The High Court held that publicly funded research (PFR) carried out by a university was, for the purposes of VAT, a separate economic activity or business from its other activities, so that tax on goods and services used exclusively for PFR was not deductible or recoverable. Moreover, tax on goods and service used partly for PFR and partly for business purposes fell to be apportioned under s. 24(5) of the Value Added TaxAct 1994 (VATA 1994).

Facts

The taxpayer university was a charity and carried on business making supplies of education and undertaking commercial research. It had nearly 20,000 students and 5,000 staff, of whom 1,000 were research staff. Of the taxpayer's £250m income, £71m derived from research grants and contracts; one-quarter of that coming from commercial sponsors and the remainder from public funds. Publicly funded research (PFR) was funded by grants from research councils, government departments or charities and commercial research was funded by industry and commerce in the UK and by overseas governments and organisations. The taxpayer also received an annual grant from the Higher Education Funding Council of which half was calculated by reference to a government research assessment exercise. That was intended to cover the cost of overheads not fully recoverable in respect of publicly funded research projects.

The taxpayer made both taxable and exempt supplies. Taxable supplies included commercial research, the exploitation of intellectual property (IP), commercial conferences and consultancy work. Exempt supplies comprised mainly the provision of education to students. The taxpayer treated as a taxable supply research to commercial sponsors which exercised control over the intellectual property arising from the research. Input tax attributable to supplies used for that purpose was deducted by the taxpayer in full. Research carried out for publicly funding organisations was treated by the taxpayer as falling outside the scope of VAT. Input tax attributable to supplies used for that type of research was treated by the taxpayer as residual input tax and was partly recoverable in accordance with the partial exemption method used by the taxpayer.

The taxpayer argued that the undertaking of PFR was integral to its other business activities, such as the supply of commercial research and education. Therefore PFR was also a business activity. The taxpayer's activities were all part of one business. Further all research helped to raise its profile and so helped its other taxable and exempt activities. The taxpayer hoped that the PFR would produce commercially exploitable intellectual property or attract further research funding. The taxpayer accepted that there was no direct link between the provider of funds and the PFR and that many public sponsors did not get a quid pro quo. However the taxpayer pointed out that there was no practical difference in the way publicly-funded and commercial research was carried out.

Customs conceded that if a university genuinely undertook publicly-funded research with the intention of producing intellectual property for commercial exploitation, then it would be a business activity. They also accepted that if a university supplied research or intellectual property rights (IPR) to a commercial organisation for consideration, that would be a business activity even if it was in part subsidised by grant funding. However they maintained that PFR was normally a non-business activity unless it was closely linked to the supply of education to the postgraduate students engaged in the research. In the present case the PFR was not a business activity and did not form part of a single business carried on by the taxpayer.

The tribunal dismissed the taxpayer's appeal. They held that PFR was completely distinct from the taxpayer's other activities ([2005] BVC 2,474; Decision No. 18,972). The taxpayer appealed.

Issue

Whether the tribunal had erred in reaching a conclusion which was inconsistent with the findings of primary fact.

Decision

Warren J dismissed the appeal. Tax on supplies to a taxable person of goods or services which were not used for business purposes was not input tax under s. 24 of VATA 1994.

In a colloquial sense, the business of the taxpayer no doubt included PFR as well as its other activities but business for the purposes of VAT was equivalent to economic activities in the sixth directive. In cases where a person carried on a number of activities it was important to establish which of those activities were economic activities since it was only the VAT on supplies used in the course of such activities which was capable of qualifying as input tax and thus deductible.

Although an objective approach had to be adopted in relation to what was and was not an economic activity, the purpose of particular activities which were not, by themselves, economic activities could be looked at to see if they qualified as overheads. If the purpose of one activity was to benefit other economic activities of the taxable person, the costs of that first activity could be regarded as overhead costs so that the input tax was deductible (either in whole or in part, depending on whether outputs included exempt as well as taxable supplies).

A cost would be an overhead where it was incurred solely for the benefit of the trader's economic activity in general. In principle, it should be possible to treat in the same way an apportioned part of a cost incurred partly in connection with business and partly with non-business activities. But in that situation, the part of the overhead apportioned to the non-business activities did not come into account in the subsequent partial exemption calculations under reg. 101of the Value Added Tax Regulations 1995.

Whether a particular activity was or was not carried out as part of a university's overall business for VAT purposes was a question of fact. The factual matrix might vary between universities and the VAT treatment might therefore differ. However there were bound to be similarities across all research institutions in both the purposes of PFR and the motives for carrying it out. It was important not to draw artificial distinctions in reaching one conclusion in relation to one university and the opposite conclusion in relation to another.

However, on the facts found in the present case, and in the light of the relevant legal principles, the tribunal was entitled to conclude that the PFR did not form part of the taxpayer's VAT business and was not an activity the costs of which could be recovered as an overhead of its VAT business (BLP Group plc v C & E Commrs (Case C-4/94) [1995] BTC 5,143; [1995] ECRI-983, Abbey National plc v C&ECommrs (Case C-408/98) [2001] BTC 5,481; [2001] ECR I-1361 and Kretztechnik AG v Finanzamt Linz (Case C-465/03) [2005] BTC 5,823; [2005] ECR I-4357 considered).

Chancery Division. Judgment delivered 17 March 2006.