Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)
36. Before the tribunal, it appears to have been regarded as uncontroversial that a lease involves separate and successive supplies of goods or services, so that the goods and services supplied during the vacant unelected period are not the same as those supplied afterwards. There was no reference to regulations 85 and 90 but the submission of counsel for the Commissioners to this effect is recorded at  V & DR, 336, 354 E, without further comment. But Park J disagreed. He said  STC 933, 947e that the regulation dealt with "the time of a supply" but not "the nature of a supply". So the supply may take place separately and successively, but the goods or services supplied are nevertheless the same. The majority of the Court of Appeal agreed, although Sedley LJ's acceptance of the proposition may have been influenced by his view that VAT was a world "in which factual and legal realties are suspended or inverted:"  STC 1476, 1490. But I find the notion of the same goods or services being supplied over and over again too hard to grasp. In my opinion the plain effect of the regulations is to treat each successive supply as different from the one before. On this point I agree with the tribunal and Arden LJ.
37. Mr Gammie QC, in his excellent submissions for RSA, did not spend much time trying to defend the view of the majority of the Court of Appeal on this point. He only referred in passing to some comments on section 5(1) of the Value Added Tax Act 1983 which I made in Customs and Excise Commissioners v Thorn Materials Supply Ltd  1 WLR 1106. That subsection provides that if a person making a supply issues a tax invoice or receives payment before the time when the supply would otherwise be treated as taking place:
38. I said of this provision (at pp 1115-1116):
39. Mr Gammie said that it was the same in this case. There was a supply of the same goods, namely the lease, treated as having taken place as to parts of its value on successive dates. But in my opinion the language of regulations 85 and 90 is quite different from the language of section 5(1) of the 1983 Act. The latter speaks of "the supply", in the singular, taking place to some extent at one time and, by implication, to the remaining extent at another time. Regulation 85 says that the goods shall be treated as "separately and successively supplied" on the dates of the invoices or payments. I would therefore reject the analogy.
40. Mr Gammie's primary argument was that it did not matter that the goods and services supplied during the vacant unelected period were different from those supplied after the new intention to make taxable supplies had been formed. He said that although as a matter of ordinary language one could not use or form an intention to use a right to occupy property for a period which had already passed, that should not prevent reattribution under regulation 109. The economic activity in which RSA had been engaged from the beginning of the vacant unelected period was the letting of property. The fact that it was intending to make exempt sub-lettings meant that it could not claim immediate repayment of VAT on its inputs. But that intention never fructified into any exempt outputs. Instead, it changed its mind and decided to make taxable outputs. So all the inputs, not having been used in making exempt outputs, became cost components in the taxable outputs which, after election, were the only kind which RSA could make.
41. This argument was attractively presented but in the end I think it is wrong. It is in truth based on a number of principles of VAT law which are not relevant to the present case because they have no application to the right to claim an adjustment under regulation 109.
42. First, Mr Gammie relies upon the principle that input tax may be deductible even though the input is not directly traceable into any particular output. If the taxpayer is engaged in an economic activity for the purpose of making taxable outputs, the tax on all inputs which are cost components of that activity, even overheads, are deductible. As Advocate General Jacobs said in Abbey National plc v Customs and Excise Commissioners (Case C-408/98)  STC 297, 307:
43. So, says Mr Gammie, it does not matter that the periods for which rent was paid in the vacant unelected period did not coincide with the period for which the properties were eventually sublet. The earlier rental payments were nevertheless cost components of the later lettings. Indeed, since there were no earlier lettings, they could not have been cost components of anything else. Secondly, it is clearly established that a trader has a right to deduct VAT from the very moment that he embarks upon the relevant economic enterprise and before he has made any outputs. Thus in Rompelman v Minister van Financiën (Case 268/83)  ECR I-655 the Court of Justice held that a trader who decided to acquire property for letting could claim repayment of VAT on the cost of a right to acquire a building which had not yet been constructed, let alone tenanted. In Intercommunale voor Zeewaterontzilting v Belgium (Case C-110/94)  ECR I-857 this principle was applied to allow deduction of VAT on the cost of a study undertaken by a company in order to decide whether to commence an economic enterprise or not, even though it decided not to proceed and never made any taxable outputs. Thirdly, in Belgium v Ghent Coal Terminal NV (Case C-37/95)  ECR I-1 the Court of Justice confirmed that once a right of deduction had been exercised because the inputs were for the purpose of investment work intended to be used in connection with taxable transactions, the authorities may not claim repayment merely because the taxpayer has been unable to use the goods or services for the intended purpose.
44. All this is clear law, but I do not see how it helps RSA. It shows that if tax is paid on inputs used or intended to be used for an economic activity carried on for the purpose of making taxable outputs, all that tax may be deducted by the trader even though the inputs are not attributable to particular outputs and even though no taxable outputs are actually made. But in the present case, RSA was not carrying on an economic activity for the purpose of making taxable outputs. If it had been, it would have had no need to rely upon regulation 109. The jurisprudence to which I have referred shows that it would have been able to deduct anyway. The claim under regulation 109 is made on the basis that during the vacant unelected period RSA was carrying on an economic activity for the purpose of making exempt outputs. In such a case, there is no right to deduction. On the contrary, the principle in the Ghent Coal Terminal case suggests that, just as a failure to make taxable supplies does not destroy a right of deduction, so a failure to make exempt supplies does not create one.
45. To go back my earlier example of the lawyer who first embarks upon the economic activity of making exempt supplies of financial services, let us assume that he is wholly unsuccessful in doing so. He does not make a single exempt output. That does not enable him to say that his inputs while he was trying to supply financial services are cost components of his second career in supplying taxable legal services.
46. Mr Gammie would, I think, accept this last example. But he says that RSA's position is different because it did not first try one economic activity and then switch to another. It was engaged throughout in the same economic activity, namely, letting property. It was at this point that Mr Gammie tended to stress that RSA was never committed to making exempt supplies. It had an open mind on the question. But, as I said earlier, the entire application of regulation 109 is predicated upon the assumption that RSA was at first intending to make exempt supplies. Nevertheless, Mr Gammie says in his printed case that the fallacy in the Commissioners' argument is that they?
47. But in my opinion that is the right way to approach the issue. The structure of VAT is built upon the notion that there are some economic activities which are taxable and some which are exempt. An activity which is taxable is by definition not the same for VAT purposes as an activity which is exempt. Usually the nature of the activity determines whether it is taxable or exempt. But letting land can be two different economic activities according to whether or not an election has been made. I therefore think that in deciding to elect and make taxable supplies, RSA were in no different position from the person in my example who decided to change from an activity which involved making exempt supplies to a different activity making taxable supplies. If there are still inputs around from the previous activity which can be used in the new taxable activity, like a building which has been constructed for exempt letting and is then used, after an election, for taxable letting, the taxpayer will be entitled to an adjustment: compare Finanzamt Goslar v Breitshol (Case C-400/98)  STC 355, 384, para 52. But he cannot rewrite history.
48. Finally I must say something about the decision of this House in Svenska International plc v Customs and Excise Commissioners  1 WLR 769, upon which Mr Gammie particularly relied. In that case a bank ("Svenska") continuously provided taxable services such as telephone and electricity to another bank ("Branch") from December 1987 but without receiving payment or rendering a tax invoice until 26 June 1992. During that period it deducted input tax on the cost of providing the services to Branch on the ground that it was intending to make a taxable supply. By the time the invoice was rendered and the supply was treated for VAT purposes as having been made, Svenska and Branch were members of the same VAT group and could not make supplies to each other. The inputs and outputs of each group company from and to outside suppliers and purchasers respectively were treated as those of the group. The Commissioners claimed repayment of the input tax deducted on the ground that the goods and services had in fact been used by the group in making exempt supplies (banking services) to its customers. The House held that the Commissioners were entitled to repayment under what is now regulation 108, the mirror image of regulation 109.
49. Mr Gammie says that Svenska was paying input tax on supplies received from third parties for the purpose of carrying on the economic activity of making taxable supplies of services to Branch. In the event, it never made a supply to Branch but used the services instead in the economic activity of making exempt supplies to customers. So it had to repay all the tax which had been deducted. Likewise in this case, RSA made no deduction on supplies received from its landlords for the purpose of carrying on the economic activity of making exempt supplies. In the event, it never made an exempt supply but used the services in the economic activity of making a taxable supply after its election to waive exemption. So it should be entitled to repayment of all the tax which it failed to deduct.
50. In my opinion the true basis of the Svenska case is not that the taxable inputs were deemed to have been accumulated and then used all at once by Svenska in making exempt supplies after Svenska and Branch had become part of the same group. Nor does it decide that it is in principle possible for the Commissioners under regulation 108 to reattribute to exempt use the inputs which in real life had already been used with the intention of making taxable supplies, simply on the basis of a later change in the nature of the economic activity. That would be contrary to the principle of the Ghent Coal case. The decision in the Svenska case turned on the special effect of the grouping provisions, which, as the House decided, made it necessary to treat the inputs to Svenska as having been inputs to the group and used by the group to make exempt supplies at the time that Branch so used them. This appears most clearly from the speech of Lord Hope of Craighead (at p 778):
51. Thus the effect of section 29 of the 1983 Act was that Svenska was treated as never having carried on the economic activity of making supplies of services. It was the group which was treated as having acquired the input services supplied to Svenska and the group which was treated as having used them for the economic activity of making exempt services supplied by Branch. The case is not authority for the proposition that, for the purposes of regulations 108 or 109, one can retrospectively form a new intention about the use of goods or services which have already been used, like the right to occupy premises for a period which has expired.
52. I would therefore allow the appeal and restore the decision of the Tribunal.
53. By virtue of section 5 of and Schedule 4 to the Value Added Tax Act 1994 the grant of a major interest in land, defined in section 96 to mean the fee simple or a tenancy for a term certain exceeding 21 years, is to be treated as a supply of goods. The grant of an interest in land for a shorter period is to be treated as a supply of services (section 5(2)). Leasing or letting of immovable property (subject to certain exceptions which do not apply here) is exempt from tax (Group 1 of Schedule 9 to the 1994 Act). But the exemption can be waived (paragraph 2 of Schedule 10 to the 1994 Act). In the context of the present case it was not suggested that there was any relevant distinction to be made between a short and a long lease. In the context of the time of supply rules set out in the Value Added Tax Regulations 1995 separate provisions are made in regulations 85 and 90 in respect of leases treated as supplies of goods and leases treated as supplies of services. But for present purposes the critical elements of these provisions are the same and no distinction need be made in the context of the present case between goods and services. They are to be treated as "separately and successively supplied" at the time of receipt of payment or the issue of a relevant VAT invoice, whichever is the earlier.
54. The respondent ("RSA") held leases of certain properties. It paid certain sums to its landlord by way of rent and service charges. For a time it occupied most of the properties for the purposes of its insurance business. Its supplies of insurance services were exempt from VAT (section31 of, and Group 2 of Schedule 9 to, the 1994 Act). But it then found the properties surplus to its requirements and decided to sub-let them. The supplies constituted by such subletting would also be exempt from VAT unless RSA waived exempt status for the properties. Exemption had been waived in respect of the supplies of the properties to RSA by its landlord and so those supplies were taxable supplies for purposes of VAT. RSA accordingly incurred input tax in respect of these supplies. Over periods referred to as "the vacant periods" RSA did not occupy the properties but tried to market them to prospective sub-tenants. During these periods the properties were neither let nor occupied. Eventually it succeeded in sub-letting them and it elected to waive exempt status for each of the properties. It then sought to recover from the Commissioners, the appellants in the present appeal, an amount equal to the input tax which it had incurred and paid in respect of the supplies of the properties to it during the vacant periods and before it had elected to waive exemption in respect of them. This is sought to be done under regulation 109 of the Value Added Tax Regulations 1995.
55. Regulation 109(1) provides:
56. Some comments may immediately be made on this section. Firstly, the dispute in the present case concerns only the final phrase of this provision. If one seeks to apply the terms of regulation 109(1) to the present case it is clear at the outset that RSA, as a taxable person, had incurred an amount of input tax and that amount had not been attributed to taxable supplies. I understand it to be accepted that the reasons for that non-attribution was because it intended to make exempt supplies. As the appellants put it in their printed case at para 1.3:
Within the time limit of six years and before the intention to make exempt supplies was fulfilled RSA formed the intention to make taxable supplies and indeed fulfilled that intention by sub-letting the properties. The only question arising in the appeal as regards the application of the regulation is whether that intention was an intention to use "the goods or services concerned in making taxable supplies". In answering that question I have not found a direct solution from the reported cases.
57. Secondly, the "goods and services concerned" are the goods and services referred to earlier as the goods and services intended to be used in making exempt supplies. The regulation requires that those goods and services are now to be used or intended to be used in making taxable supplies. The goods and services must be the same goods and services. That the use of them was at one time intended to be in exempt supplies and at a later time intended to be in taxable supplies should not make them different goods and services. It is to just such a change that the regulation applies.
58. Thirdly, what is required by the regulation is that the intention to make exempt supplies must not have been fulfilled. If use has been made of the goods and services then the regulation will not apply. What has been done by actual use cannot be undone. But if there has been no history of use at all and no use has been made of the goods and services then an adjustment may be available. The regulation may apply where there has been a failure to make exempt supplies.
59. Fourthly, the regulation envisages that a passage of time will occur between the start of the original intention to make exempt supplies and the use or intention to use the goods or services in making taxable supplies. Indeed a maximum period of six years is allowed in terms of the regulation. So the regulation may be invoked even although a multiplicity of accounting periods has passed.
60. In Midland Bank plc v Customs and Excise Commissioners (Case C-98/98)  STC 501, 518, para 19 the European Court of Justice stated, following earlier case law that:
The basic rule for deduction is set out in article 17(1) of the Directive. That has been implemented in section 26(1) and (2) of the 1994 Act. But the Directive allows in article 20 for the making of adjustments to deductions in among other cases the situation where "after the return is made some change occurs in the factors used to determine the amount to be deducted. . . ". By section 26(3) the implementation legislation empowers the Commissioners to "make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above . . . ". Regulation 109 is one of the regulations so made. No one has suggested that it fails to embody the intention of the Directive or exceeds the powers given in the Act.
61. One argument which has been put forward is to say that the goods had been used or consumed during the vacant periods. But there is no obvious warrant for equating an attempt to use the properties as a use of them. The fact is that they had remained vacant and unused. The properties remained unimpaired during the vacant periods and despite the passage of time there is nothing to justify the conclusion that they had in some sense been consumed.
62. But then it is said that the past supplies to RSA are a matter of past history and have as it were disappeared altogether. In the present case the goods and services were the interests under the lettings. Those interests no doubt require to be treated as supplied separately and successively for the purposes of the time of supply rules and no doubt what have to be treated as separate grants, separate supplies, can be regarded as having passed into history. But the present case is not concerned with the time of any supply for the purposes of a charge. The case concerns the making of an adjustment under regulation 109 in respect of the right to deduct the input tax which RSA had paid.
63. Throughout the vacant periods RSA was engaged or seeking to be engaged in the economic activity of sub-letting the properties. That activity remained as one of constant intention throughout the vacant periods and was still the intention when the decision to claim exemption was made. RSA intended throughout to sub-let the properties, although they failed to do so, and at no time during the vacant period were the goods or services put to use. The properties were the same properties all along and it seems to me that there was a direct and immediate link between the interests under the leases and the eventual output transactions constituted by the sub-letting. Had RSA intended from the outset to make taxable supplies no problem about the deductibility of the input tax it paid would have arisen and there would have been no need to resort to regulation 109 and indeed no room to do so. What happened was that it wished for commercial reasons during the vacant periods to keep its options open. In the event no use was made of the goods and services concerned and no exempt supplies were made. In my view the situation is one which the adjustment required by regulation 109 is designed to meet and so satisfy the basic intention of the deduction system in relation to the carrying on of the economic activity of subletting the properties.
64. I would dismiss the appeal.
LORD WALKER OF GESTINGTHORPE
The Statutory Provisions
65. Value added tax ("VAT") is essentially an EU tax, imposed by Member States in compliance with EU legislation, of which the most important is the Sixth Directive (EC Council Directive 77/388/EEC). Member States give effect to the EU legislation (and in particular, the Sixth Directive) by national legislation, in the case of the United Kingdom the Value Added Tax Act 1994 ("the 1994 Act") and the Value Added Tax Regulations 1995 (SI 1995/2518) ("the Regulations"). In this appeal neither side has suggested that the United Kingdom government has failed to implement the Sixth Directive correctly. Nevertheless it is convenient to make some references to it (as well as to the 1994 Act and the Regulations) since the general scheme of the national legislation can sometimes be better understood by reference to the Sixth Directive. Moreover decisions of the European Court of Justice naturally refer principally to the EU legislation in laying down some general principles (in particular the principle of fiscal neutrality, and the concept of the "direct and immediate link") which inform the interpretation of the legislation.
66. Some important general features of the VAT system have been described by the European Court of Justice in Rompelman v Minister van Financiën (Case 268/93)  ECR I-655, 663-664, paras 15-19: