Case No: A3/2000/3463
Neutral Citation Number: [2001] EWCA Civ 1476
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM CHANCERY DIVISION
MR JUSTICE PARK
Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 9th October 2001

B e f o r e :

LORD JUSTICE ALDOUS
LORD JUSTICE SEDLEY
and 
LADY JUSTICE ARDEN
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	Royal and Sun Alliance Insurance Group Plc	Respondent 	
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	Commissioners of Customs & Excise	Appellant	

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(Transcript of the Handed Down Judgment of
Smith Bernal Reporting Limited, 190 Fleet Street
London EC4A 2AG
Tel No: 020 7421 4040,  Fax No:  020 7831 8838
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Mr Kenneth Parker QC and Mr Peter Mantle (instructed by Solicitors Office, H.M. Customs & Excise for the Appellant)
Malcolm Gammie (instructed by Messrs Linklaters & Alliance for the Respondent)

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Judgment
Lady Justice Arden :

1.	The issue on this appeal is whether Royal & Sun Alliance Insurance Group plc (“RSA”) can deduct input tax which it paid on rent to the landlords of premises let to it in the period from the early 1990s to 20 November 1995.  Prior to that date, it occupied these premises for its own purposes which involve the making of exempt supplies.  It then ceased to occupy the premises and sought subtenants on the basis that the lettings would either be an exempt supply or a supply subject to  value-added tax (“VAT”).  Later on 20 November 1995 RSA made an election to make taxable supplies of lettings.  The issue on this appeal therefore concerns the period after it had ceased to occupy the premises and before that election took effect.  It seeks to deduct the input tax paid to its landlords in this period.  The Manchester VAT Tribunal (Mr David Demack, Chairman) decided that RSA could not deduct this input tax.  In some cases, the input tax was paid by a member of its group but that distinction can be ignored for present purposes as all the companies are part of the same VAT group.
2.	Under section 5(1) and (2) of and paragraph 4 of the Fourth Schedule to the Value Added Tax Act 1994 (“VATA 1994”) the letting of property is a supply if made in the course of a business by a person registered for VAT.  According to the length of the lease the supply may be of goods or services but that distinction is not important in this case.  The supply of premises by way of letting is generally an exempt supply (VATA 1994, s 31). However a lessor can make an irrevocable election to waive this exemption (VATA 1994, s 51, 10 Sched 2(1), (4)).  A trader who pays input VAT in the course of his business may recover that tax from the Commissioners of Customs & Excise (“CCE”) provided that he has made this election and pays the input tax `in the course of a taxable activity.  RSA’s principal business is the business of insurance. 
3.	RSA did not seek recovery of the input tax on rent which it paid in the relative period, that is the prescribed accounting period in which it was potentially entitled to do so, because it had not then made an election for the purposes of section 51 of  VATA 1994.  The question is whether it can deduct that tax after it has made the election under regulation 109 of the VAT Regulations 1995 (SI 1995/2518) (“the VAT regulations”).  The input tax paid on rents payable in respect of the periods when the properties were vacant and before the election took effect amounted to over £400,000.  This included input tax on service charges but I need not refer to this separately.  
4.	Regulation 109 (made pursuant to VATA 1994, s.26(3)) so far as relevant provides:
“(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 … 
and in the 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 …
(2) … the Commissioners shall, on receipt of an application made by a taxable person …, pay to him an amount equal to the input tax which has become attributable to taxable supplies …”
5.	Regulation 109 is designed to implement Article 20(1) of the Sixth EC VAT Directive (“the Sixth Directive”).  This provides:
“1  The initial deduction shall be adjusted according to the procedures laid down by the Member States, in particular:
	(a) where that deduction was higher or lower than that to which the taxable person was entitled;
	(b) where after the return is made some change occurs in the factors used to determine the amount to be deducted, in particular where purchases are cancelled or price reductions are obtained; however, adjustment shall not be made in case of transactions remaining totally or partially unpaid and of destruction, loss or theft of property duly provided or confirmed, nor in the case of applications for the purpose of making gifts of small value and giving samples specified in Article 5(6).  However, Member States may require adjustment in cases of transactions remaining totally or partially unpaid and of theft.”
It is well-established that directive provisions must be construed purposively and in accordance with the general principles of Community law (see Shanning International Ltd v Rasheed Bank [2001] UKHL 31).  In this particular instance, however, the underlying directive provision throws little direct light on the effect of regulation 109 in the present case because of the discretion conferred on member states.  But if RSA is correct in its submission that unless the input tax paid in the void unelected period is deductible after it had made the election, Article 20(1)(a) would require an adjustment to be made, regulation 109 would have to be read in conformity with Article 20(1)(a).  However the question remains: is RSA entitled to deduct those inputs?
6.	Regulations 85 and 90 (made pursuant to VATA, s.6(14)) deal with the time  when goods and services supplied in consideration of a periodic payment are taken to be supplied:
“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.
(2) Where in respect of the grant of a tenancy or lease such as is mentioned in paragraph (1) above the supplier, at or about the beginning of any period not exceeding one year, issues a VAT invoice containing, in addition to the particulars specified in regulation 14, the following particulars-
	(a) the dates on which any parts of the consideration are to become due for payment in the period.
	(b) the amount payable (excluding VAT) on each such date, and
	(c) the rate of VAT in force at the time of the issue of the VAT invoice and the amount of VAT chargeable in accordance with that rate on each of such payments,
goods shall be treated as separately and successively supplied each time that a payment in respect of the tenancy or lease becomes due or is received by the supplier, whichever is the earlier …”
90. – (1) Subject to paragraph (2) below, where services, except those to which regulation 93 applies,  are supplied for a period for a consideration the whole or part of which is determined or payable periodically or from time to time, they shall be treated as separately and successively supplied at the earlier of the following times-
	(a) each time that a payment in respect of the supplies is received by the supplier, or 
	(b) each time that the supplier issues a VAT invoice relating to the supplies.
(2) Where separate and successive supplies of services as described in paragraph (1) above are made under an agreement which provides for successive payments, and the supplier at or about the beginning of any period not exceeding one year, issues a VAT invoice containing, in addition to the particulars specified in regulation 14, the following particulars-
	(a) the dates on which payments under the agreements are to become due in the period, 
	(b) the amount payable (excluding VAT) on each such date, and
	(c) the rate of VAT in force at the time of issue of the VAT and the amount of VAT chargeable in accordance with that rate on each of such payments,
services, shall be treated as separately and successively supplied each time that a payment in respect of them becomes due or is received by the supplier, whichever is the earlier. …”
In each case, subregulation (2) deals with the situation where the supplier issues an invoice with certain particulars while subregulation (1) deals with the situation where payment is made without an invoice or the supplier issues a standard VAT invoice.  The crucial words to note are that in each case the subregulations contain provisions for treating the goods or services as separately and successively supplied on (for example) each payment of consideration.  Consideration here must mean the rental payments and not the covenant for payment of rent in the lease.  I need refer below only to regulation 85 as the issues are precisely the same under regulation 90.
7.	Subsections (1) and (14) of section 6 of the VATA 1994 provide:
“6 Time of supply
(1)  The provisions of this section shall apply, subject to [sections 18, 18B and 18C] for determining the time when a supply of goods or services is to be treated as taking place for the purposes of the charge to VAT.
(14)  The Commissioners may by regulations make provision with respect to the time at which (notwithstanding subsections (2) to (8) and (11) to (13) above or section 55 (4)) 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
(b)	it is a supply of goods for consideration the whole or part of which is determined at the time when the goods are appropriated for any purpose….
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”
	I refer below to the concluding words of section 6(14) (commencing “and for any such case”) as the tailpiece to that provision.
The Tribunal’s decision
8.	The tribunal found as a fact that RSA was attempting to make either exempt supplies or taxable supplies of each of the properties depending on the terms it could agree with a prospective assignee or sub-lessee of its lease thereof (para 81).  RSA actively marketed the properties and thus attempted to make exempt supplies of all of them.  The tribunal held that it followed that RSA attempted to make exempt supplies of the properties throughout the period under consideration.  Regulation 109(a) would therefore be met.
9.	However the tribunal considered that the direct and immediate link required by paragraph 19 of the judgment of the European Court of Justice (“ECJ”) in BLP Group v CCE [1995] ECR 1-983 was absent.  The tribunal drew a distinction between supplies of a capital nature, and supplies of an income nature, such as rent and service charges.
10.	The tribunal held that, if RSA was correct, there would be a simple and obvious tax avoidance device open to banks, insurance companies and others most of whose supplies are exempt.
11.	The tribunal held that where a taxpayer has later elected to waive exemption under section 51 of VATA 1994 it did not follow that the supplies in the earlier period must be treated as having been used in making taxable supplies.
12.	The tribunal found that RSA had used the supplies made to it on which the input tax in issue was incurred in attempting to make exempt supplies.  Accordingly, in the tribunal’s view, RSA was not entitled to adjust its initial attribution of input tax on rents and service charges on the properties in the period concerned in the appeal.
Judgment of Park J
13.	In his judgment dated 20 October 2000, Park J held that RSA formed an intention within six years to use the inputs in making taxable supplies and that it manifested this intention by making an irrevocable election that future supplies of the properties made by it would be subject to VAT (judgment, para 31).  He further held that those inputs were cost components of making supplies to the sub-tenants because the payments to the superior landlords preserved the superior leases (judgment, para 36).  I refer to this below as (“the lease preservation point”).
14.	Park J held that there had to be a direct and immediate link between the inputs and the future taxable supplies.  He held that the necessary link existed in the present case and in so doing distinguished BLP Group v CCE (above).  
15.	The judge did not find it necessary to make a ruling on a wider submission by the taxpayer that it was not necessary to link specific inputs with specific outputs.  This submission was based on CCE v Redrow [1999] STC 161, at 165 per Lord Hope and at 170 per Lord Millett, and has not been repeated in this court.
16.	CCE submitted to Park J that the inputs were consumed in unsuccessful efforts to find tenants of its properties.  The judge disagreed with this submission (judgment, para 40). CCE also submitted that the inputs were transient in that they lasted for no more than the relative rent quarter.  The judge held that there was no case directly in point. He held that the grant of the lease was a single supply under the Fourth Schedule, para 4 to the VATA 1994 (judgment, para 43).  The judge further held that regulations 85 and 90 made no difference to his conclusion.  He held that regulation 85 did not create several supplies but merely staggered the timing of a single supply.  As a result of regulation 85 the landlord accounted for tax and the tenant took credit for input tax quarter by quarter.  The judge held that his conclusion on regulation 85 was confirmed by section 6(1) and (14) of the VATA 1994.  Those provisions conferred the power to make regulations as regards the time of supply.  The judge further held that the contrary conclusion would deprive the taxable person of the right of adjustment which article 20(1)(a) of the Sixth VAT EC Directive (“the Sixth Directive”) directs member states of the EU to apply.
17.	The judge criticised the tribunal’s decision for the following reasons:-
i)	The judge held that RSA was attempting to make exempt supplies as well as taxable supplies in the relevant period.  In any event even if its sole intention had been to make exempt supplies that would not matter because it had been unsuccessful in that attempt.
ii)	The judge rejected again the consumption argument put forward by CCE which he considered that the tribunal possibly had in mind.  He held that “a failed attempt to use an input in making supplies does not use it up”. (judgment, para 58).
iii)	The judge disagreed with the tribunal’s decision that there was no direct and immediate link.
iv)	The judge held that the letting of premises for payments of periodical rent was not a series of supplies.
v)	The judge noted that the tribunal’s argument based on avoidance was not pressed by the CCE on the appeal before him (Judgment, para 60).
vi)	The judge held that it was possible for the taxpayer to change his intention.
Appellant’s submissions
18.	Mr Kenneth Parker QC, for CCE, submits that the issue is whether RSA has used the relevant services which it received in the period prior to making its election in making taxable supplies after that election took effect.  There is no issue as to whether RSA incurred input tax on separate and successive supplies in respect of that period (which I will call “the void unelected period”); that RSA did not attribute its inputs in that period to taxable supplies because they intended to make use of them in making exempt supplies, and that RSA made no exempt supplies in the void unelected period.
19.	Mr Parker submits that each supply of the premises for rent, as defined by the payment of rental or the issue of a tax invoice, is a separate supply for VAT purposes.  He submits that in this case each separate and successive supply has been used by RSA in its unsuccessful attempts to make exempt supplies.  They were not used by RSA in making taxable supplies.  Moreover there is no direct or immediate link and those supplies were not cost components of the supplies after the date of the election.
20.	Mr Parker submits that Finanzamt Goslar v Breitshol [2001] STC 355, a decision of the ECJ, is authority for the proposition that if an input is consumed in the course of an unsuccessful attempt to make taxable supplies, it cannot be reattributed and recovered from the taxpayer.  At paragraph 34, the court said this:-
“In that respect it should be recalled that a person who has the intention, confirmed by objective evidence, to commence independently an economic activity within the meaning of article 4 of the 6th Directive and who incurs the first investment expenditure for those purposes must be regarded as a taxable person.  Acting in that capacity he has therefore in accordance with the article 17 et seq of the 6th Directive the right immediately to deduct the VAT payable or paid on the investment expenditure incurred for the purposes of the transactions which he intends to carry out and which gave rise to the right to deduct without having to wait for the actual exploitation of his business to begin …”
However Mr Parker accepts that there is no case of the European Court of Justice which deals with periodic supplies.  The Breitshol case may not have been available to the judge as it was decided only one month before he gave judgment and he does not refer to it.
21.	Mr Parker submits that there has to be a direct and immediate link between the goods and services supplied and the taxable person’s business as a whole: Midland Bank plc v CCE [2000] STC 501.  There was no such link here because the rents were used in unsuccessful attempts to find subtenants in the relevant period.  The Midland case again emphasises that once an entitlement to deduct has arisen, it is retained even if the economic activity envisaged does not give rise to taxable transactions or the taxable person has been unable to use the inputs for goods or services which gave rise to the deduction in the context of taxable transactions by reason of circumstances beyond his control (page 518, para 22).  As the Advocate General explains in his opinion in the Breitshol case, this exception is allowed in the interests of legal certainty (so that the right to deduct is not withdrawn retroactively) and is also founded on the principle of neutrality of VAT as a tax burden on business.  If the right to deduct could be withdrawn retrospectively, there would be an arbitrary distinction between businesses which were successful and those which were not.  
22.	Mr Parker also submits that the result contended for by RSA produces anomalies.  Where a person discontinues a business altogether, he cannot be made to repay the amount of inputs which he has incurred in making unsuccessful attempts to make supplies (see the Breitshol case, above).  The position should not be different where a taxpayer changes his business from one where he intends to make exempt supplies to one where he makes taxable supplies or vice versa.  Likewise, in the present case if RSA had made the election but had then decided to reoccupy the premises for the purposes of its own exempt insurance business, it would on RSA’s argument have been open to CCE to attribute the input tax deducted after the election on supplies in the period of its unsuccessful attempts to let the property on a taxable basis to its exempt activities.  CCE submit that no requirement for reattribution arises in these circumstances.  In effect if RSA is correct in its contentions it will be necessary to examine the entire period of the lease in order to ascertain whether inputs were deductible from the tenant’s outputs.  Mr Parker submits that the true position in these situations is that in the period of unsuccessful attempts the goods or services supplied to the taxpayer are in fact consumed in its unsuccessful attempts to start a new business.  He relies on Finanzamt Burgdorf v Fischer (European Court of Justice, 17 May 2001).  That case concerned a transfer of goods acquired for the purposes of a taxable business to private use.  The ECJ makes reference to the entire consumption of the goods in the course of the taxable activity and concludes at paragraph 95 that the input VAT paid by the taxpayer should be readjusted “if the value of the work in question has not been entirely consumed in the context of the business activity of the taxable person before the vehicle is allocated to his private assets”.  However the court gives no guidance on the meaning of consumption in this context.
23.	Mr Parker distinguishes Svenska International plc v CCE [1999] 1 WLR 769.  In that case the taxpayer provided management services to a company which at the time of rendering the services was not in its VAT group.  However it did not raise an invoice (and was therefore not paid) for these services until some considerable time later and after both companies had become members of the same VAT group.  At that point the supply of the management services was an exempt supply.  CCE sought to recover from the taxpayer the amounts for which it had claimed credit on the services supplied to it for the purpose of providing the management services.  The House of Lords held that adjustment was appropriate because, under regulation 23 of the Value Added Tax (General) Regulations 1985, (now replaced by regulation 90 of the VAT regulations) the services supplied by the taxpayer  were deemed to be supplied when the invoice was issued and not before.  The Court of Appeal (Butler-Sloss, Auld and Aldous LJJ)and the majority of the House of Lords held that the time of supply rules determined the question whether the supply as between the two companies was exempt or taxable and accordingly the counter-factual conclusion had to be drawn that there was no taxable supply between the two companies.  The argument that the goods or services had been used by the taxpayer before that date had to be rejected because, in the artificial world of VAT, that use (viz supply of services to the other company) was deemed to take place later.  The Svenska case was not a case of unsuccessful attempts to make supplies due to circumstances beyond the taxpayer’s control: see per Lord Hutton at page 785.
24.	Mr Parker criticises the judgment of Park J.  The judge was wrong to hold that “a failed attempt to use an input in making supplies does not use it up”.  The European jurisprudence shows that, if inputs are consumed in making unsuccessful attempts to start a business of making exempt supplies, they are no longer available to be attributed to later taxable supplies.  
25.	The judge was wrong to conclude that the grant of a lease was a single supply.  This conditioned his conclusion that the payment of rent in the void unelected period was a cost component of the payment of rent in later periods.  The correct approach was to regard the supply of property under a lease as a series of separate and successive supplies: see regulations 85 and 90 (above). The VAT legislation concentrates on outputs because the accounting party for VAT purposes is a person who makes outputs and the VAT regulations look at the position from the perspective of the landlord.  However, in the case of any supply, the recipient has to know what the supply is for VAT purposes in order to know whether it is taxable or exempt.  It is not possible for the tenant to re-characterise rent in some other way.  The judge was wrong in his conclusion that these regulations merely staggered the timing of a single supply.  Because he failed to stay within the VAT framework, the judge wrongly concluded that the payment of rent in the void unelected period was a cost component of making taxable supplies after the election.  Once each relevant period has been separately identified it is clear that the inputs relative to that period were consumed in failed attempts to let the properties.  If as here those attempts fail by reason of circumstances over which the taxpayer had no control, he retains his right of deduction.  The question would remain whether he had actually used the inputs in making exempt supplies.  On the facts in this case the inputs were clearly consumed in the earlier period. The six year period in regulation 109 is to deal with a number of situations.
26.	The judge was wrong to conclude that there was a direct and immediate link between the payment of rent in the void unelected period and in the periods after the election.
27.	An input can be used without a corresponding output, contrary to the respondent’s submission.  This is supported by article 20(1)(b) of the Sixth Directive which precludes retrospective adjustment of inputs for which credit has been taken when the relevant goods are (for example) destroyed.  
28.	The situation of RSA can be distinguished from that of a taxpayer who has made an election because RSA had failed to make the election and because of RSA’s failure there is justification for the distinction. So too in the Svenska case there was no unjustified discrimination between the taxpayer and a taxpayer who gave no grouping notice because Svenska had waited until after the companies were grouped for VAT purposes before issuing the tax invoice.  The Abbey National case is distinguishable because the issue there was whether a cost could be transferred to a taxable supply and, if yes, whether it should be attributed to general overheads or only to overheads of a discrete part of its business.
Respondent’s submissions
29.	Mr Malcolm Gammie, for RSA, submits that the judge was correct.  The lease was only a single supply.  RSA has not yet used the costs which it paid in the void unelected period in a VAT sense.  It could only use those costs in a VAT sense in making supplies.  It made no supplies in the void unelected period.  Moreover the costs incurred in the void unelected period were not used in the unsuccessful attempts to make exempt supplies.  Those rents were therefore cost components of making taxable supplies.  Regulation 109 therefore applies because before the intention to make exempt supplies was fulfilled RSA reattributed the inputs.  The words “before the intention is fulfilled” mean before exempt supplies are made.  The goods and services to which regulation 85 applies are those to be supplied throughout the whole period of the lease.  
30.	Mr Gammie submits that arbitrary and distorted results would follow from CCE’s submissions.  This is because one cannot distinguish between the taxpayer who elects when the property becomes vacant and the taxpayer who waits and sees and later makes an election.  That would be a wholly arbitrary distinction. 
31.	Mr Gammie relies on Abbey National plc v CCE [2001] STC 297, a decision of the ECJ post-dating the judge’s decision in this case.  In that case Abbey National succeeded in establishing that it was entitled to deduct the costs attributable to a transaction which was not a supply, that is the transfer as a going concern of a leasehold property from which it had conducted the business of sub-letting to tenants, which formed a discrete part of a larger business involving both taxable and exempt supplies.  The ECJ held that if (1) the services supplied had a direct and immediate link with a clearly defined part of the taxable person’s economic activities (here the letting of a property), (2) the costs formed part of the overheads of that part of the business, and (3) all the transactions relating to that part of that business were subject to VAT, the VAT incurred on the costs of purchasing those services was deductible.
32.	Mr Gammie submits that the question whether there was a direct and immediate link is a question of fact (see Midland Bank v CCE, above).  The direct and immediate link exists in the VAT sense in the present case because the output could not have been earned without the input.
33.	Mr Gammie relies on the principle of neutrality in VAT.  If a person pays tax on inputs he is able to deduct that input tax from the VAT for which he is accountable on his outputs (see Midland Bank plc v CCE; Abbey National v CCE).
34.	Mr Gammie submits that the initial attribution of inputs cannot be altered just because the planned economic activity has not given rise to outputs and it then becomes impossible to make outputs at all. He submits that this is the proposition established by Belgium v Ghent Coal Terminal NV [1998] ECR, 1-1, ECJ.
35.	Mr Gammie submits that the decision in Svenska shows that inputs can be accumulated and then used later.  The reason why relief was not possible in Svenska was that the relevant invoice was not raised until after the VAT grouping.  Mr Gammie submits that the only difference between the present case and Svenska is that the critical event was an election to waive an exemption from VAT in the present case whereas it was a grouping notice in the Svenska case.
36.	Likewise on Mr Gammie’s submission it is incorrect as a matter of VAT law to distinguish inputs generated during preparatory acts and inputs generated during the activities which constitute the business.
37.	Mr Gammie submits that section 6 and regulation 85 are framed in terms of the charge to VAT, that is outputs.  Accordingly they do not affect the character of the supply, in this case a twenty-one year lease providing for rent to be payable periodically.  Regulation 85 says nothing about inputs.  Regulation 85 does not deal with the direct and immediate link between an input and an output.  Mr Gammie submits that the “consideration” for the purposes of regulation 85 is the amount of the rent received.
38.	Mr Gammie accepts that an input cannot be deducted from a later output if it has been “consumed” in the meanwhile.  However he submits that no consumption in a VAT sense takes place until there is a correlative output.
Conclusions
39.	Regulation 109 provides strong support for RSA’s case.  RSA incurred input tax on rents which it paid in the void unelected period.  It made no attribution of those supplies to any particular supplies by it.  It did not achieve its objective of subletting the properties in question in that period, and so its intention to make exempt supplies was unfulfilled for the purposes of regulation 109.  It attributed the input tax it paid in the void unelected period to taxable supplies which it made after the date on which it elected to waive the exemption for sublettings by it.

40.	The judge, who has considerable experience in matters of taxation, subjected RSA's case to detailed analysis.  His judgment proceeds in a series of sequential steps.  He examined the proposition that RSA had the necessary intent to make exempt supplies (as required by  regulation 109(a)).  He held  that RSA had this intent although RSA also intended in the alternative to make taxable supplies.  Briefly he held that it was sufficient to have an intention in the alternative because a trader could not establish a right to make a deduction for an input unless he could show that the supplies were to be used exclusively in making taxable supplies (regulation 101(2)(b) of the VAT regulations).  CCE have not sought to challenge that conclusion on this appeal.  The judge held that RSA could acquire an intention to use the inputs in making taxable supplies (judgment para. 35). The judge then moved to the question whether the supplies in the void unelected period were cost components of the later taxable supplies.  He held that because of the lease preservation point the inputs in the void unelected period were cost components of the subsequent taxable supplies.   For the same reason there was a direct and immediate link between the inputs in the void unelected period and the subsequent taxable supplies.  He rejected the arguments that the inputs were consumed in the void unelected period or were time-expired in this period (judgment para. 40).  Each lease was a single supply because the tenant undertook to pay the rent for the whole period of the lease when the lease was executed (judgment para. 42) and this conclusion was not affected by regulation 85.  Regulation 85 did not create several supplies where there would otherwise only be a single supply  (judgment para. 49). That regulation was limited to staggering the timing of the supply and does not otherwise affect the nature of the supply. If it did so it would be inconsistent with the taxpayer's right of deduction (judgment para. 51).  The judge thus tested his conclusion by the fundamental principles of VAT:  "The fundamental rule of VAT is that a business which itself makes taxable supplies outward to its customers, and which incurs input tax on some inward supply to it which it uses for the purpose of its business, should recover the input tax" (judgment, para. 14), and that VAT is only chargeable after deduction of input tax borne directly on the various cost components of taxable supplies (judgment, para. 35).  He recognised that inputs cannot be deducted twice (judgment para. 58). 
41.	I have set out the parties' cases in detail above.  However, the essence of CCE's attack on the steps in the judge's reasoning is on his conclusion that the lease was a single supply and  his conclusion that the inputs in the void unelected period were available for later use against taxable supplies. The essence of RSA's case is that inputs can only be used in making outputs and that regulation 85 does not convert the rental payments into separate and successive supplies so far as it was concerned as tenant.  The Svenska case shows that a taxpayer can accumulate  inputs and credit them against its outputs later.
42.	In most cases, it is easy to tell when goods or services have been used because they cease to be available for further use.  If a trader uses his telephone to make telephone calls about business A, he cannot subsequently seek to recover the input tax from the outputs of a different business. It is much more difficult to tell whether the goods or services whose inputs RSA seeks to deduct were used and the answer to that question in turn depends on what the supply by RSA’s landlord to RSA of premises comprised. 
43.	That takes one to regulation 85.  It is common ground that this regulation reflects requirements of the Sixth Directive (see article 10(2)).  Regulation 85  deals with the time of supply.  It makes it clear that the fiction must be adopted that the lease is a subject of a number of separate and successive supplies.  The judge’s conclusion was that this fiction was for the purpose only of defining the time at which a lessor had to account for VAT on an instalment of rent and conversely when a tenant could take credit for inputs on payments of rent.  It had no further purpose.  But this is only one aspect of the time of supply of goods or services.  The regulation is not expressed to apply to any particular aspect of the time of supply.  Accordingly I would not accept that Regulation 85 has to be regarded as limited in such a way that the time of supply rules do not affect the question whether a trader has a right to make a deduction:  the question whether he has a right of deduction depends on whether the supplies are to be used (and are available to be used) in making a taxable supply and  whether there is a sufficient direct  and immediate link for this purpose.  The time of supply may be indirectly relevant in determining these questions.  
44.	In my judgment the deeming of the time of supply must affect the nature of the supply and thus no valid distinction can be made between (on the one hand) the staggering of the time of supply for the purpose of determining when outputs must be accounted for and when credit can be taken for input tax  and (on the other hand) determining what goods and services have been supplied for the purposes of regulation 109.  For both purposes it is necessary to know whether an input should be treated as related to a specific period.  The tailpiece to section 6(14) of VATA 1994 in my judgment would have been unnecessary if power was being taken merely to make rules as to the time of supply without any further substantive effect.  That tailpiece is expressly replicated in regulations 85 and 90.
45.	Moreover in my judgment regulation 85 must apply to a supply whether it is viewed from the supplier's perspective or that of the recipient.  RSA’s argument (not an argument on which the judge relied) is that regulation 85 deals only with outputs and not with inputs because the enabling power in section 6(1) of VATA 1994 gives power to make regulations respecting the time of supply “for the purposes of the charge to VAT”.  Those rules must however necessarily affect the amount of input tax for which the recipient of those supplies can exercise the right of deduction conferred by sections 25 and 26 of VATA 1994.  Any other conclusion would produce a mismatch between outputs and inputs.  Accordingly in my judgment the judge was wrong to conclude that the lease was a single supply. He should in my judgment have held that, in the case of periodic supplies, in determining for the purpose of regulation 109 what goods and services have been supplied relative to any input tax which the trader seeks to have adjusted, the time of supply rules apply.  The regulations provide no other basis of apportionment and clearly the relevant goods and services have to be identified in some way in order that the court and the CCE may know whether the conditions in regulation 109 are fulfilled: specifically whether the trader is right in his contention that his intention to use the inputs in making exempt supplies has not been fulfilled.  
46.	Moreover, on Mr Gammie's interpretation of the words "before that intention [sc. the intention to use the goods or services in making exempt supplies] is fulfilled", the requisite intention  must always remain unfulfilled until the goods or services are utilised in making supplies and on this interpretation  re-adjustment could be claimed even where goods are destroyed.  This interpretation would be contrary to article 20 (1)(b) of the Sixth Directive and must for that reason too be rejected.
47.	The essence of RSA’s case is that there was no use of the inputs until a taxable supply of the premises was made.  However the European jurisprudence shows that it is possible to fulfil an intention to use an input by using that input in its unsuccessful attempts to carry out activities (see Belgium v Ghent Coal, above, and see also article 20(1) (b) of the Sixth Directive).  The judge held that these authorities are not concerned with a subsequent adjustment if the original intention is not fulfilled (see judgment para. 54).  That is strictly correct but the point they establish is that the taxpayer cannot be deprived of his right to deduct once it has arisen.  It follows from that point that an input must be capable of being used by a trader  in a VAT sense in his business at a stage prior to that of making supplies: in the Ghent case that  business consisted of the failed attempt.  Accordingly I do not consider that the judge was correct when he held "I cannot agree that a failed attempt to use an input in a supply uses it up" (judgment para. 58).  Nor is his narrow reading and distinction of the Ghent case one with which I can agree.  Moreover it is not suggested that it is possible for RSA to attribute inputs to further supplies once they have been used in a VAT sense.  Attribution is not merely a question of volition of the taxpayer: a trader’s ability to attribute inputs to outputs is lost once those inputs have been consumed.  Furthermore, there has to be a direct and immediate link between the input and his activities.
48.	There is no jurisprudence on the meaning of consumption. This CCE has accepted. The test of what constitutes "consumption " in a VAT sense must be a question of law, but whether in any particular case that test is fulfilled must be a question of fact.  So far as the former is concerned, there is perhaps, in the case of a periodic payment, a conflict between the principle that the existence of the direct and immediate link between an input and a taxable supply is a question of fact for the courts of the member state and the legal fiction in regulation 85.  Again there is no ECJ authority on this point.  However it seems to me in principle that in determining whether tax on a supply is available for deduction against tax for which the trader must account one must, in the context of periodic payments, continue to apply the time of supply rules.  There is nothing in the regulations or in the Sixth Directive to which our attention has been drawn which indicates that there is a distinction to be drawn here.  Nor does the case of B.J. Rice v CCE[1996] STC 581, a decision of this Court, on which the judge relied (judgment para. 50) require this distinction to be made:  in that case very different considerations arose because the issue was whether the time of supply rules could result in the imposition of a liability to account for VAT on a person who was not a taxable person at the time he supplied and raised an invoice for the services in question (and in so far as the case is thought to establish any wider restriction on the time of supply rules, see per Lord Hoffmann, dissenting, in CCE v Thorn Material Supplies Ltd [1998] 1 WLR 1106, 1119 ).  
49.	For all the reasons given above, I proceed to the question of use from the perspective of regulation 85.  Each of the words "separate" and "successive" has to be given meaning, and this can only be done in my judgment by treating each payment of rent as a payment for the supply of services for the relative period of time. Only in that way are the payments both separate and successive.  The tribunal reached its decision in effect by this route.  Neither party has asked us to remit this case to the tribunal.  Mr Gammie accepts that if he fails on his submissions and the time of supply rules apply for the purpose of determining whether consumption has occurred,  what was supplied in consideration for each payment of rent was the right to use the premises for a given period.  That was the supply in each successive and separate period.  Each supply enabled RSA either to occupy the premises itself or (with the consent of the landlord) to sublet the premises in the relative period.  It no longer had either of those opportunities once the relative period had passed.  Accordingly in my judgment each supply was fully used up when the last day of the period had expired and the tribunal was correct in its conclusion that the inputs had been used.  It follows that those supplies to RSA cannot be used by RSA in making taxable supplies at a later date and regulation 109 does not entitle RSA to a repayment of the input tax which it paid on those supplies.
50.	It follows that there was no direct and immediate link between the supply of the premises for the particular period and their use in a subsequent period.
51.	Mr Gammie places reliance on the Svenska case because in that case the House of Lords held that the taxpayer had not used inputs it obtained until it raised an invoice for the management services that it was supplying: hence it supports to that extent his submission that inputs are not used in a VAT sense until supplies are made.  It is correct that but for the grouping notice the taxpayer could in that case have accumulated its inputs and raised an invoice for the relative supply of services by it later.  Undoubtedly the Svenska case illustrates these points.  However  I agree with Mr Parker that this case is in fact against Mr Gammie's submissions: the reason why the taxpayer failed to maintain the credit it had claimed was because of the time of supply rules and the decision in that case illustrates that the time of supply rules must be applied even when to do so requires an artificial and counter-factual conclusion to be drawn as to when supplies were indeed made. 
52.	I do not consider that the result in this case contravenes the fundamental rule of deduction to which the judge referred.  A trader only has a right of deduction if he uses an input for the purpose of a taxable activity.  If RSA used the input in the course of an exempt activity, there was no right of deduction.  There would conversely have been a right of deduction if it had made an election at the start of the void unelected period and in that event, following Ghent Coal, it could not have been deprived of its right of deduction if it never succeeded in finding subtenants of the properties. (I do not consider that this point provides support for RSA, as the judge suggested in para. 44 of his judgment).  Accordingly there is no  arbitrary distinction between the position of RSA in this case and the position of a trader who made the election at the start of the void unelected period.  The position of the parties is different because their rights are different:  RSA did not acquire the right of deduction until it made the election and thereafter it could only deduct inputs which it had not already used.  The type of arbitrary distinction which was rejected in the Abbey National case (as between the whole and the discrete part of the business) does not arise here.  Nor is there any question of withdrawal of a  right of deduction for the same reason.  RSA never acquired the right of deduction in respect of inputs which it used up before it made its election and accordingly this case does not entail arbitrary or distorting results.
53.	In my judgment the appeal should be allowed.

SEDLEY LJ:

54.	Beyond the everyday world, both counsel have explained to us, lies the world of VAT, a kind of fiscal theme park in which factual and legal realities are suspended or inverted.
55.	Regulation 85 of the 1995 VAT Regulations, for example, expressly applies only where “the whole or part of the consideration” for the grant of a tenancy or a long lease is payable periodically.  It is elementary, at least in the world ordinarily inhabited by lessees, lessors and lawyers alike, that the consideration for a lease is not the periodic payment of rent, but the tenant’s covenants to do or not to do a variety of things, among them paying the rent.  The difference is far from abstract: it matters, critically, for instance, if the lessee gets into rent arrears.  
56.	It seems to follow as a simple matter of meaning that Regulation 85 does not apply to the present case.  If it had been intended to treat rental payments as if they were consideration for the grant of the leases, nothing would have been simpler than to say so.  
57.	But, in the world of VAT, it seems, this does not matter.  Both counsel (understandably unwilling to cut off the branch on which they are sitting) submit that the word “consideration” in Regulation 85(1) has to be read as if it meant something which is neither its  legal meaning nor its practical meaning nor its assigned meaning, by treating the conclusion of the provision (the deemed periodicity of supplies) as modifying its premise (the consideration for those supplies).  Since both other members of the court accept this novel method of reasoning and found their conclusions upon it, my respectful protest fades on the page.  What follows therefore adopts the premise that tenure (“goods”) is to be treated as separately and successively “supplied” quarter by quarter under the material leases.  
58.	Once through this hermeneutic turnstile, it seems to me that Park J was right in his conclusion and in the essence of his reasoning on the grounds given by Aldous LJ: the taxpayer is carried to safety by Regulation 109.  While I see the logic of Arden LJ’s impressive reasoning to the contrary, and while I agree with her that mere counter-factuality is neither here nor there in the world of VAT, I agree with Aldous LJ that the difference between “use” and “consumption” is on inspection a diversion.  I do not see in Regulation 109 a gap through which the time of supply rules can be – or need to be – introduced as an increment to the artificial periodicity created by Regulation 85.  It may be, in this complex parallel universe, that such relatively uncomplicated solutions are a snare and a delusion; but even judges can be forgiven for seeing their attraction.
ALDOUS LJ:
59.	I have had the advantage of reading in draft the judgment of Arden LJ.  As it contains a full recitation of the submissions, I will confine my judgment to the reasons why I have concluded that the appeal by the Commissioners of Customs and Excise against the order of Park J of 20th October 2000 should be dismissed.  
60.	This appeal arises out of a claim by Royal Sun Alliance Insurance Group Plc (RSA) to repayment of VAT paid by them to landlords of properties during a period in the 1990s before 21st November 1995.  I will refer to that period as the vacant unelected period.  I use the word “vacant” as during the period the properties were not occupied by RSA and had not been re-let and the word “unelected” as RSA had not elected to “opt to tax” the lettings of those properties despite their attempts to let them.  The date of 21st November 1995 is the date when RSA elected to opt to tax.
61.	There is no dispute as to the fundamental rules of VAT.  They were set out by the European Court of Justice in Abbey National Plc v Customs and Excise Commissioners (Case C-408/98) [2001] STC 297 at 312:
“24.  It should be noted, to begin with, that 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 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, Rompleman v Minister van Financiën (Case 268/83) [1985] ECR 655 at 664, para 19; Belgium v Ghent Coal Terminal NV (Case C-37/95) [1998] STC 260 at 272, [1998] ECR 1-1 at 23, para 15; Gabalfrisa SL and ors v Agencia Estatal de Administractión Tributaria (AEAT) (Joined Cases C-110/98 to C-147/98) [2000] ECR 1-1577, para 44; and Midland Bank Plc v Customs and Excise Comrs (Case C-98/98) [2000] STC 501 at 518, para 19).  
25.  Article 17(5) of the Sixth Directive, in the light of which para 2 of that article must be interpreted, lays down the rules applicable to the right to deduct VAT where the VAT relates to input transactions used by the 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’.  The use of that provision of the words ‘for transactions’ shows that to give rise to the right to deduct under para 2 the goods or services acquired must have a direct and immediate link with the output transactions which give rise to the right to deduct, and that the ultimate aim pursued by the taxable person is irrelevant in this respect (see BLP Group plc v Customs and Excise Comrs (Case C-4/94) [1995] STC 424 at 437, [1996] 1 WLR 174 at 198-199, paras 18 and 19, and Midland Bank plc v Customs and Excise Comrs (Case C-98/98) [2000] STC 501 at 518, para 20).   
26.  As the court held in para 24 of Midland Bank ([2000] STC 501 at 518), art 2 of the First Directive and art 17(2), (3) and (5) of the Sixth Directive must be interpreted as meaning 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 the right to deduct is necessary before the taxable person is entitled to deduct input VAT and in order to determine the extent of such entitlement.”			
62.	Section 5(2)(a) of the Value Added Tax Act 1994 makes it clear that the letting of property is a supply of goods or services if, as in this case, it is made in the course of business by a person registered for VAT.  Section 31 and schedule 9 provide that the grant of a lease is an exempt supply.  However section 51 and paragraph 2 of schedule 10 enable a person to opt to tax.  Although the provisions of that schedule are complicated, it is agreed between the parties that the general rule that a letting of a property is an exempt supply, can be excluded by an election made by the lessee.  The result is that from the time of the election the letting is taxable, in the sense that VAT has to be charged by the lessor and paid by the lessee.  
63.	In this country the general law considers that the grant of a lease is one transaction.  The landlord grants the lease in consideration of the covenants in the lease, one of which is to pay the rent, usually periodically in advance.  Thus it could be thought that on the grant of a lease there was just one supply.  That of course would be inconvenient for VAT purposes.  Thus deeming provisions provide for periodical accounting.  They are contained in regulations 85 and 90 of the 1995 VAT Regulations (SI 1995 No. 2518).  It is only necessary to consider regulation 85(1) which is in these terms:
“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 of 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.”
64.	The word “consideration” in Regulation 85(1) cannot be read as meaning the covenants in the lease.  It covers the periodic payments required to be paid by the lessee.  Importantly, it should be noted that the regulation is directed to when consideration is payable.  Thus it provides that the goods upon which VAT is to be charged “shall be treated as separately and successively supplied … each time the supplier issues a VAT invoice … relating to the grant.”   The consequence is a lessor who opts to tax must charge VAT on an invoice for rent or receipt of rent and the lessee must pay the VAT as of that date.  This regulation fixes the VAT date so as to coincide with the rent payment provisions in the lease.  
65.	The effect of Regulation 85 can be seen when applied to the facts of this case.  The landlords, who had opted to tax, invoiced RSA for the quarterly rents during the vacant unelected period.  The invoices included VAT.  To the lessors that was an output.  The rent and the VAT was paid by RSA.  That VAT was an input tax of RSA’s, but during the vacant unelected period RSA made no letting.  Further during that period they had no right to repayment of the VAT charged by the lessors as they were not carrying on an economic activity which was subject to VAT (see the Abbey National case).  RSA’s attempts to let the properties were activities relating to exempt supplies and their general business did not have the relevant direct and immediate link.  
66.	It is at this stage that the views of the Commissioners diverge markedly from those advanced on behalf of RSA.  Mr Parker QC, who appeared for the Commissioners, submitted that the supplies to RSA were, during the vacant unelected period, fully used by RSA before it commenced making taxable supplies after the vacant unelected period ended in November 1995.  He also submitted that there was no sufficient direct and immediate link between the input and the outputs represented by the granting of the leases after the period had expired.  
67.	Mr Gammie for RSA was not prepared to accept those submissions.  He submitted that inputs could only be used by treating the costs as a cost component of an output and that there could be no use of an input unless there was an economic activity subject to VAT to which it related.  In support he referred us to Svenska International Plc v Customs and Excise Commissioners [1999] 1 WLR 769.  He went on to submit that in the vacant unelected period the inputs (the VAT on the rent) had not been used by RSA.  He also submitted that as from the end of the vacant unelected period there was a direct and immediate link between the inputs and the subsequent outputs.  
68.	It may be that Mr Parker and Mr Gammie are attributing different meanings to the word “used”.  In one sense the inputs were used because the relevant accounting period had come and gone.  In another they had not been “consumed” in a VAT transaction in that they had not been set off against an output nor had they been reclaimed.  They had in fact been paid during a relevant accounting period and were not recoverable as there had been no option to tax.  
69.	For my part, I believe that the difference between Mr Parker and Mr Gammie is irrelevant to a resolution of the essential dispute, namely whether RSA are entitled to repayment of the input payments made during the vacant unelected period, after they had opted to tax on 21st November 1995.  That in my view depends upon the construction of regulation 109 of the 1995 Regulations.  It provides:
“109 – (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 6 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 a 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 questions 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.”	

70.	At the outset it must be noticed that sub-regulation (1) is concerned with the 6 year period commencing with a particular accounting period.  Thus it requires payment by the Commissioners in respect of all accounting periods that fall within the 6 year period.  In essence there is a 6 year limitation period.  Further it is said to apply where a tax payer meets the criteria set out.  There is no other qualification.  

71.	The regulation requires RSA, a taxable person, to establish that:
(1)  it has incurred an amount of input tax;
(2)  the amount of input tax incurred has not been attributed to taxable supplies;
(3)  the reason why the input tax was not attributed to taxable supplies was because RSA intended to use the services in making exempt supplies or taxable and exempt supplies;
(4)  the intention was not fulfilled;
(5)  RSA used or formed the intention to use the services concerned in making taxable supplies.

72.	It is noteworthy that the regulation does not talk about an input being “used”.  The stated threshold is in (2) above, namely that the amount of input has not been attributed to taxable supplies.  Thus it is contemplated that some of an input could have been attributed and some may not have been.  

73.	I conclude that RSA have satisfied all the five requirements of regulation 109.  RSA incurred an amount of input tax when they paid the lessors.  Nothing was attributed to a taxable supply in that any supply made was an exempt supply.  The reason why the input tax was not attributed was because RSA were, in the words of the tribunal, “attempting to make either exempt supplies or taxable supplies of each of the properties depending upon the terms it could agree with a prospective assignee or sub-licensee of its lease thereof … in other words …, viewed subjectively, RSA attempted to make whichever type of supply suited its own purposes.”  To that I add that the arrangement when viewed objectively would be the same as when viewed subjectively.  

74.	RSA did not grant any leases and therefore no exempt supplies were made.  It followed that the intention was not fulfilled until they changed their minds and opted to tax.  At that stage they formed an intention to use the services in making taxable supplies and subsequently did so.  
75.	To my mind the crucial question that arose on the appeal was not whether RSA had “used” the inputs, but was whether the inputs which were incurred during the vacant unelected period had been used or were intended to be used “in making a taxable supply … or both taxable and exempt supplies.”  In effect that requires there to be a direct and immediate link between the inputs and the taxable supplies to be made after the vacant and unelected period had ended.  
76.	In my view the judge was right to consider the relevant supply as the grant of the lease.  That remained the relevant supply despite the fact that regulation 85 provided that VAT had to be charged and paid periodically.  It was the lease which RSA sought to supply to others and did ultimately supply.  No doubt RSA would have had to charge VAT periodically, but that does not alter the nature of the supply made.  In any case there was a direct and immediate link between the VAT charged by the lessors and that charged by RSA after their decision to opt to tax.  Certainly if there was a link, it was not indirect.  It was also immediate after that decision.  That is emphasised by the six year period allowed for a change of use in regulation 109.  There was in my view a direct and immediate link between the supply by lessors to RSA and the supply by RSA to their lessees.  
77.	For the reasons that I have given I believe that the judge came to the right conclusion for essentially the right reasons.  I therefore would dismiss the appeal.  
Order: Appeal dismissed with costs; permission to appeal to the House of Lords refused.

(Order not part of approved judgment)