The High Court allowed an appeal by Customs against a decision of the VAT tribunal that the taxpayer was entitled to deduct the whole of its input tax in respect of certain construction works where part of the input tax did not relate to any taxable supply and so was not recoverable.

Facts

At the beginning of November 1994, the taxpayer and another company (P) were members of a group both for the purposes of VAT and more generally. P was entitled to the benefit of an agreement for a long lease of certain premises and wished to redevelop them. On 25 November 2004, P and the taxpayer entered into a detailed agreement (‘the development agreement’) for the taxpayer to undertake the development. The nature of the development was clearly defined and the price was to be 105 per cent of the development expenditure defined as the costs, expenses and payments made, incurred or discharged by the taxpayer in connection with the carrying out of the development and the proper discharge of its duties under the development agreement. Under cl. 11(1) the price was to be paid as to £20m on the date of the development agreement ‘as an advance payment’, such other advance payments as might be agreed and the balance within seven days of completion. The advance payment of £20m was duly paid on 25 November 1994.

On 29 November 1994, the taxpayer left the group and was separately registered for the purposes of VAT. Thereafter it entered into the subcontracts necessary for the proper discharge of its duties under the development agreement. From time to time the taxpayer paid the sums due under the various subcontracts plus VAT and accounted for the VAT as input tax for deduction from output tax or for repayment. The aggregate of the input tax paid and accounted for by the taxpayer was £4,944,814. The development was completed in December 1997. The taxpayer invoiced P for the balance of the price, since there had been no further advance payments, in the sum of £10,506,970 plus VAT of £1,751,162. It was not in dispute that by virtue of the advance payment of £20m made by the taxpayer on 25 November 1994, at a time when the taxpayer and P were members of the same VAT group, the services to which it related would have been treated as supplied by the taxpayer to P on that date by virtue of VATA 1994, s. 6(4) but for the terms of s. 43(1)(a) which required the supply of services by one group company to another to be ‘disregarded’. The only output tax paid by the taxpayer in the relevant accounting periods was the sum of £1,751,162 paid on completion of the development in respect of the balance of the contract price. However, the taxpayer had already deducted from other output tax or been repaid the whole of the input tax it had paid its contractors, namely £4,944,814. Customs did not accept that the taxpayer had been entitled to do so. By an assessment dated 14 April 1998 they sought to recover the difference, namely £3,193,652, on the basis that, to that extent, the input tax did not relate to any taxable supply and was not recoverable by deduction from output tax or otherwise.

The taxpayer appealed successfully to the VAT tribunal and the assessment was set aside (Decision No. 19,785). Customs appealed to the High Court seeking to restore the assessment. They contended that the court was obliged to follow the decision of Park J in BUPA Purchasing Ltd v C & E Commrs [2004] BTC 5,003.

Article 17(2) of Directive 77/388 (‘the sixth directive’) provided that a taxable person was entitled to deduct input tax in so far as he used the supply for the purposes of his taxable transactions. VATA 1994, s. 24(1) provided that input tax was VAT on the supply to a taxable person of goods or services used or to be used for the purposes of any business carried on by him.

Issue

Whether the input tax was recoverable in full.

Decision

Sir Andrew Morritt C (allowing the appeal and confirming the assessment) said that the use of the introductory phrase in art. 17(2) of the sixth directive ‘In so far as’ showed that deduction of input tax was only allowed if and to the extent that the incoming goods or services were used for the purposes of taxable (output) transactions. The condition was not satisfied in the case of outgoing supplies in fact made but required by s. 43 to be disregarded.

The decision of the House of Lords in C & E Commrs v Apple and Pear Development Council [1986] BTC 5,024 was clear authority as to the proper application of art. 17(2) of the sixth directive and supported Customs’ case. If the supplies in fact made were to be disregarded pursuant to s. 43 then they were non-supplies. But in that event art. 17(2) applied to disallow the deduction of input tax to that extent. There was nothing in the decisions of the ECJ in Lennartz v Finanzamt München III (Case C-97/90) [1993] BTC 5,202; [1991] ECR I-3795, Seeling v Finanzamt Starnberg (Case C-269/00) [2003] BTC 5,343; [2003] ECR I-4101 or Charles & Anor v Staatssecretaris van Financiën (Case C-434/03) [2005] ECR I-7037, which had been relied on by the taxpayer, to undermine that conclusion.

Assuming that the obstacles arising from the terms of VATA 1994, s. 24(1) and (5) had been overcome, deduction of input tax still depended on compliance with s. 26(1) and the regulations made thereunder. Regulation 101(1)(b) required that the input tax should be attributable to ‘such of those goods or services as are used or to be used by him exclusively in making taxable supplies’. Plainly that requirement echoed that of art. 17(2). When the subsidiary used its inputs only to the extent of two per cent in making taxable supplies, it was difficult to see how it could be said that it used the inputs (i.e. 100 per cent of them) ‘exclusively’ in making taxable supplies. Accordingly, in a case such as the present, the input tax had to be apportioned and only the part attributable to a taxable transaction was deductible from output tax (BUPA Purchasing applied).

Chancery Division.
Judgment delivered 3 April 2007.