Neutral Citation Number: [2007] EWHC 319 (Ch)
Case No: CH/2006/APP/0491
IN THE HIGH COURT OF JUSTICE
CHANCERY DIVISION

Royal Courts of Justice
Strand, London, WC2A 2LL

Date: 26/02/2007

Before :

MR JUSTICE MANN
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Between :

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE AND CUSTOMS	
Appellant	
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	DUNWOOD TRAVEL LIMITED	Respondent	

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MR. J. PUZEY (instructed by The Solicitor’s Office for H.M. Customs & Excise) for the Appellant.
MRS. N. PRESTON (instructed by Wolters Kluwer (UK) Limited, Hinckley) for the Respondent.

Hearing date: 7th February 2007
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Judgment

Mr Justice Mann : 
Introduction
1.	This is an appeal by HM Revenue & Customs (“HMRC”) from a decision of the VAT Tribunal (Chairman Mr David S Porter) given on 19th May 2006) in which it allowed an appeal from an assessment of which a notice was issued on 24th June 2004 assessing the respondent (“Dunwood”) to VAT under the Tour Operators’ Margin Scheme (“TOMS”) in an amount which was (after an amendment in September 2004) determined at £17,260.85. The main question which arises in this case is whether the assessment is barred by the provisions of section 77(1)(a) of the Value Added Tax Act 1994 (“VATA”).  I have to determine whether that assessment was a separate assessment for the purposes of s 77(1)(a), or whether it is in law and substance an assessment in respect of the 4 preceding quarters.  If it was the latter it is barred by section 77; if the former it is not.
Background
2.	In order to understand the appeal it is necessary to understand TOMS, at least in outline.  Dunwood was a tour operator, and therefore it fell within TOMS and its regime.  I shall have to set out some of the detailed provisions, but for present purposes the following outline will suffice.  In describing and setting out the scheme in the manner appearing in this section I do not intend to assume the answer to the questions which arise in this appeal.  
3.	HMRC have published a notice which contains an explanation of the TOMS scheme and which also contains the binding regulations made to implement it.  Section 2.6 of that notice contains an explanation:
"Under the TOMS, you cannot reclaim any UK or EU VAT charged on the travel services and goods you buy in and re-supply -- the tax on such goods or services is accounted for in the relevant State by the providers of those services (hotels, airlines and so on).
However as a tour operator based in the UK, you only account for VAT on the margin you make on your margin scheme supplies (see paragraph 2.7), that is, the difference between the amount you receive from your customer (including any amounts paid on behalf of your customer by third parties) and the amount you pay your suppliers.
…
you can still reclaim, subject to the normal rules, VAT on overheads outside the Toms (see paragraph 4.3).”
4.	Section 2.7 explains what a "margin scheme supply" is:
"a margin scheme supply is defined in law … as a 'designated travel service’.  This means it is a supply of goods or services which is… bought in from another person and resupplied without material alteration or further processing…”
5.	A “margin scheme package" is a single transaction entered into with a customer which includes one or more margin scheme supplies.  The additional elements may include "in-house supplies" (that is to say goods or services supplied by the operator which have not been bought in or bought in and materially altered before being passed on) and agency supplies (that is to say supplies of goods or services which the operator provides as a true agent).  Because of the special treatment of margin scheme supplies and the blend of services sold to customers, requiring the calculation of a margin, the more conventional way of ascertaining the amount of VAT for which the operator has to account does not work.  In those circumstances there is a year-end calculation which is to take place in the first quarter of the financial year end of the operator.  Its purpose is described in paragraph 5.1 of the notice:
"the year-end calculation will --
-- work out a total margin achieved;
-- apportion the total margin between different types of supplies, that is: a margin scheme, in-house, agency;
-- apportion the total margin between supplies with different VAT liabilities, for examples standard-rated, zero-rated or exempt;
-- work out the output tax due on margin scheme supplies and packages; and
-- work out net values for supplies with different VAT liabilities."
6.	The method of carrying out the year-end calculation is set out in section 8 of the note.  It actually has the force of law by virtue of section 53 of the Value Added Tax Act 1994 and the VAT (Tour Operators) Order, SI 1987/1806.   It is applied to margin scheme packages and margin scheme supplies. It contains 30 steps designed to achieve the objectives referred to in paragraph 5.1.  It does so by providing a mechanism for breaking down the value of what is supplied and what has been acquired as between margin scheme supplies and other elements and a method (involving proportions and aggregates) for attributing value and VAT to the various elements.  It is unnecessary to set out this complex mechanism in detail.  What it is important to appreciate for the purposes of this appeal is that the various elements have to be identified for the purposes of this calculation. The result is a final figure which is intended to correct quarterly provisional figures, to which I now turn.
7.	During each quarter of a given financial year a provisional amount of VAT is payable in respect of TOMS items.  Its method of calculation is set out in Section 9 of the notice.  The principle behind it is to look at the year end calculation for the previous year, ascertain the aggregate of the sales of the margin scheme packages (that is, of all packages comprising or containing designated travel services), ascertain the aggregate of the constituent parts of those packages which were subject to standard rate VAT, and identify what percentage of the whole those constituent parts were.  That calculation shows what percentage of total sales represented standard rated items (calculated by amount).  That percentage is then applied to the total TOMS sales for each quarter, presumably on the footing that, from one year to the next, the proportion of standard rated items in packages is overall likely to be roughly the same.  VAT is then calculated and accounted for on that reduced percentage, quarter by quarter.
8.	Thus the overall scheme requires provisional payments during the course of a financial year, quarter by quarter, based on applying a percentage derived from the previous year's trading to relevant turnover, and charging VAT on that. The final figure for a year is ascertained at the end of the year by doing a more analytical calculation of the year's turnover.  Any difference between the amounts provisionally paid and the amounts finally calculated is paid or repaid as the case may be.  The provisions requiring the calculations to be done, and specifying what happens when they are done, appear in section 12 of the notice under a paragraph entitled "TL5 ".
9.	What happened in the present case, which generated the assessment and the various appeals, can be described shortly.  At some point in 2004 a VAT officer investigated the books of Dunwood.  It was discovered that the quarterly calculations had been done incorrectly.  There were two errors which are relevant to the arguments on this appeal.  The first is that there was an incorrect treatment of coach travel.  Coach travel supplied to customers was treated by Dunwood as if it were zero-rated when in fact it should have been treated as standard rated.  That had a material effect on the tax calculations.  Second, Dunwood had not been applying the correct methodology.  They were not taking a percentage from a preceding year and applying that to total relevant turnover in order to calculate the quarterly VAT.  They were carrying out some sort of rolling, changing calculation as if they had to recalculate every quarter.  The details do not matter (and indeed were not fully disclosed to me).  In addition, they had not carried out end of year calculations for several years (if indeed they had ever carried them out).  HM Customs and Excise carried out an assessment for the period from 6/01 (i.e. the period ending June 30, 2001), resulting in an assessment in the figure referred to above.  This assessment was an assessment in respect of the end of the year calculation which ought to have been carried out in that period and which ought to have resulted in a return of figures in that period for the financial year ending the 31st March 2001.
10.	Dunwood appealed the assessment to the VAT Tribunal.  Its principal submissions relied on section 77(1) of the 1994 Act which provides for a three-year limitation period outside which an assessment cannot be made.  The details of its argument appear below in the section of this judgment containing my decision.  It also had an alternative point relating to the calculation of the sums which fell to be deducted from the gross sum thrown up by the year end calculation.  Again, the nature of this argument appears below, because it was run again on this appeal.
The Tribunal's decision
11.	The decision appealed from sets out the background and the relevant legal provisions.  It then set out the various arguments, and the Tribunal’s decision and reasoning was set out in two paragraphs at the end of the decision. 
“13.	We are being asked to decide whether the 3 year cap [in section 77] prevents the Commissioners raising an assessment under the TOMS provisions, where the assessment arises from an adjustment of the prescribed accounting period, because that is the only way the earlier prescribed accounting period assesses the correct amount of VAT.  In our judgement the three year cap is paramount and as the assessment for the period to 06/01 related to the prescribed accounting period 04/00 to 03/01 must fall.   
14.	Section 77 (1) (a) effectively prevents the Commissioners from circumnavigating the 3 year period, except in the case of fraud or where the VATA specifically provides for it.  This is the primary legislation.  In applying the annual adjustment the Commissioners must, of necessity, carry out the calculation in the following quarter and apply the results to the prescribed accounting period immediately preceding that calculation.  The legislature has decided that an appellant should be protected from any VAT liability which is more than new rules three years old.  The "prescribed accounting period" under section 77(1)(a) for the purposes of this appeal is the period 06/00 to 03/01.  That period is outside the 3 year cap.  The annual adjustment is no more than a method of re-calculating the "prescribed accounting period".  It may be calculated in 06/01 but the Commissioners cannot assess other than for the periods 04/00 to 03/01 and in attempting to assess the period in 06/01 they will “widened the purpose of the Act" … which they cannot do under the interpretation rule of primary intention." (my emphasis)
The Tribunal then went on to refer to the secondary argument advanced by Dunwood but considered it was not necessary to reach a decision on it.
12.	The appeal to the Tribunal was therefore successful.
The arguments and decision on this appeal
13.	The essence of the decision of the Tribunal is contained in the words which I have italicised in the recitation of paragraph 14 above.  The Tribunal decided that the assessment of the annual adjustment was in fact and in law an adjustment and assessment of each of the previous 4 quarters.  Since those 4 quarters fell outside the period of 3 years prior to the 2004 assessment, HMCE was seeking to assess in respect of a period barred by virtue of section 77(1)(a).  
14.	On this appeal HMRC (through Mr Puzey) challenges that finding.  Its argument is that what HMCE did in 2004 was issue an assessment in respect of the period 06/01, because it was assessing in respect of a return that was not made or was wrongly made in that period – it was assessing for the year end calculation.  The correct figure for the year end calculation is a necessary figure or return in its own right, which has to be made in that period.  That period is within 3 years of the 2004 assessment, so section 77 does not bar it.  
15.	Dunwood, through Mrs Preston, seeks to uphold the Tribunal’s decision and its reasoning.  It repeats the reasoning of the Tribunal (where its case was upheld) and says that what HMCE has sought to do is to tax periods outside the 3 year period provided by section 77 because the annual adjustment (which is what HMCE’s assessment relates to) adjusts the earlier periods.   It is the returns for those earlier periods that were wrong, and while they could have been corrected by assessments made within 3 years, the assessment in this case (June 2004) was made more than three years after all those periods, and so is out of time.  So far as the TOMS scheme purports to allow that then as secondary (or tertiary) legislation it would be in conflict with the primary legislation in section 77, and should not be construed, or given effect to,  so as to do so.  
16.	The answer to this appeal lies in the proper construction of the legislation and the assessment.  The relevant legislation is as follows.
17.	Section 25 of the VATA provides for VAT to be accounted for by reference to accounting periods:
“25(1)  A taxable person shall –
(a)  in respect of supplies made by him, and
(b)  in respect of the acquisition by him from other member States of any goods,
account for and pay VAT by reference to such periods (in this Act referred to as " prescribed accounting periods") at such time and in such manner as may be determined by or under regulations and regulations may make different provision for different circumstances."
18.	Subject to variations which do not apply in the present case, Regulation 25 of the Value Added Tax Regulations 1995 provides that every person registered for VAT shall submit quarterly returns.  This regulation applied to Dunwood.  Its returns were required to account for VAT in a manner which took the TOMS scheme into account in relation to relevant inputs and outputs.
19.	Special provision is made for tour operators by section 53 of the VATA.  It provides:
"53(1) The Treasury may by order modify the application of this Act in relation to supplies of goods or services by tour operators or in relation to such of those supplies as may be determined by or under the order."
20.	The Value Added Tax (Tour Operators) Order 1987 (SI 1987/1806) was made pursuant to that provision.  It defines "designated travel service" in the way described in the notice (see above) and paragraph 7 provides that the value of a designated service is to be determined by the margin between the buying and the selling prices:
“calculated in such manner as the Commissioners of Customs and Excise shall specify”.
21.	The specification was done in the TOMS notice referred to above.  The manner of calculation is set out in the sections that I have identified.  I do not have to set out those sections.  However, section 12 at paragraph TL5 is important because it contains the obligation to calculate and account in the manner set out in the preceding sections.  It reads as follows:

“TL5
1.	Subject to Section TL3 of Section 12 of this Notice, the value of designated travel services, in-house supplies and agency supplies shall be determined by applying the formula set out in Section 8 of this Notice (hereinafter referred to as "the full calculation"), unless during the relevant period all such supplies are liable to VAT  at the same rate, in which case the value shall be determined by applying the formula set out in Section 10 of this Notice (hereinafter referred to as "the simplified calculation"). 
2.	The provisional value of designated travel services, in-house supplies and agency supplies shall be determined in accordance with the formula set out in:
(a) Section 9 of this Notice, where the full calculation applies; or
(b) Section 11 of this Notice, where the simplified calculation applies.
3.	A tour operator shall be required to account for VAT on the provisional value of his supplies of designated travel services, in-house supplies and agency supplies on the VAT return for the prescribed accounting period in which the supplies are made.
4.	The difference between the amount of VAT due on the value of designated travel services, in-house supplies and agency supplies supplied during a tour operator’s financial year, and the amount of VAT paid on the provisional value of those supplies, shall be adjusted by the tour operator on the VAT return for the first prescribed accounting period ending after the end of the financial year during which the supplies were made.”
22.	It is important to understand the structure of this provision.  Paragraph 1 determines and requires the method for calculating the value of the relevant services and supplies.  It is to be done by applying the formula in Section 8, that is to say the formula which is applied in the year end calculation in the course of carrying out that calculation.  Section 10 (which I have not hitherto referred to) provides for a simplified year end calculation, but the point is still the same -- it is only at the year end, as a result of the calculation carried out then, that the relevant value is "determined".  Until that is done, in any given year, the provisional value is ascertained in accordance with other sections of the notice.  Paragraph 3 provides for that provisional value to be accounted for on normal quarterly returns.  It is paragraph 4 that deals with payment and accounting for annual amount calculated in accordance with Sections 8 and 10.  It does not in terms provide for an amount to be “accounted for”, and it does not even require anything to be paid.  It requires a “difference” to be “adjusted” on a “return”.  This is not elegant language.  However, its effect is clear.  The year end calculation will throw up the “amount of VAT due”, and the difference between the “amount of VAT paid” on provisional values has to be entered on the return and thus accounted for.  If that generates a further payment due, it will have to be paid.  If it generates a repayment, a repayment will have to be made.
23.	Thus the structure of this provision is one which makes the year end calculation, and exercise, the one which generates the true VAT figure, and the figure thus generated is offset by the amounts already paid.  The nature of this process is not that propounded by Dunwood.  It is not one in which provisional payments are adjusted so as to make them accord with reality.  It is one in which a final liability has been provisionally paid in part over a preceding period.  I do not consider that it is really correct to regard anything as adjusted, but if it is then it is certainly not the provisional payments and calculations that are adjusted.  They are left intact, and are merely a method of paying on account.
24.	This means that the analysis of the Tribunal is wrong.  It is not correct to say that there is an “annual adjustment” despite the fact that that is a description appearing in the heading to section 8, and certainly not correct to say that “The annual adjustment is no more than a method of re-calculating the ‘prescribed accounting period’, or even “re-calculating the amounts due in the previous ‘prescribed accounting periods’ if that is what the Tribunal meant.  The year end calculation produces the amount due, and is offset by the provisional figures.  The year end calculation is carried out in the “first prescribed accounting period ending after the end of the financial year during which the supplies were made” (TL5 para 4).  It cannot be done before then (for obvious logical reasons) but has to be done in that particular period.  It therefore becomes a liability calculated, and arising, in that period.  
25.	I now turn to take that analysis back into the VATA.  Section 73 provides for what happens when late or incomplete returns are made:
“73 Failure to make returns etc
(1)  Where a person has failed to make any returns required under this Act (or under any provision repealed by this Act) … or where it appears to the Commissioners that such returns are incomplete or incorrect, they may assess the amount of VAT due from him to the best of their judgment and notify it to him."
26.	The right to make such an assessment has a time limit under section 77:
“ 77: time limits and supplementary assessments
(1) Subject to the following provisions of this section, an assessment under section 73 … shall not be made -- 
(a) more than 3 years after the end of the prescribed accounting period… concerned”
27.	In this case the assessment of 24th June 2004 purported to assess for the period 06/01 (so far as relevant to this part of the appeal – it also contained assessments for subsequent periods, but they do not matter for the moment).  It relied on an “underdeclaration” in a specified amount.  A preceding letter had set out details of the calculation which led to that sum, and was in effect a calculation setting out the steps of a TOMS Section 8 year end calculation.  In the penultimate step (as required) it calculated the provisional output tax paid in the preceding 4 quarters, and the last step (again as required) deducted that amount from the annual total previously calculated.  There was therefore no doubt as to what was being claimed and why.  What was being alleged was an under-declaration of the annual amount, on the footing of a proper calculation of a year end amount and giving credit for sums paid.  This has been treated by HMCE (and now HMRC) as being an incomplete or incorrect return in the period 06/01.  
28.	For that exercise to be barred by section 77 it must be the case that the assessment is being raised more than 3 years after the prescribed accounting period concerned.  It is therefore necessary to identify the “prescribed accounting period … concerned”.  Is it the period 06/01, or is it the preceding 4 periods (which contained the provisional calculations brought into the calculation).  In my view it is plainly the former.  On its face the assessment complains of an under-declaration in the 06/01 period, and on analysis that is what has happened.  The return for that period contained an error in that it did not contain any figure based on any year end calculation (no such calculation had been carried out).  TL5 paragraph 1 requires that VAT for the preceding financial year be determined by carrying out a section 8 calculation.  That amount becomes payable in the first prescribed accounting period of the following year under paragraph 4, less, of course, the amounts already paid.   The prescribed accounting period concerned is therefore that for 06/01.   That conclusion is not affected by the fact that the sum due is calculated by taking into account sums paid in previous periods.  It is the activities in the period 06/01 that were incorrect.  It does not matter that the returns for earlier periods were also incorrect.  It is not those earlier periods that are being adjusted.  Mrs Preston relied on the fact that the sums returned and paid in those earlier years are paid by reference to a value described in the notice as “provisional”, and submitted that a two stage exercise was required – correct the provisional returns, and then carry out the year end calculation.  That is what HMCE seem to have done in respect of later periods.  I do not consider that that exercise is necessary.  A year end calculation can and should be carried out by reference to the correct figures after the year end, and it is neither necessary nor sensible to recalculate the provisional values and amounts in the preceding 4 quarters.  It is no part of the required exercise.  What is required is that the sums paid be deducted from the year end figure.  
29.	Accordingly the decision of the Tribunal that the assessment related to the earlier periods (paragraph 13) and its implicit determination that HMCE had assessed for the earlier periods (paragraph 14) were wrong.   Nor is it the case that HMCE have somehow sought to “widen the purpose of the Act” (pace the decision) in some impermissible way by means of the notice and the assessment.  The notice has provided for a method of calculation which is, in itself, unobjectionable (apart from its complexity).  It throws up a liability in a given prescribed accounting period in respect of a preceding year, and it is not some sort of impermissible evasion of the section 77 limitation provision that it is calculated by reference to sums paid on account in the preceding yearly period.
30.	It follows that the appeal should be allowed and the decision of the Tribunal set aside.  That means that, unlike the Tribunal, I have to go on to consider the alternative argument of Mrs Preston.  That argument was as follows.  This argument assumes that which I have found to be correct, namely that HMCE was entitled to raise an assessment on the footing that the 06/01 return was incorrect as not containing a figure reflecting the year end calculation, but says that the manner in which the provisional payments were taken into account was wrong.  It is said that the assessment ought to have been calculated on the footing that the provisional payments had been correctly calculated.  She pointed out (correctly) that the same assessment actually did that for later years, so that what was deducted from the whole year figure in later years were the correctly calculated provisional sums. For the year prior to the 06/01 period there was no such recalculation by HMCE; it simply took into account the actual figures already paid.  Those figures were based on errors – a failure to treat coach travel values correctly, and an error in the whole methodology each quarter.  Mrs Preston says that the correct implementation of TL5 requires that what is brought into the adjustment is the correctly calculated quarterly figures.
31.	I find that that is not the correct way of carrying out the exercise.  There is no basis for it in the wording of TL5.  What is required to be brought into the adjustment is “the amount of VAT paid on the provisional value of those supplies” (my emphasis).  It is not the amount of VAT correctly calculated on that provisional value.  The wording is clear.  It also coincides with common sense.  If Mrs Preston were right then the taxpayer ought to check the provisional valuations to arrive at correct figures before then calculating the year end figure.  That seems to me to be completely pointless.  If the year end figure is calculated correctly then it does not matter if the provisional figures are calculated wrongly.  The effect of the error will be corrected in the year end figure, and as I have pointed out the main tax liability is calculated for the year, and not for the quarter anyway.  When HMRC or HMCE makes an assessment for the year end, it is doing what the taxpayer should have done, so there is no warrant for (or sense in) the tax authorities doing the back calculation either.  The fact that HMRC have apparently done it for the period after 06/01 (that is to say, they seem to have corrected the quarterly assessments as well) does not mean to say that it has to be done. If there were errors in the quarterly returns it was technically open to HMCE to assess the relevant quarters under section 73 (but subject to the limitation period in section 77), but it did not have to.  
32.	Accordingly, Dunwood’s alternative point fails too.  
Decision
33.	I therefore allow this appeal and set aside the Tribunal’s decision.  The assessment of 24th June 2001 for the period 06/01 stands.  
34.	The parties have agreed that costs shall follow the event.  This judgment is to be handed down without the further attendance of the parties, and they have invited me to make a costs order in accordance with their common position on costs, and to assess the costs.  I therefore order that Dunwood shall pay HMRC’s costs of this appeal, which I assess at £4,500. The Tribunal awarded costs to Dunwood.  Obviously that part of its order will be set aside too, but HMRC does not claim any of its own costs in the Tribunal.