Viomichaniki kai Antiprossopeion v Greece (Case C-62/93) [1995] STC 805 at 821, [1995] ECR I-1883 at 1913, para 16).
30. It follows from that principle as well as from the rule enshrined in the judgment of BLP Group plc v Customs and Excise Comrs (Case C-4/94) [1995] STC 424 at 437, [1995] ECR I-983 at 1009, para 19 according to which, in order to give rise to the right to deduct, the goods or services acquired must have a direct and immediate link with the taxable transactions, that the right to deduct the VAT charged on such goods or services presupposes that the expenditure incurred in obtaining them was part of the cost components of the taxable transactions. Such expenditure must therefore be part of the costs of the output transactions which utilise the goods and services acquired. That is why those cost components must [2000] STC 501 at 519 generally have arisen before the taxable person carried out the taxable transactions to which they relate.
31. It follows that, contrary to what the Midland claims, there is in general no direct and immediate link in the sense intended in BLP Group, between an output transaction and services used by a taxable person as a consequence of and following completion of the said transaction. Although the expenditure incurred in order to obtain the aforementioned services is the consequence of the output transaction, the fact remains that it is not generally part of the cost components of the output transaction, which art 2 of the First Directive none the less requires. Such services do not therefore have any direct and immediate link with the output transaction. On the other hand, the costs of those services are part of the taxable person's general costs and are, as such, components of the price of an undertaking's products. Such services therefore do have a direct and immediate link with the taxable person's business as a whole, so that the right to deduct VAT falls within art 17(5) of the Sixth Directive and the VAT is, according to that provision, deductible only in part."
"35. However, the costs of those services form part of the taxable person's overheads, and as such are cost components of the products of a business. Even in the case of a transfer of a totality of assets, where the taxable person no longer effects transactions after using those services, their costs must be regarded as part of the economic activity of the business as a whole before the transfer. Any other interpretation of art 17 of the Sixth Directive would be contrary to the principle that the VAT system must be completely neutral as regards the tax burden on all the economic activities of a business provided that they are themselves subject to VAT, and would make the economic operator liable to pay VAT in the context of his economic activity without giving him the possibility of deducting it (see, to that effect, Gabalfrisa SL and ors v Agencia Estatal de Administración Tributaria (AEAT) (Joined Cases C-110/98 to C-147/98) [2000] ECR I-1577, para 45). An arbitrary distinction would thus be drawn between expenditure incurred for the purposes of a business before it is actually operated and that incurred during its operation, on the one hand, and, on the other hand, the expenditure incurred in order to terminate its operation.
36. Thus in principle the various services used by the transferor for the purposes of the transfer of a totality of assets or part thereof have a direct and immediate link with the whole economic activity of that taxable person.
37. It follows from art 17(5) of the Sixth Directive that a taxable person who effects both transactions in respect of which VAT is deductible and transactions in respect of which it is not may deduct only that proportion of the VAT which is attributable to the former transactions.
38. However, as the court held in the para 26 of the Midland Bank judgment ([2000] STC 501 at 519), a taxable person who effects transactions in respect of which VAT is deductible and transactions in respect of which it is not may nevertheless deduct the VAT charged on the goods or services acquired by him, where those goods or services have a direct and immediate link with the output transactions in respect of which VAT is deductible, without it being necessary to differentiate according to whether art 17(2), (3) or (5) of the Sixth Directive applies.
39. That rule must apply also to the costs of the goods and services which form part of the overheads relating to a part of a taxable person's economic activities which is clearly defined and in which all the transactions are subject to VAT, since those goods and services thus have a direct and immediate link with that part of his economic activities."
"32. Moreover, the court has consistently held that for there to be the direct and immediate link required by the court, the costs incurred in acquiring the input transactions must be part of the cost components of the taxable output transactions, that is to say they must be incorporated into their price. The court has also made it clear that this also covers the input transactions attributable to the taxable person's general overheads. In the case of such input transactions the required link exists not with certain output transactions but rather with the taxable person's economic activity as a whole, that is to say all of his output transactions.
…
34. Clearly, these abstract requirements of the court are not straightforward to implement in a specific case. It itself pointed out early on that the link between input and output transactions necessary for deduction cannot be described more accurately in abstract terms on account of the large variety of economic activities. Therefore, in principle it is for the national court to apply the 'direct and immediate link' test specifically to the facts of each case before it."
"58. It is, however, also accepted that a taxable person has a right to deduct even where there is no direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct, where the costs of the services in question are part of his general costs and are, as such, components of the price of the goods or services which he supplies. Such costs do have a direct and immediate link with the taxable person's economic activity as a whole (see, inter alia, Midland Bank (paras 23 and 31); Abbey National (para 35); Kretztechnik (para 36); and Investrand (para 24)).
…..
60. It follows that whether there is a right to deduct is determined by the nature of the output transactions to which the input transactions are assigned. Accordingly, there is a right to deduct when the input transaction subject to VAT has a direct and immediate link with one or more output transactions giving rise to the right to deduct. If that is not the case, it is necessary to examine whether the costs incurred to acquire the input goods or services are part of the general costs linked to the taxable person's overall economic activity. In either case, whether there is a direct and immediate link is based on the premise that the cost of the input services is incorporated either in the cost of particular output transactions or in the cost of goods or services supplied by the taxable person as part of his economic activities.
….
62. ….. In order to establish whether there is such a direct and immediate link, it is necessary to ascertain whether the costs incurred are likely to be incorporated in the prices of the shares which SKF intends to sell or whether they are only among the cost components of SKF's products."
"31. The acquisition or production of capital goods therefore has two different purposes. Firstly, we see the availability of the recreational trail to the public free of charge (primary use) which does not, under Article 168 of the VAT Directive, confer any right to deduct input tax. Secondly, we see however, use of the recreational trail as a means of supplying to visitors services which are liable to tax (secondary use), from which the right to deduct input tax arises. Which of these two purposes is then decisive in the context of Article 168 of the VAT Directive?"
"33. The Court has however developed its case-law. Although it is true that application of Article 168 of the VAT Directive, which confers entitlement to the deduction of input tax, presupposes again the finding of a direct and immediate link between a particular input transaction and a particular output transaction or transactions, such a connection may also exist with the taxable person's business as a whole where the costs of input services are part of that taxable person's general costs and are, as such, components of the price of the goods or services that it supplies.
34. According to more recent case-law, whether there is a direct and immediate link will depend on whether the cost of the input services is incorporated either in the cost of particular output transactions or in the cost of goods or services supplied by the taxable person. The same applies, irrespective of the fact that this is question of use of goods or services by the taxable person.
35. A right to deduct input tax therefore exists in this case if the costs of acquisition or of production of the capital goods of the recreational trail are incorporated, within the meaning of case-law, in the costs of output services taxed by virtue of the VAT Directive."
"41. If the referring court were however to find that setting in place of the recreational trail by Sveda does not constitute, vis-a-vis the National Paying Agency, a taxed transaction, the right to deduct input tax would then depend solely on the question of whether the capital goods of the recreational trail are used, within the meaning of Article 168 of the VAT Directive, for the future supply of services for consideration to its visitors. To this end, it is appropriate to determine whether the costs of acquisition and of production of these capital goods are integrated in the price of these services.
a) The objective notion of costs
42. Contrary to the opinion of the United Kingdom, it is appropriate to answer this question irrespective of the taxable person's intention to integrate the respective costs in the price of these output transactions.
43. According to the judgment Becker, the finding of a direct and immediate link between input transactions and output transactions is based on the objective content of the input services. In the judgment BLP Group, the Court had already determined in this sense that the necessary link between input transactions and output transactions may not be determined by the intention of the taxable person.
44. In addition, in the common system of VAT, services supplied below the cost price are also taxed. In this case, the price is fixed by the taxable person subjectively, without taking account of the entirety of the costs of supply of the output service. In this case, it is however, out of the question that the entirety of the input transactions which, under paragraph two of Article 1(2) of the VAT Directive, belong objectively to the components of the costs of the output transactions, can justify the deduction of input tax. In fact, according to established case-law, the deduction system is meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities, because the common system of VAT is intended to tax only the final consumer and not the taxable trader.
45. The existence of an objective economic link between input transactions and output transactions is therefore decisive for the question of whether the costs may be integrated in the price of a service within the meaning of case-law. A simple causal link is not sufficient. If an input transaction however, objectively serves the purpose of execution of certain output transactions of a taxable person, or of all of them, there also exists then between both, a direct and immediate link within the meaning of case-law. In fact, in this case, the input transaction constitutes, from an economic point of view, a component of the cost of the supply of output services. As already shown by the content of Article 168 of the VAT Directive, it is therefore the objective purpose of the use of an input transaction which is decisive.
46. In this case, the installation of the recreational trail serves, according to the findings of the referring court, to attract visitors in order to supply services to them for consideration. From an economic point of view, installation of the recreational trail therefore comes under the components of the costs of these transactions.
47. There is therefore, in principle, between the acquisition and production of the capital goods and services for consideration offered to visitors a direct and immediate link within the meaning of case-law."
"48. The fact that the recreational trail is made available to visitors free of charge does not constitute a restriction on the right to deduct input tax.
49.·Although this is question of [sic] the primary use of capital goods of the recreational trail, primary use may only interrupt the direct and immediate link with the secondary use of output transactions in two cases.
50. This is the case, firstly, when the primary use occurs for services supplied for consideration but which are exempt from VAT. Input transactions then come under the components of cost of exempt output transactions and are therefore integrated in their price. For these transactions, Articles 168 et seq. of the VAT Directive do not provide however, in principle, for any right to deduct input tax. In such circumstances, it is irrelevant, according to case-law, that the input transactions pursue another "ultimate" aim which also entails taxed output transactions.
51. In this particular case, primary use does not however occur for exempt transactions for consideration, but for a use free of charge."
"75. I agree with Mr Thomas that the search in the present case is for a fair and reasonable proxy for the "use" of the sports complex in making the exempt and taxable supplies made by the School. However, I also agree with Miss Simor that the physical use of the complex is not necessarily a fair and reasonable proxy for that use. I consider that her use of the phrase "economic use" is a helpful approach to establishing what the search is for.
…
77. On the facts of the present case, it seems to me that the overwhelming economic use of the sports complex by the School is in relation to the provision of educational services. In that context, I agree with Miss Simor that the source of funds and the purpose of constructing the sports complex are relevant considerations. To regard those factors as relevant is not, in my judgment, to fall into the error, as Mr Thomas would say it is, of categorising the nature of a supply by reference to the purpose or motive in making it. There is no doubt that in the present case, the supplies are distinct and readily identifiable, that is to say the taxable supply of the licence to SHEL and the exempt supply of education. Nor, in my judgment, is there any question, in taking those factors into account of treating a taxable supply as an exempt supply or vice versa. The question is what "use" is being made of the inputs in producing the outputs. It seems to me that the purpose of the School, objectively ascertained, in constructing the sports complex is a highly relevant factor in attributing cost components between the relevant outputs and is an entirely different issue from identifying the nature of the output by reference to purpose or motive (which is inadmissible), the issue addressed by Patten J in Yarburgh Children's Trust.
78. On the evidence, it is clear that, objectively assessed, the principal purpose of the School in building the sports complex was the furtherance of its educational activities and was carried out in connection with its business of making exempt supplies of education. That conclusion is clear from the way the matter was put in the first draft of the business plan and the approach of the School to the generation of funds by out-of-school use which was designed to meet the running costs of the complex and, if possible, something over and above that. Further, the capital cost of the complex was met out of funds which were either charitable funds or derived from a fund-raising exercise and which were clearly dedicated to the educational purposes of the School. The generation of income by out-of-school use was essentially a secondary consideration, albeit that the benefit thereby produced was an aspect of the whole project from the beginning."
"33. The need for a process of attribution only arises where an item is a cost component (within Article 2 of the First Directive) of two supplies, one taxable and one exempt: Dial-a-Phone Ltd v Customs and Excise Commissioners [2004] STC 987 (especially at [28] and [71]). If the standard (turnover) method does not result in a fair and reasonable attribution of the cost component, the search is for a more fair and reasonable method of attribution. The onus is on the taxpayer to show that the proposed PESM is more fair and reasonable, that is to say, more accurate: Case C-488/07 Royal Bank of Scotland Group plc v Revenue and Customs Commissioners [2009] STS 461 at [24].
34. A fair and reasonable attribution to a taxable supply must, for the purposes of Article 17(2) and (5) of the Sixth Directive and regulation 101(2)(d) of the Regulations, reflect the use of a relevant asset in making that supply. In assessing that use, and its extent, consideration is not limited to physical use. The assessment must be of the real economic use of the asset, that is to say having regard to economic reality, in the light of the observable terms and features of the taxpayer's business."
"41. That case and the reasoning of the Tribunal, with which I agree, is illustrative of three points of principle. First, it shows the importance in these cases of close attention to the facts in order to understand the economic or commercial reality underlying the use of the relevant VAT inputs. Secondly, identification of the source or potential source of profit in a business may be an important feature of a business throwing light on whether or not the standard method or a PESM is a more fair, reasonable and accurate method of attribution. It all depends on the facts of each case: cf. Banbury Visionplus Ltd v Revenue and Customs Commissioners [2006] STC 1568 at [68]. Thirdly, depending again on the precise factual situation under consideration, the approach of the Tribunal in Aspinall's Club at [49] may well be appropriate in a case where the taxable supplies are not, in themselves, a source of profit:
"Those costs are funded by the gaming. That in itself does not make them cost components of those exempt supplies. But in this case it is additional proof, if any is needed, that gaming is the foundation of the business and it is the furtherance of that gaming which causes and is seen as justifying commercially the decisions to incur the expenditure."
42. As both St Helen's School and Aspinall's Club show, and as was emphasised in Dial-a-Phone v Customs and Excise Commissioners [2004] STC 987 at [72] by Parker LJ (with whom the other members of the Court agreed), analysis of attribution for the purposes of Article 2 of the First Directive, Article 17 of the Sixth Directive and Regulation 101 is highly fact sensitive."
"86. Business is carried on with a view to profit. If the only activity of the respondent capable of generating a profit in the foreseeable future was its gaming activity, then the principal purpose and effect of any other activity capable of generating a positive return, short of profit, would simply be to enable a greater proportion of the profits from gaming to be retained than would otherwise be the case. The only possible purpose of the non-gaming activity would be to help to defray some of the overheads that would otherwise have to be defrayed by the gaming revenue.
87. As the Commissioners have pointed out, that would not mean that the loss-making catering function did not use any residual costs. Plainly, catering would use some of those costs. The issue is whether, on the hypothetical facts, the more fair, suitable and accurate proxy for attribution of those costs between taxable catering activity and exempt gaming activity would be the existing method, based primarily on the standard turnover method, or the proposed floor space PESM. On the hypothetical facts, without the gaming activity there would not merely be no present profit, but, more importantly, no profit in the foreseeable future, and hence no commercial purpose to the existence of respondent. In the absence of some special funding arrangements, it would presumably be insolvent and would have to be wound-up. On the hypothetical facts, the reality, in terms of the true economic use of the relevant overheads, would be that the driver for the catering activity and any expenditure associated with that activity would be the gaming activity and the enhancement of the profits to be made from the gaming activity. Adopting the language and test in paragraph 49 of Aspinall's Club, gambling would be the foundation of the business and it would primarily be the furtherance of that gaming which would cause and would be seen as justifying commercially the decisions to incur the expenditure. It would be the maintaining and enhancing of the gaming profits that would be the principal driver of all the overheads. As it presently seems to me, that would make the existing PESM, under which attribution of residual input tax is primarily related to the respective turnover of the catering and gambling activities, more fair, suitable and accurate than the proposed floor space PESM, under which (on the figures before the FTT) nearly 50 per cent of residual inputs would attributed to the loss-making catering activity."
The decision of the FtT
"64. … In our view, when one is looking at overhead costs, what the cases say is that because these are overhead, or general, costs, they are, by virtue of that fact, cost components of the price of the taxable person's products. There is no separate test or hurdle of incorporation into price that has to be met or overcome. Those costs are then directly and immediately linked with the taxable person's economic activity as a whole.
65. Mr Thomas submitted that the issue in this case is not whether the costs in question are residual at all – it is common ground that they are – but whether the methodology put forward by VWFS is fair and reasonable despite the fact that the input tax on those costs is not a cost component of the price (or even the intended price) of the taxable output represented by the sale of the car. He argued that the input tax in making the HP transaction should either be passed on to the consumer as part of the supply of the vehicle (in respect of which value VWFS has a liability to account for output tax) or consumed by VWFS as the final consumer in making the supply of exempt credit.
66. Mr Thomas further submitted that the plain result of VWFS's methodology is that there is a third category of input tax which is incurred in making the supply of goods, but is not passed on to the consumer as part of the value of the supply of goods but is passed on as part of the value of the supply of exempt credit but in respect of which it nonetheless enjoys a right to deduct. He argues that such an outcome frustrates the normal operation of the tax. It is illogical, he says, and artificial as it assumes that one element of a single transaction (which has two component VAT supplies) cross subsidises the remainder of the same transaction.
67. Miss Shaw submitted that HMRC's argument in this respect proceeded on the fallacious basis that an input must be a cost component of the price of an onward taxable transaction before it can be recovered by the trader. She referred to Revenue and Customs Commissioners v London Clubs Management Limited [2010] STC 2789 where (at [36] – [38]) Proudman J in the Upper Tribunal (Tax and Chancery) had rejected HMRC's submission that the supplies in question in that case were made at a loss and could not support the costs attributed to them in the proposed partial exemption special method. The learned judge held that this submission conflated the issue of profitability with the costs of making it. As Etherton J had observed in Banbury Visionplus Limited v Revenue and Customs Commissioners [2006] STC 1568 (at [68]):
"… the issue of profitability or loss is of no significance … The critical 30 issue is the use of inputs in the provision of outputs. There is no obvious or necessary correlation between that issue and the issue of profitability or loss."
68. We have concluded that, in relation to overheads, there is no requirement that the input tax referable to those expenses should be reflected in the price of the products of the overall economic activity to which the expenses are related. It is not necessary to trace the costs into the price of particular products. What is needed is a fair and reasonable proxy for the use by VWFS of the relevant costs in making both taxable and exempt supplies. Whilst it is clear that the use in question is economic use, and not physical use (see St Helen's School Northwood Ltd v Revenue and Customs Commissioners [2007] STC 633, per Warren J at [75]), that is not directed at profitability, but at the true nature and characterisation of the taxable person's business."
"69. ….. overhead costs are, to the extent that they are apportioned to the HP transactions, used for those transactions as a whole. It follows therefore, in our view, that the overhead costs are cost components of each of the supplies that make up those transactions. We agree therefore with Miss Shaw that the individual supplies comprised in the HP transactions must be respected so as to allow recovery to the extent that a cost component of the whole transaction can be regarded as a cost component of a taxable supply.
70. Accordingly, in our view, any method that has the effect of treating the overhead costs as solely cost components of a particular element, or elements, of the transactions, to the exclusion of another element, or other elements, cannot be fair and reasonable. The relevant economic activity is the carrying out of the HP transactions. This is simply a reflection of the way in which the business of VWFS is carried on. We do not agree with Mr Thomas when he seeks to apply the label "finance business" to VWFS, pointing to the way in which VWFS accounts for the HP transactions, to argue that such a business ought not to recover the vast majority of its input tax. The 20 observable features of the HP transactions are that they comprise not only exempt supplies of finance but also taxable supplies of the vehicles.
71. What HMRC's argument amounts to, in essence, is that there is a limit to the amount of cost that can be a cost component of a supply, and that because the supply of the vehicle is at cost, and so reflects only the price paid by VWFS to the dealer, and input tax on the acquisition of the vehicle by VWFS is directly attributable to that supply, the cost component capacity of the vehicle supply has been exhausted, with the result that no other costs can be cost components of that supply. We consider that to be wrong in principle. The mere fact that only particular costs are recovered by a supplier in the price he charges for the making of a particular supply does not lead to the conclusion that no other costs are cost components of that supply. Unrecovered costs not directly attributable to a particular supply, or such costs recovered in other ways, for example by marking up other supplies, are nonetheless cost components of transactions of the business in general, and to the extent that those transactions include taxable supplies, the input tax incurred on those costs is deductible."
"75. ….. We agree that economic purpose, objectively ascertained, is an important element in such cases, and also in a fair and reasonable attribution under a partial exemption special method (St Helens School, at [77]). However, we do not accept that the purpose of the supply of the vehicle in an HP transaction is, as Mr Thomas submitted, to give rise to a supply of credit. The economic purpose of VWFS is not simply to supply credit; it is to supply credit on hire purchase terms. It may be the case that, according to those terms, the supply of the vehicle cannot take place without the supply of the credit, and that the supply of the vehicle lacks the normal characteristics of a simple sale of goods, but that does not in our view change the essential economic characteristics of an HP transaction, objectively ascertained, namely that it is one indivisible transaction that comprises, for VAT purposes, two supplies, one taxable and one exempt."
"94. We much regret that we are unable to agree with the FTT on this issue. It seems to us that the observable terms and features of VWFS's business start with the fact that it is the finance arm of Volkswagen AG. It exists in order to provide finance to those purchasing Volkswagen's brands of vehicle, and will only be involved in any transaction when the purchaser requires such finance. Specifically, in VWFS's retail sector, VWFS provides credit to enable the customers of Volkswagen's dealers to pay for the vehicles they want – whether by way of HP terms or other credit arrangements.
95. The residual cost inputs with which this case is concerned are normal overheads for a sales or a finance business, including temporary staff expenses, hotel, travel and training expenses, marketing expenses, IT and legal and accountancy expenses. It is true that the marketing expenses appear to be shared in some respects between dealers and the finance arm. But it is the way that HP transactions are universally invoiced and processed that gives a clear clue to the objective economic reality of VWFS's business. It is true also that, in every case, VWFS will buy and sell the vehicle in question, but it does so at whatever cost the dealer has in fact agreed with the ultimate consumer without any mark-up, and the transaction is not even shown in its statutory accounts. VWFS does not appear to have any say in the price. Indeed, the price is irrelevant to its finances because it is always put through without any mark-up, and is not even shown in its statutory accounts. The price of the vehicle and indeed the sale of the vehicle have no economic impact on VWFS's business whatsoever. It simply does not matter to VWFS what the price of the vehicle is.
96. The question of profit also points against the real economic activity of VWFS being the sales of vehicles. No profit is or will ever be made by VWFS in respect on vehicle sales. All VWFS's profits will always, for whatever reason (and the reason does not seem to us to matter), be made from the finance transactions that are predominantly exempt.
97. We feel that the FTT may have been misdirected by looking at the matter purely through VAT-tinted spectacles. What is required is a focus on economic realities. It is true that VWFS's transactions will always involve a taxable transaction and an exempt transaction inextricably intertwined. But the finance transaction is, to put the matter colloquially, the 'main event' for VWFS. It is what VWFS is all about. Without it, VWFS would be a wholly unnecessary intervener.
98. We have taken into account the fact that, notionally at least, VWFS is the vendor of the vehicle and receives complaints about quality and maintenance. But in reality, it must pass those complaints on to the dealer to process, since it has no workshops or vehicle service facilities itself.
99. As in the St. Helen's School Northwood case, the economic reality of the school's new sports hall was to provide facilities for the pupils, not to provide an income from incidental after-hours usage by parents or third parties. It is not the case, in our view, that residual input tax can never be deductible when the taxable part of the trader's business is loss-making or cost-neutral, but in this case it seems really quite obvious to us that a proper application of the correct tests shows that there is no direct or immediate link between the residual input costs in question and the taxable sales of vehicles by VWFS. The direct and immediate link is between the residual input costs and the finance supplies which are predominantly exempt outputs. Likewise, the residual input costs are not, properly regarded, cost components of the taxable part of VWFS's entire economic activity. They are cost components, as the FTT correctly found, of the financing part of VWFS's business. That is the economic reality of VWFS. Its overheads are used for its financing business, which is exempt from VAT.
101. For these reasons, by an application of the statutory "used for" test and of the explanation of that test reflected in both the CJEU and English cases, the residual input tax is not deductible against VWFS's taxable sales of vehicles. For these reasons, a PESM which attributes 50% of the residual input costs to the taxable outputs would not be a fair and reasonable apportionment. Accordingly, we think the appeal must be allowed."
Discussion
(1) there is an established need to find a "direct and immediate link" between the overheads and the taxable transactions. The existence of such a link is a matter of objective assessment and is not determined by the subjective aim of the taxable person: see BLP at [19];
(2) a direct and immediate link exists where the expenditure is "part of the costs of the output transactions which utilise the goods and services acquired": see Midland Bank at [30]. This is why the costs must generally be incurred before the output supply is made; and
(3) even where the costs are not directly linked to a particular supply in the sense described above they will be treated as having a direct and immediate link to the taxable person's business as a whole and will therefore be deductible under Article 173 of the Principal Directive (formerly Article 17(5) of the Sixth Directive) if they are "part of the taxable person's general costs and are, as such, components of the price of an undertaking's products": see Midland Bank at [31].
Ground 2
"[The] value of the car does not bear on the use of overheads. What [VWFS] says is [that] if [that is done] it would be 80%, but 50% is fair. But why? The Appellant does not say. 50% is an arbitrary selection of a figure. No analysis has been put forward. [This] comes from the weighting exercise. HP contracts [are] treated as 2 transactions. [It is] wholly unexplained as [to] why it is fair to treat HP [transactions] 1:1. Why not another fraction?"
Conclusion
Lady Justice Sharp :
Lady Justice King :
