TC00145

Value Added Tax  -  pre-incorporation expenditure and expenditure incurred prior to the date of registration and the date when registration was required -  Appeal dismissed as regards expenditure incurred before the individual who formed the company decided that the company would conduct the property development work, such that only thereafter was expenditure incurred “for the company” -  appeal allowed as regards such minor amounts of expenditure as can be shown to have been incurred by the company itself for the purposes of a business about to be conducted by it

FIRST-TIER TRIBUNAL                                         Reference no: LON/2008/1994

TAX

OAKS PAVILION LIMITED
Appellant

-and-

THE COMMISSIONERS FOR HER MAJESTY’S REVENUE AND CUSTOMS
Respondents

Tribunal:  HOWARD M. NOWLAN

Sitting in public in London on 23 July 2009 

Martin Westall of Optimum Tax Solutions on behalf of the Appellant
Sarabjit Singh, counsel, on behalf of the Respondents

©CROWN COPYRIGHT 2009
DECISION

Introduction

1.     This was a slightly unsatisfactory case.     It should have been a simple case dealing firstly with when pre-incorporation expenditure incurred “for” a company could qualify for an input deduction when the company was later incorporated and then registered for VAT purposes, and dealing secondly with the ability to claim an input deduction for expenditure incurred by the company itself for the purposes of its business, or a business about to be conducted, and incurred prior to its VAT registration.

2.     My decision is that to a large extent the denial of the input deduction was correct and justified, so that to that extent the appeal is dismissed.     I consider however that the Respondents wrongly disallowed input deductions for a short period prior to actual registration, and to that extent I allow the appeal. 

3.     The respects in which the case was unsatisfactory were firstly that counsel for the Respondents suggested that the facts were simple and were not in dispute so that it would be superfluous to enquire into the detailed facts (which proved unfortunately to be wrong), and secondly that the basis on which the Respondents interpreted and applied Regulation 111 of the VAT Regulations 1995 was also wrong in at least two respects. 

The facts

4.     In 2004 and 2005, Mr. Coram conducted building operations in the garden of his own dwelling-house, building two five-bedroom houses.    It was asserted that his original intention was to sell the two houses on completion, but that at some point he changed his mind and decided to let them both, which is what he eventually did. 

5.     At some time, and probably towards the end of 2005 (December being tentatively suggested) Mr. Coram enquired of his accountants how he might recover VAT in respect of the supplies of building materials.    It was suggested that if he formed a company and the company conducted the business of constructing “new build” houses, for which it charged him as the owner of the land, then the company’s services would be zero-rated so that the company would be able to recover VAT borne on building materials etc supplied to it when it rendered its overall charges for the building work. 

6.    Mr. Coram and his accountants decided to check the position with the VAT authorities and on February 21 2006 a letter or e mail was sent to the authorities asking whether this structure would enable VAT to be recovered.    On 22 February the VAT authorities replied, and although there was some confusion as to what they had said, they were understood to have confirmed that VAT would be recoverable if the building services were undertaken by a company, which thus charged Mr. Coram for the construction work.    More doubtfully Mr. Coram and his accountants also  understood the VAT authorities to be saying that if the work so far paid for by Mr. Coram in his personal capacity was reimbursed by the company once it was incorporated, the VAT in respect of those costs would also be recoverable. 

7.     As a result of this advice, Mr. Coram formed the Appellant company on the very next day, 23 February, and although there was no written contract, it seems that from that day onwards, the arrangement between Mr. Coram and the company was that the company would be conducting all the construction activities.    Future costs would thus be incurred by the company, and if building supply companies wrongly invoiced Mr. Coram personally, he would treat this as a case where he was acting as a nominee, such that the cost was beneficially incurred by the company, and should be borne directly by it.    No detailed evidence was given as to how the company financed its expenditure, though I inferred that the company simply ran up a “Director’s loan account”, becoming indebted to Mr. Coram for the amount of its expenditure.     I should add that I was given little detail as to how the company operated.    However there was no suggestion that the company’s method of operation changed from that between 23 February and 30 April, when the company was registered for VAT purposes, and in the periods following 30 April 2006.    Since HMRC have conceded VAT repayments for the period after 30 April, and I was told that the company conducted the finishing work on the two houses for some period ending after April 2006, and that at some time after October 2006 it continued similar operations in relation to other projects, I assume that, the start date for allowing deductions for input tax apart, HMRC had no other objections or criticisms to make of the way the company operated.    I assume thus that the method of operation was similar from 23 February onwards. 

8.    It was claimed shortly after the company was incorporated that the company reimbursed Mr. Coram for all of his earlier expenditure on the two houses, the reimbursement being in the form of an equivalent increase in the Director’s loan account.   I was not shown any accounts or management accounts made up during the period between the date when (i) the company began to bear the expenditure referred to in paragraph 7 above, and ostensibly reimbursed Mr. Coram for all the earlier expenditure and the date when (ii) it charged Mr. Coram for all the work in September 2006, but I was told that management accounts confirmed that the company was indebted to Mr. Coram for the aggregate amount of the debts during this period.

9.     On 4 March 2006 the company applied for VAT registration as from 1 March 2006.    HMRC in fact registered the company with effect from 30 April 2006, it being claimed by the Appellant and its accountants that someone, unknown to them, had deleted the date “1 March”, and inserted the date “30 April” in the company’s form, requesting registration. 

10.     On 29 March 2009 the relevant local authority issued its Certificate of Completion under the Building Regulations, confirming that the building requirements had been duly fulfilled in relation to the two houses. 

11.    One of the houses was let on 19 April 2006, and the other on 1 September 2006.

12.     On 1 September 2006 the company invoiced Mr. Coram for building services, and rendered a second invoice on 28 February 2007. 

13.     In October 2006 the company submitted its first VAT return for the 08/06 period, claiming a repayment of £84,038.40.     In due course this claim was largely disallowed, and the claim was only allowed in the amount of £15, 988.99, that being the amount of VAT included in the supplies received by the company after the date of its registration.   In refusing the majority of the claim, the Commissioners added that “an exempt supply of leased property has been made, which has the effect of blocking the claiming of input tax on this project”.

14.    I was told that following the period in contention, the company has continued its activities and has been undertaking other “new build” projects.

15.    I should mention four other points that it seemed to me to be important to clarify.   Mr. Coram took the witness stand in order to give his evidence on the first of the points, and gave evidence on oath.    The further facts were that:

•	From 22 February 2006 it was definitely Mr. Coram’s intention that his company would conduct the property development activities.    He said that he had been considering this, as a distinct possibility, for a long period before 22 February, but I only felt able to accept as a clear fact that from 22 February 2006 onwards, the intention was that the company would definitely conduct the activity.   Since the company was formed on the very next day, and no-one suggested that its method of operation changed on 30 April (after which date the Commissioners allowed all input claims), it seems clear that the company did commence its business on 23 February, and that from one day before, it was the intention that this would be so. 
•	The input claims that were allowed by the Commissioners (i.e. the amount of £15,988.99) all related to post 30 April work on the completion of the two houses.     The representatives of HMRC acknowledged that this element of the claim had been allowed, but were unclear whether it related to the completion of the two relevant houses, or to other later projects.    Since I was informed that by the October date, no other projects of any sort had actually been undertaken, and since it was asserted on behalf of the Appellant that the relevant £15,988.99 costs did relate to the further building costs in relation to the two houses, this point seemed fairly self-evident. 
•	I asked whether the basis on which the Appellant company invoiced Mr. Coram for building works would render it profitable or not.       No points had been advanced in argument along the lines that if the company merely billed Mr. Coram for the VAT exclusive amount of its costs, it might appear that the company had barely got a business at all and that it was just being used as a type of nominee in order to recover VAT.    The answer that I was given was that on the basis of the honest expectation that the company would recover all of the VAT for the costs that it had incurred, and those that it had reimbursed, it would have made a profit.    As it was, with the disallowance of the majority of the VAT, it would make a loss. 
•	Finally I should confirm that, while HMRC did not suggest that the company’s claim to recover VAT in respect of the reimbursed pre-incorporation costs was remotely dishonest, it was nevertheless contended that the reimbursement machinery was extremely unrealistic, and that it achieved no business purpose other than the hoped for recovery of VAT.     The only point that I make in relation to this is to say that Mr. Coram’s and the Appellant’s approach seems to me to have been entirely honest and straight-forward at all times.   They may or may not have been mistaken as to what the VAT authorities said to them on 22 February, but the reimbursement mechanics were only designed to achieve an object which Mr. Coram and the company thought the VAT authorities had actually sanctioned or even suggested, and there was nothing remotely underhand in proceeding as they did. 

The relevant terms of Regulation 111 of the Value Added Tax Regulations 1995

16.    It may be clearest, before referring to the law generally and to my interpretation of Regulation 111 to quote the relevant terms of Regulation 111 in exactly the form in which they were quoted to me in the Respondents’ counsel’s skeleton argument, adopting the same black type, which reflected the arguments on behalf of the Respondents during the hearing.       The relevant full extract was as follows:

“Exceptional claims for VAT relief

(1)   Subject to paragraphs (2) and (4) below, on a claim made in accodance with paragraph (3) below, the Commissioners may authorise a taxable person to treat as if it were input tax:
(a)	VAT on the supply of goods or services to the taxable person before the date with effect from which he was, or was required to be, registered, or paid by him on the importation or acquisition of goods before that date, for the purpose of a business which either was carried on or was to be carried on by him at the time of such supply or payment, and
(b)	in the case of a body corporate, VAT on goods obtained for it before its incorporation, or on the supply of services before that time for its benefit or in connection with its incorporation, provided that the person to whom the supply was made or who paid VAT on the importation or acquisition – 
(i)	became a member, officer or employee of the body and was reimbursed, or has received an undertaking to be reimbursed, by the body for the whole amount of the price paid for the goods or services,
(ii)	was not at the time of the importation, acquisition or supply a taxable person, and 
(iii)	imported, acquired or was supplied with the goods, or received the services, for the purpose of a business to be carried on by the body and has not used them for any purpose other than such a business.
(2) No VAT may be treated as if it were input tax under paragraph (1) above – 
(a) in respect of -
(i)	goods or services which had been supplied, or
(ii)	save as the Commissioners may otherwise allow, goods which had been consumed,
by the relevant person before the date with effect from which the taxable person was, or was required to be, registered;

…(c) in respect of services performed upon goods to which sub-paragraph (a) or (b) above applies; or

(c)	in respect of services which had been supplied to the relevant person more than 6 months before the date with effect from which the taxable person was, or was required to be, registered. 

(2B)  In paragraph (2) above references to the relevant person are references to – 
(a)	the taxable person; or
(b)	in the case of paragraph (1) (b) above, the person to whom the supply had been made, or who had imported or acquired the goods, as the case may be”

The contentions on behalf of the Appellant

17.    The essential contention on behalf of the Appellant was that all the conditions of Regulation 111 (1) (b) had been satisfied, so that the Appellant company should be entitled to the input deduction for all of the expenditure that it had reimbursed to Mr. Coram, as well as all the expenditure, under sub-paragraph (1)(a) that it had borne since 23 February. 

The contentions on behalf of the Respondents

18.     It was contended on behalf of the Respondents that:-
•	it was not clear on the facts that the Appellant had reimbursed, or undertaken to reimburse, Mr. Coram for the pre-incorporation expenditure;
•	Regulation 111(1)(b) only applied to expenditure obtained “for” a company intended to be incorporated, once that clear intention had been formed, and in the present case it was not clear that such an intention had been formed until one day before the company was in fact incorporated;
•	Since the local authority Certificate of Completion had been issued, demonstrating that the houses had been completed, prior to the registration of the company, no goods were still “on hand” by the point that the company was registered, so that sub-Regulation (2) would deny any claim for input deductions in respect of any expenditure incurred before 30 April; and 
•	The materials purchased by the company after 23 February were “consumables” which had been consumed by the date of  registration, so that again an input deduction was denied for any purchases of goods prior to 30 April; and 
•	(whilst this point had little bearing on the dispute) as a matter of interpretation, a company claiming deductions for pre-incorporation expenditure had to satisfy the requirements of both Regulation 111(1) (a) and (b) because the two were joined by the word “and”, and not the word “or”. 

19.     Whilst I will not list them as separate contentions on behalf of the Respondents, it is fair to record that during earlier discussions, the Respondents appeared to have been influenced by the point that Mr. Coram, in his personal capacity, could not have sought any recovery of VAT because he ended up leasing the houses, and thus making exempt supplies.     More relevantly it was definitely contended that as the local authority Certificates had been issued on 29 March, before the Appellant had been registered, the reality was that Mr. Coram himself had completed the developments, and that any attempt by the company to claim any input deductions was misconceived. 

My decision

20.     Since in my view there has been considerable confusion in this case, I will first describe the simple way in which it seems to me that Regulation 111 is meant to operate.

A general description of how Regulation 111 is designed to operate

21.     In the case addressed by Regulation 111(1)(a), where it is the taxable person who is later registered that is claiming an input deduction for earlier expenditure, that person first has to demonstrate that the acquisition of goods or services was for the purpose of a business which either was or was to be carried on by him at the time of supply or payment.       There are then two very obvious exceptions.     If some of the goods bought as mentioned have already been sold or supplied prior to the person being registered, or being required to be registered (so that the onwards supply has occasioned no liability to VAT) then obviously an input deduction cannot later be claimed because the input VAT would have nothing to do with the later taxable supplies.    Similarly with consumables, if petrol, gas, electricity or other consumables have been supplied in the period prior to registration, then broadly the same rule applies.    Since consumables that have been consumed will self-evidently not be the subject of an onwards supply either before or after the date of registration, the deductibility of the input tax will depend on the facts.    If the cost of the consumables all related to activity and supplies made prior to registration, then logically the input deduction should be denied.    If however the consumables related for instance to factory manufacturing costs, and no stock had been supplied at all by the point of registration, the cost of the consumables would obviously be a cost referable to later supplies that would only be made once the factory started to sell its products, all in taxable transactions for VAT purposes.    Thus, as the paragraph indicates, it would then be appropriate for an input deduction to be allowed for the earlier consumables. 

22.     Where expenditure is incurred for a company, prior to its incorporation, the contention on behalf of HMRC that both paragraphs 111(1)(a) and (b) have to be satisfied cannot be right.    Satisfying sub-paragraph (1)(a) would in all cases of “pre-incorporation” expenditure be impossible, so the contention on behalf of the Respondents would lead to a complete absurdity.     Furthermore Regulation 111(1)(b) itself contains all the relevant requirements.

23.      Where expenditure is incurred by another person prior to the incorporation of a company, the company can claim an input deduction for the expenditure if:

•	the expenditure was incurred “for the company”;
•	on or after incorporation the company reimburses or undertakes to reimburse the person who incurred the expenditure for those costs;
•	the person who originally incurred the expenditure became a member, officer or employee of the company, and had not ranked himself as a “taxable person” when he incurred the expenditure; and
•	the person who incurred the expenditure incurred it for the purpose of a business to be carried on by the company, and has not used the acquired goods or services for any purpose other than the intended business of the company. 

24.     The most material of those requirements, at least in the context of this case is the one that I have listed first in paragraph 23.    It is not remotely sufficient that an individual incurs costs, and then later decides to form a company.    The situation contemplated by this Regulation is that one of the people likely to be involved with the formation of a company incurs the costs on the basis that it is incurring costs “for the company” which is about to be incorporated.    It is not sufficient for an individual to be incurring building costs with a view to selling a house or to letting it, and then later to form the intention to put the property development role into a company.   

25.     Once all the requirements listed in paragraph 23 above have been shown to be satisfied, then of course no input deduction will be available if any of the provisions of Regulation 111(2) is in point.   

26.     The final general observation that I make on the Regulation is that in applying Regulation 111(2), I consider that counsel for HMRC was wrong to be arguing that the supply of building materials was a supply of consumables that had been consumed.     The building material were goods that will either have been incorporated in an onwards supply of services that was made before the date of registration, or else there will have been no such onwards supply, whereupon the input deduction will not be denied by sub-paragraph (2)(a).  My simple point is that it is sub-paragraph (2)(a)(i) that is possibly in point, and not (as was suggested in argument) sub-paragraph (2)(a)(ii).

Applying Regulation 111 to the facts in this case

27.     The fundamental fallacy underlying the Appellant’s case is that although all the detailed conditions of sub-Regulation (1)(b) may have been satisfied, the fundamental one that I described in paragraph 24 above was not satisfied.  In the present case, I am not satisfied that the actual decision to operate through a company was made until 22 February.   A company might have been seen as likely or as a distinct possibility before that date, but it was only when the requested confirmation was obtained from the VAT authorities that expenditure could be said to have been incurred “for the proposed company”.    This feature undermines any claim for an input deduction in respect of any expenditure incurred by Mr. Coram prior to 22 February 2006.

28.     The conclusion in paragraph 27 above, coupled with the fact that the Appellant company was incorporated on 23 February, whereupon the expenditure was incurred directly by the company itself means that a claim for pre-incorporation expenditure under Regulation 111(1)(b) can only be sustained for expenditure incurred after the receipt of the confirmation from the VAT authorities on 22 February and the time of incorporation of the company on the following day.     Since I was not told that any expenditure had actually been incurred in this very short period, and since the basis of “reimbursement” was somewhat tenuous, it seems superfluous to consider whether the company can claim any input deduction for expenditure incurred in this very short period.    

29.    This thus leaves as the remaining important question the issue of whether the company itself can claim input deductions for expenditure incurred between 23 February and 30 April. 

30.     It is unsatisfactory to have to address this question without having any detailed knowledge of how the company operated.    For the reasons given in paragraph 7 above however, I consider that I can and must proceed on the basis that from 23 onwards, the company conducted the construction services on “new build” houses that HMRC plainly accepted were zero rated services from 30 April onwards, and there was no remote suggestion that the method of operation had been any different in the period prior to 30 April.    I thus consider that the Appellant company was incurring expenditure for the purpose of a business that it was then conduction and that the terms of Regulation 111(1)(a) were satisfied as regards the expenditure incurred on and after 23 February.      This then raises the issue of whether anything in Regulation 111(2) results in the denial of the input deduction. 

31.       I have already said that I did not consider that the building materials that were doubtless the items bought in the period between 23 February and 30 April were consumables, and that I thus consider the speculation during the hearing, as to whether the materials should be treated as consumed consumables if for instance plaster had been applied to a wall, were irrelevant.    In my view the important question is whether there had been any onward supply before 30 April by the Appellant company to Mr. Coram of services that incorporated the materials purchased such that because the supply was made when the Appellant was neither registered nor required to be registered, the provision of Regulation 111(1)(a) would deny an input deduction for material that could not, so to speak, be “supplied again”. 

32.     In addressing this question, I note that the Statement of Case on behalf of HMRC made the point explicitly that HMRC regarded there as being a supply of services on 29 March by the Appellant company, on the basis that the company’s services must have been performed if the local authority issued the Completion Certificate under the Building Regulations on that date. 

33.     Whilst I accept that an input deduction would be denied by sub-Regulation (2) where there had been any onward supply of goods or services acquired by the taxable person prior to it being registered or being required to be registered, I do not consider that the issue of that Certificate resulted in a tax point for VAT purposes.     The Appellant company certainly issued no invoice and received no payment for its services until 1 September.     There was also no detailed contract specifying phased payment dates, albeit that I accept that under a formal construction contract, the issue of the Building Certificate might trigger a liability for one of various stage payments to be made.   It thus appears that the issue of the Certificate can only be said to occasion a tax point for VAT purposes if that issue indicates that the Appellant’s services had been entirely performed.   This, however, is not what the Certificate indicates at all.  The Building Regulations Certificate is all to do with the structural features of the building and pays no regard to internal decoration, fittings and many items that the constructor will attend to after the structural Certificate has been obtained.    This appears to be confirmed by the fact that the company continued to incur expenditure not only after March 29, but after 30 April, all apparently in moving towards final completion of its construction work. 

34.     My decision is thus that there was no tax point on 29 March, or indeed at any time between 23 February and the date when the Appellant was registered, with the result that Regulation 111(2)(a)(i) does not deny the deduction for input tax, available under Regulation 111(1)(a) for expenditure incurred by the Appellant itself after 23 February. 

35.    My conclusions, thus, are that:-

•	the Appeal is dismissed in respect of all expenditure incurred before February 22, because I am not satisfied that Mr. Coram was specifically incurring expenditure for the proposed Appellant company before that date; 
•	expenditure incurred on 22 February might qualify for deduction under Regulation 111(1)(b), but since the company was formed on the very next day, and the position from 23 February is governed by Regulation 111(1)(a) and Regulation 111(2)(a)(i), it may be appropriate to ignore the expenditure (if any) incurred on the one single date, quite aside from the difficult issue of whether the various assumptions and discharge of debts can be said to have resulted in the company reimbursing Mr. Coram for pre-incorporation expenditure;
•	expenditure incurred by the Appellant after its incorporation should have been allowed under Regulation 111(1)(a), unless there had been any onward supplies by the Appellant prior to 30 April, for instance and as asserted by the Respondents, on 29 March; 
•	my conclusion is that the issue of the Building Regulations Certificate did not establish that the services to be rendered by the Appellant had been completed, and thus the services fully supplied, and so I decide that all expenditure incurred on and after 23 February 2006 should have been allowed; and
•	if the immediately preceding conclusion is wrong, it would nevertheless follow that expenditure incurred between 29 March and 30 April should be allowed. 

36.     It was suggested to me by counsel for the Respondents that I could not give a decision in this form, because it was for the Appellants to prove every item of their claim, and they had not itemised expenditure that had been incurred on the various dates.    To this the Appellants indicated that they had given a full list of all expenditure, and presumably the dates when it was incurred.   The fact that, when the claim was made in October 2006, it was rejected for all items incurred before 30 April, seems to indicate that it was perfectly easy to ascertain when various items of expenditure had been incurred, so that it should be simple to apply the decision of principle that I have given, in order to ascertain what additional input tax should be allowed.    Were this not possible, and were the parties unable to agree the figures, then they would have to revert to the Tribunal

Costs

37.     It was specifically mentioned that no order for costs was being sought by the Respondents, whose contentions have broadly prevailed.    Accordingly no order is made as regards costs. 

HOWARD M. NOWLAN 
(Tribunal Judge)
Released: 31 July 2009