JUDGMENT
Commissioners for Her Majesty’s Revenue and
Customs (Appellant) v Frank A Smart & Son Ltd
(Respondent) (Scotland)
before
Lord Reed, Deputy President
Lord Wilson
Lord Hodge
Lord Briggs
Lady Arden
JUDGMENT GIVEN ON
29 July 2019
Heard on 6 March 2019
Appellant Respondent
Kieron Beal QC David Small
Ross Anderson
(Instructed by Office of
the Advocate General for
Scotland (Edinburgh)
)
(Instructed by Addleshaw
Goddard LLP
(Edinburgh)
)
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LORD HODGE: (with whom Lord Reed, Lord Wilson, Lord Briggs and Lady
Arden agree)
1. This appeal is concerned with the entitlement of a taxpayer to deduct input
VAT and claim repayment of surplus input VAT. It concerns the interpretation of
articles 167 and 168(1) of Council Directive (EC) 2006/112/EC of 28 November
2006 on the common system of value added tax (“the Principal VAT Directive” or
“the PVD”) and the case law of the Court of Justice of the European Union (“CJEU”)
relating to those articles. In short, the question is whether a taxpayer can deduct as
input tax the VAT which it has incurred in purchasing entitlements to an EU farm
subsidy, the Single Farm Payment (“SFP”). The taxpayer has used those
entitlements to annual subsidies over several years and intends to use money
resulting from the receipt of those subsidies to fund its current and future business
activities, which currently involve only taxable supplies.
2. The factual background to this appeal involves an interesting business model.
Frank A Smart & Son Ltd (“FASL”) is a Scottish company which carries on a
farming business in Aberdeenshire. FASL is wholly-owned by Mr Frank Smart, who
is its sole director. Mr Smart and his wife are the partners in a partnership which
owns Tolmauds Farm, a farm of about 200 hectares which the partnership leases to
FASL for a rent of £30,000 per year. FASL produces beef cattle and certain crops
at Tolmauds Farm. FASL’s whole output from its business was and is taxable under
the VAT regime.
3. FASL received SFPs from the Scottish Government. SFPs were agricultural
subsidies which between 2005 and 2014 were paid to farmers who had eligible land
at their disposal on 15 May of each year and who met the requirements of ensuring
plant and animal health and maintaining the land in question in “Good Agricultural
and Environmental Condition” (“GAEC”). The farmer did not have to cultivate the
land or stock it with animals in order to meet the GAEC requirement. When the
scheme was initiated in 2005, farmers in the United Kingdom were allocated initial
units of entitlement to single farm payments (“SFPEs”) for no consideration. The
SFPEs were tradeable and a market in them developed over time.
4. FASL took advantage of the market in SFPE units to accumulate a fund for
the development of its business. With the assistance of bank funding, it spent about
£7.7m between 2007 and 2012 on purchasing 34,477 SFPE units in addition to its
initial allocation of 194.98 units for Tolmauds Farm. In this period FASL paid VAT
on the SFPE units which it purchased and it has sought to deduct that VAT as input
tax. In order to receive the SFPs to which the purchased SFPE units entitled it, FASL
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leased a further 35,150 hectares of land under seasonal lets. FASL did not cultivate
or stock this land. The leases were typically qualified by an agreement, entered into
after the lease, which allowed the landlord to stock the land or cultivate it himself,
provided that the ground was kept in GAEC. This was done to preserve FASL’s
entitlement to SFPs. The rent payable for the seasonal lets was generally about £1
per acre but could be up to £10 per acre.
5. The result of this business model was that between 2010 and 2013 (in each
case FASL’s financial year ending on 30 September) FASL’s income from
subsidies, which were principally SFPs, dwarfed its income from cattle sales from
Tolmauds Farm. FASL received SFPs of £1,166,290 in 2010, £1,761,205 in 2011,
£2,488,949 in 2012 and £3,285,650 in 2013. The parties presented the court with
agreed figures derived from the profit and loss accounts of FASL in those financial
years:
2010 2011 2012 2013
Cattle Sales 99,284 48,601 97,530 280,997
Cattle subsidies
(incl SFPs)
1,202,908 1,795,589 2,515,057 3,312,597
Costs of Sales (53,925) (38,666) (111,885) (275,389)
SFP
Amortisation
(1,141,159) (1,766,118) (1,835,693) (917,840)
Net Profits (37,079) (41,812) 534,910 2,499,085
6. During the years 2010 to 2013, Mr Frank Smart was paid no director’s salary
or bonus but FASL paid him dividends of £20,000 in each of 2010 and 2012 and of
£15,000 in each of 2011 and 2013. None of the SFPs have been withdrawn from
FASL’s bank account for Mr Smart’s personal use or for his benefit.
7. The First-tier Tribunal (“FTT”), to whom FASL appealed against HMRC’s
refusal to allow it to deduct VAT of £1,054,852.28 in its quarterly VAT returns
between December 2008 and June 2012, made important findings of fact (in para 38
of its decision) which have a bearing on the outcome of this appeal. The FTT found
that when it purchased the SFPE units, FASL intended to apply the income which it
received from the SFPs to pay off its overdraft and to develop its business
operations. The SFPs were accumulated in FASL’s bank account and have been
used to pay off its overdraft. Tolmauds Farm was worked during the relevant period
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by Mr Smart and one of his sons, Roderick, on a full-time basis and another son
assisted for part of that period. FASL had no other employees. During the relevant
period FASL did not increase its stock numbers on the farm significantly. But FASL
had been contemplating three principal developments of its business. First, from
about 2011, FASL was considering establishing a windfarm. It spent over £119,000
on preliminary investigations, including technical information and costings, on
investigating community responses and on a planning application and enquiries.
Secondly, other proposed developments have included the construction of further
farm buildings, including cattle courts and a Dutch barn. FASL has undertaken site
preparation works for an additional cattle court and has made the needed planning
applications. Thirdly, FASL has been considering the purchase of neighbouring
farms, which were expected to come on to the market for sale.
8. Based on those findings of fact, the FTT concluded (para 39) that the
acquisition of the SFPE units was a funding exercise which related to FASL’s
business overheads in its farming enterprise. FASL had raised finance for its future
economic activities as a whole. There was a direct and immediate link between the
expenditure and FASL’s future taxable supplies. The FTT stated the conclusion
based on its findings of primary fact that the funding opportunity afforded by the
purchase of the SFPE units did not form a separate business activity of FASL but
was “a wholly integrated feature of the farming enterprise” and not a separate
enterprise (para 42). The FTT therefore allowed FASL’s appeal.
9. HMRC appealed to the Upper Tribunal (Lord Tyre), which confirmed the
FTT’s findings of fact, which were by then uncontroversial, and refused the appeal,
finding that the FTT had not erred in law. HMRC then appealed with the permission
of the Upper Tribunal to the Inner House of the Court of Session. An Extra Division
of the Inner House (Lord Menzies, Lord Brodie and Lord Drummond Young) in a
judgment delivered by Lord Drummond Young dated 8 December 2017 ([2017]
CSIH 77) dismissed HMRC’s appeal. HMRC now appeals to this court with its
permission.
The VAT system
10. Before setting out HMRC’s challenge it may be useful to discuss the basic
structure of the VAT system so far as relevant. In order to understand the case law,
which I will discuss, it is necessary also to set out relevant provisions of the PVD as
they show the central importance to the question of deductibility, which arises in
this appeal, of the connection between input expenditure and the economic activity
which a taxable person is carrying on or intends to carry on.
11. Article 2(1) of the PVD imposes VAT on:
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“(a) the supply of goods for consideration within the territory
of a member state by a taxable person acting as such …
(c) the supply of services for consideration within the
territory of a member state by a taxable person acting as such;
…”
12. Article 9(1) of the PVD defines “taxable person” and “economic activity”:
“1. ‘Taxable person’ shall mean any person who,
independently, carries out in any place any economic activity,
whatever the purpose or results of that activity.
Any activity of producers, traders or persons supplying
services, including mining and agricultural activities and
activities of the professions, shall be regarded as ‘economic
activity’. The exploitation of tangible or intangible property for
the purposes of obtaining income therefrom on a continuing
basis shall in particular be regarded as an economic activity.”
13. In the provision of goods or services for consideration there is often a chain
of production or supply from raw material to finished product. At its simplest, VAT
is a tax on the value added by a supplier of goods to its purchases of raw materials
or goods upon sale of the product. The same principle extends to the supply of
services. Under the common system of VAT in the United Kingdom and throughout
the European Union, the taxation of the value so added by the particular supplier is
achieved by calculating the tax due on the output of the supplier at the specified rate
(“output tax”) and deducting from that sum the VAT which that supplier has paid
on the components of that output or on general overheads of the business which are
cost components of its taxable outputs (“input tax”).
14. The principle is articulated in article 1(2) of the PVD which provides:
“The principle of the common system of VAT entails the
application to goods and services of a general tax on
consumption exactly proportional to the price of the goods and
services, however many transactions take place in the
production and distribution process before the stage at which
the tax is charged.
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On each transaction, VAT, calculated on the price of the goods
or services at the rate applicable to such goods or services, shall
be chargeable after deduction of the amount of VAT borne
directly by the various cost components.”
15. The mechanism, by which the deductions mentioned in article 1(2) are
effected, is set out, so far as relevant, in articles 167 and 168, which provide:
“Article 167
A right of deduction shall arise at the time the deductible tax
becomes chargeable.
Article 168
In so far as the goods and services are used for the purposes of
the taxed transactions of a taxable person, the taxable person
shall be entitled, in the member state in which he carries out
these transactions, to deduct the following from the VAT which
he is liable to pay:
(a) the VAT due or paid in that member state in
respect of supplies to him of goods or services, carried
out or to be carried out by another taxable person …”
16. If a taxable person uses goods and services, on which it has paid VAT, both
for its own transactions in respect of which VAT is deductible and for its own
transactions in respect of which VAT is not deductible, article 173 provides that
only the proportion of the VAT that is attributable to the former transactions may be
deducted.
17. The PVD and its predecessor directives have been implemented in the United
Kingdom by the Value Added Tax Act 1994, which in section 1(1) charges VAT on
the supply of goods and services in the United Kingdom. Section 4 provides:
“(1) VAT shall be charged on any supply of goods or
services made in the United Kingdom, where it is a taxable
supply made by a taxable person in the course or furtherance of
any business carried on by him.
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(2) A taxable supply is a supply of goods or services in the
United Kingdom other than an exempt supply.”
Sections 24 to 26 implement the regime for deduction of input tax which is now set
out in the PVD. Section 24 provides:
“(1) Subject to the following provisions of this section,
‘input tax’, in relation to a taxable person, means the following
tax, that is to say –
(a) VAT on the supply to him of any goods or
services; …
being … goods or services used or to be used for the
purpose of any business carried on or to be carried on by
him.
(2) … ‘output tax’, in relation to a taxable person, means
VAT on supplies which he makes …
(5) Where goods or services supplied to a taxable person …
are used or to be used partly for the purposes of a business
carried on or to be carried on by him and partly for other
purposes –
(a) VAT on supplies … shall be apportioned so that
only so much as is referable to the taxable person’s
business purposes is counted as that person’s input tax
…”
18. Section 25(2) empowers the taxable person to take credit at the end of each
prescribed accounting period for the input tax which is allowable under section 26
and to deduct that amount from any output tax due from it. The prescribed
accounting periods are quarterly. Section 26 provides:
“(1) The amount of input tax on which a taxable person is
entitled to credit at the end of any period shall be so much of
the input tax for that period (that is input tax on supplies,
acquisitions and importations in the period) as is allowable by
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or under regulations as being attributable to supplies within
subsection (2) below.
(2) The supplies within this subsection are the following
supplies made by the taxable person in the course or
furtherance of his business –
(a) taxable supplies …”
19. Accordingly, the VAT legislation provides for the taxable person to make
“taxable supplies”, the cost components of which may give rise to input tax which
is deductible from the output tax due on those taxable supplies. The taxable person
may also make “exempt supplies”, defined in section 31 and Schedule 9, which do
not give rise to a right to deduct input tax. Further, the taxable person may engage
in activities which are not “economic activities” under article 9 of the PVD and are
outside the scope of the VAT regime. VAT incurred by the taxable person on
supplies which are used as components of such non-economic activities are not
deductible.
20. With that introduction, I turn to HMRC’s challenge.
HMRC’s challenge
21. HMRC submit that the Inner House erred in law because, on a proper
analysis, FASL acquired the SFPE units to generate the receipt of SFPs, which was
a form of investment income outside the scope of VAT. The receipt of the SFPs was
a non-economic activity. Input tax incurred in acquiring the SFPE units was not
recoverable because there was a direct and immediate link between the expenditure
on those units and the receipt of the SFPs. There was no direct and immediate link
between the acquisition of the SFPE units and a taxable output transaction by FASL.
Secondly, HMRC submit that the Inner House erred in treating the VAT incurred on
the purchase of the SFPE units as deductible on the basis that it was a general
overhead of FASL’s business. This is again because the expenditure was directly
and immediately related to the receipt of the SFPs, which was outside the scope of
the VAT system. Thirdly, HMRC submit that the FTT, the Upper Tribunal and the
Inner House each erred in taking into account an irrelevant consideration, namely
the evidence of Mr Smart’s intention, as the director of FASL, to use the funds
generated by the receipt of the SFPs to fund the development of FASL’s business
which would involve the making of taxable supplies in future.
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22. Mr Kieron Beal QC, who presented the case for HMRC skilfully, makes two
central submissions. First, he relies on the judgment of the CJEU in BLP Group plc
v Customs and Excise Comrs (Case C-4/94) [1996] 1 WLR 174 (“BLP”) in support
of the proposition that VAT which a taxable person has paid on costs incurred
directly and immediately in relation to an exempt supply cannot be reclaimed as
input VAT even if the outcome of the expenditure is to produce funds which are
used or will be used to subsidise the taxable person’s downstream taxable activities.
Secondly, he submits that there is no reason in fact or law for reaching a different
conclusion in relation to costs incurred directly and immediately in relation to a
transaction which is outside the scope of VAT. If there is any doubt on this matter,
HMRC invite the court to refer a question or questions to the CJEU under article
267 of the Treaty on the Functioning of the European Union (“the TFEU”).
FASL’s response
23. Mr David Small, advocate, in a succinct and skilful submission, founds on
the principle of neutrality: the VAT system gives fully taxable traders, in other
words people, such as FASL, who make only taxable supplies, a right to recover all
input tax incurred in raising finance for their business so long as (i) the finance which
they raise is spent on funding the business which goes on to make further taxable
supplies and (ii) the financing exercise itself remains outside the scope of VAT
because it does not involve the taxable person in making any taxable or exempt
supplies. FASL does not dispute that if it were in the future to use part of the funds,
which it has obtained through the receipt of SFPs and kept in its bank account, on
downstream activities which were outside the scope of VAT, that use would restrict
the input tax to which it had been entitled and might give rise to an obligation to
repay a proportionate part of any deduction which it had made or any repayment of
VAT which it had received from HMRC. Disagreeing with HMRC, FASL submits
that the case law of the CJEU is clear and supports its position.
Discussion
(i) Overview
24. I am persuaded that Mr Small is correct in his submission that FASL is
entitled to deduct input VAT incurred in its acquisition of the SFPE units and that
the tribunals and the Inner House did not err in law in so concluding. Because the
answer to the question lies in an analysis of the jurisprudence of the CJEU in relevant
cases, and because HMRC submit that the matter is not acte clair, it is necessary to
examine the relevant cases with care.
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25. Before turning to the cases about which there is a dispute, it is necessary to
set the scene by considering Mohr v Finanzamt Bad Segeberg (Case C-215/94)
[1996] ECR I-959; [1996] STC 328, in which the CJEU held that an undertaking by
a farmer to discontinue milk production, for which he received compensation, did
not constitute a supply of services by him to the EC institutions or the competent
national authorities with the result that the compensation was not subject to VAT.
The CJEU in its judgment (paras 19-23) observed that VAT was a tax on
consumption, and that the authorities on payment of compensation obtained no
goods or services for their own use from the farmer but acted in the common interest
of promoting the proper functioning of the Community’s milk market.
26. It is not contested in this appeal that the sales on the market of the SFPE units
to FASL were transactions which fell to be treated as taxable supplies. It is also not
contested that a farmer’s actions to qualify himself to receive SFPs did not amount
to the provision of a service to the relevant authorities and that the receipt of SFPs
was outside the scope of VAT. The central question in the appeal therefore is
whether the receipt of the SFPs, which were transactions outside the scope of VAT,
prevented FASL from deducting the VAT which it has paid on the purchase of the
SFPE units.
(ii) The disputed case law
27. In BLP a management holding company sold shares in a subsidiary company
and sought to recover as input tax the VAT which it had paid on invoices for
professional services connected to the sale. The share sale was an exempt
transaction. But BLP argued that it was entitled to deduct the VAT as input tax
because the purpose of the sale was to raise funds to pay off debts which had arisen
as a result of its taxable transactions. The legal question turned on the interpretation
of the predecessors of articles 1(2), 168 and 173 of the PVD, namely article 2(2) of
EC Council Directive 67/227 (“the First Directive”) and article 17(2) and (5) of the
EC Council Directive 77/388 (“the Sixth Directive”) and in particular the words
“goods and services are used for the purposes of his taxable transactions” in article
17(2), which remain in article 168 of the PVD (para 15 above). The CJEU held in
para 19 of its judgment:
“The use [in article 17(5)] of the words ‘for transactions’ shows
that to give the right to deduct under [article 17(2)], the goods
or 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 that respect.”
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The CJEU went on to point out that the Sixth Directive provided a right to deduct
VAT on goods and services used for exempt transactions only by way of exception.
It recognised (para 25) that if BLP had taken out a bank loan, instead of selling
shares, it would have been able to deduct VAT on accountants’ professional services
required for that purpose because the costs of those services would form part of the
company’s overheads and hence of the cost components of its products. Thus it held
(in para 28):
“article 2 of the First Directive and article 17 of the Sixth
Directive are to be interpreted as meaning that, except in the
cases expressly provided for by those Directives, where a
taxable person supplies services to another taxable person who
uses them for an exempt transaction, the latter person is not
entitled to deduct the input VAT paid, even if the ultimate
purpose of the transaction is the carrying out of a taxable
transaction.”
28. It is clear that this ruling in terms relates only to the use of services on exempt
transactions. But as HMRC set great store by this case and submit that its reasoning
extends to services used on a form of fund-raising which is outside the scope of
VAT, it is necessary also to cite para 24 of the CJEU’s judgment in BLP, which
suggests that policy considerations might point to a wider exclusion of the right to
deduct:
“Moreover, if BLP’s interpretation were accepted, the
authorities, when confronted with supplies which, as in the
present case, are not objectively linked to taxable transactions,
would have to carry out inquiries to determine the intention of
the taxable person. Such an obligation would be contrary to the
VAT system’s objectives of ensuring certainty and facilitating
application of the tax by having regard, save in exceptional
cases, to the objective character of the transaction in question.”
In BLP, the objective character of the transactions was that the services were used
for an exempt transaction, namely the sale of shares in a subsidiary by a holding
management company. When addressing the subsequent case law of the CJEU I will
have to consider how, when a taxable person legitimately claims that costs of
services are part of its overheads, the tax authorities are to ascertain that those costs
are eventually cost components of its products or activities in taxable transactions.
29. In Midland Bank plc v Customs and Excise Comrs (Case C-98/98) [2000] 1
WLR 2080, the bank was the representative member of a group of companies, one
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of which, Samuel Montagu & Co Ltd, provided taxable services to one of its clients
in relation to a proposed corporate takeover and engaged a firm of solicitors to
provide legal services in that connection. To simplify matters I will present Samuel
Montagu & Co Ltd as the bank because the group was treated as a single person for
the purposes of VAT. In a dispute in relation to the proposed takeover, the bank was
sued for damages for negligence and the bank engaged the same firm of solicitors
to represent it in the legal proceedings. The bank then sought to deduct as input tax
the whole of the VAT which it paid in respect of its legal fees on the ground that it
was to be attributed to its taxable supplies to its client in the takeover. The Customs
and Excise Commissioners (“CEC”) argued that the VAT incurred on the legal fees
relating to the claim for damages was attributable to the bank’s business generally
and, as the bank made both taxable and exempt supplies, fell to be apportioned in
accordance with article 17(5) of the Sixth Directive (now article 173 of the PVD).
The dispute gave rise to questions (i) whether there needed to be a direct and
immediate link between a particular input transaction and particular output
transactions in order to entitle the taxable person to deduct VAT as input tax and (ii)
if so, what was the nature of that link. In relation to the first question the CJEU
applied BLP but (in paras 22 and 23) confirmed, as an exception to the rule in BLP,
that:
“entitlement to deduct, once it has arisen, is retained even if the
economic activity envisaged does not give rise to taxed
transactions or the taxable person has been unable to use the
goods or services which gave rise to the deduction in the
context of taxable transactions by reason of circumstances
beyond his control.”
In support of that exception it cited Intercommunale voor Zeewaterontzilting (INZO)
v Belgian State (Case C-110/94) [1996] ECR I-857, paras 20 and 21 and Belgian
State v Ghent Coal Terminal NV (Case C-37/95) [1998] ECR I-1, para 24. It held
(in para 24 and dispositif (1) of its judgment) that:
“in principle, the existence of a direct and immediate link
between a particular input transaction and a particular output
transaction or transactions giving rise to entitlement to deduct
is necessary before the taxable person is entitled to deduct input
VAT and in order to determine the extent of such entitlement.”
In relation to the second question the CJEU declined to define what amounted to a
direct and immediate link because of the diversity of professional and commercial
transactions and left it to national courts to apply the test to the facts of the individual
case. But it stated (para 33 and dispositif 2) that a taxable person which carries out
taxable and non-taxable transactions could deduct the entirety of VAT as input tax
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only if it could show by objective evidence that the expenditure involved in the
acquisition of the services was part of the various cost components of the taxable
output transaction.
30. In Abbey National plc v Customs and Excise Comrs (Case C-408/98) [2001]
1 WLR 769, a life assurance company, Scottish Mutual Assurance plc (“SM”), in
addition to its life assurance business, carried on business leasing premises for
professional and commercial use. SM opted to charge VAT on the rent received
from its commercial tenants. SM later sold a property in Aberdeen to a third party
in a transaction which CEC, in accordance with domestic legislation, treated as a
transfer as a going concern so that no supply of goods or services had taken place.
As a result, the transfer was not a taxable transaction. SM sought to deduct as input
tax the whole of the VAT which it had paid on professional services relating to the
sale, while CEC took the view that only part of the tax was deductible and sought to
apportion the VAT in accordance with article 17(5) of the Sixth Directive. The case
is important because, like the present appeal, it concerns a claim to deduct as input
tax VAT incurred on a transaction outside the scope of VAT.
31. In his opinion Advocate General Jacobs contrasted the CJEU’s approach in
BLP in relation to an exempt transaction with other case law which recognised a
right to deduct as input tax VAT incurred as part of the overheads of a taxable
person’s business. In his view, what mattered was whether the taxed supply was a
cost component of a taxable output, and not whether the most closely-linked
transaction was itself taxable. It was inherent in an exempt transaction that it broke
the chain between a supply and the taxable person’s taxable economic activities. As
a result, VAT incurred on supplies used by the taxable person for an exempt
transaction could not be deducted from VAT paid on a subsequent output supply by
that person (para 35). Where no supply of goods or services had taken place in a
transaction outside the scope of VAT, the chain between a supply to the taxable
person and that person’s subsequent taxable economic activity was not broken. One
was required to look beyond the immediate transaction to see whether the supply, in
respect of which a claim to deduct VAT was made, formed a cost component of
some other taxable transaction, including in the form of general overheads (paras
38, 42 and 46).
32. I will consider below whether Mr Small is correct in his contention that the
CJEU has in its later case law adopted the reasoning of the Advocate General. To
simplify the later discussion of the case law concerning fund-raising transactions, I
will refer to the transaction on which the supply was used, such as the sale of the
subsidiary in BLP, the transfer of the office in Abbey National, and the purchase of
SFPEs and the steps taken to obtain the SFPs in this case as “the initial transaction”
and, adopting the phrase which Mr Small derived from later CJEU case law, will
call the taxable person’s subsequent transaction or transactions, of which he asserts
the relevant supply is a cost component, as “the downstream transaction”. It is,
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admittedly, a simplification to speak of “subsequent transactions” because, as the
Advocate General recognised, there may not always be such a chronological
sequence in economic reality or inherent in the VAT system (para 41). But it is
nonetheless the norm.
33. The CJEU in its judgment did not expressly adopt the Advocate General’s
distinction between the chain-breaking effect of the use of a supply in an initial
transaction which is an exempt transaction and the absence of that break in an initial
transaction outside the scope of VAT. But the CJEU’s reasoning in this case is not
only consistent with the Advocate General’s approach but also difficult to reconcile
with its reasoning in BLP unless it was accepting his approach. In particular, the
court rejected the principal position of the United Kingdom Government (para 20)
that, since the costs incurred to effect the transfer were used for the purposes of an
initial transaction which was not taxable, there was no right to deduct the input VAT
paid on those costs. The CJEU’s reasoning started (para 24) with the principle of
neutrality, namely that the deduction system is meant to relieve the taxable person
entirely of the burden of the VAT payable or paid in the course of all his economic
activities (ie his activities that are themselves subject in principle to VAT paid by
the recipient of his goods or services and accounted to the tax authorities by the
taxable person). Referring to BLP and Midland Bank, the CJEU held (para 28) that
the right to deduct VAT borne by goods and services presupposed that the
expenditure incurred in acquiring them was part of the cost components of taxable
output transactions (ie including taxable downstream transactions). The CJEU found
no direct and immediate link between the professional services and one or more
taxable outputs because it rejected Abbey National’s arguments, including that the
transfer of the property should be treated as if it were a taxable transaction. But that
was not the end of the matter as the CJEU held that the costs of the professional
services formed part of the taxable person’s overheads and as such were cost
components of the products of a business. The services used by SM for the purposes
of the transfer thus had a direct and immediate link with the whole economic activity
of that taxable person (para 36). As the taxable person effected downstream
transactions which were subject to VAT and exempt transactions, it could only
deduct (under article 17(5) of the Sixth Directive) the proportion of the VAT which
was attributable to the taxable transactions (para 42 and dispositif). The CJEU thus
looked through the initial transaction and recognised a right to deduct by reference
to such downstream transactions as were economic activities.
34. In Kretztechnik AG v Finanzamt Linz (Case C-465/03) [2005] 1 WLR 3755;
[2005] ECR I-4357, an Austrian company, which developed and distributed medical
equipment, raised capital by a share issue on the Frankfurt Stock Exchange. The
Austrian tax authority disallowed a deduction of input tax which Kretztechnik had
paid on the supply to it of services linked to the share issue, which the national tax
authority treated as exempt from VAT. The company challenged the assessment to
tax and this gave rise to questions whether the share issue was within the scope of
Page 15
VAT and, if not, whether there was a right to deduct input tax on the ground that the
services in respect of which the deduction of input tax was claimed were used for
the purposes of the company’s downstream taxable transactions.
35. As I will show, the CJEU treated the share issue as being outside the scope
of VAT and supported the right to deduct the VAT charged on the expenses incurred
for the supplies acquired in connection with a share issue.
36. In his opinion Advocate General Jacobs repeated the analysis which he had
adopted in his opinion in Abbey National (paras 35 and 46). He stated:
“73. … if a trader uses the services of a broker or valuator
when acquiring a commodity, the cost of those services may be
said to be directly, immediately and exclusively linked to the
acquisition. That does not however determine whether the VAT
on the services is deductible. The right to deduct must be
determined by the output transactions for the purposes of which
the services are used. The transactions in question will usually
be the onward supply of the commodity or the goods or services
for which it is used or in which it is incorporated. The right to
deduct will depend on whether that supply is taxed or not.
74. Thus, if the transaction with which the input is most
closely linked is one which falls entirely outside the scope of
VAT because it is in any event not a supply of goods or
services, it is irrelevant for the purpose of determining
deductibility. What matters is the link, if any, with such output
supplies, and whether they are taxed or exempt …
75. The question to be asked in [Kretztechnik’s] case is
therefore whether the capital raised by the share issue was used
for the purposes of one or more taxed output transactions.”
37. The CJEU’s judgment on the deductibility of VAT on the services provided
to Kretztechnik is wholly consistent with the Advocate General’s approach in its
disregard for an initial transaction which is outside the scope of the VAT system.
The court stated:
“34. The deduction system is meant to relieve the trader
entirely of the burden of the VAT payable or paid in the course
of all his economic activities. The common system of VAT
Page 16
consequently ensures complete neutrality of taxation of all
economic activities, whatever their purpose or results, provided
that they are themselves subject in principle to VAT: see, to
that effect Rompelman v Minister van Financiën (Case C268/83) [1985] ECR 655 … para 19; Belgian State v Ghent
Coal Terminal NV … para 15; Gabalfrisa [SL v Agencia
Estatal de Administración Tributaria] (Joined Cases C-110/98
to C-147/98) [2000] ECR I-1577, para 44; the Midland Bank
case [2000] 1 WLR 2080, 2097-2098, para 19, and the Abbey
National case [2001] 1 WLR 769, 785, para 24.
35. It is clear from the last-mentioned condition that, for
VAT to be deductible, the input transactions must have a direct
and immediate link with the output transactions giving rise to
a right of deduction. Thus, the right to deduct VAT charged on
the acquisition of input goods or services presupposes that the
expenditure incurred in acquiring them was a component of the
cost of the output transactions that gave rise to the right to
deduct (see the Midland Bank case, para 30, and the Abbey
National case, para 28, and also Cibo Participations SA v
Directeur regional des impôts du Nord-Pas-de-Calais (Case C16/00) [2001] ECR I-6663, para 31).
36. In this case, regard being had to the fact that, first, a
share issue is an operation not falling within the scope of the
Sixth Directive and, second, that operation was carried out by
[Kretztechnik] in order to increase its capital for the benefit of
its economic activity in general, it must be considered that the
costs of the supplies acquired by that company in connection
with the operation concerned form part of its overheads and are
therefore, as such, component parts of the price of its products.
Those supplies have a direct and immediate link with the whole
economic activity of the taxable person (see the BLP Group
case … para 25; the Midland Bank case, para 31; the Abbey
National case, paras 35 and 36, and the Cibo Participations
case, para 33).”
38. The CJEU, disregarding the share issue itself, held that article 17(1) and (2)
of the Sixth Directive conferred the right to deduct in its entirety the VAT charged
on the expenses incurred by a taxable person for the various supplies acquired by
him in connection with a share issue, provided that all the transactions undertaken
by the taxable person in the context of his economic activity constitute taxed
transactions (para 38 and dispositif 2).
Page 17
39. The next relevant case in chronological sequence was Investrand BV v
Staatssecretaris van Financiën (Case C-435/05) [2007] ECR I-1315 which
concerned the sale by a company in 1989 of a substantial shareholding in another
company (“company A”). The CJEU decided the case without the assistance of an
opinion from the Advocate General and followed its decisions in Midland Bank,
Abbey National and Kretztechnik. The sale of the shares was treated as an activity
outside the scope of VAT and the central question was whether the relevant costs
were overheads related to the taxpayer company’s economic activity as a whole
(para 24). It is nonetheless of interest because in my view it casts light on later
judgments of the CJEU and I will return to the case in this judgment. The
consideration for the 1989 sale was a fixed sum and a further sum which depended
upon the profits earned by company A between 1989 and 1992. At the time of the
sale and until 1 January 1993 the taxpayer company was a passive holding company
which took no part in the management of the companies in which it invested. From
1 January 1993 the taxpayer company provided management services to company
A. A dispute arose between the taxpayer company and the purchaser of company A
over the calculation of the sum due by reference to company A’s profits. The
taxpayer company incurred professional costs in an arbitration on that matter and
sought to deduct the VAT which it paid on those costs in the financial year 1996,
which was at a time that it was carrying on economic activity. The CJEU rejected
the taxpayer’s claim in essence because the taxpayer company would have incurred
the professional costs whether or not it had commenced economic activity after 1
January 1993 (paras 32-33). It distinguished Kretztechnik on the basis that in that
case the costs were incurred in relation to a share issue intended to increase the
taxable person’s capital for the benefit of its economic activity (paras 35-37).
Accordingly, the CJEU held (para 38 and dispositif):
“… the costs for advisory services which a taxable person
obtains with a view to establishing the amount of a claim
forming part of his company’s assets and relating to a sale of
shares prior to his becoming liable to VAT do not, in the
absence of evidence establishing that the exclusive reason for
those services is to be found in the economic activity, within
the meaning of [the Sixth] Directive, carried out by the taxable
person, have a direct and immediate link with that activity and,
consequently, do not give rise to a right to deduct the VAT
charged on them.”
In other words, the VAT on inputs which were incurred in relation to a company’s
non-economic activity and which had no link to its subsequent economic activities
would not be deductible.
40. The CJEU returned to the issue of deductibility of VAT in the context of
fund-raising by a taxable person in Securenta Göttinger Immobilienanlagen und
Page 18
Vermögensmanagement AG v Finanzamt Göttingen (Case C-437/06) [2008] ECR I4177; [2008] STC 3473. In this case the taxpayer company, Securenta, carried out
both economic and non-economic activities. It acquired capital for its business by
the issue of shares and atypical silent partnerships and sought to deduct the input tax
which it had paid for services relating to its raising of capital in this way. A dispute
about the extent of its entitlement to deduct resulted in a reference to the CJEU. The
relevant question, as reformulated by the court, was how the right to deduct input
tax was to be determined in the case of a taxpayer who carries out both economic
and non-economic activities. The CJEU observed (para 26) that Securenta carried
on three downstream activities, namely (i) non-economic activities outside the scope
of VAT, (ii) economic activities which were within the scope of the Sixth Directive
but were exempt and (iii) taxed economic activities. The court repeated its ruling (in
Abbey National para 28 and other cited cases) that in order for the input VAT to give
rise to a right to deduct the expenditure incurred on the fund-raising must be a
component of the cost of the output transactions that gave rise to the right to deduct
(para 27). If Securenta’s downstream activities had been solely economic activities,
the supplies of services would have had a direct and immediate link with those
economic activities, but part of Securenta’s downstream activities were noneconomic (para 29). The CJEU therefore held (para 31 and dispositif 1):
“… where a taxpayer simultaneously carries out economic
activities, taxed or exempt, and non-economic activities
outside the scope of the Sixth Directive, deduction of the VAT
relating to expenditure connected with the issue of shares and
atypical silent partnerships is allowed only to the extent that
that expenditure is attributable to the taxpayer’s economic
activity within the meaning of article 2(1) of that Directive.”
41. More recently, the CJEU has called into question its ruling in BLP in the light
of its developing jurisprudence attributing input expenditure on the raising of capital
to the general overheads of an undertaking. In Skatteverket v AB SKF (Case C-29/08)
[2009] ECR I-10413; [2010] STC 419 (“SKF”), the parent company which
managed an industrial group proposed to sell a wholly-owned subsidiary and a
minority stake in another company, which had formerly been a wholly-owned
subsidiary, to obtain funds to finance other activities of the group. It proposed to
engage professional services in the sale and sought a ruling from the Swedish
Revenue Law Commission on whether it would be entitled to deduct input VAT
paid on those services. The tax authority challenged the affirmative answer given by
the Commission and the Swedish Court made a reference to the CJEU.
42. In his opinion, Advocate General Mengozzi endorsed the distinction which
Advocate General Jacobs made in Abbey National between the chain-breaking effect
of an exempt transaction and the absence of such an effect where the fund-raising
transaction is outside the scope of VAT (paras 69 and 79). He opined (para 89(3))
Page 19
that where the taxable person acquires supplies of services in order to carry out a
share disposal which is an exempt transaction, he does not have the right to deduct
input VAT on those services, even when the disposal of shares is a transaction which
contributes to the restructuring of the taxable person’s industrial activities.
43. The CJEU disagreed with his conclusion in relation to an exempt transaction
involving a sale of shares in circumstances which were analogous to the facts of the
case and held (para 73) that there was a right to deduct input VAT paid on services
acquired for the purposes of a disposal of shares “if there is a direct and immediate
link between the costs associated with the input services and the overall economic
activities of the taxable person”. It held that the referring court should take account
of all the circumstances surrounding the transactions to determine whether the costs
incurred were likely to be incorporated in the price of the shares sold or whether
they were among only the cost components of transactions within the scope of the
taxable person’s economic activities.
44. The CJEU’s reasoning, based on prior case law, on the way to this conclusion
is instructive. It reasoned:
i) The right of deduction is an integral part of the VAT scheme and is
necessary to achieve neutrality of taxation of all economic activities (paras
55-56);
ii) In principle there needs to be a direct and immediate link between a
particular input transaction and a particular output transaction or transactions
giving rise to an entitlement to deduct before a taxable person is entitled to
deduct input VAT to determine the extent of that entitlement: the expenditure
incurred in acquiring the supplies must be a component of the cost of the
output transactions that gave rise to the right to deduct (para 57);
iii) But, absent that link between an input transaction and specific output
transactions, the taxable person has a right to deduct where the costs of the
services in question are part of his general costs and, as such, components of
the price of the goods or services which he supplies, there thus being a direct
and immediate link between the costs and the person’s economic activity as
a whole (para 58);
iv) On the other hand, where the taxable person acquires goods or services
and uses them for the purposes of transactions that are exempt or do not fall
within the scope of VAT, no output tax can be collected or input tax deducted
(para 59).
Page 20
45. The CJEU stated (para 60):
“It follows that whether there is a right to deduct is determined
by the nature of the output transactions to which the input
transactions are assigned. Accordingly, there is a right to
deduct when the input transaction subject to VAT has a direct
and immediate link with one of more output transactions giving
rise to the right to deduct. If that is not the case, it is necessary
to examine whether the costs incurred to acquire the input
goods or services are part of the general costs linked to the
taxable person’s overall economic activity. In either case,
whether there is a direct and immediate link is based on the
premise that the cost of the input services is incorporated either
in the cost of particular output transactions or in the cost of
goods or services supplied by the taxable person as part of his
economic activities.”
46. Applying this reasoning to the circumstances of SKF’s proposed transaction,
the CJEU advised that the referring court would have to ascertain whether the costs
incurred were likely to be incorporated in the price of the shares which SFK intended
to sell or whether they were only among the cost components of SKF’s products
(para 62). It referred to the cases which I have discussed (Midland Bank, Abbey
National, Kretztechnik and Securenta), acknowledging that they concerned financial
output transactions which were outside the scope of VAT. But it went on to observe
that the main difference between an exempt share sale and a share sale which was
outside the scope of VAT was whether the taxable company was or was not involved
in the management of the companies whose shares were being sold. There was
therefore a risk of infringement of the principle of fiscal neutrality through treating
objectively similar transactions differently for tax purposes. It held (para 68) that if
the costs relating to the disposals of shareholdings are considered to form part of a
taxable person’s general costs in cases where the disposal itself is outside the scope
of VAT, the same tax treatment must be allowed where the disposal is classified as
an exempt transaction. In my view it is implicit in the CJEU’s reasoning that it
accepted the distinction which Advocate General Jacobs made in his opinions in
Abbey National and Kretztechnik but recognised the need to modify the result for
the purpose of VAT of an exempt initial transaction in order to avoid discriminatory
fiscal treatment.
47. It is important to consider further the statement in para 59 of the judgment,
summarised in para 44(iv) above. It was that in contrast to the circumstance where
the costs of services are part of a taxable person’s general costs and components of
the price of the goods and services which he supplies (para 58).
Page 21
“… where goods and services acquired by a taxable person are
used for purposes of transactions that are exempt or do not fall
within the scope of VAT, no output tax can be collected or
input tax deducted …” (para 59)
In order to be consistent with the CJEU’s reasoning outlined above, that statement,
when applied in the context of a fund-raising transaction such as a sale of shares,
must be a reference to the downstream transactions of which the input costs form a
cost component, and not the initial fundraising transaction, unless the cost of the
inputs was a component of the price of the shares in the initial transaction.
48. It is also noteworthy that the cases to which the CJEU referred in para 59 of
its judgment as vouching its proposition of law did not involve an initial fund-raising
transaction and a downstream transaction. Proceedings brought by Uudenkaupungin
kaupunki (Case C-184/04) [2006] ECR I-3039; [2008] STC 2329 concerned the
costs of a building which was initially used in a non-taxable activity but later was
used in a taxable activity. The relevant questions concerned the meaning of article
20 of the Sixth Directive and, in particular, whether during the adjustment period
for which it provided the taxable person could seek to deduct input tax, when there
was no entitlement to deduct at the outset. In Hausgemeinschaft Jörg und Stephanie
Wollny v Finanzamt Landshut (Case C-72/05) [2006] ECR I-8297; [2008] STC
1617, a household business had constructed a building as a business asset and made
private use of rooms within the building. The business had deducted as input tax the
VAT it had paid on its construction and the dispute with the German tax authorities
was over the mechanism for calculating the liability to VAT for the private use under
articles 6(2)(a) and 11A(1)(c) of the Sixth Directive. Vereniging Noordelijke Landen Tuinbouw Organisatie v Staatssecretaris van Financiën (Case C-515/07) [2009]
ECR I-839; [2009] STC 935 concerned an organisation which promoted the interest
of the agricultural sector, a non-taxable activity, and provided taxable services to its
members. The case concerned the extent to which VAT relating to the goods and
services which the organisation acquired could be deducted from the VAT which it
paid on its taxable services.
49. In my view, it is clear that in SFK the CJEU has not extended the reasoning
of BLP to apply it to fund-raising transactions which are outside the scope of VAT.
On the contrary, in order to avoid discriminatory treatment of taxable persons, it has
extended the reasoning in the cases about share disposals that are outside the scope
of VAT to share disposals which are exempt, by requiring an examination as to
whether the costs associated with the input services are incorporated in the price of
the shares sold in the initial transaction or in the prices of the taxable person’s
products in downstream transactions. If the latter, the costs would be “among only
the cost components of transactions within the scope of the taxable person’s
economic activities”.
Page 22
50. The next case which I have to consider is also important because it vouches
the direct and immediate link between an input incurred in the context of an initial
transaction, which is not an economic activity, and the taxable person’s general
economic activity in downstream transactions. It also confirms the CJEU’s approach
to that link where there is a significant time lapse between the input transaction and
the downstream activity. In “Sveda” UAB v VMI (Case C-126/14) EU:C:2015:712;
[2016] STC 447, a Lithuanian company, Sveda, entered into an agreement with the
Lithuanian Ministry of Agriculture in which it undertook to construct a Baltic
mythology recreational and discovery path and to offer it to the public free of charge.
The Ministry undertook to pay 90% of the construction costs and Sveda was to pay
the balance. Sveda undertook to provide the path to the public free of charge for five
years. Sveda sought to deduct as input tax VAT which it paid on the acquisition or
production of capital goods for the construction of the path. The Lithuanian tax
authorities refused to allow the deduction and Sveda appealed that decision. On
appeal the Supreme Administrative Court found that Sveda intended to carry out
economic activities in the future as it would sell food or souvenirs to visitors to the
recreational path. It referred to the CJEU the question (as re-formulated by the
CJEU) whether article 168 of the PVD must be interpreted as granting a taxable
person the right to deduct input VAT paid for the production or acquisition of capital
goods, for the purposes of a planned economic activity related to rural and
recreational tourism, which (i) are directly intended for use by the public free of
charge, and (ii) may be a means of carrying out taxed transactions.
51. The CJEU answered the question in the affirmative, “provided that a direct
and immediate link is established between the expenses associated with the input
transactions and an output transaction or transactions giving rise to the right to
deduct or with the taxable person’s economic activity as a whole” and stated that
this was a matter for the referring court to determine on the basis of objective
evidence (para 37 and dispositif). In reaching this conclusion, the CJEU stated (para
19) that a taxable person may be acting for the purposes of an economic activity
within the meaning of article 9(1) of the PVD when it acquires goods for the
purposes of an economic activity even if the goods are not used immediately for that
economic activity. If the taxable person is so acting, the right to deduct arises
immediately when the goods or services are delivered (para 20), but their use in an
economic activity may occur some time later. The CJEU continued (para 21):
“Whether a taxable person acts as such for the purposes of an
economic activity is a question of fact which must be assessed
in the light of all the circumstances of the case, including the
nature of the asset concerned and the period between the
acquisition of the asset and its use for the purposes of the
taxable person’s economic activity (see inter alia, to that effect,
the judgment in Klub OOD v Direktor na Direktsia
‘Obzhalvane I upravlenie na izpalnenieto’ – Varna pri
Page 23
Tsentralno upravlenie na Natsionalnata agentsia za prihodite
(Case C-153/11), paras 40 and 41 and the case law cited). It is
for the referring court to make that assessment.”
52. The CJEU held that the court has to determine whether there is a direct and
immediate link between the particular input transaction and either (i) a particular
output transaction or transactions, or (ii) the taxable person’s economic activity as a
whole because the expenditure incurred on the input transaction is part of its general
costs and as such is a component of the price of the goods or services which it
supplies in a downstream transaction. In so doing, the court must consider all the
circumstances and take account only of transactions that are objectively linked to
the taxable person’s economic activity (paras 27-29). See also Finanzamt Köln-Nord
v Becker (Case C-104/12) EU:C:2013:99 (21 February 2013, unreported), paras 22,
23, 33 and 35.
53. The CJEU (para 23) concluded from the Lithuanian court’s findings of fact
that Sveda acquired or produced capital goods for the recreational path
“with the intention, confirmed by objective evidence, of
carrying out an economic activity and did, consequently, act as
a taxable person within the meaning of article 9(1) of the
Directive.”
It also recorded (para 30) the finding of fact by the Lithuanian court that Sveda’s
expenditure incurred on the construction of the recreational path would come partly
within the price of the goods and services which it would provide in the context of
its planned economic activity. The CJEU went on to comment on the doubts of the
referring court whether there was a direct link between the input transactions and
the planned economic activity as a whole because the path was intended to be used
by the public free of charge. It stated:
“32. In that regard, the case law of the court makes it clear
that, where goods or services acquired by a taxable person are
used for purposes of transactions that are exempt or do not fall
within the scope of VAT, no output tax can be collected or
input tax deducted (judgment in Eon Aset Menidjmunt OOD v
Direktor na Direktsia ‘Obzhalvane I upravlenie na
izpalnenieto’ – Varna pri Tsentralno upravlenie na
Natsionalnata agentsia za prihodite (Case C-118/11)
EU:C:2012:97, para 44 and the case law cited). In both cases,
the direct and immediate link between the input expenditure
Page 24
incurred and the economic activities subsequently carried out
by the taxable person is severed.
33. First, in no way does it follow from the order for
reference that the making available of the recreational path to
the public is covered by any exemption under the VAT
Directive. Second, given that the expenditure incurred by
Sveda in creating that path can be linked, as is apparent from
para 23 of this judgment, to the economic activity planned by
the taxable person, that expenditure does not relate to activities
that are outside the scope of VAT.
34. Therefore, immediate use of capital goods free of charge
does not, in circumstances such as those in the main
proceedings, affect the existence of the direct and immediate
link between input and output transactions or with the taxable
person’s economic activities as a whole and, consequently, that
use has no effect on whether a right to deduct VAT exists.
35. Thus, there does appear to be a direct and immediate
link between the expenditure incurred by Sveda and its planned
economic activity as a whole, which is, however, a matter for
the referring court to determine.”
I observe that in para 32 the CJEU repeated the interpretation, which it gave in SKF
at para 59, which I have discussed in paras 47 and 48 above and to which I return
below.
54. The CJEU also recognised that a taxable person having obtained a deduction
might later use the goods or services acquired in the input transaction for purposes
other than its economic activity. If that were shown to have occurred, the taxable
person would have to repay the relevant input VAT to the tax authorities (para 36).
55. The final case which I must consider is Direktor na Direktsia “Obzhalvane i
danacho-osiguritelna praktica” – Sofia v “Iberdrola Inmobiliaria Real Estate
Investments” EOOD (Case C-132/16) EU:C:2017:683; [2017] BVC 39
(“Iberdrola”). In this case the property developer, Iberdrola, which wished to
construct 300 apartments in a holiday village, entered into an undertaking with the
municipality to reconstruct a wastewater pump station, which the municipality
owned, to serve both its proposed development and the wider holiday village.
Without that reconstruction, Iberdrola would not have been able to connect its
Page 25
development to the pump station. A dispute arose with the Bulgarian tax authorities
as to whether Iberdrola could deduct as input tax the VAT which it incurred on
paying a third party construction company for the works on the pump station.
56. The CJEU held that a taxable person has the right to deduct input VAT in
respect of a supply of services consisting of the construction or improvement of a
property owned by a third party when that third party enjoys the results of those
services free of charge and when those services are used both by the taxable person
and the third party in the context of their economic activity, in so far as those services
do not exceed that which is necessary to allow that taxable person to carry out the
taxable output transactions and where their costs are included in the price of those
transactions (para 40 and dispositif). In so holding, the CJEU followed its reasoning
in SKF and Sveda in recognising that there could be a direct and immediate link
between an input and either (i) particular output transactions or (ii) the taxable
person’s economic activity as a whole. This link would exist if the cost of the input
was in the first case a cost component of the particular transactions and in the second
case if it was a cost component of the price of goods and services which it supplies
(paras 27-32).
57. In this review of the CJEU’s case law I have sought to set out the
development of the jurisprudence and have focussed attention on the proposition
recorded in SKF (para 59) and Sveda (para 32) that where goods or services acquired
by a taxable person are used for purposes of transactions that are exempt or do not
fall within the scope of VAT, no output tax can be collected or input tax deducted.
This is because Mr Beal invites the court to make a reference to the CJEU under
article 267 of the TFEU if it disagrees with his submission which I have recorded in
paras 21 and 22 above.
58. He supports that invitation by referring to the judgment of the Court of
Appeal of England and Wales in Revenue and Customs Comrs v Chancellor,
Masters and Scholars of the University of Cambridge [2018] EWCA Civ 568;
[2018] STC 848, in which the court decided to make a reference to the CJEU because
it concluded that the correct approach to be taken to the issue of attribution in that
case was not acte clair.
59. I am satisfied that there is no need for a reference in the present appeal. This
is because, as I will seek to show, there are findings of fact that entitled the FTT to
conclude that FASL when it acquired the SPFEs was acting as a taxable person
because of its aim of accumulating sums to develop its taxable business through
capital expenditure on assets which it would use to generate taxable output
transactions.
Page 26
60. The statements in para 59 of SKF and para 32 of Sveda are wholly consistent
with the principle of the neutrality of VAT enshrined in article 2(2) of the PVD.
Thus in Investrand, which I discussed in para 39 above, the expenditure on the
arbitration related to a financial claim arising out of a transaction carried out while
Investrand was not a taxable person and the fact that the costs relating to the
arbitration were incurred after it had become a taxable person was irrelevant because
the expenditure had no connection with Investrand’s activities as a taxable person.
Similarly, on the facts in Uudenkaupungin kaupunki (para 48 above), absent the
arrangements under article 20 of the Sixth Directive, the intention to use and initial
use of the building for a non-taxable activity would have prevented the recovery as
input tax of VAT incurred on its construction notwithstanding the later decision to
use it for a taxable activity because when the costs were incurred they were not
incurred by a taxable person acting as such. Similarly, in Wellcome Trust Ltd v
Customs and Excise Comrs (Case C-155/94) [1996] ECR I-3013; [1996] STC 945,
it was because the purchase and sale of shares by a charitable trust was not an
economic activity that the VAT paid on the fees for professional services relating to
those transactions were not recoverable; there was no downstream economic activity
to which the costs could be linked.
61. Since the hearing in this appeal and the preparation of this judgment in draft,
the Eighth Chamber of the CJEU has issued its judgment on the Court of Appeal’s
reference in the University of Cambridge case on 3 July 2019 (Case C-316/18)
EU:C:2019:559. As the CJEU records (para 9) the university is a not-for-profit
educational institution whose principal activity is the provision of educational
services, which are VAT exempt, but which also makes taxable supplies including
commercial research, the sale of publications, etc. The university’s activities are
financed in part by charitable donations and endowments, which it places in a fund
and invests. The university has claimed a right to deduct input VAT relating to fees
which it has paid to third party managers of the fund on the basis that the income
generated by the fund has been used to finance the whole range of its activities.
62. The CJEU (para 19) interpreted the questions of the Court of Appeal in the
reference as asking, in essence:
“whether article 168(a) of the VAT Directive must be
interpreted as meaning that a taxable person that (i) is carrying
out both taxable and exempt activities, (ii) invests the donations
and endowments that it receives by placing them in a fund, and
(iii) uses the income generated by that fund to cover the costs
of all of those activities is entitled to deduct, as an overhead,
input VAT paid in respect of the costs associated with that
investment.”
Page 27
63. The CJEU answered that question in the negative. Its reasoning is as follows.
First, the collection of donations and endowments is not an economic activity and is
outside the scope of the PVD. VAT paid in respect of costs incurred in connection
with such collection is not deductible, regardless of the reason for the receipt (para
29). Secondly, the activity of collection and the activity of the investment of the
collected funds are treated for VAT purposes as one non-economic activity as the
investment is merely a direct continuation of the non-economic activity of
collection. Accordingly, input VAT paid in respect of costs associated with the
investment is also non-deductible (para 30). Thirdly, and in my view critically, the
CJEU distinguished the case on its facts from the line of authority which I have
discussed and of which Kretztechnik is a part. It stated (para 31):
“It is true that the fact that costs are incurred in the acquisition
of a service in the context of a non-economic activity does not,
in itself, preclude those costs giving rise to a right to deduct in
the context of the taxable person’s economic activity, if they
are incorporated into the price of particular output transactions
or into the price of goods and services provided by the taxable
person in the context of that economic activity (see, to that
effect, judgment of 26 May 2005, Kretztechnik, C-465/03,
EU:C:2005:320, para 36).”
But, referring to the documents before the court, it concluded that the costs of
management of the funds were not incorporated into the price of a particular output
transaction. It also concluded, by reference to those documents, that the costs were
incurred to generate resources to finance all of the university’s output transactions,
thereby allowing the price of its goods and services to be reduced. The costs
therefore were not components of the price of goods and services provided by the
university and could not form part of its overheads. The VAT therefore was not
deductible (para 32).
64. In my view, the ruling that the income was used to reduce all of the costs of
the university’s goods and services prevented the fund managers’ fees from being a
component of the costs of those goods and services and thus part of the university’s
overheads, which is the second alternative in Kretztechnik. The University of
Cambridge judgment, which the CJEU has delivered without requiring an opinion
from an Advocate General, is therefore an application of established CJEU
jurisprudence which I have discussed above and summarise below.
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(iii) Summary of the case law
65. I derive the following propositions which are relevant to this appeal from the
case law:
i) As VAT is a tax on the value added by the taxable person, the VAT
system relieves the taxable person of the burden of VAT payable or paid in
the course of that person’s economic activity and thus avoids double taxation.
This is the principle of deduction set out in article 1(2) and operated in article
168 of the PVD and vouched, for example, in Rompelman v Minister van
Financien (Case C-268/83) [1985] ECR 655, para 19; Abbey National, para
24; Kretztechnik, para 34 and SKF, paras 55-56.
ii) There must be a direct and immediate link between the goods and
services which the taxable person has acquired (in other words the particular
input transaction) and the taxable supplies which that person makes (in other
words its particular output transaction or transactions). This link gives rise to
the right to deduct. The needed link exists if the acquired goods and services
are part of the cost components of that person’s taxable transactions which
utilise those goods and services: see for example Midland Bank, paras 24 and
30; Abbey National, para 28; Kretztechnik, para 35; Securenta, para 27; SFK,
para 57 and HMRC v University of Cambridge, para 31.
iii) Alternatively, there must be a direct and immediate link between those
acquired goods and services and the whole of the taxable person’s economic
activity because their cost forms part of that business’s overheads and thus a
component part of the price of its products: see for example BLP, para 25;
Midland Bank, para 31; Abbey National, paras 35 and 36; Kretztechnik, para
36; SKF, para 58 and HMRC v University of Cambridge, para 31.
iv) Where the taxable person acquires professional services for an initial
fund-raising transaction which is outside the scope of VAT, that use of the
services does not prevent it from deducting the VAT payable on those
services as input tax and retaining that deduction if its purpose in fundraising, objectively ascertained, was to fund its economic activity and it later
uses the funds raised to develop its business of providing taxable supplies.
See, for example, Abbey National, paras 34-36; Kretztechnik, paras 36-38;
Securenta, paras 27-29 and SKF, para 64. The same may apply if an
analogous transaction involving the sale of shares is classified as an exempt
transaction: SKF, para 68.
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v) Where the cost of the acquired services, including services relating to
fund-raising, are a cost component of downstream activities of the taxable
person which are either exempt transactions or transactions outside the scope
of VAT, the VAT paid on such services is not deductible as input tax. See for
example Securenta, paras 29 and 31; SKF, paras 58-60 and Sveda, para 32.
Where the taxable person carries on taxable transactions, exempt transactions
and transactions outside the scope of VAT, the VAT paid on the services it
has acquired has to be apportioned under article 173 of the PVD.
vi) The right to deduct VAT as input tax arises immediately when the
deductible tax becomes chargeable: article 167 of the PVD, Securenta, paras
24 and 30 and SKF, para 55. As a result, there may be a time lapse between
the deduction of the input tax and the use of the acquired goods or services
in an output transaction, as occurred in Sveda. Further, if the taxable person
acquired the goods and services for its economic activity but, as a result of
circumstances beyond its control, it is unable to use them in the context of
taxable transactions, the taxable person retains its entitlement to deduct:
Midland Bank, paras 22 and 23.
vii) The purpose of the taxable person in carrying out the fund-raising is a
question of fact which the court determines by having regard to objective
evidence. The CJEU states that the existence of a link between the fundraising transaction and the person’s taxable activity is to be assessed in the
light of the objective content of the transaction: Sveda, para 29; Iberdrola,
para 31. The ultimate question is whether the taxable person is acting as such
for the purposes of an economic activity. This is a question of fact which must
be assessed in the light of all the circumstances of the case, including the
nature of the asset concerned and the period between its acquisition and its
use for the purposes of the taxable person’s economic activity: Eon Aset
Menidjmunt OOD v Direktor na Direktsia “Obzhalvane I upravlenie na
izpalnenieto” – Varna pri Tsentralno upravlenie na Natsionalnata agentsia
za prihodite (Case C-118/11) EU:C:2012:97; [2012] STC 982, para 58; Klub
OOD v Direktor na Direktsia “Obzhalvane I upravlenie na izpalnenieto” –
Varna pri Tsentralno upravlenie na Natsionalnata agentsia za prihodite
(Case C-153/11) EU:C:2012:163; [2012] STC 1129, paras 40-41 and Sveda,
para 21.
Application to the facts of this case
66. I have set out the factual background in paras 2-7 above. There was objective
evidence that FASL when carrying out its fund-raising activity was carrying out a
taxable business and was contemplating using the funds raised on three principal
Page 30
developments – a windfarm, the construction of further farm buildings and the
acquisition of neighbouring farmland.
67. I do not detect in the jurisprudence of the CJEU any basis for distinguishing
expenditure incurred in a fund-raising exercise which takes the form of a sale of
shares from a fund-raising exercise that involves the receipt of a subsidy over several
years. The fact that the subsidies were included in FASL’s profit and loss account
and counted as the business’s income for income tax purposes is not a basis for
distinguishing the share sale cases such as Kretztechnik and Securenta. I do not view
the annual payment of the subsidies under the SFP scheme as a separate transaction
from the acquisition of the entitlement to those subsidies which is capable of
breaking the link between the purchase of the SFPE units and the deployment of the
net proceeds of the subsidies in FASL’s subsequent economic activities. In any event
the FTT was not bound to hold that the acquisition of the SFPE units and the receipt
of the subsidies were separate transactions. On the FTT’s findings of fact, the
purchase of the SFPE units was part of an exercise raising funds for FASL’s
economic activities. The underlying principle is the principle of neutrality which
relieves the taxable person of the burden of VAT payable and paid in the course of
all its economic activities: Rompelman, para 19; Belgian State v Ghent Coal
Terminal NV, para 15; Gabalfrisa SL v Agencia Estatal de Administración
Tributaria (Cases C-110/98 to C-147/98) EU:C:2000:145; [2000] ECR I-1577;
[2002] STC 535, para 44.
68. While it is not clear from the FTT’s findings when any of FASL’s projects
will come to fruition, I am persuaded that the FTT was entitled to conclude that
FASL when it incurred the costs of the purchase of the SFPE units was acting as a
taxable person because it was acquiring assets in support of its current and planned
economic activities, namely farming and the windfarm. On that basis FASL was
entitled to an immediate right of deduction of the VAT paid on the purchase of the
SFPE units and is entitled to retain that deduction or repayment so long as it uses
the SFPs which it received as cost components of its economic activities. A start-up
business can acquire goods and services to support its future taxable supplies and
claim VAT paid on those acquisitions as input tax; so too in principle can an existing
business which proposes to expand its economic activity. On the facts found, FASL
does not carry out and does not propose to carry out downstream non-economic
activities or exempt transactions. Therefore, no question of apportionment under
article 173 of the PVD arises.
The task for HMRC
69. I recognise that a claim for deduction which depends on the future behaviour
of the taxable person, such as the claim in this case, may create practical difficulties
for HMRC in administering the VAT system fairly and, in particular, in avoiding
Page 31
unwarranted repayments of VAT. But it is an established part of the VAT system
that a taxable person is entitled to an immediate deduction of the VAT which it has
paid (para 60(vi) above). It is also well-established that a taxable person can claim
to deduct as input tax VAT which it has paid on the acquisition of goods or services
although it will not use those goods and services as components of taxable
transactions immediately: Rompelman, para 22; Lennartz v Finanzamt München III
(Case C-97/90) [1991] ECR I-3795, paras 13-16 and Sveda, para 20.
70. The recognition that fund-raising costs may, where the evidence permits, be
treated as general overheads of a taxable person’s business means that the taxable
person must be able to provide objective evidence to support the connection between
the fund-raising transaction and its proposed economic activities. The taxpayer also
needs to maintain adequate banking arrangements and records to vouch the later use
of the funds so raised to demonstrate its entitlement to deduct and to retain the
deduction, if investigated. As the CJEU recorded in Sveda (para 36) the taxpayer
will have to repay input VAT if it does not use the input goods or services for the
purposes of its economic activity. HMRC has power to charge VAT under regulation
3 of the Value Added Tax (Supply of Services) Order 1993 (SI 1993/1507), where
a taxable person uses services supplied to it for its business for a purpose other than
a business use, by treating that use as a supply of services in the course of its
business. This may involve HMRC in more investigations than the CJEU envisaged
in BLP (para 24). But this supervision of the subsequent use of the raised funds, with
which the services were associated, seems to me to be an inevitable consequence of
the CJEU’s interpretation of the PVD.
Conclusion
71. I would dismiss the appeal.
