The High Court held that the taxpayer charity was entitled to deduct the input tax on payments to production companies to put on plays in its theatre as residual tax since the taxpayer was making both exempt and taxable supplies in the furtherance of its objects of encouraging the arts.

Facts

The taxpayer was a registered charity with the principal aim of encouraging the arts. It carried on business from a theatre in Southampton and paid production companies to put on performances in the theatre. Prior to the judgment in C & E Commrs v Zoological Society of London (Case C-267/00) [2002] BTC 5,224; [2002 ECR I-3353, the taxpayer charged and accounted for VAT on the sale of tickets, but following the judgment the taxpayer obtained agreement that it was making supplies within the terms of the cultural exemption so that its ticket sales were exempt from VAT. The taxpayer successfully applied for a refund of VAT overpaid and sought to extend the scope of its VAT recovery by contending that the input tax on amounts paid to production companies was attributable to both taxable and exempt supplies and was, therefore, to be treated as residual input tax within its partial exemption calculations. On that basis, the input tax would be partly deductible.

Customs argued that the input tax was wholly attributable to the exempt sale of tickets and was non-deductible. It was common ground that the legal test to be applied to the facts was that of a direct and immediate link. The primary case for the taxpayer was that its business comprised a wide range of outputs and, even though the main output was the sale of tickets, the non-ticket income formed an integral part of the business and was critical to its profitability. The taxpayer contended that there was an inextricable link between the consideration paid to the production companies and all of the income received and if just one of its taxable supplies was directly and immediately linked with the production that was sufficient to render the consideration a residual cost.

Customs maintained that there was no direct and immediate link between the consideration paid to the production companies and the taxable supplies made by the taxpayer.

The tribunal upheld Customs’ contention that the whole of the services supplied by the production companies were used by the group exclusively in making the exempt supplies represented by the sale of tickets, and that therefore no part of the input tax paid was deductible ([2006] BVC 2,199; Decision No. 19,254).

The taxpayer appealed to the High Court contending, among other things, that the tribunal had misunderstood the principles enunciated in BLP Group plc v C & E Commrs (Case C-4/94) [1995] BTC 5,143; [1995] ECR I-983, in particular it had been wrong to look at the way in which the prices of the various taxable supplies had been set, and to conclude that the consideration paid was not a cost component of the taxable supplies.

Issue

Whether the input tax paid by the group on the supplies made by the production companies could be deducted.

Decision

Hart J (allowing the appeal) said that the fundamental question posed by reg. 101 of the Value Added Tax Regulations 1995 (SI 1995/2518) in this kind of case was whether a particular input had been used exclusively in making exempt supplies. If the input had been exclusively so used the input tax could not be deducted (reg. 101(2)(c)). If, on the other hand, it had not been exclusively so sued, then, unless it had been exclusively used in making taxable supplies (reg. 101(2)(b)), the residual tax could be deducted (reg. 101(2)(d)). Those were the only three possibilities.

In the present case, the tribunal seemed to have driven itself into applying a very narrow view of ‘costs components’ by its initial finding that they could not constitute overheads. That finding was based on the treatment of the inputs in the gross profit and loss account and its reasoning was flawed.

While it might be true that the accounts did not present the relevant inputs as overheads, nothing in the way in which they were presented in the accounts enabled one to conclude that they were not ‘used for’ the taxable supplies, at least in part, still less that were used exclusively for the exempt supplies. On the contrary, in so far as the accounting treatment gave any steer on those questions, it was that the inputs concerned were being treated as a ‘cost’ of the taxable supplies which were, with the exempt supplies, lumped together in the figure given for turnover. The only taxable supplies not included in the turnover figures were those represented by ‘other operating income’ which consisted principally of sponsorship income.

In all the circumstances, on the facts found by the tribunal, there had been taxable supplies of the right to see the productions and the production costs were linked to those supplies in the same way as to the exempt supplies. Accordingly, there was a sufficiently direct and immediate link between the relevant inputs and any of the taxable supplies so as to make it impossible to say that the inputs were used exclusively for the exempt supplies ( BLP Group plc v C & E Commrs (Case C-4/94) [1995] BTC 5,143, Midland Bank plcvC&E Commrs (Case C-98/98) [2000] BTC 5,199; [2000] ECR I-4177, Abbey National plc vC&E Commrs (Case C-408/98) [2001] BTC 5,481; [2001] ECR I-1361 and Dial-a-PhoneLtdvC&ECommrs[2004] BTC 5,581 considered).

Chancery Division. Judgment delivered 31 March 2006.