Judgments - Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)

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    67. The proviso in the last sentence of the quotation is important, because it is possible (through the exemption of some economic activities under article 13 of the Sixth Directive) to be a taxable person without making any taxable supplies. In those circumstances the tax does not cascade down from one taxable person to another until the end products or "outputs" (whether goods or services) reach the ultimate consumer. That is one of the complications which detract from the grand simplicity of the tax structure as it has to be considered on this appeal. The other complications are those of the special treatment of the letting of land or buildings, including the so-called "option to tax". I must mention the statutory provisions bearing on these three complicating factors. I can do so fairly briefly because the proceedings below at every stage are reported (the VAT and Duties Tribunal at [1999] V & DR 336, Park J at [2000] STC 933 and the Court of Appeal at [2001] STC 1476) and they cover the relevant provisions of the Sixth Directive, the 1994 Act and the Regulations in some detail.

    68. Article 17(5) of the Sixth Directive deals with the position of a trader whose business is such that his output supplies are partly exempt and partly taxable. The respondent Royal & Sun Alliance Insurance Group Plc ("RSA", so as to include where appropriate all other companies registered as members of the same group) is in that position. RSA is in the business of insurance, which is (under section 31 of, and Group 2 of Schedule 9 to, the 1994 Act) treated as the making of exempt supplies. But as Park J explained (in para 23 of his judgment) typically an insurance company also makes some supplies which are taxable, even though the bulk of its supplies are exempt. That often happens because the insurer owns property leased to tenants or subtenants and held as an investment, and has exercised its option to tax.

    69. Article 17(5) is in the following terms:

    "As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions.

    This proportion shall be determined, in accordance with article 19, for all the transactions carried out by the taxable person."

    This is followed by a proviso enabling Member States to depart from this principle in certain cases. Article 19 provides for the calculation of the deductible proportion. Article 20 provides for the initial deduction to be adjusted "according to the procedures laid down by the Member States," in particular where the deduction made was higher or lower than that to which the taxable person was entitled (but in general there is to be no adjustment for bad debts or for lost or stolen stock).

    70. The significance of the simple form of words "for transactions" in article 17(5) has been explained by the European Court of Justice in BLP Group Plc v Commissioners of Customs and Excise (Case C-494) [1995] ECR I-983, para 19:

    "The use in that provision of the words 'for transactions' shows that to give the right to deduct under paragraph 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 this respect".

    This is the concept of the "direct and immediate link" which has played an important (although somewhat intermittent) part in the argument at different stages of the appeal process.

    71. The provisions of article 17 are given effect principally by sections 24, 25 and 26 of the 1994 Act and by Part XIV of the Regulations, made under section 26(3). In particular section 26(3)(c) provides for the Regulations to cover two converse cases:

    "the making of payments in respect of input tax, by the Commissioners to a taxable person (or a person who has been a taxable person) or by a taxable person (or a person who has been a taxable person) to the Commissioners, in cases where events prove inaccurate an estimate on the basis of which an attribution was made".

    72. These two cases are provided for (in reverse order) by regulations 108 and 109. It is sufficient to set out regulation 109, which is of central importance to this appeal:

    "(1) This regulation applies where a taxable person has incurred an amount of input tax which has not been attributed to taxable supplies because he intended to use the goods or services in making either—

    (a) exempt supplies, or

    (b) both taxable and exempt supplies,

    and during a period of six years commencing on the first day of the prescribed accounting period in which the attribution was determined and before that intention is fulfilled, he uses or forms an intention to use the goods or services concerned in making taxable supplies or, in the case of an attribution within sub-paragraph (a) above, in making both taxable and exempt supplies.

    (2) Subject to regulation 110 and where this regulation applies, the Commissioners shall, on receipt of an application made by the taxable person in such form and manner and containing such particulars as they may direct, pay to him an amount equal to the input tax which has become attributable to taxable supplies in accordance with the method which he was required to use when the input tax was first attributed.

    (3) For the purposes of this regulation any question as to the nature of any supply shall be determined in accordance with the provisions of the Act and any Regulations or Orders made thereunder in force at the time when the input tax was first attributed".

    73. Under Group 1 of Schedule 9 to the 1994 Act (implementing article 13, para B(b) of the Sixth Directive) the grant of an interest in land (such as the grant of a lease or tenancy) is (if made by a taxable person) an exempt supply, subject to various exceptions which are not material (other than as the subject-matter of some submissions made by each side as to supposed anomalies and absurdities). But under Schedule 10, para 2 (and article 13 para C) a taxable person may elect to waive exemption under Schedule 9 Group 1. By Schedule 10, para 3(1) and (4) an election to waive exemption cannot in general be retrospective, and is irrevocable. The practical consequences of these provisions, and the fiscal and commercial considerations which a landlord and his prospective tenant would have in mind in relation to them, are discussed by Park J in paras 11 to 13 of his judgment.

    74. By the combined effect of section 5, section 96 (1) (definition of "major interest") and Schedule 4, para 4 to the 1994 Act the grant (in England) of a lease for more than 21 years is a supply of goods; the grant of a lease for 21 years or less is a supply of services. The distinction may make a difference in some circumstances, but it was not suggested that it makes any significant difference in this case.

    75. Finally (in regard to the statutory provisions) I must refer to regulations 85 and 90, which seem to have received little attention at the hearing before the Tribunal but featured in the argument before Park J and the Court of Appeal. Section 6 of the 1994 Act sets out rules in relation to the time at which a supply of goods or services is treated as being made. These rules are capable, in some circumstances, of producing surprising and apparently artificial results (see for instance Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769). Section 6(14) provides, so far as material, as follows:

    "The Commissioners may by regulations make provision with respect to the time at which . . . a supply is to be treated as taking place in cases where—

    (a) it is a supply of goods or services for a consideration the whole or part of which is determined or payable periodically, or from time to time, or at the end of any period, or . . .

    and for any such case as is mentioned in this subsection the regulations may provide for goods or services to be treated as separately and successively supplied at prescribed times or intervals".

    The last words quoted (which Arden LJ in the Court of Appeal referred to as the subsection's "tailpiece") may be important as establishing the width of the power to make this part of the Regulations.

    76. Regulation 85 is headed "Leases treated as supplies of goods". regulation 90 is rather wider, as its heading indicates: "Continuous supplies of services". It is sufficient for present purposes to set out regulation 85:

    "(1) Subject to paragraph (2) below, where the grant of a tenancy or lease is a supply of goods by virtue of paragraph 4 of Schedule 4 to the Act, and the whole or part of the consideration for that grant is payable periodically or from time to time, goods shall be treated as separately and successively supplied at the earlier of the following times—

    (a) each time that a part of the consideration is received by the supplier, or

    (b) each time that the supplier issues a VAT invoice relating to the grant."

    Regulation 85(2) provides an alternative mechanism for periodic invoices, but keeps the same basic idea of separate and successive supplies at appropriate intervals.

    77. The difficulty of this appeal arises from the need to reconcile these complex provisions in a way which is compatible with the general principles laid down by the European Court of Justice, and which provides a fair result in this case without creating unfairness in other cases. At different stages in the argument each side has, I think, showed some inclination to press supposed anomalies on your Lordships while at other times urging your Lordships to decide the case on its own facts, and not to worry about other hypothetical cases which are not before the House. This is a familiar feature in litigation on complex tax legislation and your Lordships are generally disinclined to go far in considering competing anomalies. Nevertheless it is important to try to discern a coherent structure in the tax.

The Facts and the Proceedings Below

    78. The tribunal (Mr David Demack) had a detailed agreed statement of facts supplemented by agreed bundles of documents and some oral evidence. The tribunal reduced this to eight paragraphs of findings of fact. As the case has progressed through the courts the essential facts have been further refined, and for present purposes they can be summarised very shortly indeed.

    79. RSA had leases of office accommodation from landlords who had themselves exercised the option to tax. Initially RSA occupied the offices for the purposes of its insurance business (making exempt outputs) and so was unable to deduct input tax on rent and service charges which it paid. Then at various dates between November 1991 and April 1993 some of the office accommodation became vacant as it was surplus to the requirements of the insurance business. RSA wished to let it so as to produce rental income. But because of the difficult state of the property market the accommodation remained vacant for a considerable time, that is (with exceptions which can be ignored) until November 1995. On 21 November 1995 RSA made an election (under Schedule 10, para 2 to the 1994 Act) to waive exemption, and the election was notified to the Commissioners on 21 December 1995.

    80. During what were called the vacant unelected periods RSA was trying to sublet the offices, but was unable to achieve a letting. It was of course obliged to continue to pay rent and service charges to its own landlords, although the premises were vacant and unproductive. RSA did not elect to waive exemption at an earlier date because it wanted to keep its options open. It could not foresee whether any prospective subtenant would itself be making taxable or exempt supplies.

    81. Both sides' arguments have varied a good deal during successive stages of the appeal process. It is unnecessary to record the evolving arguments in great detail, but I must attempt a brief summary. The tribunal decided in favour of the Commissioners principally on the ground that there was no direct and immediate link between RSA's inputs between 1991 and 1995 and its taxable outputs thereafter (although that bald summary does scant justice to Mr Demack's very careful analysis and discussion of the submissions made to him). Park J reached the opposite conclusion, largely (although again this does scant justice to his very careful analysis and discussion) on the ground that regulations 85 and 90 were concerned only with the time of supply, and were not concerned (and as a matter of vires, could not be concerned) with its nature. On this point Park J followed the majority of the Court of Appeal in B J Rice & Associates v Customs and Excise Commissioners [1996] STC 581: see especially the judgment of Ward LJ at p 590, considering section 5(9) of the Value Added Tax Act 1983 (the counterpart of section 6(14) of the 1994 Act) but not referring to its "tailpiece". Park J therefore rejected the tribunal's view as to the lack of a direct and immediate link. He said (para 59):

    "The tribunal's second reason for its conclusion was that the direct and immediate link which was required was missing. If I agreed that the link was missing I would agree with the result which the tribunal reached. But, as I have said earlier, I consider that the direct and immediate link was not missing. If I understand the tribunal correctly, it considered that the quarterly rental payments which RSA made during the vacant unelected periods secured for it a series of separate inputs, each of which lasted for only three months. For the reasons which I have given earlier in this judgement, and which I will not repeat, I do not accept this analysis. In my view RSA's superior lease of each property was one input, not a multiplicity of separate short-term inputs, and all RSA's payments of rents (including service charge rents) during the vacant unelected periods were cost components of the input".

    82. In the Court of Appeal the majority (Aldous and Sedley LJJ) followed Park J in treating the relevant supply (as I understand it, to RSA) as the grant of the lease, despite regulation 85 (see especially the judgment of Aldous LJ at para 76). Arden LJ took a broader view of the scope of section 6(14) and regulation 85 (see paras 44, 45 and 49 of her judgment) and concluded (para 50), as the tribunal had, that there was no direct and immediate link. So the majority reached the same conclusion as Park J on broadly the same grounds.


    83. In my opinion Arden LJ was correct in her analysis and conclusion as to the scope of section 6(14) and regulation 85. That does not necessarily involve saying that B J Rice & Associates v Customs and Excise Commissioners was wrongly decided, as it was concerned with a different factual situation (an invoice sent to a client before the consultant was registered for VAT). On this point I cannot usefully add more to the observations of my noble and learned friend Lord Hoffmann, whose opinion I have had the advantage of reading in draft.

    84. However in a further evolution of the argument Mr Gammie QC did not really seek to uphold the reasoning of the majority of the Court of Appeal. He argued that even if the lease held by RSA ought to be regarded as a series of separate and successive supplies to it, those supplies had not been used for any purpose so long as the offices were vacant and unproductive. They were therefore still available, he said, to be attributed to taxable outputs made after 1995.

    85. In support of this proposition Mr Gammie cited a number of well-known authorities, including the decisions of the European Court of Justice in Intercommunale voor Zeewaterontzilting v Belgium (Case C-110/94) [1996] ECR I-857, Belgium v Ghent Coal Terminal NV (Case C-37/95) [1998] ECR I-1and Abbey National plc v Customs and Excise Commissioners (Case C-408/98) [2001] STC 297 and the decision of your Lordships' House in Svenska International plc v Customs and Excise Commissioners [1999] 1 WLR 769. I agree with Lord Hoffmann that the principles stated in these cases, although not in doubt, do not really assist RSA. Svenska turned on specific statutory provisions about grouping (which might be thought to have produced an artificial result, but arguably the real artificiality lay in Svenska's uncommercial conduct in leaving its output supplies unbilled for so long). Abbey National makes clear that cost components may include overheads, which is not in dispute but does not really get RSA home. Ghent Coal and Intercommunale were concerned with a single economic activity which would have made taxable supplies in due course, had it not been interrupted by compulsory acquisition (in Ghent Coal) or failed to get beyond the stage of a feasibility study (in Intercommunale).

    86. RSA's real grievance, it seems to me (emphasised by Mr Gammie's occasional references in his submissions to his clients having been honest and played fair) arises from the inescapable difference between a trader who makes taxable supplies and a trader who makes exempt supplies. If a trader is in business making only taxable supplies, and finds itself with a rented office or warehouse vacant because of over-capacity, it would be able to continue to deduct the input tax paid to the landlord (assuming the landlord to have opted to tax). That would be so even in the trader saw no prospect of subletting before the end of the lease, and resigned itself to some wasted expenditure. The wasted expenditure would still be a cost component of the business as a whole. It would be comparable (although the analogy cannot be taken too far) to perishable trading stock which had to be written off.

    87. Mr Gammie argued that his clients should not be at a disadvantage because they genuinely did not know what they wanted to do with the vacant offices, and were candid enough to acknowledge that. The point is made in RSA's printed case, para 5.16:

    ". . .the perishable quality of an input does not prevent its cost being a component of future outputs with a direct and immediate link to those outputs".

    The printed case also (in para 5.18) disputes whether there is any real analogy between perishable goods and:

    "the supply of the properties to RSA by its landlords for a quarterly period, [which] was part of a continuous chain of supply on which RSA's current ownership and ability to make taxable outputs depended".

    88. As I have said, the analogy cannot be pressed too far. But it is an inescapable consequence of the general structure of VAT that a trader who makes partially exempt and partially taxable supplies (or who switches from exempt to taxable supplies) cannot expect precisely the same treatment as one who makes taxable supplies throughout. That would be pressing the principle of fiscal neutrality too far. A trader whose outputs have in the past been wholly or partially exempt must, if he is to be able to reclaim input tax, be able to show that his position meets the fairly precise requirements of regulation 109, which is ultimately derived (through a chain of provisions which I need not repeat) from article 17(5) of the Sixth Directive. Even if successive input supplies of office accommodation can in some sense be described as a continuous chain of supply (which RSA had to pay for in order to avoid forfeiture), it was simply not possible for RSA, in or about November 1995, to use or form an intention to use (the crucial words in regulation 109(1)) supplies of accommodation for successive periods of three months, each of which was then past history. (That is not to say that some past supplies, especially of goods of a permanent nature, might not have come within regulation 109.)

    89. In my opinion the scope of section 6(14) of the 1994 Act, and the language of regulation 85, are ultimately decisive. For these reasons and for the further reasons in the opinion of Lord Hoffmann I would allow this appeal and restore the decision of the tribunal. In accordance with the terms on which leave to appeal was granted I would not disturb the order as to costs below and I would make no order as to costs before the House.

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