[2010] UKFTT 149 (TC)

TC00455

Appeal number TC/2009/09915

INPUT TAX - voluntary registration - pre-registration supplies - whether subsequent backdating possible - VATA Sch 1 para 9 - no backdating permitted.  Software - whether goods or services - disallowance of input tax on supplies of services made more than six months before registration - VAT Regulations 1995 reg 111(2) - appeal dismissed

FIRST-TIER TRIBUNAL
TAX 

PET STREET LIMITED
		Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

				TRIBUNAL: Paulene Gandhi (tribunal judge)
						Sandi O’Neill (member)

Sitting in public in London on 18 January 2010

Mr Athanas, accountant appeared for the Appellant

Mr Richard Smith, counsel for the Respondents 

© CROWN COPYRIGHT 2010

DECISION

1.     This is an appeal by Pet Street Ltd against HMRC’s decision of 16 March 2009 made under regulation 111 (2) (d) of Value Added Tax Regulations 1995  to disallow the Pet Street’s claim for input tax in the sum of £7943.11 on the basis that the VAT claimed was incurred too long prior to Pet Street’s effective date of registration (EDR) for VAT to be recoverable as input tax.  

2.      There are two main issues for us to resolve:
a)  Whether the supplies to which the claim for input tax relate are for goods or services.  This is important because the time allowed prior to registration is different in each case.  It is three years for goods and six months for services.  

b)  Were the supplies in question made within the period prior to the EDR allowed by statute for the making of a claim for input tax.  

3.      There are two other issues raised by Pet Street.  These are whether:
a)  Pet Street’s effective date of registration should be considered to be some other date than that from which it applied to be and was registered

b) The legislation providing for the time limit on pre registration claims was validly enacted.

Legislation  
4.      Schedule 1 paragraph 9 Value Added Tax Act 1994 (VATA) provides:
  “Where a person who is not liable to be registered under this Act and is not already so registered satisfies the Commissioners that he –

	(a)	makes taxable supplies; or

(b)	is carrying on a business and intends to make such supplies in the course or furtherance of that business,

they shall, if he so requests, register him with effect from the day on which the request is made or from such earlier date as may be agreed between them and him.”

5.      Section 26 VATA provides so far as relevant:
(1) The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies with subsection (2) below. 

6.    The Value Added Tax Regulations 1995 provide under Regulation 111 so far as is relevant:
“(1)  Subject to paragraphs (2) and (4) below, on a claim made in accordance 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 

(2)  No VAT maybe treated as if it were input tax under paragraph (1) above –
(c)  	in respect of services which had been supplied -
(i) to the taxable person, or
(ii) ……
more than 6 months before the date of the taxable person’s registration.

(3)   A claim under paragraph (1) above shall, save as the Commissioners may otherwise allow, be made on the first return the taxable person makes and, as the Commissioners may require, be supported by invoices and other evidence.

Undisputed facts
7.     Pet Street was incorporated on 20 November 2006.  This business created a website for people and organisations handling pets. Although Pet Street operated free membership and free access to the website the ulterior motive was trading for profit in the long term.  Pet Street registered at Companies’ House as a business trade and not as a non profit making organisation.

8.     In January 2007 HMRC received from Pet Street an application form VAT 1 dated 15 December 2006 by which Pet Street applied to be registered for VAT with effect from 1 December 2006.  Pet Street indicated on the form that it expected to make taxable supplies totalling £100,000 within the ensuing 12 months.  Pet Street also indicated on the form that it had not yet made any taxable supplies and that it expected to make its first taxable supply on 1 July 2007. 

9.     HMRC asked for information about this application by letter of 24 January 2007, specifically about the nature of the business that Pet Street had intended to enter into. Pet Street completed a questionnaire dated 6 February 2007. On the questionnaire Pet Street indicated that it owned a networking website and that it would begin charging advertisers to place adverts on the website shortly after returning the questionnaire.  Pet Street explained that it would issue invoices to various advertisers including pet charities, pet food manufacturers, and consumer brand owners.  By way of supporting evidence Pet Street provided a copy of a letter dated 15 January 2007 from an established web based trader which indicated that Pet Street and the trader were in negotiations in respect of a proposed advertising contract.  Pet Street did not provide any other supporting evidence.

10.   On considering this information HMRC decided to refuse to register Pet Street as they were not satisfied that there was sufficient evidence to show that Pet Street intended to make taxable supplies.  They had looked at Pet Street’s website and decided that they were unable to identify any advertising on the site which appeared to be a free social networking site.  On 16 February 2007 HMRC therefore wrote to Pet Street informing them that HMRC would not register Pet Street for VAT because HMRC were not satisfied on the basis of the available evidence that Pet Street was in business and either making or intending to make taxable supplies.  This letter of 16 February 2007 also informed Pet Street that they could ask for a reconsideration if they disagreed with HMRC’s conclusion and they could provide any further information.  The letter also informed Pet Street that they could appeal to the VAT and Duties Tribunal.   Pet Street did not respond to this letter. 

11.  Pet Street again applied for VAT registration on 8 May 2008.  This was an application for voluntary registration on the basis that Pet Street intended to make taxable supplies in the future.  The online application form submitted on Pet Street’s behalf specified 1 March 2008 as the date from which its registration should commence and that it estimated its anticipated taxable turnover in the 12 months following registration at £80,000.  This application was granted by HMRC and Pet Street was registered with effect from 1 March 2008 as requested.

12.   On or about 22 September 2008 Pet Street submitted its first VAT return which covered the period 1 March 2008 to 31 August 2008.  Pet Street made a claim in the return for repayment of £8,530.22 input tax.  

13.    On 22 September 2008 HMRC initiated a pre credibility check into the return and on 10 October 2008 HMRC visited Pet Street.  HMRC ascertained that Pet Street had recently made its first taxable supply (raised in its first sales invoice on 3 October 2008) and that Pet Street intended in due course to charge a subscription to those using its web site and to attract sponsorship.  HMRC concluded that £7,943.11 of Pet Street’s repayment claim related to supplies of services it had received more than 6 months prior to its EDR.  HMRC also concluded that the business was genuine and that Pet Street’s accountants had made a genuine error in failing to apply for an earlier EDR.

14.   By letter of 10 October 2008 HMRC notified Pet Street that the return would be amended to reduce Pet Street’s repayment claim to £587.11.  The goods which were allowed as within the three year time limit of regulation 111 (2)(b) were the following:
(a)    16/1/07 - invoice from Zone Ltd for the purchase of a computer. VAT element £272.11

(b)   20/6/07 - invoice from Mr Melzak for the purchase of equipment. VAT element £315

Total input tax allowed £587.11

15.   HMRC disallowed the balance of £7,943.11 as they contended it was incurred in relation to services supplied to Pet Street more than 6 months prior to the EDR and was therefore disallowed under regulation 111(2) (d) of VAT Regulations 1995.

Effective date of registration
16.    Pet Street submits that they did not opt for a reconsideration of HMRC’s decision of 16 February 2007 refusing to register them for VAT from 1 December 2006 because they had provided all the evidence they could.  Further Pet Street contends that the decision letter of 16 February 2007 was misleading, out of context, and did not advise appropriately on how to proceed with the appeal procedures.  They also state that HMRC should have accepted the evidence that Pet Street provided in 2007 as to their business as HMRC’s website did not ask for any particular type of evidence.  They state that the second application which was made for VAT registration on 8 May 2008 was made in circumstances which were almost identical to the earlier application.  This application was accepted without any requirement for additional information.

17.   HMRC state in their decision letter of 16 March 2009 that at the time of the original application, received in January 2007, Pet Street did not meet the business tests as set out in C & E Commrs v Lord Fisher QB [1981] stc 238.  We note that Pet Street said it would make £100,000 of sales in 2007 yet its first sales invoice was raised on 3 October 2008 nearly two years later. We therefore accept HMRC’s view that in 2006 there was insufficient evidence that Pet Street intended to make taxable supplies

18.   In our view Pet Street had two opportunities to challenge the EDR neither of which they took.  

19.  The first opportunity was after receiving the decision letter of 16 February 2007 refusing to register Pet Street for VAT.  This letter in our view clearly states that Pet Street may ask HMRC to reconsider their decision.  Pet Street in their skeleton argument (paragraph 6) states the letter was ‘misleading, out of context, and did not advise appropriately how to proceed with the appeals procedure’. Yet at paragraph 5 of the same skeleton Pet Street states they had no further evidence to adduce so did not ask for a reconsideration.  It is clear to us that Pet Street did understand this letter but made a conscious decision not to ask for a reconsideration as they had no further evidence to submit. 

20.    In relation to appealing HMRC’s decision Pet Street state in their skeleton argument (paragraph 6) ‘in the penultimate paragraph of the letter it states “if you are still not satisfied you may be able to appeal to an independent VAT and Duties Tribunal.  Whether or not you have asked for reconsideration, you have the right of appeal against the Commissioners’ decision that you were required to be registered for the period stated and/or the liability to a penalty”.  The Officer of the HMRC has used a standard letter in refusing the application which indicates that the Officer did not consider the application fully within the scope of VAT Regulations’.   It is clear that this letter spells out Pet Street’s right to appeal to the VAT and Duties Tribunal whether or not the company applied for a reconsideration of HMRC’s decision and gave details of how to obtain the leaflet explaining the Tribunals’ appeals procedure.  Further it is clear that Pet Street understood this part of the letter as they state it uses standard wording.  

21.   Even the appeal we are considering now is against the refusal to allow Pet Street’s claim for input tax and not against HMRC’s refusal to register Pet Street from the earlier date.  No appeal against the latter decision has ever been made.  In any case any such appeal would be two years out of time by the time this appeal was issued, the time limit being 30 days (see rule 20 of the 2009 Procedure Rule and Section 83 (g) of the VATA 1994).   

22.   The second time Pet Street had an opportunity to challenge its EDR was when on 8 May 2008 Pet Street applied to be registered for VAT under VATA 1994 Schedule 1 paragraph 9.  On its application form Pet Street indicated that it made its first taxable supplies on 1 March 2008 and that it wished its registration to commence from that date.  Under paragraph 9 of the above Schedule at the time of application it would have been open to Pet Street to approach HMRC to agree an earlier EDR.  Had Pet Street made such an approach it would have been able to make representations to HMRC in respect, inter alia, of its circumstances at the time of its earlier application to be registered.  However Pet Street made no such approach.

23.    It was only after Pet Street registered for VAT under paragraph 9 that it submitted its claim for repayment.  The rights conferred in paragraph 9 Schedule 1 VATA are conferred on persons not liable to be registered for VAT and not already registered.  Therefore the opportunity to agree an EDR earlier than the date of the request to be registered is only available to a person who is not already registered.  Pet Street did not challenge HMRC’s decision on registration dated 16 February 2007.  This option is thus no longer available to them now.

24.   Pet Street submit in their skeleton argument (paragraph 15) that they acted in good faith in following HMRC notices in the process of voluntary registration and that Pet Street were not fully aware of the time limits imposed by the new rules in claiming VAT.

25.    In their bundle (pages 49 and 50) Pet Street include the VAT1 (notes)
Number 13 (page 49) states the following:
 “You can apply for voluntary registration where your turnover does not go over the registration threshold…

Enter the date you would like to be registered from….

Important – the date you put here, once we have agreed it, will be your registration date. You must account for output tax on all your taxable supplies from that date.  Once a date is agreed, you cannot change your mind and ask us to alter your voluntary registration to a different date.  We will only agree to change the date of registration in exceptional circumstances.”

26.    Under voluntary registration (pg 50) it states
“If you are thinking about registering voluntarily, you might want to check the rules for reclaiming VAT on purchases made before registration.  There is a time limit of three years for goods and six months for services.”

27.   The above clearly shows that Pet Street knew about the importance of considering the date of registration.  

28.   Pet Street additionally in their grounds of appeal state that HMRC failed to use its powers of discretion in allowing the earlier date (thereby making the claim on the expenditure within the time limit). 

29.    HMRC state in their review letter dated 16 March 2009 that Departmental Guidance VI-28 chapter 8 paragraph 8.8 provides guidance on requests from registered traders to amend their EDR to an earlier date than that already allocated. As in this case this commonly occurs where they belatedly find that input tax incurred prior to the EDR cannot be claimed outside of the time limits of regulation 111 (2)(d). In these instances the request is refused as schedule 1 paragraph 9 does not allow an EDR to be varied after a trader is registered. When the trader applied for registration he had the opportunity to negotiate his EDR then and the legislation does not allow this date to be changed retrospectively.  VI-28 chapter 33 paragraph 33.1 provides further guidance on a change of the EDR at the request of the trader. One of the conditions for applying any discretion and allowing an amended EDR is that the request is made before the due date of the first VAT return which must not have been rendered. In this instance the request was made after the first return was rendered and once an assessment to disallow pre registration input tax was issued.  In order to ensure consistency the reviewing officer contacted the relevant departmental policy team.  It was agreed from the facts of the case that there are no grounds for exceptional discretion in this instance.  

30.   As can be seen from the above HMRC did not consider Pet Street’s circumstances exceptional.  Mr Smith, counsel for HMRC, stated that what would be considered exceptional would be a genuine error in completing the VAT registration and not an error in judgment as has happened in this case. Given that Pet Street did not pursue the matter at the time in our view HMRC’s decision was reasonable in the circumstances.  

Validity of the legislation
31.  HMRC’s decision to disallow Pet Street’s claim for input tax was based on regulations 111(1) and (2) of the VAT Regulations (“the regulations).  These provide that a tax payer may make a claim for input tax on supplies which were made to him before his effective date of registration.  In the case of goods the time within which the supply must have been made prior to the EDR is 3 years and in the case of services it is 6 months.

32.   In this case HMRC were of the view that the supplies in question were of services and were made more than six months prior to the EDR on 1 March 2008.  On that basis the majority of the claim was disallowed.

33.    Pet Street calls into question the validity of regulation 111 and relies on the case of Fleming v Commissioners for HMRC [2008] UKHL 2.  This case concerned the validity of Regulation 29(1A) of the Regulations which was enacted to impose a time limit on claims to deduct input tax by registered persons.  It was held that because prior to its enactment there was no such time limit, in order to be lawful under European Union law, there had to be a transitional period to allow those whose rights had already accrued to exercise them without being penalised by the new limit. 

34.   HMRC states that this is not a case where Pet Street had a right to deduct input tax which had accrued prior to the enactment of Regulation 111 on 20 October 1995.  The VAT which Pet Street argues is deductable input tax was incurred in 2007. In Fleming the House of Lords did not reject the whole concept of the three year cap but dealt with the lack of transitional arrangements.  The judgment in Fleming is clear in only applying to claims based on rights which had accrued prior to the enactment of the time limit (see paragraph 83 of the judgment).  The three year cap was not declared unlawful and the time limit for making repayment claims remains at three years as set out in Section 80 VAT Act 1994 and Regulation 29 Value Added Tax Regulation 1995. We agree with HMRC’s view that Pet Street’s argument is misconceived.

The disallowed claim
35.   We now turn to what in our view is the main issue in this case and that is whether there was a supply of goods or services.  It is common ground between the parties (subject to the matters we have dealt with above) that if we find there was a supply of goods Pet Street can reclaim their input tax and if we find there was a supply of services they cannot.

36.   HMRC maintains that the supplies in question were of services.  They state that the supplies are evidenced by invoices and all relate either to the development of Pet Street’s website or of the marketing of Pet Street’s website. HMRC contends that Pet Street received nothing tangible and that no title to, or ownership of any goods has passed from the suppliers to Pet Street and the suppliers did not purport to provide anything physical.  On the contrary insofar as the website development is concerned it is clear that the suppliers were working on something owned by PetStreet, the website itself, and adding value to it.  This is a supply of a service.  In addition the disallowed invoices included those for services of a cartoonist providing cartoons on the website, public relations services and the placement of advertising.  All of these are services rather than goods.
37.  HMRC submits that this analysis of website design as a service is indirectly supported by domestic and European legislation.  Paragraph 7C of the now repealed Schedule 5 to VATA 1994 lists website supply and the supply of software as services (this was in the context of their being services supplied where the recipient belonged prior to the change in the supply rules - that change does not cast any doubt on the characterisation of the supply as a service.)

38.  This provision derived from annex II to the principal VAT directive, which is supplemented by article 11 of the council regulation 1777/05.  These provisions are not determinative of the question as to whether the supply is of goods or services as they are directed at characterising services which were deemed to be supplied where the recipient belonged but HMRC state that they are helpful in underlining that the supplies in dispute were of services and not goods.

39.    However Pet Street argue that what was purchased were goods rather than a service.  Pet Street state that the majority of invoices where input tax was claimed were computer software and accessories and should be categorised as a supply of goods thus making the input VAT repayable.  They state that HMRC has accepted the purchase of a computer and the video camera with built in software as a valid claim and repaid the VAT input tax whilst HMRC have refused to accept the other invoices relating to the purchase of the software package.

40.  In his witness statement of 27th November 2009 Mr Melzak states that what he brought from Zone Ltd was a finished product: a functioning social network that formed the basis of his business plan for Pet Street. He states that purchasing a social network is so entirely recognised as buying a product, that it is possible to buy less sophisticated off the shelf social networks exactly as one might go into a computer store and buy word processing or accounts packages off the shelf.  In other words he brought a finished product – a functioning web site.  

41.   He goes on in his statement to give details of the invoices from Zone Ltd: 
(a) Invoice no. 4225 dated 15/1/07 subtotal £25,000 plus £4,375 VAT.  This invoice’s description “phase 1 of website development as agreed” we understand from Mr Melzak’s statement included such things as custom designed and built software, the art work for the site and graphic design, bespoke functionality that a social network for pet lovers would need, such as ways to upload pet photographs, a specific forum, a photographic competition called Pet Idol, an ability to allow members to set up “Pet Clubs” on any specific subject they chose, and to contact other members of the site directly or indirectly.  All this required specific custom designed and built software.

(b) Invoice no. 4281 dated 5/2/07 was for ‘additional work including poll, picture voting, forms, etc, 50% upfront’ £4700 plus £822 VAT 

(c) Invoice no. 4368 dated 5/3/07 was for ‘additional work, including poll, picture voting, forms, balance due’ £4700 plus £822 VAT
(d)  Invoice no. 4401 dated 15/3/07 was for ‘track and display of last login time on site for each user’ £200 plus 335 VAT

(e) Invoice no 4224 dated 15/3/07 was for “recharges of expenses incurred on behalf of Pet Street” and included ‘software design, Beach-o-Matic (illustrations), taxis, URL registration costs, use of photograph on advertising material’. £5422.16 plus VAT £948.88  
 
(f) Invoice no 4943 is for £897.26 plus £157.02 VAT.  This invoice was for Google Ad words whereby Google is paid to inform people who search for pet related words of Pet Street (no invoice has been provided)

42.   In oral evidence Mr Melzak stated that the extra software was in the form of CDs.  He bought two of the CDs with the computer and then another three later as and when his finances enabled him to do so.  Mr Melzak stated that this software was needed for Pet Street to run the system they had in place for their website.  He stated that the website had complex functionality and needed to do lots of different tasks.  The web design company (Zone Ltd) created this software in the form of CDs which Mr Melzak could then insert.  By loading this software onto the computer the software formed part of the business assets.  It was therefore submitted that the physical existence of CDs made it a supply of goods rather than services.
 
43.   As can be seen from the above it is important to identify the exact nature of what is being supplied.  In our view even if we found the end product was a CD (and that is disputed by HMRC as the existence of CDs was only mentioned for the first time at the hearing) that is not necessarily determinative of whether the product supplied was a service or goods.  The fact that Pet Street chose to have a physical embodiment of their website in the form of CDs does not automatically make it a supply of goods rather then services. If the CDs were simply a by product of the website and the website was the product being supplied then in our view this would be a supply of services and not goods.  

44.   Having seen and heard Mr Melzak give evidence we have no reason to
doubt his evidence.  On his own evidence however the purpose of the
CDs was to increase the content and functionality of the website as it was initially “rudimentary”.  Over time the web site has evolved.  On day one there
was little on the website.  It simply enabled people to register their
profiles and there were some news items on the website.  Now the
website has more news items, videos, advice from vets, competitions, 
forums, club information, and profiles of members and their pets.  The
CDs were the method by which this improved functionality was
introduced to the Pet Street website.  This improved functionality was supplied to and retained by Pet Street in the form of CDs in case Pet Street’s computer went down so Pet Street would always have a back up. This suggests to us that what was in fact being supplied was a service as it was intended to develop and enhance the website. 

45.    Further despite it being argued by Pet Street that the CDs were akin to buying an off the shelf CD to make a new Apple computer functional it is clear to us that what Zone Ltd have produced for Pet Street (software to increase the website’s  functionality) is not an off the shelf product but a bespoke service.  Our view on this matter is further strengthened by looking at Mr Melzak’s description of the invoices contained in his statement.  Here he says the work done for Pet Street by Zone Ltd was “custom designed and built software” with “bespoke functionality”.  

46.  We also take into consideration as a useful guide that both paragraph 7C Schedule 5 to VATA 1994 (now repealed) and annex II to the principal VAT directive, which is supplemented by article 11 of the council regulation 1777/05 lists website supply and the supply of software as services. We are satisfied that the supplies to Pet Street were those of services rather than goods. 

47.   Taking all of this into consideration in our view the CDs were simply a back up to what was essentially a supply of services to improve the functionality of the website.   

48.   The supplies in question were made between January 2007 and June 2007 i.e. more than six months before PetStreet’s EDR of 1 March 2008.  Therefore under regulations 111(1) and (2) the VAT incurred on those supplies cannot be treated by Pet Street as input tax.

49.    The appeal is therefore dismissed.

The Appellant has a right to apply for permission to appeal against this decision pursuant to rule 39 of the rules. The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this Decision Notice.

TRIBUNAL JUDGE 

RELEASE DATE: 6 April 2010