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	First-tier Tribunal (Tax)
You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> London Clubs Management Ltd v Revenue & Customs [2009] UKFTT 201 (TC) (05 August 2009) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2009/TC00154.html Cite as: [2010] STI 1405, [2009] UKFTT 201 (TC)

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[2009] UKFTT 201 (TC)

TC00154

Appeal number LON/2008/1874

VAT – partial exemption – special method – reg 102, Value added Tax regulations 1995 – whether proposed method fair and reasonable and more fair and reasonable than existing method

FIRST-TIER TRIBUNAL

TAX

LONDON CLUBS MANAGEMENT LIMITED Appellant

- and -

THE COMMISSIONERS FOR HER MAJESTY'S

REVENUE AND CUSTOMS (VAT) Respondents

TRIBUNAL: ROGER BERNER (Judge)

SHEILA WONG CHONG FRICS (Member)

Sitting in public in London on 7 and 8 July 2009

Andrew Hitchmough, instructed by BDO Stoy Hayward LLP, for the Appellant

Richard Smith, instructed by the General Counsel and Solicitor to HM Revenue and Customs, for the Respondents

© CROWN COPYRIGHT 2009

DECISION

1. This is the appeal of London Clubs Management Ltd ("the Appellant") against the rejection by HM Revenue and Customs ("HMRC") of the Appellant's application to use a floor-area based partial exemption special method. The proposed method was rejected by HMRC by way of a letter dated 2 October 2007 to the Appellant's advisers, BDO Stoy Hayward, and this rejection was confirmed, following a reconsideration, by a letter dated 7 August 2008.
2. The Appellant is the representative member of the VAT group concerned in this appeal. For ease of reference we refer throughout this decision to the Appellant, although the business activities are carried on by a number of different members of the VAT group.
3. Oral evidence was given by Mr Michael Rothwell, who is a chartered accountant and the Group Finance Director of the London Clubs International Limited ("LCI") group of companies. The Appellant is a wholly-owned subsidiary of LCI. The Tribunal was referred to an agreed bundle of documents and to a supplementary bundle, and in addition had the benefit of a site visit to the Appellant's premises at The Sportsman Casino in Old Quebec Street, London.

The Facts

4. The Appellant group is engaged in the casino, restaurant, bar and entertainment business. It has operations in the UK, Egypt and South Africa.
5. The group is owned by Harrah's Entertainment, Inc, a US casino and entertainment group that incorporates brands such as Caesar's Palace, Paris, Bally's, Harrah's and the World Series of Poker.
6. In the UK the group operates 11 casinos. Five of these operations are in London, and there is one in each of Manchester, Leeds, Glasgow, Nottingham, Brighton and Southend.
7. Part of the background to this appeal relates to the enactment and implementation of the Gambling Act 2005, which followed a lengthy period of consultation on the modernisation of casino gambling regulation foreshadowed in the publication of the Budd Report (Gambling Review Report) in 2001. This report included recommendations of relaxation of marketing restrictions, increases in the number of slot machines which could be operated on casino premises and proposals for different categories of casino - Small, Large and Regional.
8. The Appellant planned its business strategy throughout this period to enable its business to benefit fully from the anticipated changes. The strategy had to adapt to frequent changes in Government policy. One of these changes was that proposals for increased slot machine numbers were reduced down to a level (which applies today) of 20 such machines per casino. This was a major disappointment for the Appellant, which had taken leases of substantial premises in anticipation of greater floor area being available for slot machines. Its new casinos, for example, have a floor area typically in excess of 50,000 to 60,000 square feet. With the reduction in the number of such machines the Appellant had to develop a new strategy to enable it to make the best use of this space to generate profits. This translated into the addition of restaurants and bars, and entertainment business, including corporate events, and dedicated space for poker.
9. The legislative changes also included permitting immediate entry into casinos (formerly there had been a "cooling off" period) and allowing customers to consume alcohol on the gaming floor. Furthermore, casinos are no longer required to operate as private members' clubs. All the Appellant's casinos allow customers immediate access, without the requirement to produce identification on entry. (Identification requirements remain in place for money laundering reporting purposes, but the requirement to produce identification is no longer a barrier to entry.) As a consequence the Appellant regards itself as able to compete on a level playing field with other operators in the food and beverage and hospitality sectors.
10. The Appellant is targeting what it regards as a significant customer base who attend casinos solely to access the food and beverage and entertainment facilities on offer, rather than to participate in gaming. However, apart from the casino at St James, the Appellant has no figures for those who attend solely for the restaurants and bars, and the Tribunal was not provided with any such figures.
11. As well as those customers who enter the casino solely to use the bars and restaurants, gaming customers also expect food and beverage services to be available on-site. The quality of the restaurant and bar offering is dictated by the strategy to attract customers with greater spending power.
12. The following supplies are made by the Appellant at its casinos^[1]:

(1) Gaming (for example roulette, blackjack). This is exempt from VAT, but subject to gaming duty.

(2) Slot machines. Standard rated.

(3) Dedicated poker facilities. Standard rated up to 27 April 2009, thereafter exempt from VAT but subject to gaming duty.

(4) Bar sales. Standard rated.

(5) Catering. Standard rated.

(6) Entertainment. Standard rated.

(7) Venue hire. Standard rated.

13. In the course of his evidence Mr Rothwell referred us to floor plans and photographs for each of the casinos at Empire Casino, Leicester Square, London and Manchester 235, Great Northern Building, Manchester. We also reviewed the floor plan for The Sportsman Casino, which we visited on the second day of the hearing. We find the following facts in relation to those premises:

(1) The premises in each case have a mixed use of gaming, restaurants and bars and entertainment, all within a casino context.

(2) Some areas were physically separated, for example the restaurant area in The Sportsman was separated from the main gaming floor by being on a separate floor of the premises, and was separated from the poker room by a curtain. In the case of other areas such as the bars, there was less physical separation. In some cases the delineation is clearer than in others, for example in the use of railings to fence off a bar area or part of it. This is the case for the bar at The Sportsman, for example. In others, such as the Icon bar at Manchester 235, where a small area of the bar contained gaming tables, there was no physical separation. However, we find that in all areas separate and identifiable floor space was occupied by the different parts of the business.

(3) Full restaurant dining facilities are provided, in defined restaurant areas, with extensive menus and table service. The type of restaurant offering differs from venue to venue, but includes fine dining in the Linen restaurant at Manchester 235 and in Glasgow and cuisine by a Michelin-starred chef at the Leeds casino.

(4) It is possible, indeed it is encouraged that customers are able to move easily between the different areas, for example from the restaurant to the gaming areas and from the gaming areas to the bar.

(5) Customers may consume drink in the gaming area, and may be served light snacks, such as sandwiches, at the gaming tables.

(6) Use of a particular area of floor space for a particular activity is liable to change. This had happened for example at the Icon bar and the Chill Out room at the Empire casino, where, to increase profitability, the space formerly occupied by those activities was now used for gaming. Although in theory the delineation of use could be altered by simply moving bar tables, for example, a few feet into the gaming area, Mr Rothwell's evidence, which we accept, was that this would not make commercial sense and that it would not be done in practice.

(7) Substantial areas of floor space are designated for none of gaming, food and beverages and entertainment. These areas include reception, toilets, staff rooms, management offices and corridors and lifts. Also included in a non-designated area is the space occupied by the cashiers. Evidence was given that cash for all elements of the business is dealt with by the cashier function, and that this function consequently cannot be allocated to any particular element or elements for the purpose of giving it a floor space designation. There was no evidence that the cashier function should be regarded as substantially related to gaming such that it ought to have been included in the area designated for gaming, and we find as a fact that the cashier space is properly designated as a communal or mixed area.

14. Not all of the food and drink provided is charged for. A significant percentage is supplied free of charge to certain gaming customers. Food and beverage non-charge percentages of total food and beverage sales for the period April 2008 to March 2009, broken down by venue, were as follows:

The Sportsman 63%
Golden Nugget 49.9%
Rendezvous 94%
Empire 22%
St James 24.5%
Southend 21%
Brighton 30%
Manchester 25.1%
Glasgow 23.7%
Nottingham 31.8%
Leeds 14.6%
Aggregate 35%

15. The food and beverage element of the business, comprising the restaurants and bars, is not currently profitable in its own right. It was described by Mr Rothwell as a "profit centre", but this expression is of significance only for management accounting purposes. In May 2009 for example, according to the management accounts, the food and beverage operation generated a positive contribution to overheads of £386,000. Each of the casino venues generated a positive return for the period in question and a contribution to overheads in management accounting terms, except for The Sportsman, which achieved a break even result. However, the picture provided by the management accounts, whilst we have no doubt that it is perfectly valid and of value for accounting purposes, includes as revenue the value of non-charge food and drink items, which is a corresponding expense in the management accounts as a cost of the gaming part of the business.
16. There was produced to us a table showing that the property-related costs incurred by the business amounted, in aggregate, to 71% of total residual costs over the most recent quarterly VAT period (January to March 2009) for which such figures were available. Mr Smith criticised this table in a number of respects, pointing to the fact that it was arguable whether certain of the costs (an example being refuse disposal) ought properly to be classified as property-related, and arguing that no adjustment should be made for notional VAT on properties not opted to tax. The table sought to arrive at a percentage comparison of actual costs by reference to figures that related to the VAT on those costs. It follows that an adjustment for notional VAT on costs that have not borne VAT is appropriate in order that a costs comparison can be derived from a comparison of input tax. We therefore reject Mr Smith's objection in this respect. As to whether refuse disposal should be classified as property-related or not, we heard no evidence on this and make no determination. It does not materially affect the calculation. We therefore accept that the figure of 71% is a fair estimate of the proportion of the residual costs of the business that are property-related.

Partial exemption methods

17. The Appellant's existing partial exemption method is itself a special method that took effect from 1 April 1993. According to this, following initial direct attribution to taxable and exempt supplies, input tax on goods or services which are not used or to be used wholly in making taxable supplies or exempt supplies (residual input tax) is recovered in the proportion that the value of taxable supplies bears to the value of all supplies. This can be described as a "turnover based method". The method differs from the standard method (to which we refer below) in that it recognises that a certain proportion of catering supplies are, as we have seen, supplied free of charge, and accordingly requires input tax on costs relating to catering to be apportioned in the ratio that charged catering bears to total catering (including catering supplied free of charge).
18. The new proposed method, which is the subject of this appeal, proposes the following:

(1) Directly attributable input tax is first identified. That which is directly attributable to taxable supplies is fully recoverable and, subject to de minimis limits, that which is directly attributable to exempt supplies is irrecoverable.

(2) In determining what element of input tax is recoverable in respect of catering supplies, the input tax directly relating to those supplies is apportioned in the ratio that total chargeable catering supplies bears to total chargeable and non-chargeable catering supplies. Chargeable catering supplies include staff meals provided free of charge. This again recognises the fact that a proportion of the food and drink supplies is made free of charge to customers, and restricts input tax recovery in this respect accordingly.

(3) The remaining input tax is apportioned according to a formula which uses the floor space occupied by the business as the means of making that apportionment. To ascertain the recoverable element of the total residual input tax a fraction is applied to it. We set out the fraction and the key to its components in the Appendix to this decision. The following is a narrative description.

(4) The fraction has as its numerator the sum of four component parts (although it is accepted that, due to a change in the law from April 2009, those components would now be reduced to three). The component parts are:

(a) The proportion of the floor space ("the F&B floor space") used for making taxable supplies of food and beverages, in other words restaurant and bar areas, that can be allocated to chargeable catering supplies. This proportion is calculated by applying to the F&B floor space the ratio that chargeable catering supplies bears to total catering supplies (the same formula as in (2) above).

(b) The proportion of the floor space which is used for making supplies of gaming ("the Gaming floor space") that can be allocated to taxable gaming (there being – as we have noted above – gaming supplies that are taxable supplies and those that are exempt). This proportion is calculated by applying to the Gaming floor space the ratio that the number of seats for taxable gaming bears to the total number of seats for gaming.

(c) Floor space for poker rooms, to which an entrance fee is charged ("the Poker Room floor space"). (This would no longer be applicable to the extent that such supplies are exempt supplies.)

(d) Floor space comprised in designated areas specifically for entertainments ("the Entertainment Area floor space").

(5) The denominator of the fraction is the sum of the F&B floor space (before apportionment), the Gaming floor space (before apportionment), the Poker Room floor space and the Entertainment Area floor space. It does not include any of the communal or mixed areas that have not been specifically designated as one of the component parts of the numerator of the fraction.

19. Floor plans for each of the casino premises illustrate how these areas are defined. The floor spaces designated for gaming, for food and beverages and for entertainments are clearly marked, as are the areas of communal and mixed use. We find as a fact that it is possible for the floor space occupied by each of these areas to be ascertained in such a way to enable the fraction to be reasonably calculated, including the cases where there are limited or no physical barriers between the different areas of use.

The Law

20. Entitlement to credit for input tax is provided for by sections 25(2) and 26 of the Value Added Tax Act 1994, and by regulations, as follows:

25 Payment by reference to accounting periods and credit for input tax against output tax

(2) Subject to the provisions of this section, [the taxable person] is entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under section 26, and then to deduct that amount from any output tax that is due from him.

26 Input tax allowable under section 25

(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below.

(2) The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business—

(a)     taxable supplies;

…

(3) The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above, and any such regulations may provide for—

(a)     determining a proportion by reference to which input tax for any prescribed accounting period is to be provisionally attributed to those supplies;

21. Regulations have been made pursuant to s 26(3). Those relevant to this appeal are regulations 101 and 102, Value Added Tax Regulations 1995 ("the Regulations"). Although not directly relevant to the issues we have to decide, regulation 101 provides for the standard method which, in relation to residual input tax, and with effect from 1 April 2009, provides as follows in regulations 101(2)(d) and (e):

(d)     … subject to subparagraph (e) below, 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,

22. As described above, the Appellant's existing method is not a standard method, although like the standard method it provides for recovery of residual input tax based on turnover. Because it makes provision for the free of charge catering supplies it is a special method approved under regulation 102, the provision under which the Appellants now seek approval for the proposed new method. Regulation 102 provides, so far as material, as follows:

Use of other methods

102—

(1) Subject to paragraph … (9) below … the Commissioners may approve or direct the use by a taxable person of a method other than that specified in regulation 101.

(1A) A method approved or directed under paragraph (1) above—

(a)     shall be in writing,

…

(3) A taxable person using a method as approved or directed to be used by the Commissioners under paragraph (1) above shall continue to use that method unless the Commissioners approve or direct the termination of its use.

(4) Any direction under paragraph (1) or (3) above shall take effect from the date upon which the Commissioners give such direction or from such later date as they may specify.

(5) Any approval given or direction made under this regulation shall only have effect if it is in writing in the form of a document which identifies itself as being such an approval or direction.

…

(9) With effect from 1st April 2007 the Commissioners shall not approve the use of a method under this regulation unless the taxable person has made a declaration to the effect that to the best of his knowledge and belief the method fairly and reasonably represents the extent to which goods or services are used by or are to be used by him in making taxable supplies.

(10) The declaration referred to in paragraph (9) above shall—

(a)     be in writing,

(b)     be signed by the taxable person or by a person authorised to sign it on his behalf, and

(c)     include a statement that the person signing it has taken reasonable steps to ensure that he is in possession of all relevant information.

Discussion

Jurisdiction

23. Our jurisdiction, agreed by both parties, is a full appellate, and not a supervisory one. It is, we think, best described by Mr Justice Warren in St Helen's School Northwood Ltd v Revenue and Customs Commissioners [2007] STC 633 at [27]:

"This is not to say that the tribunal is able to put forward its own version of a more reasonable special method (if there is one). It cannot do so, as the tribunal recognised in para 43 of the decision. Accordingly, a tribunal can substitute its own view for that of Customs in deciding whether a proposed special method is fair and reasonable. If on an appeal by a taxable person from a refusal of Customs to allow a proposed special method the tribunal decides that the method is fair and reasonable and also that it is more fair and reasonable than the method in operation (be it the standard method or some other special method), the appeal should be allowed. But if the tribunal thinks that both the existing method and the proposed method are unfair or unreasonable, it could not allow the appeal even if it considers that the proposed special method is less unfair and unreasonable than the existing method."

24. Accordingly, we must consider first if the proposed special method is fair and reasonable. If we decide that it is, we must compare it with the existing method, and only if the new method is in our judgment more fair and reasonable than the existing method should we allow the appeal. Otherwise the appeal should be dismissed, even if we consider that both methods are unfair or unreasonable, but the new method is less unfair or unreasonable. What we cannot do is substitute our own version of a more reasonable method. The most we could suggest by way of modification is in relation to factual particulars in the proposed method, without departure from the proposed method as such (see DCM (Optical Holdings) Ltd v Revenue and Customs Commissioners [2008] STC 1294); that does not arise in this appeal.

General

25. Where, as in this case, a business makes both taxable and exempt supplies, it is necessary to attribute VAT incurred on inward goods and services for the purposes of the business to those separate supplies. This VAT, which is termed "input tax", is recoverable to the extent that it is attributable to taxable supplies; to the extent that it is attributable to exempt supplies input tax is irrecoverable.
26. In order that input tax on goods and services acquired by a business can be deducted there must be a "direct and immediate link" between those goods and services on which input tax has been incurred and the taxable outputs of the taxable person: see St Helen's School Northwood Ltd per Warren J at [17], citing, by way of example, the ECJ cases of BLP Group plc v Customs and Excise Commissioners (Case C-4/94) [1995] STC 424 and Midland Bank plc v Customs and Excise Commissioners (C-98/98) [2000] STC 501. Another way of expressing this "direct and immediate link" is to say that the relevant inquiry is whether the input cost is a "cost component" of the output supply (see Dial-a- Phone Ltd v Customs and Excise Commissioners [2004] STC 987 per Jonathan Parker LJ at [28].
27. The starting point therefore is to identify the costs of goods and services acquired that can be directly and immediately linked to taxable supplies or represent a cost component of those supplies. This is direct attribution, and is a common feature of both the existing and proposed special methods of the Appellant.
28. Direct attribution will not however be capable of being achieved in respect of all inward costs. In those cases, such costs nevertheless represent cost components of the total supplies of the business (both taxable and exempt) and are thus deductible in whole or in part (see per Warren J in St Helen's School at [22]). That does not answer the question how the input tax incurred on the inward acquisitions of goods and services should be apportioned amongst the total supplies made by the business to determine what part of it can be deducted. A proxy is needed to provide a fair and reasonable approximation of the cost component of each supply. This can be provided by a standard method under regulation 101 of the Regulations, or as for both the existing and proposed new methods in this case, a special method under regulation 102. In relation to the new method the Appellant has, as required by regulation 102(9), declared that to the best of its knowledge and belief the method fairly and reasonably represents the extent to which goods or services are used by it in making taxable supplies. HMRC have refused to approve the new method.
29. Of its very nature a method that seeks to apportion input tax on goods and services acquired by a business that cannot be directly attributed to taxable supplies must be an approximation. The question is whether it is a reliable proxy so as to fairly and reasonably represent the use of VAT bearing inputs by the business in making taxable and exempt supplies.

HMRC's contentions

30. HMRC contend that the Appellant's proposed partial exemption method fails to meet the objective of a fair and reasonable attribution of input tax to taxable supplies as it does not reflect how the business uses the costs and therefore does not produce a fair and reasonable result.
31. In support of this general proposition, HMRC contend as follows:

(1) Proxies based on physical factors, including floor area, are acceptable if they give an economically meaningful result, subject to the method and calculation being capable of being implemented by the business and capable of being verified by HMRC. In this case, the gaming areas have driven the need for building costs because the gaming generates the bulk of the turnover and the bulk of the profits.

(2) HMRC do not argue that a business must be profitable before it can recover input tax. However, the allocation of costs under a partial exemption method must give a commercially sensible result that reflects the overall economics of why the costs are incurred. A partial exemption method that ignores a significant level of cross-subsidisation between separate activities does not give a reasonable apportionment of input tax recovery.

(3) The different activities of the Appellant's business are not economically separable in the manner required for the method to produce a fair and reasonable approximation. Whilst they are separate supplies, they are inter-dependent such that, to the extent that residual costs support one activity, they also support other activities. The activities are not dissociable. This is most clearly illustrated by the supply of catering, which does not cover the cost of making the supply (even before the residual costs are taken into account) and is often provided free of charge.

(4) To a significant extent there are no clearly definable areas which can be allocated to any specific activity. When the casinos are open plan, the use is mixed for all activities that take place there.

(5) There is no reason to suppose that floor area that has not been specifically attributed is used in the same proportion as the floor area occupied by the identified activities.

(6) A floor space based method produces inappropriate results where a significant proportion of the costs have little or no relationship with the floor area concerned. Although floor area will, in the right circumstances, be an appropriate proxy for costs that have a link to the building, for example rent, service charges and the repair and upkeep of a building. There is no obvious nexus between floor area and other costs incurred by a business, for example marketing, legal costs, computing and advertising, and no reason to suppose these are used in the same way, that is in the same ratio as between taxable and exempt floor space.

Economic use

32. It is clear that the physical use of premises is not necessarily a fair and reasonable proxy for the use of inward goods and services in making taxable and exempt supplies. In St Helen's School, Warren J considered (at [75]) that the phrase "economic use" is a helpful approach in searching for a fair and reasonable proxy.
33. Mr Smith for HMRC argues that it is necessary to have regard to the purpose for which the costs are incurred in determining, from an economic perspective, how those costs are used. He points to the fact that gaming generates the greater part of the turnover and profit, that gaming subsidises the catering activities and that gaming is the predominant activity. On this basis he argues that in considering the economic reality it is necessary objectively to ascertain the overall character of the business. This, he says, inevitably involves inquiry into why the relevant costs are incurred.
34. Mr Hitchmough argues that the question of "use" or of what the cost component of a particular supply might be should not be affected by the ultimate purpose of the incurring of the cost. He referred us to the opinion of the Advocate-General in BLP Group plc at page 431, where the fact that the particular transaction and expense in that case was for the benefit of the taxable activity of the taxable person was said to be irrelevant, and to the decision of the Court in the same case (at page 437) that "to give the right to deduct under para 2 [of Article 17 of the VAT Sixth Directive], the goods and 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".
35. We have already referred to St Helen's School. In that case a special method was proposed in order to claim to deduct a proportion of the VAT incurred on the construction of a sports complex by attributing part of the VAT to a taxable supply by the school under a licence to a wholly-owned subsidiary to occupy the complex outside school hours. This attribution was to be calculated by a formula based on the hours of use by the subsidiary as a proportion of the total hours of use. Mr Justice Warren summarised the approach to be taken to the ascertainment of "use", and in response to a submission on behalf of the School that the fact that the primary purpose of the facilities was for the School's own use was an irrelevance, he said this (at [60]):

"I would also mention the decision of Patten J in Customs and Excise Comrs v Yarburgh Children's Trust [2002] STC 207 albeit that it was not cited to me. Patten J clearly holds that the motive of a person in making a supply is not relevant to and cannot dictate the correct tax treatment of a transaction. This is perhaps another way of saying what the ECJ said in Halifax. But, as the judge says, the exclusion of motive or purpose does not allow the tribunal to disregard the observable terms and features of the transaction and the wider context in which it came to be carried out. Although what the judge said was in the context of deciding whether a transaction was an economic activity or not, similar remarks can, I think, be made in relation to establishing the use (for VAT purposes) to which an item of property is put and in determining what is or is not a valid proxy for that use in determining whether a proposed special method is fair and reasonable. I do not, therefore, consider that the establishment of the primary purpose of the construction of the facilities is to be excluded from consideration."

36. On this basis the learned judge held that 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. In terms of VAT, the provision of an exempt supply of education was the principal use of the sports complex and the taxable licence to the subsidiary was a secondary use. On that footing the standard method produced a more fair and reasonable allocation that the School's proposed special method.
37. On the authority of St Helen's School we consider that we are bound in this case to have regard to the observable terms and features of the Appellant's business and its output supplies and inputs, and the wider context. This includes examining the purpose for which the Appellant incurs the expenditure on the goods and services in respect of which input tax falls to be apportioned.
38. The residual costs with which we are here concerned are not one-off costs of the nature considered in St Helen's School, but are ongoing costs, such as rent, in running the business as a whole. Taking premises costs, such costs are incurred in order to provide premises for the carrying on of the whole of the Appellant's business. We have found that the food and beverage supplies made by the Appellant are made from defined and measurable parts of the Appellant's premises and accordingly we find that part of the purpose of the Appellant in incurring that expenditure is to provide space for the provision of those supplies. Although it is accepted that gaming is able to generate a higher turnover and profit for each square foot of the premises that it occupies as compared with the restaurants and bars, that does not, in our view, lead to the conclusion that gaming is the principal user or consumer of the premises costs incurred and that, as a result, a partial exemption method must reflect that in assuming greater use by the gaming part of the business. It seems to us that the proposed floor space method does provide a fair and reasonable allocation of such costs, as it reflects directly the use of those costs.
39. This conclusion is not affected by the fact that the catering activities cannot currently support the costs that would be apportioned under the proposed method to those supplies. The fact that part of a business might make a loss if certain costs were attributed to it does not in any sense mean that those costs cannot be regarded as a cost component of that part of the business. Nor is it of any relevance whether the internal management accounts of the business choose to reflect those costs as costs of a particular part of the business or, alternatively, regard those costs as expenses of the business as a whole. In St Helen's School, Mr Justice Warren held that the source of funds was a relevant consideration in the circumstances of that case (see [78] of his judgment). This supported the view that the principal purpose of the School was the furtherance of its educational activities. Here, by contrast, we are of the view that the ongoing residual costs are not incurred for the purpose, either solely or predominantly, of the gaming activities, but for the activities of the business as a whole. We do not therefore consider that the lack of resources of the catering element of the business can affect our view that the floor space method is fair and reasonable.
40. As we have earlier described, in determining whether a partial exemption method is fair and reasonable, we must have regard to the observable terms and features of the Appellant's business. One significant such feature is that the catering activities are used, to an extent, to support and foster the gaming activities by means of the provision of food and drink free of charge to certain gaming customers. An argument that suggests that costs that would otherwise be attributable to one supply must instead be attributed to another because the first supply supports or enhances the other in some way cannot be right as it ignores the overriding objective that requires a direct and immediate link to be sought between the inputs and the supplies made. But on the other hand it can be said that, although the gaming activities do not physically use those areas of the floor space that are given over to the restaurants and bars, the gaming activities nevertheless make economic use of those areas. Any special method must recognise this feature and provide a fair and reasonable proxy for the attribution of input tax having regard to that economic use.
41. In our judgement the proposed method does so. The important feature is that the effect of the formula is not only to apportion the food and beverage floor space between the chargeable and non-chargeable catering supplies (so effectively converting the physical use of that space into economic use), but to regard the element of non-chargeable catering use as economic use for the purpose of the exempt gaming activities. This is the effect of excluding the non-chargeable catering use from the numerator in the fraction, but including the whole of the food and beverage floor space in the denominator. The result is therefore the same as would be the case if, instead of, say, 35% of the catering supplies being non-chargeable, 35% of the physical space were instead to be occupied by exempt gaming. (We note, in passing, that the formula does not attempt to apportion any part of the non-chargeable catering to taxable gaming.) Given this analysis, we find that the formula proposed by the new special method does fairly and reasonably reflect the economic use of the floor area.
42. We are also satisfied that the formula operates so as to take account of such changes as there may be in the use of the floor space, for example, as has happened, if a space used for a restaurant area is converted to gaming use. The numerator in the fraction will then reflect this change. We are also satisfied that the delineations made by the business in the areas of use are sufficiently clear and have a sufficient degree of permanence (though of course subject to change as business policy dictates) as to be capable of reasonably being reflected in the formula. We accept that the position might be different in a case where a business uses a single space for a number of different activities, with constantly shifting patterns of use, but this is not such a case.
43. We have found that a substantial proportion of the residual costs of the Appellant's business are property-related. Although this proportion may fluctuate from quarter to quarter, we accept that the figures presented to us, which showed property-related costs at 71 % of total residual costs, are a fair representation of the position. A floor space method is, in our view, appropriate for providing a reasonable proxy for such costs. It assumes that costs that cannot be directly-attributed are used or consumed by the separate parts of the business by reference to the amount of floor space those separate parts occupy. The greater the space so occupied, the more consumption of those inward supplies is assumed.
44. For costs that are not property-related, the floor space method does not provide such a close approximation to use. The consumption of such costs is likely to depend on a number of factors, of which the area of the floor space occupied by a particular part of the business is only one. We had no evidence that in this case the use of a floor space method for non-property related costs would be so distortive as to render the proposed method, as it would operate in relation to costs in the aggregate, unfair or unreasonable. A substantial proportion of the costs in this case are property-related, for which we consider the proposed method to be fair and reasonable, and it is not prevented from being fair and reasonable by the fact that it also operates in respect of the minority of non-property related costs.

Vision Express

45. Mr Smith referred us to the VAT and Duties Tribunal decision in Vision Express (UK) Limited v Commissioners for Revenue and Customs (V20870), where the Tribunal held that although the taxpayer optician carried on different activities in different parts of its stores, it nevertheless carried on a single business, each part of which was dependent on every other. The core of the business was the sale of dispensed spectacles and contact lenses. The Tribunal said, at para 43:

"A trader such as VEUK, though it carries on different activities in different parts of the store, is nevertheless carrying on a single business, each part of which is dependent on every other. The core of the business is the sale of dispensed spectacles and contact lenses. While it is true that parts of the process are carried out at the front, and other parts at the rear, of the store, the reality is that virtually all of the store is used, in one way or another, for the core business. If VEUK were able to segregate its core business and undertake those parts which give rise to exempt supplies in less expensive premises, while undertaking those which result in taxable supplies in other, dearer, premises there might be merit in its argument. The fact is, however, that it does not, and in practical terms cannot, segregate its business in that way. It requires the whole of the store in order to carry on every part of its chosen business, and it follows that the rent cannot be said to weigh more heavily on one aspect of the business than another."

46. Mr Smith argued that the same principles should apply in this case. Each part of the Appellant's premises, he said, is used in one way or another by the core gaming business. The core business that the Appellant is seeking to run would not work without the gaming and catering activities being housed in the same premises as they are. That latter proposition may well be correct, but to the extent that the result is that the gaming part of the business can be regarded as making economic use of the restaurant and bar areas we have already held that the proposed method caters for this. In contrast to Vision Express we have found that the floor space used by the different parts of the Appellant's business can be delineated, and that the segregation said to be missing from the case of the dispensing optician is present in this case. In any event, we do not regard this passage from Vision Express as relevant to the proposed method in this case. The passage relates to an argument on zoning, where different costs weighting was proposed for different parts of the optician's premises. That is not applicable here. There is no question of the proposed method in this case seeking to weight more expensive costs to the taxable supplies. Finally, in this case we agree with Mr Hitchmough when he says that the business of the Appellant is not that of "catered gaming", another feature which, in our view, distinguishes it from the dispensing optician's business in Vision Express.

Aspinall's Club

47. Mr Smith also referred us to the Tribunal decision in Aspinall's Club Limited (17797) and argued that this was useful in considering how to approach partial exemption cases involving casinos generally and the issues in this case in particular. In that case the Tribunal rejected a floor area based method on the basis that it did not produce a fair and reasonable attribution of input tax. It was found that 90% of the catering supplies were given away to members engaged in gaming.
48. In one of the Appellant's premises, Rendezvous London, in the nine months to 31 December 2006, 97% of food and drink supplied was given away. At other premises the percentage was lower; the average was 35%. We are considering a proposed method for the whole of the Appellant's business. Taking the average for the whole business, the Appellant's case is different from that of Aspinall's Club. In that case the Tribunal found that the catering activities were not conducted for profit. By contrast, in the Appellant's case, although the catering activities are not currently profitable, we are satisfied that they are businesses in their own right and are not merely ancillary to the gaming business. Unlike Aspinall's Club, we have found that the business costs are not primarily incurred to facilitate gaming, but to facilitate all parts of the Appellant's business. Furthermore, in this case, as we have described, the proposed method does provide fairly and reasonably for the fact that some elements of the catering supplies are made free of charge.

Comparison of proposed method with existing method

49. We have found that the proposed method is fair and reasonable. We now consider if it is more fair and reasonable than the existing method. This does not involve any determination whether the existing method is itself fair and reasonable. What is required is a comparison between the two.
50. The Appellant made three criticisms of the existing method. These are:

(1) The existing method assumes that it costs exactly the same amount (in terms of VAT-bearing inputs) to generate £1 of exempt income as it does to generate £1 of taxable income. The Appellant says this is unsound and not in accordance with the reality of the business. In fact, it argues, it actually costs more to generate each £1 of taxable income (from, for example, supplies of food, drink and entertainment) than it does to generate £1 of exempt income (from, broadly, exempt gaming).

(2) Input tax recovery under the existing method is susceptible to what the Appellant termed "wild variations" based on luck. The amount of the Appellant's exempt income depends on the success or failure of those participating in gaming against the house. The Appellant argued that if a large player were to have a lucky night, and win substantial sums against the house, the Appellant's income would be low, with a corresponding increase in the amount of input tax that it was able to recover. The opposite is also true. Yet the cost of supplying exempt gaming does not fluctuate in this manner (or at all).

(3) Whereas VAT charged on taxable supplies made by the Appellant is excluded in calculating the Appellant's taxable turnover when applying the existing method, the Appellant's exempt turnover includes amounts of gaming duty (the top marginal rate of which is 50%).

51. We turn first to the last of these criticisms. Mr Hitchmough did not place great reliance on this point, and we think he was right not to do so. A proxy based on turnover will necessarily include all elements that make up that turnover (other than VAT), and we do not consider that this feature would of itself render a turnover based method less fair and reasonable than the floor space method. We agree here with Mr Smith's argument that this is just a consequence of the way the value of a supply is calculated for VAT (see s 19, Value Added Tax Act 1994).
52. We can take the first and second of the Appellant's criticisms together. We heard argument on the difference between the actual and budgeted hold/drop ratio, namely the ratio, expressed in percentage terms, between the house gaming win and the total cash drop. However, we do not base our decision on the effect of such a variable. The fluctuation in exempt income that could be brought about by changes in the hold/drop ratio seems to us to be one of the normal exigencies of this particular business, and of itself would not be decisive. What we regard as the essential question is: which of the methods, the existing or the proposed method, is the more fair and reasonable approximation for the use of costs? We accept Mr Hitchmough's analysis of the assumption that effectively underlies the existing method. In our view, in the case of a business whose residual costs are predominantly property-related, the existing method does not, in our view, provide as coherent a proxy for the use of those costs as does the floor space method proposed by the Appellant. That method, as we have found, takes account of the economic use of the floor space (including the effect of the non-chargeable catering supplies) and thus the use and consumption of property-related costs, in a way that the existing method fails to do. The treatment of non-property related costs we regard as neutral as between the two methods. Accordingly, we conclude that the proposed method is more fair and reasonable than the existing method.

Decision

53. For these reasons, we allow the appeal.

Costs

54. This appeal was made on 21 August 2008 and accordingly well before the commencement of the new Tribunal system. Accordingly, pursuant to para 7(3), Sch 3, The Transfer of Tribunal Functions and Revenue and Customs Appeals Order 2009, to ensure that these proceedings were dealt with fairly and justly, we directed at the commencement of the hearing that rule 29 (Awards and directions as to costs) of the Value Added Tax Tribunals Rules 1986 should apply to this appeal, and that rule 10 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009 should be disapplied.
55. As this appeal has been allowed we direct that the Respondents pay the Appellant's costs of this appeal, to be assessed if not agreed.

The Respondents have a right to apply for permission to appeal against this decision pursuant to Rule 39 of The Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009. The parties are referred to "Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)" which accompanies and forms part of the decision notice.

ROGER BERNER

TRIBUNAL JUDGE

RELEASE DATE: 5 August 2009

Cases cited but not referred to in the decision

CCE v Southern Primary Housing [2003] EWCA Civ 1662; [2004] STC 209

Banbury Visionplus v HMRC [2006] EWHC 1024 (Ch); [2006] STC 1568

Camden Motors Holdings Limited (VTD 2064)

APPENDIX

Proposed method partial exemption formula

( F&B x Chargeable catering) + ( Gaming x No of seats ) + Poker floor + Entertainments

( floor supplies ) ( floor space for taxable ) space floor space

( space ) ( gaming )

( ______________ ) ( _________ )

( ) ( )

( Total catering ) ( Total number )

( supplies ) ( of seats for )

( ) ( gaming )

Total floor space

Definitions

F&B floor space = floor space which is used for making taxable supplies of food and beverages ie restaurant and bar areas.

Gaming floor space = floor space which is used for making supplies of gaming.

Poker room floor space = floor space for poker rooms, to which an entrance fee is charged.

Entertainments area floor space = designated areas specifically for entertainments. These areas are only found in three clubs – Manchester, Glasgow and Leeds.

Total floor space = Total F&B + gaming = poker room = entertainments floor space. This does not include any communal areas.

Number of seats = the number of fixed positions for players at any gaming station. Typically, this is one per slot machine, one per electronic roulette, and between five and eight at a gaming table.

Note 1   We summarise the VAT treatment of each of these supplies purely for information. We make no findings in this respect.    [Back]