The European Court of Justice ruled that, under art. 26 of Council Directive 77/388 ('the sixth directive'), a travel agent or tour operator who, in return for a package price, supplied to a traveller services bought in from third parties and in-house services, had to identify the part of the package corresponding to his in-house services on the basis of their market value where that value could be established. In such a case, a taxable person might use the criterion of actual costs only if he proved that it accurately reflected the actual structure of the package. It was for the national tribunal to establish, in the light of the circumstances, the market value of the flights supplied in the main proceedings as part of package holidays. The national tribunal might establish that market value from average values and, in that context, the market based on seats sold to other tour operators might constitute the most appropriate market.

Facts

The taxpayer sold package holidays to be taken in foreign countries. It invariably bought in the accommodation from third parties. However, as it had its own airline, it generally used its own aircraft to take holidaymakers to their destinations. It also sold individual aeroplane tickets to the public, referred to as'seat-only' sales, for seats on its own aircraft or seats bought in from other airlines, and sold seats on planes to other tour operators ('broked seats'). It declared its VAT liability for the years 1995 to 1999 using the TOMS (tour operators' margin system) method. Following the judgment in C & E Commrs v Madgett and Baldwin (t/a Howden Court Hotel)Joined Cases C-308/96 and C-94/97) [1998] BTC 5,440; [1998] ECR I-6229 it recalculated its VAT liability for the years 1995 to 1997, taking as a basis the market value of seats sold as part of package holidays. To obtain that market value, the taxpayer used two methods. For 1995 and 1996, it began with the cost of aeroplane seats sold as part of packages, to which it added a percentage mark-up equal to the mark-up that it claimed to have achieved on seat-only sales in the same period. In 1995, the taxpayer also sold packages including cruises, fly-drive and campsite accommodation. However it recalculated its liability applying the market value criterion only in respect of flights, taking the view that it had no appropriate comparator for the other in-house supplies. For 1997, the taxpayer, using an internal document, calculated the average across-the-board revenue obtained by it for aeroplane tickets sold to the public not as part of packages, arriving at a figure of £153, applicable to all the seats sold.

Having recalculated on those bases the cost of seats on flights sold as part of package holidays, the taxpayer claimed from Customs the repayment of VAT for 1995, 1996 and 1997 since the effect of the method used by the taxpayer was to increase the proportion of the package price attributed to transport which, under the applicable national law, was zero-rated. Customs rejected the taxpayer's claims on the basis that, when identifying the part of the package relating to in-house supplies, the market value method could not be used where, as in the taxpayer's case, it produced an artificial figure for the margin on supplies bought in from third parties and significantly changed the VAT liability. They argued that the judgment in Madgett and Baldwin did not provide ground for using such a method selectively and that £153 was not the market value of aeroplane seats sold as part of packages.

The taxpayer considered that it was entitled to use the market value method where it had an appropriate comparator, as was the case for flights, and that art. 26 of the sixth directive did not preclude it from using that method and the actual cost method at the same time. As for the sum of £153, it reflected the average value of all seat-only sales and could serve as basis for pricing journeys sold as part of packages, since in Madgett and Baldwin the court had required the trader to set the market value of in-house services not by reference to identical services but on the basis of similar services. In the circumstances, the VAT and Duties Tribunal stayed the proceedings and made a reference to the ECJ for a preliminary ruling.

Issue

Whether, and in what circumstances, a tour operator such as the taxpayer might recalculate the taxable margin referred to in art. 26 of the sixth directive in accordance with the market value method described in the judgment in Madgett and Baldwin.

Decision

The ECJ (ruling accordingly) said that a travel agent or a tour operator who had completed his VAT return for a tax period using the method laid down by the national rules which transposed the sixth directive into domestic law might recalculate his VAT liability in accordance with the method held by the court to comply with Community law, under the conditions laid down by national law, which had to observe the principles of equivalence and effectiveness (Amministrazione delle Finanze dello Stato v SpA San Giorgio (Case 199/82) [1983] ECR 3595 and Weber's Wine World Handels-GmbH v Abgabenberufungskommission Wien (Case C-147/01) [2004] BTC 8,019; [2003] ECR I-11365 considered). Apportionment of the package price, by a taxable person covered by art. 26, using the criterion of market value for in-house services was not subject to the condition that it must be simpler than use of the actual cost method. Further, the use by a taxable person covered by art. 26, who supplied to travellers, in return for a package price, services bought in from third parties and in-house services, of the criterion of market value to apportion that package price was not subject to the condition that it must produce a VAT liability comparable to that which would be obtained using the criterion of actual costs.

The basic principle of VAT was that it was a consumption tax designed to be borne only by the final consumer. VAT was precisely proportional to the price of the goods and services and it was collected by taxable persons at each stage of the production or distribution process on behalf of the tax authorities to which they were required to pay it. In accordance with the basic principle of that system and the detailed rules for its operation, the VAT to be levied by the tax authorities must be equal to the tax actually collected from the final consumer. The conditions governing the application of the special scheme established by art. 26 should not call into question that basic principle of the VAT system.

It was apparent from the judgment in Madgett and Baldwin that the market value method might be adopted where it was possible to identify the part of the package corresponding to the in-house service on the basis of the market value of services similar to those which formed part of the package. Nonetheless that must not result in a taxable person being conceded the right to use that method at his own discretion, according to whether or not the effect of its use was to reduce his tax liability compared with the tax liability which would result from using the actual cost method. The grant to taxable persons of such a right could have the consequence of allowing them to increase artificially the taxable amount subject to the lowest rate and of thus creating an inequality in competition between businesses, in favour of those which had established their business or had a fixed establishment in a member state which taxed certain transactions at very low rates or even zero-rated them, as in the UK in relation to passenger transport. Such an interpretation could, therefore, run counter to the principle of neutrality of VAT.

The EC Commission was justified in its view that the apportionment of the package price between services bought in from third parties and in-house services should be made on the basis of the market value of the latter services where that value could be established. On the other hand, it was difficult to rule out altogether the option of derogating from that principle. Accordingly, it was acceptable for a travel agent or tour operator who was able to prove that the actual cost method accurately reflected the actual structure of the package to apportion his package prices using that method rather than the market value method.

Article 26(3) provided that where transactions entrusted by the travel agent to other taxable persons were performed both inside and outside the European Community, only that part of the package price relating to transactions outside the Community was exempted. The implementation of such a provision might also require travel agents to make fairly technical apportionments of their package prices. Accordingly, there was not sufficient justification, in an instance such as the present case, for not applying the criterion of market value. A taxable person might therefore, in the same tax period, apply the criterion of market value to certain services and not to others where he was not able to establish the market value of those other services.

Application of the criterion of market value was not subject to the condition that it must be simpler than application of the actual cost method or to the condition that it must produce a VAT liability identical or close to that which would result from using the actual cost method. Therefore, a travel agent or tour operator could not use the market value method at his own discretion. That method was applicable to in-house services whose market value might be established even if, in the same tax period, the value of certain in-house components of the package could not be established inasmuch as the taxable person did not sell similar services on a non-package basis.

There was nothing to preclude the practice of taking average values as a basis for establishing market value. An average value might prove more representative where, as here, there was significant variation in the prices of similar services sold on a non-package basis. The tribunal, which had the task of identifying in each individual case the value that best reflected the spirit of the sixth directive, might thus legitimately establish the market value of flights sold by the taxpayer as part of package holidays on the basis of the average selling price of aeroplane tickets sold by that taxable person for the same destination or comparable destination. It would be for that tribunal to make the necessary corrections to those averages to take into account, for example, the fact that, as part of packages, seats on flights were offered free or at reduced prices for passengers' children. Thus the national tribunal might establish that market value from average values and the market based on seats sold to other tour operators might constitute the most appropriate market.

European Court of Justice (Third Chamber). Judgment delivered 6
October 2005.