Case No: CH/2005/APP/0729

Neutral Citation Number: [2006] EWHC 706 (Ch)
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

Royal Courts of Justice
Strand, London, WC2A 2LL

Friday 31st March 2006

Before :

THE HONOURABLE MR JUSTICE HART
- - - - - - - - - - - - - - - - - - - - -
Between :

	THE MAYFLOWER THEATRE TRUST LTD	Appellant	
	- and -		
	THE COMMISSIONERS OF HER MAJESTY’S REVENUE AND CUSTOMS	
Respondents	

- - - - - - - - - - - - - - - - - - - - -
- - - - - - - - - - - - - - - - - - - - -

Ms. Philippa Whipple (instructed by Deloitte & Touche LLP) for the Appellant. 
Mr Sean Wilken and Ms. Eleni Mitrophanous (instructed by HM Revenue & Customs, Solicitor's Office) for the Respondents. 

Hearing dates: 21/22 March 2006
- - - - - - - - - - - - - - - - - - - - -
 Judgment

Mr Justice Hart : 
Introduction
1.	This is an appeal by The Mayflower Theatre Trust Ltd (“the appellant”) against the decision of the VAT & Duties Tribunal given on 26th August 1995.  The appellant (which together with its wholly owned trading subsidiary is and has since 1st April 1997 been registered as a group for VAT purposes) is a charity which runs one of the largest theatres in the country and has as its objects “the encouragement of the Arts, the promotion and advancement of education and the cultivation and improvement of public education in drama, mime, opera, singing, music, dance, painting and sculpture, cinema, literature and other arts”.  In furtherance of those objects it puts on performances at the theatre.  The performances are all bought in from production companies.  The cost of purchasing those supplies is financed largely by sales of tickets to the general public which admit them to the performances, but also by a variety of ancillary activities carried on by the group, such as sales of programmes, sales of food and drink, sale of sponsorship rights and so forth.  Consequent on the decision of the ECJ in CEC v The Zoological Society of London [2002] STC 521 the group’s sales of tickets to the public have been treated as exempt supplies for VAT purposes, coming within the cultural exemption from VAT established by Article 13A(1)(n) of the Sixth VAT Directive (77/388/EC).  The other supplies made by the group are, however, taxable.
2.	The question raised by this appeal is whether the input tax paid by the group on the supplies made by the production companies in the period from 1st March 1999 to 7th December 2002 can be deducted.  
3.	So far as domestic legislation is concerned the answer to that question is, by virtue of the provisions of s. 26(1) – (3) of VATA 1994, that the tax can be deducted so far as “attributable to” taxable supplies, the rules for determining what may be so attributable being found in Regulation 101(2) of the VAT Regulations (SI 1995/2518) which (so far as material) provide
“(b)	 there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies,
(c)	no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies … shall be attributed to taxable supplies,
(d)	there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period.”
4.	The Tribunal upheld the contention of the Commissioners that the whole of the services supplied by the production companies were used by the group exclusively in making the exempt supplies represented by the sale of tickets, and that therefore, by virtue of Regulation 101(2)(c), no part of the input tax paid was deductible.  The appellant’s contention had been that the case was one where Regulation 101(2)(d) applied.  Although the term is not one used in the legislation, tax which is deductible by virtue of Regulation 101(2)(d) is commonly referred to by the convenient shorthand expression “residual tax” and I use that expression accordingly in this judgment.
The European legislation
5.	The material provisions contained in s. 26 VATA and Regulation 101(2) derive from Article 2 of the First Council Directive (67/227/EC) and from the Sixth Directive itself.  Article 2 of the First Council Directive provides that
“…On each transaction, value added tax, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components.”
6.	By Article 17(2) of the implementing Sixth Directive a taxable person is given the right to deduct input tax
“in so far as the goods and services are used for the purposes of his taxable transaction”
7.	Article 17(5) provides: 
“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”
Within certain parameters Member States are at liberty to devise their own methods of determining the attributable proportion.
The European jurisprudence
8.	Four cases decided by the ECJ were cited to me as relevant to an understanding of input tax deduction, namely Case C-4/94 BLP Group plc v CCE [1995] STC 424 (“BLP”) ; Case C-98/98 Midland Bank plc v CCE [2000] STC 501 (“Midland Bank”); Case C-408/98 Abbey National plc v CCE [2001] STC 297 (“Abbey National”); and Case C-465/03 Kretztechnik AG v Finanzamt Linz (“Kretztechnik”).  
9.	In BLP the issue concerned input tax on invoices rendered by professional advisers in connection with the sale by BLP of shares held by it in a subsidiary.  That sale was an exempt transaction.  The purpose of the sale had been to raise money to pay debts which BLP had incurred in connection with its taxable transactions.  The ECJ held (at paragraph 19 of its judgment) that:
“..The use [in Article 17(5)] of the words “for transactions” shows that to give the right to deduct under para 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”
and (in paragraph 28) that
“where a taxable person supplies services to another taxable person who uses them for an exempt transaction, the latter person is not entitled to deduct the input VAT paid, even if the ultimate purpose of the transaction is the carrying out of a taxable transaction.”
10.	In Midland Bank the issue concerned input tax on legal fees incurred by Midland in defending itself from a claim that it had acted negligently in supplying services in connection with a transaction which was in fact aborted.  The services supplied in relation to the abortive transaction were taxable, but Midland’s business consisted of the supply of both taxable and exempt services.  The issue was whether the tax on inputs which it had incurred in defending itself against the subsequent claim for negligence was deductible.  Midland argued that the input tax on the legal fees was sufficiently closely connected with the taxable supply to entitle it to deduct the whole of the input tax.  The UK argued that it was not but that it should be treated as part of Midland’s general business activities and apportioned accordingly as between its exempt and taxable supplies.  The court upheld the latter contention, and its reasoning was expressed thus:
“29.  It should be borne in mind that, according to the fundamental principle which underlies the VAT system, and which follows from art 2 of the First and Sixth Directives, VAT applies to each transaction by way of production or distribution of the VAT directly borne by the various cost components (see, to this effect, BP Supergras Anonimos Etairia Geniki Emporiki-Viomichaniki kai Antiprossopeion v Greece (Case C-62/93) [1995] STC 805 at 821, [1995] ECR I-1883 at 1913, para 16).
30.  It follows from that principle as well as from the rule enshrined in the judgment of BLP Group plc v Customs and Excise Comrs (Case C-4/94) [1995] STC 424 at 437, [1995] ECR I-983 at 1009, para 19 according to which, in order to give rise to the right to deduct, the goods or services acquired must have a direct and immediate link with the taxable transactions, that the right to deduct the VAT charged on such goods or services presupposes that the expenditure incurred in obtaining them was part of the cost components of the taxable transactions.  Such expenditure must therefore be part of the costs of the output transactions which utilise the goods and services acquired.  That is why those cost components must generally have arisen before the taxable person carried out the taxable transactions to which they relate.
31.  It follows that, contrary to what the Midland claims, there is in general no direct and immediate link in the sense intended in BLP Group, between an output transaction and services used by a taxable person as a consequence of and following completion of the said transaction.  Although the expenditure incurred in order to obtain the aforementioned services is the consequence of the output transaction, the fact remains that it is not generally part of the cost components of the output transaction, which art 2 of the First Directive none the less requires.  Such services do not therefore have any direct and immediate link with the output transaction.  On the other hand, the costs of those services are part of the taxable person’s general costs and are, as such, components of the price of an undertaking’s products.  Such services therefore do have a direct and immediate link with the taxable person’s business as a whole, so that the right to deduct VAT falls within art 17(5) of the Sixth Directive and the VAT is, according to that provision, deductible only in part.
32.  It could only be otherwise if the taxable person were able to prove that, exceptionally, the costs relating to the goods or services which he has utilised as a consequence of making a deductible transaction are part of the cost components of that transaction.
33.  The answer to the second question must therefore be that it is for the national court to apply the ‘direct and immediate link’ test to the facts of each case before it.  A taxable person who makes transactions in respect of which VAT is deductible and transactions in respect of which it is not may deduct the VAT in respect of the goods or services acquired by him, provided that such goods or services have a direct and immediate link with the output transactions in respect of which VAT is deductible, without it being necessary to take into account art 17(2), (3) or (5) of the Sixth Directive.  However, such a taxable person cannot deduct in its entirety the VAT charged on input services where they have been utilised not for the purpose of carrying out a deductible transaction but in the context of activities which are no more than the consequence of making such a transaction, unless that person can show by means of objective evidence that the expenditure involved in the acquisition of such services is part of the various cost components of the output transaction.”
11.	In Abbey National, the taxpayer’s business also consisted of supplies some of which were taxable and some of which were exempt.  It carried out a sale transaction which, because it amounted to a transfer as a going concern within art 5(1) of the Value Added Tax (Special Provisions) Order 1995, was not a supply for VAT purposes.  It incurred input tax on professional fees incurred directly in connection with the sale and sought to deduct that tax in its entirety.  Once again the UK argued that only a proportion could be deducted, and the court upheld that contention.  The court’s reasoning was that since the transaction in question was not a taxable transaction it could not be said that there was any link between the input tax sought to be deducted and one or more taxable output transactions.  The court added:
“35.  However, the costs of those services form part of the taxable person’s overheads, and as such are cost components of the products of a business.  Even in the case of a transfer of a totality of assets, where the taxable person no longer effects transactions after using those services, their costs must be regarded as part of the economic activity of the business as a whole before the transfer.  Any other interpretation of art 17 of the Sixth Directive would be contrary to the principle that the VAT system must be completely neutral as regards the tax burden on all the economic activities of a business provided that they are themselves subject to VAT, and would make the economic operator liable to pay VAT in the context of his economic activity without giving him the possibility of deducting it (see, to that effect, Gabalfrisa SL and ors v Agencia Estatal de Administración Tributaria (AEAT) (Joined Cases C-110/98 to C-147/98) [2000] ECR I-1577, para 45).  An arbitrary distinction would thus be drawn between expenditure incurred for the purposes of a business before it is actually operated and that incurred during its operation, on the one hand, and, on the other hand, the expenditure incurred in order to terminate its operation.
36.  Thus in principle the various services used by the transferor for the purposes of the transfer of a totality of assets or part thereof have a direct and immediate link with the whole economic activity of that taxable person.
37.  It follows from art 17(5) of the Sixth Directive that a taxable person who effects both transactions in respect of which VAT is deductible and transactions in respect of which it is not may deduct only that proportion of the VAT which is attributable to the former transactions.
38.  However, as the court held in the para 26 of the Midland Bank judgment ([200] STC 501 at 519), a taxable person who effects transactions in respect of which VAT is deductible and transactions in respect of which it is not may nevertheless deduct the VAT charged on goods or services acquired by him, where those goods or services have a direct and immediate link with the output transactions in respect of which VAT is deductible, without it being necessary to differentiate according to whether art 17(2), (3) or (5) of the Sixth Directive applies.
39.  That rule must apply also to the costs of the goods and services which form part of the overheads relating to a part of a taxable person’s economic activities which is clearly defined and in which all transactions are subject to VAT, since those goods and service thus have a direct and immediate link with that part of his economic activities.
40.  So if the various services acquired by the transferor in order to effect the transfer of a totality of assets or part thereof have a direct and immediate link with a clearly defined part of his economic activities, so that the costs of those services form part of the overheads of that part of the business, and all the transactions relating to that part are subject to VAT, he may deduct all the VAT charged on his costs of acquiring those services.
41.  It is for the national court to determine whether those criteria are satisfied in the case in point in the main proceedings.”
12.	In Kretztechnik the questions were (1) whether a share issue leading to a listing was a supply for consideration for VAT purposes and (2) depending on the answer to that question whether VAT paid on services acquired in connection with the issue was deductible.  The court held that the share issue was not a supply.  In relation to the second question the rival contentions were, on the one hand, that the input VAT was not deductible at all since the services concerned had no relevant connection with its general (taxable) business, and, on the other, that the inputs could be regarded as “part of the overheads of the company and constitute components of the price of the products marketed by it” (at paragraph 32).  The court’s conclusion was expressed in the following terms:
“33  	In that connection, it must be borne in mind that, according to settled case-law, the right of deduction provided for in Articles 17 to 20 of the Sixth Directive is an integral part of the VAT scheme and in principle may not be limited.  It must be exercised immediately in respect of all taxes charged on transactions relating to inputs (see, in particular, Case C-62/93 BP Supergaz [1995] ECR I-1883, paragraph 18, and Joined Cases C-110/98 to C-147/98 Gabalfrisa and Others [2000] ECR I-1577, paragraph 43).
34		The deduction system is meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities.  The common system of VAT 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, Case 268/83 Rompleman [1985] ECR 655, paragraph 19; Case C-37/95 Ghent Coal Terminal [1998] ECR I-1, paragraph 15; Gabalfrisa and Others, paragraph 44; Midland Bank, paragraph 19, and Abbey National, paragraph 24).
35		It is clear from the last-mentioned condition that, for VAT to be deductible, the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction.  Thus, the right to deduct VAT charged on the acquisition of input goods or services presupposes that the expenditure incurred in acquiring them was a component of the cost of the output transactions that gave rise to the right to deduct (see Midland Bank, paragraph 30 and Abbey National, paragraph 28, and also Case C-16/00 Cibo Participations [2001] ECR I6663, paragraph 31).
36		In this case, in view of the fact that, first, a share issue is an operation not falling within the scope of the Sixth Directive and, second, that operation was carried out by Kretztechnik in order to increase its capital for the benefit of its economic activity in general, it must be considered that the costs of the supplies acquired by that company in connection with the operation concerned form part of its overheads and are therefore, as such, component parts of the price of its products.  Those supplies have a direct and immediate link with the whole economic activity of the taxable person (see BLP Group, paragraph 25; Midland Bank, paragraph 31; Abbey National, paragraphs 35 and 36, and Cibo Participations, paragraph 33).”
13.	The court therefore concluded that the whole of the input tax was deductible provided that all of the company’s supplies were taxable, but that if they were not there would have to be an apportionment.
Domestic cases
14.	Three domestic cases were cited to me namely:  Customs & Excise Commissioners v. Southern Primary Housing Association Ltd [2003] EWCA Civ 1662 (“Southern Primary”), Dial-a-Phone Ltd v. Customs & Excise Commissioners [2004] EWCA Civ 603, [2004] STC 987 (“Dial-a-Phone”), and RAP Group plc v. Customs & Excise Commissioners [2000] STC 90 (“RAP”).
15.	In Southern Primary, input tax had been incurred by the taxpayer on its acquisition of certain land.  It had then sold the land (an exempt supply) to a housing association and, simultaneously, entered into a development contract with the housing association under which it made taxable supplies.  The question was whether the inputs were sufficiently connected to the taxable outputs to enable them to be deducted in their totality.  No question seems to have arisen as to the possibility of treating the inputs as overheads and thus apportionable.  Both the Tribunal and, on first appeal, the High Court held that there was a sufficient link, essentially because the sale of the land and the entering into the development contract were part of one overall commercial transaction.  On appeal to the Court of Appeal, Customs argued that the decisions below had wrongly:
“(a) focused on the taxpayer’s overall commercial aim;  (b) treated the two separate supplies as if they were one; (c) asserted that the question whether two supplies are commercially linked is the same as the question whether inputs are attributable to either or both supplies; (d) applied a test of attribution for which there is no authority—namely whether the input enable the taxpayer to make a taxable supply; (e) failed to appreciate that the taxpayer’s use of the land was exhausted on its sale and the land could not thereafter be attributed to construction works carried out thereafter.”
16.	Jacob LJ (with whom Mantell LJ and Lord Phillips MR agreed) rejected point (a), but concluded:
“[32] But there is substance in Mrs Hall’s remaining points (which, by and large) are different ways of looking at the same question.  I particularly consider that point (d) is right.  The land purchase transaction was commercially necessary to make its performance commercially possible, but it was not a cost component of the contract itself in the same way as the costs of materials used.  There is a link with the contract but the link was not direct and immediate.  The development contract would not have been made but for the associated land purchase and sale.  But ‘but for’ is not the test and does not equate to the ‘direct and immediate link’ and ‘cost component’ test.
[33] One can look at it another way.  There is nothing about the development contract as such which makes the land purchase and sale essential.  If the housing association had already pre owned the land or had bought it from some third party, the inputs of the development contract would have been just the costs of carrying it out.  The fact that there were commercially linked land transactions does not mean that those transactions are directly linked to the costs of the development contract.  One would not say that the cost of buying the land was a cost of the development contract itself.  It follows that the input tax on that cost is not a cost of the contract.” 
and added:
“[37] Turning back to the tribunal, it concluded that there was a direct and immediate link between the land purchase and both the land sale and development contract, with both an exempt and a non-exempt transaction. VAT law does not work in such a generalised way.  You have to look at transactions individually, component transaction by component transaction.  They may be linked in the sense that one would not have happened without the other, but they remain distinct transactions nonetheless.  Only if one transaction is merely ancillary to the main transaction can one disregard the distinct nature of each transaction (see Card Protection Plan Ltd v Customs and Excise Comrs (Case C-349/96) [1999] STC 270, [1999] 2 AC 601, para 29).  If that were not so, the principle of neutrality would be violated.  Moreover there would be intractable problems as to which input was being attributed to which part of the ‘overall transaction’.  You may find, as here taxable and exempt transactions all mixed up in the same ‘overall’ transaction—which is illegitimate.”
17.	In Dial-a-Phone the taxpayer marketed mobile telephones with a “free” three month period of insurance.  Its earnings were partly commissions from network service providers and partly commissions from the underwriter of the insurance.  So far as the latter were concerned the taxpayer was acting as an insurance intermediary and thus making an exempt supply.  The issue was whether input tax payable in respect of its marketing and advertising costs was exclusively attributable to its taxable outputs (as the taxpayer contended) or were to be treated as used both for the taxable supplies and the exempt supplies and therefore to be treated as residual.  The Tribunal found that the supply of the insurance services took place at the same time as the supply of the mobile telephones, and that the advertising and marketing costs related to both supplies made by the taxpayer.  Jonathan Parker LJ (with whom Waller and Dyson LJJ agreed) held that these were “well-nigh irresistible inferences from the undisputed facts” and that the Tribunal had applied the correct test (see paragraph 73).  He added:
“[74] As to Mr Anderson’s submissions directed at the factual relationship between the insurance intermediary services and the taxable supplies made by DaP (and in particular his submissions regarding timing), it is important to bear in mind that (as the Advocate General observed in Abbey National (see [29] above)) a ‘direct and immediate link’ may exist between the marketing and advertising costs and the insurance intermediary services despite the fact that there may be an even closer link between those costs and DaP’s taxable supplies.  In other words, the quest is not for the closest link, but for a sufficient link.”
18.	RAP concerned input tax in respect of professional fees incurred in connection with a share issue (a transaction then treated as an exempt supply) undertaken for the purpose of the acquisition of the share capital in another company (a taxable supply).  The Tribunal found as a matter of fact that the fees had been incurred exclusively in connection with the share issue, so that the input tax was not deductible.  On that finding the case was directly governed by the decision in BLP.  On appeal Patten J. emphasised that the finding was one of fact for the Commissioners but found, on an analysis of the narrative contained in one of the invoices, that the Tribunal’s decision could not, in relation to that invoice, be supported on the evidence before it.
The facts in the present case
19.	The Tribunal found that in the relevant period approximately 80% of the appellant’s turnover was represented by “ticket sales”, the remaining 20% being represented by what it described as “non-ticket sales” (paragraph 10 of the Decision).  It is clear from the Decision that “ticket sales” in this context means ticket sales which were exempt supplies.  That is clear because in paragraph 19 it described the ticket sales as exempt supplies, and because its analysis of the “non-ticket sales” proceeded on the basis that those were taxable supplies.
20.	The distinction implied by the descriptions given to the two types of supply does however give rise to a potential source of confusion since the evidence before the Tribunal was that supplies which had been treated by the appellant as taxable supplies had themselves to a certain extent included the provision of tickets.  I return to this point below.
21.	The appellant buys in all its theatrical productions under agreements with independent production companies under which the latter receive a consideration stipulated for partly as a guaranteed sum and partly by reference to a percentage of ticket sales.  The Tribunal found to be typical the contract which had been concluded for the run of Miss Saigon which it described in paragraph 13 in the following terms:
“(1) A guaranteed weekly amount to the production company during the performance of the show.
(2) The Appellant and the production company shared the proceeds of the weekly ticket sales for the show which exceeded the guaranteed weekly amount.  The proportion shared was calculated by means of a formula agreed in the contract.
(3) The Appellant charged the production company rent for use of the Theatre during the weeks of “Get in and Fit-up” prior to the performance.  Also the Appellant recovered expenses for specific services to the company, such as, piano tuning, use of the Theatre’s car park and provision of dry ice.
Thus the eventual consideration paid by the Appellant to the production company was the guaranteed weekly amount plus the agreed share of the ticket sales over and above the guaranteed amount less the rent for rehearsal weeks and the expenses incurred by the Appellant for specific services provided by the company.”
The size of the consideration would depend on the relative strength of the negotiating positions of the parties, the costs of the production and the projected ticket sales for the performance.  The Tribunal commented:
“According to the Chief Executive the representatives would be well aware of the level of non-ticket income that the Appellant would receive from the production.  There was no documentary evidence, however, produced by the Appellant which demonstrated a tangible link between the level of consideration paid to the companies by the Appellant and the Appellant’s income received from the non ticket sales.  The consideration in the “Miss Saigon” contract was based solely on the ticket sales less the Appellant’s expenses for specific services provided to the production company.”
The Tribunal further found that:
“The pricing of the tickets for the performances would again be a matter of negotiation between the parties.  In “Miss Saigon” the production company had the upper hand because it was a national tour with a national pricing structure.  However, the Appellant did retain the exclusive right to issue complimentary tickets to the Press and bona fide bill exhibitors displaying bills advertising the attractions to the Theatre.  The Appellant with the consent of the production company retained the right to issue additional discounted, standby and other categories of complimentary tickets.”
22.	The appellant’s payments to the production company are subject to VAT at the standard rate.  It is that input tax which the appellant claims to be able to deduct as “residual” tax.
23.	The appellant’s taxable supplies (what the Tribunal described as “non-ticket income”) consisted of the following:
i)	programme sales (zero-rated for VAT purposes);
ii)	sale of confectionary and drinks (standard rated for VAT purposes);
iii)	sale of the appellant’s own merchandise (standard rated);
iv)	a percentage commission on the sale of the production company’s merchandise (standard rated);
v)	corporate entertainment under which the corporate could buy the right to a range of eating opportunities coupled with the right to see the show.  The Tribunal appears to have found that, although only one price was charged for the “eating entertainment” coupled with the right to see the show, only the eating entertainment was standard rated for VAT purposes:  see paragraph 26 of its decision.
vi)	supplies of sponsorship (standard rated).  A typical example might be the grant of the right to advertise  within the theatre in return for a fee under an arrangement with also entitled the sponsor to a set number of complimentary tickets and programmes and/or the ability to buy tickets for its staff at a discounted rate;
vii)	supplies to the production companies of items such as dry ice, cleaning or repair as a result of smoking, piano-tuning, telephone/fax/photocopying services, agency/credit card commissions, hire of plant and provision of late night transport.  These were recouped as expenses under the Miss Saigon agreement.
viii)	supply of opera glasses and payphone facilities to patrons under arrangements whereby the sale proceeds were split between the appellant and the provider.
24.	In addition the appellant contended before the Tribunal that two other heads of taxable supply existed namely:
i)	radio sponsorship arrangements in relation to specific productions.  Under these the radio station agreed to promote a particular production for a particular period in return for a lump sum and a package of non-monetary benefits consisting of advertising the radio station in its programmes, supplying tickets and programmes and so forth.  The Tribunal seems to have found those arrangements to constitute a supply by the radio station to the appellant rather than a taxable supply by the appellant to the radio station;
ii)	income derived from “Theme evenings”.  In broad terms these appear to have involved the sale of a package, tailored to the particular production, in which the theatre customer would have a meal in the function suite, both suite and meal being themed to the production, before or after watching the show.  Such theme evenings did not in fact take place during the period under review by the Tribunal and for that reason, amongst others, the Tribunal declined to make specific findings about the nature of the supply of the Theme evening.  The evidence before the Tribunal suggested that the purchaser of a Theme evening package paid a single price both for the meal and the right to see the show.
The Tribunal’s reasoning
25.	The Tribunal correctly identified the question before it as to whether the input tax was attributable to taxable and exempt supplies in which case residual tax could be deducted, or whether the input tax was attributable exclusively to the ticket sales which were an exempt supply:  see paragraph 2 of its Decision.  In so doing it described the input tax as tax “on the consideration paid by [the appellant] to the production company”.  Criticism has been made in this court of that expression but I do not myself think that anything turns on this use of language.
26.	The Tribunal began by concluding that the consideration paid did not form part of the general overheads of the appellant (paragraphs 17-18, and 58).
27.	Having so concluded it examined in turn each of the heads of taxable supply and asked itself the question whether the consideration paid was a “cost component” of that taxable supply.  In each case it concluded that it was not.  It dealt collectively with programmes, drinks, confectionary, sale of own merchandise, corporate entertainment and supply of opera glasses and payphones, and expressed its findings in paragraph 62 as follows:
“(1)  The “Miss Saigon” contract revealed that there was no relationship between the consideration paid and the Appellant’s sales of these items.  The size of the consideration was determined solely by the ticket sales.  We prefer the evidence of the contract to the evidence of the Chief Executive about the intentions of the negotiating parties.  We consider that the contract was an objective statement of the business relationship between the Appellant and the production company.  Whereas the Chief Executive’s evidence required us to consider the subjective intentions of the negotiating parties which was contrary to the decision in BLP.
(2)  The analysis of the Statutory Reports and Accounts showed that the consideration paid to the production companies did not form part of the costs of these taxable supplies by the Appellant.  The costs of the taxable supplies were grouped together under “selling and marketing expenses” whereas the consideration paid was allocated to “costs of sales”.
(3)  The evidence of the Appellant’s Chief Executive confirmed that the price of these taxable supplies did not vary from production to production.  The selling price for the supplies were arrived at by fixing the appropriate mark up from the costs of the materials that made up the supplies which did not include the consideration paid to the production companies together with an assessment of the market by the Appellant’s management.
(4)  The selling price of these taxable supplies was not included in the ticket price for the show.  The programmes, confectionary, drinks, sundry items and merchandise were all purchased separately from the ticket for the performance.  The Appellant’s evidence about the corporate entertainment was that there were two tickets, one for the entertainment and one for the performance.  Also the Appellant’s documentation clearly stated that the terms and conditions of the ticket sales were different from those for the corporate entertainment.
(5)  Patrons attending the theatre could choose whether to purchase the programmes, confectionary, drinks, sundry items and merchandise.  The prior purchase of the ticket for the performance would break the link if there was one with the consideration paid by the Appellant to the production company because of the exempt nature of the supply of the ticket.
We are satisfied on the facts found when taken together that the consideration paid to the production companies was not used for the Appellant’s taxable supplies of programmes, confectionary, drinks, merchandise, sundry items and corporate entertainment.  We, therefore, find that there was no direct and immediate link between the consideration paid and the Appellant’s taxable supplies of programmes, confectionary, drinks, merchandise and corporate entertainment.”
28.	In relation to the re-charge items it concluded that those were cost components of the production, and that the consideration paid was not a cost component of the appellant’s taxable supplies to the production companies:  see paragraph 59.
29.	In relation to the radio sponsorship, it found that the costs incurred by the appellant were in reality marketing campaign costs borne by the production company:  see paragraph 60.
30.	In relation to the production company’s merchandise it seems to have rejected the proposition that the commission earned was earned in respect of a taxable supply in the following passage at paragraph 61:
“We question the Appellant’s assertion that the sale of this merchandise was one of its own taxable supplies.  Rather we consider that the sale was a taxable supply of the production companies.  In this instance the Appellant was acting as agent for the companies charging commission in the form of a fixed percentage for its services.  This commission was part of the companies’ costs and reflected as such in the contract for the Miss Saigon production.  Thus we find that there was no direct and immediate link between the consideration paid to the production companies and the commission received by the Appellant on the sale of the production companies’ merchandise.”
31.	In relation to sponsorship income it found (at paragraph 28) that
“The Appellant offered exclusive sponsorship packages to local commercial firms which allowed the sponsor to advertise the firm within the Theatre and/or the Appellant’s publications ..The extent of the advertising would determine the size of the fee paid by the sponsor.  As part of the agreement the Appellant would also give the sponsor a range of benefits which may include a set number of complimentary tickets and programmes, use of the corporate hospitality suites without charge, purchase of show tickets at corporate rate by the sponsor’s members of staff and backstage tours of the theatre.   The size of the fee would fix the range of benefits received by the sponsor..”
32.	It expressed its conclusion, at paragraph 63, as follows:
“(1)  The sponsorship income was recorded under the separate heading of “other operating income” in the Appellant’s Statutory Reports and Accounts.  The consideration paid to the production company was recorded under “cost of sales” which was not connected with “other operating income” in the Accounts.
(2)  The “Miss Saigon” contract specified that the Appellant would have exclusive rights over sponsorship income.  Thus sponsorship formed no part of the negotiations between the Appellant and the production companies.  The contract mentioned that sponsorship relating specifically to the production required the written consent of the Touring Manager of the production company.  The Appellant, however, produced no evidence of sponsorship of individual shows except for the marketing campaigns with the local radio companies which we have dealt with previously.
(3)  The Appellant’s Chief Executive confirmed that the pricing of the various sponsorship packages was arrived at independently from the consideration paid.  The size of the sponsorship was determined by the extent of the advertising taken up by the sponsor together with an assessment by the Appellant’s management about what the sponsor would pay.
(4)  There was no temporal link between the sponsorship agreements and the contract with the production companies.  The Appellant could strike a sponsorship deal at any time and its duration was not fixed with reference to the productions.
We are satisfied on the facts found when taken together that the consideration paid to the production companies was not used for the Appellant’s taxable supplies of sponsorship.  We, therefore, find that there was no direct and immediate link between the consideration paid to the companies and the Appellant’s taxable supplies of sponsorship.”
33.	Having thus disposed of the argument that the consideration paid formed a cost component of any of the taxable supplies, and having rejected the proposition that it formed part of the appellant’s overheads, the Tribunal concluded that the consideration paid was used exclusively in making exempt supplies of ticket sales for productions.
The appellant’s case
34.	Miss Whipple on behalf of the appellant submitted that the Tribunal’s central error lay in a misunderstanding of the principles enunciated in BLP.  In particular the Tribunal had been wrong to look at the way in which the prices of the various taxable supplies had been set, and to conclude from the fact that they had been set otherwise than by reference to the consideration paid that the latter could not be seen as forming a cost component of the taxable supplies.  Insofar as the BLP test was described as being a “cost component test” it could equally and interchangeably be described as a “use” test: the true question was whether the taxable supplies made by the production companies were used for (emphasis supplied)  the making of the taxable supplies.
35.	In support of that general criticism she submitted that, even if the Tribunal’s method of application of the BLP test was correct in principle, it had not applied it in relation to the exempt ticket sales themselves.  The prices of the tickets were a function of the market and not a reflection of the amount paid by the appellant to the production companies:  if anything the converse was true.
36.	In addition she submitted that the Tribunal’s conclusion that the supplies made by the production companies were not “overheads” was based on a misunderstanding of what was meant by that expression in the context of residual tax, and a misapplication of the company’s statutory accounts.  In VAT law the notion of overheads simply means those costs which are attributable to the business as a whole because they cannot be determined to be exclusively attributable either to taxable or to exempt supplies.
37.	Miss Whipple also criticised the Tribunal’s analysis of certain of the individual items.  Thus, in relation to the re-charge items, she questioned how the Tribunal could conclude from the fact that these admittedly taxable supplies were recouped to the appellant as expenses for which the production company was liable that they could not be supplies with which the production inputs bore a direct and immediate link.  She further criticised the finding that no taxable supplies were made by the appellant under the radio sponsorship arrangements.  The Tribunal’s finding that the sale by the appellant as agent for the production company of the latter’s own merchandise under which the appellant was paid a commission involved no taxable supply by the appellant was also, she submitted, plainly wrong.  She advanced further criticisms of the reasoning adopted by the Tribunal in paragraph 62.  In particular she submitted, first, that the fact that an input (A) is not included in the price of a particular output (B) does not answer the question whether A has been used for B; and, secondly, that the proposition that the prior exempt supply of a ticket breaks any link which might otherwise exist between the production inputs and the taxable supplies was wrong and based on a misunderstanding of BLP and Abbey National.
38.	Miss Whipple accepted that it was not enough for her to demonstrate that each of the taxable supplies would not have been made but for the production costs having been incurred, but contended that in each case it could be demonstrated that the production costs had in the relevant sense been “used for” the taxable supplies.
39.	She emphasised that she needed only to show that those costs had been used for one of the taxable supplies in addition to the exempt supplies for the input tax to be residual tax.  In that connection she relied strongly on what she called the “taxable ticket” supplies, namely:
i)	tickets supplied to sponsors as part of the services supplied to them;
ii)	tickets supplied to “corporates” in respect of the corporate entertainment packages;
iii)	tickets supplied to customers as part of the Theme evening packages;
iv)	tickets supplied to radio stations in connection with the promotional campaigns.
40.	Accordingly she submitted that the production inputs should either (1) be regarded as not exclusively attributable either to taxable or exempt supplies but rather to the income-generating business as a whole or (2) as being directly and immediately linked not only with exempt ticket sales but with one or more specific taxable outputs.  She labelled the two possible approaches as “the overhead analysis” and the “specific attribution analysis”.
Customs’ case
41.	On behalf of Customs Mr Wilken, who appeared with Ms Mitrophanous, submitted that the Tribunal’s application of the “cost component” test was entirely orthodox, that the question whether a particular input was exclusively attributable to a particular output was a question of fact for the Tribunal, and that the Tribunal could not be said to have misdirected itself in any way in reaching the conclusion which it did.  He submitted that what the appellant was ultimately relying on was, on analysis, no more than the proposition that, but for the productions, the taxable supplies would not have been made.  That was conceded by the appellant not to be the right test.  For a direct and immediate link to exist the input has to be a cost component of the supply in question.  When one analyses the cost components of the various taxable supplies they are easy to identify and do not include the production costs.  Thus, to take one of Mr Wilken’s examples, the cost component of the programmes consist of the paper and printing costs.  Mr Wilken analysed the cost components of each of the taxable supplies in similar fashion.
Discussion
42.	There is some danger of losing sight of the fundamental question which Regulation 101 poses in a case of this kind.  That is not only whether a particular input has been used in making exempt supplies but whether it has been exclusively so used. If it has not been exclusively so used it is irrelevant that it may have been primarily or predominantly so used.  If the input has been exclusively so used then the input tax cannot be deducted:  Regulation 101(2)(c).  If, on the other hand, it has not been exclusively so used, then, unless it has been exclusively used in making taxable supplies (Regulation 101(2)(b)), the residual tax can be deducted:  Regulation 101(2)(d).  There are only the three possibilities.
43.	If the inputs fall into the third category it may be for one of two reasons.  First, they may not be specifically attributable either to exempt or to taxable supplies.  In that situation they are described in the European jurisprudence as being overheads, i.e. cost components of the business as a whole:  see paragraph 31 of Midland, paragraph 35 of Abbey National and paragraph 36 of Kretztechnik.  Secondly they may be specifically attributable both to particular exempt and taxable supplies.  The European jurisprudence has not in terms had to consider such a case, but Dial-a-Phone provides an example in the domestic context:  the advertising and marketing inputs were used directly and immediately both for the purposes of the taxable supplies (consisting of the services provided to the network providers) and the exempt supplies (consisting of the services provided as an insurance intermediary).  Whether in the latter case it is helpful to describe the inputs as “overheads” may be doubted.  What is clear is that Regulation 101(2)(d) applies.
44.	Dial-a-Phone seems to me to be instructive for three further reasons.  First, Jonathan Parker LJ emphasised in his judgment that in BLP the court had treated the expression “cost components” in Article 2 of the First Directive as synonymous with the test of “direct and immediate link” enunciated by the ECJ in BLP in explaining the meaning of the expression “used for” in Article 17(2) of the Sixth Directive:  see Dial-a-Phone paragraphs 19, 28 and 71.  Secondly, as noted above, he pointed out, at paragraph 74, that the quest was not for the closest link but for a sufficient link.  Thirdly, in finding that what he described as the BLP test was satisfied in that case, no reliance was placed either by the Tribunal or the higher courts on any finding that the price charged for the insurance intermediary services had been calculated by reference to the cost of the advertising and marketing inputs.  These were nonetheless found to have been “used for” supplying those services.  A sufficient nexus existed without it being necessary to show that those inputs were a “cost component” of the price charged for the relevant outputs in the very narrow sense adopted by the Tribunal in the present case.
45.	In the present case the Tribunal seems almost to have driven itself into applying this very narrow view of “cost components” by its initial finding that they could not constitute overheads.  This finding was based on the treatment of the inputs in the Group Profit and Loss Account.  For the year ended 31st March 2002 the relevant figures were presented as follows:
						Note
TURNOVER				3		 6,543,672
Cost of Sales						(4,735,157)
								--------------
GROSS PROFIT				 	1,808,515

Selling and marketing expenses Administrative expenses			
(1,028,950)	    (    892,397)

								(1,921,347)
Other operating income		4		       23,822
								--------------
OPERATING (LOSS)		6		(      89,010)

46.	The Tribunal’s observations on these figures were as follows:
“17.  	The consideration paid to the production companies was recorded in the Appellant’s accounts as “cost of sales” not as general overheads.  The consideration was also distinguished in the accounts from the selling costs of the Appellant’s taxable activities which were recorded under the separate heading of “selling and marketing expenses”.
18.  	The Appellant’s Finance Director explained that this was the way the consideration had always been treated historically in the accounts and was not an accounting requirement.  In his view the accounting treatment was not any indication of how the consideration contributed to the Appellant’s business as a whole.  We are of the view that the accounting treatment is a valid indicator of the status of the consideration, particularly as the accounts have been signed off by reputable auditors expressing the opinion that the accounts give a true and fair view of the Appellant’s state of affairs.  Also the consideration was specific to each production, the size of which varied depending upon the nature of production.  We, therefore, find that the consideration paid to the production companies was not part of the Appellant’s general overheads.
…
57.  	Before analysing each of the Appellant’s transactions objectively we wish to highlight the following:
(1)  We placed weight on the Appellant’s Statutory Reports and Accounts which in our opinion provided an objective, true and fair view of the Appellant’s business.  We were not impressed with the Appellant’s evidence that the Statutory Reports and Accounts were not indicative of the way the Appellant organised its business.
…
58.	We found at paragraphs 17 and 18 that the consideration paid by the Appellant to the production companies did not form part of the general overheads of the Appellant’s business.  We reached this conclusion from the fact that the consideration was recorded under the separate heading “costs of sales” not as general overheads in its Statutory Reports and Accounts from 1999 – 2004.  Further the consideration paid to the companies was specific to each production, the size of which varied depending upon the nature of the production.”
47.	This reasoning is in my judgment flawed.  While it may be true that the accounts do not present the relevant inputs as overheads, nothing in the way in which they are presented in the accounts enable one to conclude that they were not “used for” the taxable supplies, at least in part, still less that they were used exclusively for the exempt supplies.  On the contrary, in so far as the accounting treatment gives any steer on those questions, it is that the inputs concerned are being treated as a “cost” of the taxable supplies which are, with the exempt supplies, lumped together in the figure given for turnover.  The only taxable supplies not included in the turnover figure are those represented by “other operating income” which, the notes tell us, consists principally of sponsorship income.
48.	The Tribunal’s observation in the second sentence of paragraph 17 also strikes an odd note in so far as it implies that the “selling and marketing expenses” represent only the selling costs of the appellant’s taxable activities.  The relevant note says:
“Selling and marketing costs include the costs of the company’s box office, bars and other ancillary sales areas, together with the expenses incurred in marketing and publicising the Mayflower Theatre.”
While the point is not directly relevant to this appeal, I would comment that it is difficult to see why expenses incurred in marketing and publicising the theatre are not incurred both in respect of its exempt and its taxable supplies.
49.	I return to the question whether there is any sufficiently direct and immediate link between the relevant inputs and any of the taxable supplies so as to make it impossible for it to be said that the inputs were used exclusively for the exempt supplies.  The strongest case put by Ms. Whipple in this respect related to what she described as “taxable tickets”.  The argument was simply that the inputs were directly and immediately linked with the exempt supplies of tickets to the general public because the production costs had been incurred for the purpose of producing the show to which the public would be granted admission.  If the appellant was also earning income from granting a right of admission under the umbrella of a taxable supply, there could be no difference in principle, so far as the directness and immediacy of the link was concerned, between the exempt and the taxable supplies.  I found that argument compelling.  The only difficulty with the submission was the lack of any explicit findings of fact by the Tribunal as to the existence of taxable supplies of tickets, no doubt due to the fact that this particular argument had not been deployed before it in the same manner as before me.  The findings showed that tickets were supplied in connection with four types of supply which the appellant claimed were taxable, namely corporate entertainment, theme evenings, radio “sponsorship”, and general sponsorship.  The Tribunal made no finding in relation to theme evenings, and in relation to the radio sponsorship found, on the somewhat exiguous evidence before it, that there was no supply by the appellant.  In relation to corporate entertainment, a debate took place before me as to whether the Tribunal had found that this comprised in each case a single taxable supply or two separate supplies, one taxable and one exempt.  I do not think that the Tribunal addressed itself to this legal question, nor do I think that its findings of fact in paragraph 26 enable me to resolve the issue.  However, in relation to sponsorship the evidence before the Tribunal of particular examples admitted, in my judgment, only of the conclusion that the sponsorship income was the result of a single taxable supply by the appellant which included the provision of tickets.  On that footing I accept Ms. Whipple’s submission that there were taxable supplies of the right to see the productions, and that the production costs were linked to those supplies in precisely the same way as to the exempt supplies.  That conclusion prevents an analysis, such as was applied in BLP and Southern Primary, under which the attribution of particular costs exclusively to the exempt supplies results in their being wholly consumed by the exempt supplies and incapable of being viewed as general overheads of the business.
50.	For those reasons I would allow the appeal.