INPUT TAX – Standard-rated purchase of property by Appellant property development company for conversion and sale for relevant residential purpose – Zero-rated sale of that property – Contract between purchaser and another building company – “Management fees” to be paid by builder to Appellant subject to conditions – “Contract” between builder and Appellant said to be contained in letter proposing terms and inviting agreement – Whether VAT paid on purchase of property claimable as input tax attributable to “management fees” – Whether “direct and immediate link” between VAT on purchase and “management fees” – Whether purchase part of “cost component” of “management fees” – EEC First Directive, Art 2 – EEC Sixth Directive, Art 17 – VATA 1994, ss 24(1), 25(2) – VAT Regs 1995, reg 101(2)
LONDON TRIBUNAL CENTRE

	GOLDMAX RESOURCES LTD	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	ANGUS NICOL  (Chairman)
						MR M R JAMES

Sitting in public in Plymouth on 25 March 2003

Mr S Taylor, Chartered Tax Adviser, for the Appellant

Ms S Rahman, counsel, instructed by the Solicitor for the Customs and Excise, for the Respondents

© CROWN COPYRIGHT 2003

DECISION

1.	This appeal arises out of an inquiry by the Appellant as to the claim for input tax in respect of the standard-rated purchase of a property.  The issue concerns the question whether the Appellant, a partially exempt trader, was entitled to deduct input tax in respect of the purchase of property, and whether that expenditure was incurred exclusively in making taxable supplies, partly taxable and partly exempt supplies, or only exempt supplies.  The circumstances surrounding the transactions, some of which are in dispute, are set out below.

The facts

2.	The facts are taken from a statement by and the oral evidence of Frank Morrison, a director of Goldmax, and from documents and correspondence produced to the Tribunal.

3.	Goldmax is a building and property development company with its offices in Exeter.  Mr Morrison was privy to all the negotiations relating to this series of transactions, between Goldmax, Exeter City Council, Signpost Housing Association Ltd (“Signpost”), and Connaught PLC (“Connaught”).  On 30 April 2001 Goldmax purchased a lease for three years, together with an option to purchase the freehold, of Marwood House in Exeter. We were shewn what appeared to be draft leases of Marwood House by Abbotsdale Homes Ltd to Goldmax; however, the facts of the lease and option were not in dispute.  The purchase price of the freehold was to be £420,000.  At the time of the purchase of the lease and option, Marwood House was an office block.  It was originally intended that Goldmax should sell Marwood House to Signpost, which wished to convert the building into residential accommodation for the rehabilitation of those dependent upon alcohol or drugs.  The conversion was to be carried out by Goldmax.  The option to purchase was exercised on 4 March 2002, and Goldmax purchased Marwood House for £420,000 together with VAT of £73,500.  Goldmax had elected under paragraph 2 of Schedule 10 to the 1994 Act to waive the exemption to tax in respect of Marwood House. On the same day Goldmax sold Marwood House to Signpost for £460,000, the sale being exclusive of VAT because it was for conversion to a relevant residential purpose within Group 5 of Schedule 8 to the Value Added Tax Act 1994 (“the 1994 Act”). 

4.	During the negotiations for the sale to Signpost, Signpost made it clear that it required to have clear title to the property before entering into a separate contract for the construction work.  That was a requirement of the Housing Corporation, and was a prerequisite of providing funding to a housing society.  Furthermore, it was also a requirement that a recognised developer which was a member of Construction Line, a controlling body, should be used to carry out the conversion work.  Goldmax was not a member of Construction Line.  Mr Morrison said that Goldmax agreed to act as the agent responsible for sourcing and negotiating the building contract.  This is one of the points on which there is some disagreement.  Goldmax did not produce any written agreement between Goldmax and Signpost for Goldmax to act as agent, nor was any specific evidence adduced as to any term of such an agreement, nor was anyone from Signpost called to give evidence of such an agreement.

5.	Mr Morrison said that Goldmax negotiated a contract between Signpost and Connaught for the conversion work to be carried out for a fixed price of £970,000, “but with Goldmax being financially responsible for certain aspects of the works throughout the contract. This was a prerequisite without which Signpost would not have entered into a JCT contract with Connaught.  This was based on the costings negotiated by Goldmax.”  There was no contract as such between Signpost and Goldmax, nor between Connaught and Goldmax, nor were we referred to any contract between Signpost and any other party of which it was a term that Goldmax would be responsible for certain aspects of the works.  There was produced a copy of a letter from Signpost to Goldmax dated 20 August 2001.  In view of later correspondence, this letter is of great evidential importance as to the existence of a contract between Signpost and Goldmax, and we therefore set it out in extenso.

“Thank you for your letter dated 13 August 2001 concerning [Marwood House].

Both the costs and grant rates have already been fixed with the City Council and unless all parties are prepared to delay the scheme until the relevant Local Authority Committee can consider increasing the grant I am limited to the original budget.

With relation to the Category 1 items contained within your letter, whilst I would accept that the design fees were not included with the original budget figure, I would not agree that the other items should not be included, because they are essential requirements for any new build or refurbishment scheme.	
If the scheme is to be carried out under a design and build contract I may have some leeway above the £1.365 million figure, because a greater share of the risk lies with the Contractor.  In such a situation the maximum figure that I could accept is £1.400 million inclusive of all the items contained in Category I and II but excluding design fees.  

Should the infrastructure charges of £39,490 prove to be less I would expect the Contract sum to be reduced accordingly.

I have received a valuation on the building of £430,000 and therefore the figure would need to be made up as follows:

	Acquisition			£430,000
	JCT Contract			£930,000
	Infrastructure charges		  £40,000
	Design fees			  £40,000 
				         £1,440,000

Should this proposal be acceptable, I would be grateful if you could contact me as soon as possible so that I can arrange a meeting with all interested parties later this week.”

That letter was addressed to Mr Morrison by name, and signed by John Findley, Development Manager of Signpost, whose name does not appear among the list of directors on the headed writing-paper.  The letter from Goldmax of 13 August 2001 was not produced in evidence.

6.	Mr Morrison said that on 7 March 2002 Connaught contracted to pay to Goldmax a fee, described as the management fee, of 23.26 per cent of the value of the contract between Connaught and Signpost, up to a maximum of £225,631.  There were certain conditions:  if certain costs in the conversion were more than Connaught had budgeted for, Connaught could recover the excess from Goldmax by deducting it from the management fee.  In a letter on behalf of Goldmax, dated 25 September 2002, by Mr Stephen Taylor of Pearce Taylor Taxation (who represented Goldmax at the hearing), in answer to a letter from the Commissioners of 11 September 2002 asking, inter alia, for a copy of the contract or agreement between Goldmax and Connaught which set out what services Goldmax was required to provide to Connaught in return for the management fee, Mr Taylor said,

“I am advised that the basis for the contract, or contracts, for the management services is found in three letters.  There is no other relevant documentation.

The first letter was on 20 August 2001 from Signpost to Goldmax.  A copy is enclosed.  Connaught wrote the other two letters on 7 March 2002.  One is to Signpost, the other to Goldmax.  Again, copies are enclosed.”

We understood that the copy of the letter of 7 March 2002 to Signpost was not, in fact, enclosed.  That letter was not produced to the Tribunal.  The letter of 20 August 2001 is that set out in paragraph 5 above.   

7.	The letter from Connaught to Goldmax of 7 March 2002 we also set out in full because of the reliance placed upon it as constituting or being evidence of a contract between Signpost and Goldmax.  The letter is addressed to Goldmax itself, and is signed on behalf of Signpost with an illegible signature.  The letter is as follows:

“We are writing to confirm that we have submitted our revised Contractor’s Proposal to Signpost Housing Association and a copy is enclosed.  You will note that our revised proposal contains qualifications, and we anticipate Signpost wishing to discuss these matters with us further.  There is a possibility that the outcome of discussions may impact on the fee of £225,631.00 included within our proposal in respect of the fee to be paid to you in the event of us entering into a formal contract with Signpost.  You will note by reference to the enclosed documents that in our proposal sent to Signpost we have classified the sum of £225,631 as Management Fee.

The Management Fee represents 23.26% of the contract sum and we propose that following each and every payment made by Signpost to us we will pay to you 23.26% of the actual payment received excluding VAT.  Such payment to be made within 7 days following receipt of payment by us from Signpost.  It is proposed that following receipt of payment to us by Signpost we will send to you a copy of the relevant Payment Certificates and that you in turn will send to us a VAT invoice in respect of the sum due to you.  Following receipt of the VAT invoice we will make payment in accordance with the period set out above.

In any event the payments to you will not exceed in total the sum of £225,631.

There is a possibility that as a result of our qualifications Signpost may not wish to exceed the sum of £970,000 set out in our proposed Contract Sum Analysis.  They may wish the additional costs arising out of our qualifications to be taken out of the Management Fee being the sum due to be paid to you.  Therefore the costs of carrying out additional works may have to be met out of the Management Fee and we propose the following procedure in such an event:

1.	Upon it being necessary either by instruction from the client or good working practice as dictated by Connaught, to carry out additional works arising out of the qualifications mentioned above and varied work from own original priced schedule. The cost of carrying out the additional works be met by a reduction in the Management Fee.  We will give you a formal notice of such additional expenditure and the resultant reduction in the sum to be paid to you.  The percentage mentioned above being 23.26% will be reduced and a new percentage fixed.

2.	Within 21 days of us giving you notice of expenditure we will provide you with a detailed breakdown of the price stated in the notice of expenditure, including attendance and profit.

3.	Within 7 days of receipt of the detailed breakdown you may serve a notice of objection and in the said notice you will provide your valuation in respect of the additional works being the sum you propose be deducted from the Management Fee of £225,631.  Should you decide not to give notice of objection within the 7 day period the parties will proceed on the basis that the sum set out in the detailed breakdown sent by us is agreed, and that the percentage in respect of the Management Fee will be reduced accordingly.

4.	In the event of you serving a notice of objection within the 7 day period mentioned above, the parties will seek to resolve their differences within 14 days failing which the parties agree to appoint an independent Quantity Surveyor to ascertain the value of the additional works.  The independent Quantity Surveyor will be appointed as an Expert, and the parties will be jointly and severally liable for his fees.

5.	In the event of the parties being unable to agree on the appointment it is proposed that the parties jointly request the president of the RICS to appoint an independent Expert.  The cost of such application for appointment to be shared equally by the parties.

6.	Following the service of the notice of expenditure mentioned above and during steps 1-5 set out above, we will adjust the percentage in respect of the Management Fee for the purposes of interim payment.

The above process will be utilized on each and every occasion when there is a change in respect of a cost to be met out of the Management Fee.

We invite your agreement on the above.

For the avoidance of doubt the above proposal is conditional upon us entering into a formal contract with Signpost in the sum of £970,000 incorporating a Management Fee of £225,631.”

It is clear from the penultimate sentence that no agreement had yet been reached.  However, Mr Morrison said that by 5 August 2002 Connaught wished to deduct £57,409.01 from the management fee, but that that sum was negotiated down to £27,273.

8.	Mr Morrison said that when Goldmax agreed the contract with Connaught it had been in negotiation for some months.  He said that Goldmax was left with some responsibilities in the contract, and a retention of 5 per cent on each payment was held against Goldmax as well.  Goldmax had to be responsible for extra costs which Connaught could not quantify, and was also responsible for asbestos and plastering.  Goldmax had obtained the structural survey, before selling the property of Signpost, and assigned it to Connaught which reimbursed Goldmax.  After the sale of the property Goldmax had to bring it to a good state of repair, and was closely involved with the architects and with everyone who was concerned in the matter.  Goldmax met the cost of the damp proofing.  Mr Morrison said that Goldmax had always seen this as what he termed “a total deal” or “ a tripartite deal”.  Marwood House would never have been sold to Signpost at a loss unless it had been part of the greater deal.  It was the understanding of Mr Morrison and Goldmax that if Goldmax bought the building and carried out the conversion it could recover input tax on the purchase price.   Mr Morrison said that  by March 2002 Goldmax was aware that it would not be able to do the construction work, and never had expected to do it.  He said that the letter from Mr Taylor of 26 July 2002 might not be quite accurate, although he did not point to any specific inaccuracies.

9.	That letter, addressed to the Exeter VAT Office, contains a little additional factual matter.  After listing certain documents which were enclosed, including the letter of 7 March 2002 from Connaught to Goldmax (see paragraph 7 above), the letter continued:

“I am advised that although the enclosed lease/option to purchase contract is signed only by the landlord the enclosure is a copy of the final contract.  Likewise I am informed that the agreement between Connaught and Goldmax is as recorded in the letter of 7th March 2002.  A formal contract was not drafted or signed.  Further Goldmax did not receive the enclosure referred to in the second line of the letter.”

Later, among the submissions (to which we refer later) relating to input tax, the letter said,

“Goldmax needed to generate the management fees/services.  It costed the deal on the basis that Marwood House would cost Goldmax £493,500 (i.e. VAT inclusive price) and would be sold for £460,000.  Thus Goldmax would make a loss without the management fees.  In order to make the management fees they had to purchase Marwood House (you will note from the above that it was purchased a few days before the agreement for the management fees was finalised).  It follows that the purchase of Marwood House was, at least in part, a cost component of the management fees.

The purchase of Marwood House and the management fees/service are inextricably linked.  There would not have been a management fee without the sale to Signpost.  The property would not have been sold to Signpost without the management fee.  It follows that the purchase of Marwood House is directly linked to the management fee.  Clearly it is also directly linked to the sale to Signpost.  Thus it is attributable to taxable and exempt supplies and should be dealt with accordingly.”

10.	In cross-examination Mr Morrison, asked what the management fee was for, said that Goldmax had agreed the £970,000 cost of conversion with Connaught, Signpost had not done that.  Goldmax had been responsible for some of the cost of certain key areas of work, for which it paid neatly £28,000.  Goldmax leased the building, purchased the property, sold it to Signpost, agreed to find a contractor (having discovered that it itself, not being in Construction Line could not carry out the conversion), and agreed to provide all those services.  In short, Goldmax negotiated the whole deal.  Marwood House would never have been sold unless there had been a deal with Connaught.  Signpost, Mr Morrison said, was paymaster for Connaught, which is now owned by Signpost.  Goldmax had never agreed the cost of the works with Signpost; it had agreed with Signpost that the building would be ready for occupation for £1,440,000.  The only reason why Connaught was paid by Signpost was that the Housing Corporation required it.  Goldmax employed some subcontractors to do minor works such as the damp course, asbestos, and plastering.  It had been decided that Goldmax was to do that work before March 2002.

The legislation

11.	Article 2 of the First Council Directive (67/227/EEC) provides:

“The principle of the common system of value added tax involves the application to goods and services of a general tax on consumption directly proportional to the price of the goods and services....

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.”

Article 17 of the Sixth Directive (77/388/EEC) provides, so far as is relevant, as follows:

“1.	The right to deduct shall arise at the time when the deductible tax becomes chargeable.

2.	In so far as the goods or services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:
(a)	value added tax due or paid within the territory of the country in respect of goods or services supplied or to be supplied to him by another taxable person.
	. . .”

The European legislation is reproduced in the United Kingdom legislation in the following sections of the 1994 Act:

“24	Input tax and output tax
(1)	Subject to the following provisions of this section, ‘input tax’, in relation to a taxable person, means the following tax, that is to say—
	(a)	VAT on the supply to him of any goods or services;
	. . .
being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him.”
. . .
25.(1)	. . .
(2)	Subject to the provisions of this section, [a taxable person] is entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under section 26, and then to deduct that amount from any output tax that is due from him.
. . .
26.(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 tad 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 within subsection (2) below.

(2)	The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business—
	(a)	taxable supplies;
	. . .”

The Regulations referred to are the Value Added Tax Regulations 1995 (“the 1995 Regulations”).  So far as is relevant, regulation 101 provides:

“(1)	Subject to regulation 102, the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.

(2)	In respect of each prescribed accounting period—
(a)	... goods or services supplied to the taxable person in the period shall be identified,	 
(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 to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies, and
(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.”

Regulation 102 has no application in this case.

The Appellant’s contentions

12.	Mr Taylor began by referring to the letter from himself to the Commissioners dated 26 July 2002, expressed as being further to a previous letter from him of 15 June 2002 of which no copy was produced.  This letter set out some of the background, and described “the actual deal” after mentioning what was originally contemplated.  It was described in the following terms:

“In the event Signpost went further than insisting that there were separate contracts for the purchase of the Marwood House and necessary building work.  They demanded that the building work be done by another local construction firm - Connaught Property Services Ltd. In the event the deal went ahead on the following basis:

Ÿ	Goldmax sold the Marwood House to Signpost
Ÿ	Signpost contracted with Connaught for the building work
Ÿ	Connaught contracted to pay a ‘management fee’ for the building work to Goldmax

The amounts involved were as follows:

Ÿ	Marwood House sold to Signpost for £460,000
Ÿ	Building work contracted for £970,000 plus VAT as appropriate
Ÿ	Management fee of 23.26% of building contract payable to Goldmax subject to further conditions

The conditions relating to the management fee were that in no circumstances it would exceed £225,631 and if the building work exceeded £970,000 due to conditions imposed by Signpost the excess would be deducted from the management fee.”

There then followed the first of the two passages set out in paragraph 9 above.  Mr Taylor said that that letter was written after the deals had been struck, and contained the facts as then known.  He went on to say that “the correspondence contained ifs and buts” and that the Tribunal should consider the evidence as given by Mr Morrison and not as contained in the correspondence.  However, we feel that, since the letters from Mr Taylor were written after all the facts were known, and on the instructions of Goldmax, no doubt through Mr Morrison, we should consider the correspondence as well as Mr Morrison’s evidence, especially since there are one or two contradictions in Mr Morrison’s evidence. 

13.	Mr Taylor conceded that the input tax incurred in the purchase of Marwood House was not used by Goldmax exclusively in making taxable supplies, but was used in making exempt supplies, namely the sale to Signpost, and also in making taxable supplies, namely under the contract for the management fee with Connaught.  If that contention were right, Mr Taylor contended, the input tax would fall within regulation 101(2)(d), and would fall to be apportioned.  He contended that the right to deduct input tax presupposed that the expenditure incurred in obtaining the relevant supplies was part of the cost component of the taxable transactions: Customs and Excise Commissioners v Midland Bank PLC Case C-98/98 [2000] STC 501.  Further, the right to deduct input tax depends upon a ‘direct and immediate link’ between the relevant expenditure and taxable outputs: BLP Group PLC v Customs and Excise Commissioners Case C-4/94 [1995] STC 424.  Mr Taylor contended that the purchase of Marwood House and the management fee/service were inextricably linked.  There would, he said, have been no management fee without the sale to Signpost; the property would not have been sold to Signpost without the management fee.  It followed that the purchase of Marwood House was directly linked to the management fee, and to the sale to Signpost.  The costs were incurred in order to make the transaction, not as a consequence of making the original transaction, that is, in order to make the transactions with Signpost and Connaught, in the knowledge and expectation that those transactions would take place.  It had to be established that the costs were incurred in order to make taxable supplies, and not as a consequence of the taxable supplies.

14.	Mr Taylor suggested three ways to approach the issue.  First, the layman’s view. Goldmax saw the opportunity presented by Marwood House and negotiated with Exeter City Council and Signpost.  Goldmax facilitated the deal.  The aim was, throughout, to produce for Signpost suitable accommodation, but Goldmax was unable to undertake the construction work, not being a member of Construction Line.  Connaught agreed to pay a fee to Goldmax.  This was a tripartite agreement facilitated by Goldmax.  The sale of Marwood House was clearly linked to the supply to Connaught.

15.	Mr Taylor’s second approach was what he termed the reasoned approach.  Mr Taylor referred to the Advocate General’s opinion in Midland Bank, where he said, in paragraph 29,

“The use [in BLP] of the two adjectives ‘direct’ and ‘immediate’ cannot but refer to a particularly close link between the taxable transactions ... Carried out by a taxable person ... And the goods or services supplied by another taxable person....

	In particular the adjective ‘direct’ means that there cannot be the appropriate link between the two transactions where a third transaction takes place between them breaking the causal chain, or where the link between the two transactions is very distant in time....
	
The adjective ‘immediate’ denotes a particularly close temporal proximity between the two transactions....”

The close link existed in the present case, Mr Taylor contended, and the time between the purchase of Marwood House and the contract between Goldmax and Connaught was only a few days.  There was no identifiable transaction which broke the link.  Goldmax would not have purchased Marwood House unless it was certain that it would have the opportunity of entering into the contract for management services with Connaught.  That is one of the inconsistencies in the evidence: the original intention had been that Goldmax itself would carry out the construction work.

16.	There was much discussion in correspondence between Mr Taylor and the Commissioners as to the effect of the decision in Customs and Excise Commissioners v Wiggett Construction Ltd [2001] STC 933, and it was the contention of Goldmax that that case closely resembles the present.  Mr Taylor particularly relied upon the observation by Lightman J in paragraph 4 that “Wiggett would never have entered into the land sale agreement but for the entry at the same time into the other three agreements.”  Those other three agreements included an JCT standard form building contract for the construction by Wiggett of 45 flats in the property which Wiggett itself was selling.  Lightman J came to the conclusion that the Tribunal was entitled to reach the decision that Wiggett used the property to make the taxable supply of the building services under the JCT contracts as well as the exempt sale of the property.  He held that the Tribunal was entitled to conclude that there existed the necessary direct and immediate link, and that the purchase of the land was a cost component of the sale and of the redevelopment.  Southern Primary Housing Ltd v Customs and Excise Commissioners (2002) (Decision No 17770) was a similar case, in which the appellant purchased land in a standard-rated transaction, sold it in an exempt supply, and simultaneously entered into contracts to carry out building works to the building, which were zero rated.  Mr Taylor drew particular attention to a finding of the Tribunal, in paragraph 5, that,

“The facts which we regard as important are that the input transaction is an acquisition of land, and the output transaction is a single transaction comprising a sale of land plus building contract.  The single transaction was carried out by two simultaneous contracts each specifying a separate price and each having different VAT results but none of this detracts from the fact that commercially they are a single transaction in the sense that neither party contemplated one occurring without the other.”

The Tribunal held that the land was used both for the sale of the land and for the building contracts, and that the purchase of the land was a cost component of the sale of the land and building contracts because it enabled the joint supplies of land plus building services to be made.  The Tribunal therefore held accordingly.  In the Chancery Division, Rattee J considered that the Tribunal was well entitled to reach that decision.

17.	Mr Taylor’s third approach was through the legislation.  He said that the deal would have been better constructed if Goldmax had carried out all the construction work, in which case it could have recovered all the input tax.  Under Note (4) to Group 5 of Schedule 8 to the 1994 Act Goldmax could reclaim part of the input tax, which would go some way to meeting the objective of the legislation, which was to relieve this mind of housing from the burden of VAT.

The Commissioners’ contentions

18.	Miss Rahman pointed out that no taxable supplies had been made until the time came (if it ever came) when Goldmax carried out the first of the residual works to Marwood House.  It was necessary to identify what taxable supplies had in fact been made.  The sale of Marwood House was an exempt supply.  No building work was carried out by Goldmax, which was attempting to recover the input tax in any event, which was not permissible.  Goldmax had not supplied the construction services.  There appeared to be some sort of relationship between Goldmax and Connaught, but it had nothing to do with the construction services supplied by Connaught.  The ultimate subjective intentions were irrelevant.  Where a partially exempt trader establishes that it has incurred expenditure exclusively in connexion with making a taxable supply, the VAT incurred in that expenditure mad be deducted as input tax.  But where expenditure is incurred exclusively in connexion with an exempt supply no input tax may be deducted. Miss Rahman referred us to Article 2 of the First VAT Directive, and posed the question of what were the costs which could be said to have been incurred in the provision of any management services?  Under Article 17(2) of the Sixth Directive, only goods and services which were used for the purposes of taxable transactions could give rise to deductible input tax.  The input tax which Goldmax claimed to deduct was too remote from any taxable supplies.  Under regulation 101(2)(a) of the 1995 Regulations, the goods or services supplied to the taxable person, in respect of which VAT was sought to be deducted, had to be identified.  Miss Rahman contended that the case fell within regulation 101(2)(c), and not (d) as Goldmax contended.  The costs of the purchase of Marwood House was attributable only to the exempt sale, and not to any management services; the supply was not a cost component of the subsequent services.

19.	BLP established that in order to be entitled to deduct input tax under Article 17(2) of the Sixth Directive the taxed input must have a “direct and immediate link” with the taxable output so as to be properly attributable to it, and the ultimate aim pursued by the taxpayer is irrelevant; and also that the taxed input must be a “cost component” of the taxable output to which it is attributed.  If those conditions are fulfilled, and not otherwise, the taxed input can be said to have been “used” for the purpose of making the taxable transaction.  Between them, BLP and Midland Bank establish a three-stage approach.  First, the supplies in question must be identified. Secondly, it must be considered whether the goods or services acquired have a direct and immediate link with the taxable supplies.  Thirdly, if there is a direct and immediate link, the question whether the expenditure incurred in acquiring the goods or services was part of the cost component of the taxable supplies.  For the first two stages an objective analysis was required (consistent with the principle of neutrality), in which factors such as the intention of the taxpayer and the purpose of the supplies fell to be ignored.  The third stage involved a factual consideration of whether the transaction was a cost component of the taxable supplies.

20. 	Miss Rahman, having referred to the opinion of the Advocate General in BLP at paragraph 51, said that in order to achieve neutrality it was necessary to have regard to the economic substance or inherent characteristics of a transaction rather than its legal form or appearance or any broad impressions of the commercial intention.  In the present case, Goldmax had made an exempt supply of land, and the costs	of the purchase of that land, in respect of which input tax was claimed, were attributable entirely to the exempt supply; any subsequent taxable supplies made by Goldmax to Connaught were “chance factors” which fell to be ignored.  The Court of Justice had applied that principle in order to look through contractual arrangements to arrive at an objective analysis of the economic substance of a transaction.  In BLP it was held that the ultimate aim of the taxable person was irrelevant; if they were, the authorities in a Member State would have to carry out inquiries to determine the intention each time of the taxpayer.  It was Goldmax’s case that that was the correct approach.  But the Court held in BLP that 

“Such an obligation would be contrary to the VAT system’s objectives of ensuring legal certainty and facilitating the application of the tax by having regard, save in exceptional circumstances, to the objective character of the transaction in question.”

21.	The answer to Goldmax’s argument that this was “a tripartite agreement” and was all one deal, was, Miss Rahman contended, to be found in the opinion of the Advocate General at paragraphs 36 to 38, in which he said,

“Even if it were possible to construct such an effect in commercial or book-keeping terms, that would merely be a cascade effect, which can always occur if taxable and exempt transactions are carried out at the same time within a unitary undertaking.  That circumstance does not made the services in question into costs components of the taxable transactions and cannot therefore alter the attribution.”

22.	Goldmax’s arrangement with Connaught was a circumstance which could not alter the proper VAT treatment of costs attributable to the exempt sale of Marwood House to Signpost.  The Tribunal was referred to the Advocate General’s opinion in Midland Bank, at paragraph 29, as to what constituted a direct and immediate link:

“...In particular the adjective ‘direct’ means that there cannot be the appropriate link between two transactions where a third transaction tames place between them breaking the causal chain, or when the link between the two transactions is very distant in time.... The adjective ‘immediate’ denotes a particularly close temporal proximity between the two transactions.”

Miss Rahman said that it appeared that Goldmax had agreed to stand down from the original understanding that it would carry out the building work in return for consideration from Connaught, subject to deductions if Goldmax’s quotation for the building work were exceeded.  The agreement was entered into on 7 March 2002, and the invoices were dated between May and September 2002, the sale to Signpost having taken place on 4 March 2002.  There was, Miss Rahman contended, clearly a third transaction within the meaning of that passage from Midland Bank that broke the causal chain between the purchase of the property and the management fees.

23.	It was demonstrable, Miss Rahman said, that the purchase of Marwood House was not an input that could properly be described as being “used” for the purpose of providing services to Connaught nor as a cost component of that supply.  Goldmax had not purchased that property for the purpose of providing supplies to Connaught.

24.	Finally, Miss Rahman said that both Wiggett and Southern Primary Housing could be distinguished from the present case, since in each of those cases the appellants had purchased property and had entered into agreements to sell the properties and themselves to carry out the building works on them.  That may be what Goldmax had wished to do, but was not what Goldmax had achieved.  (It was also the Commissioners’ case that the Tribunal’s application of the legal tests in Wiggett was wrong; leave was being sought to appeal to the Court of Appeal in Southern Primary Housing.)

The principles to be applied

25.	Paragraph 5 of Article 17 of the Sixth Directive lays down the rules governing the right to deduct VAT relating to goods or services which are used by the taxable person “both for transactions covered by paragraphs 2 [taxable transactions] and 3 [certain exempt transactions], in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible” (BLP, judgment, paragraph 19).  That paragraph continues:

“The use in that provision of the words ‘for transactions’ shows that to give the right to deduct under paragraph 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.”

The judgment concluded, in paragraph 28:

“The answer to question (1) must therefore be that Article 2 of the First Directive and Article 17 of the Sixth Directive are to be interpreted as meaning that, except in the cases expressly provided for by those directives, 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.”

26.	In Midland Bank, the further question was asked, what was the nature of the direct and immediate link, and, to put it briefly, whether there was a different test as between Article 17(2), (3), and (5) of the Sixth Directive.  In paragraph 24 of the judgment, the Court said:

“The answer to the first question must therefore be that Article 2 of the First Directive and Article 17(2), (3) and (5) of the Sixth Council Directive must be interpreted as meaning that, in principle, the existence of a direct and immediate link between a particular input transaction and a particular output transaction or transactions giving rise to entitlement to deduct is necessary before the taxable person is entitled to deduct input VAT and in order to determine the extent of such entitlement.”

Having stated that it is for the national courts of the Member States to apply the “direct and immediate link” test in each case, the judgment continued:

“29.	It should be borne in mind that, according to the fundamental principle which underlies the VAT system, and which follows from Article 2 of the First and Sixth Directives, VAT applies to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components (see BP Supergas Anonimos Etairia Geniki Empori-Viomichaniki kai Antiprossopeion v Hellenic Republic Case C-62/93 [1995] ECR I-1883, paragraph 16).

30.	It follows from that principle as well as from the rule enshrined in paragraph 19 of the judgment in BLP Group, cited above, 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.”

27.	Those two decisions lay down the rules and the principles upon which it must be determined in any case whether input VAT may properly be deducted.  In order that it may be discerned whether a direct and immediate link exists, or whether the expenditure on the taxable supplies of goods or services was part of the cost components of the taxable transactions, it is necessary first to identify what the relevant transactions, that is, the services supplied, were: regulation 101(2)(a).  We therefore consider that the three-stage approach suggested by Miss Rahman by reference to BLP  and Midland Bank is the correct approach, and proceed to apply it.

Conclusions

28.	We begin therefore by looking to see what the relevant transactions are.  The first is the purchase on 4 March 2002 by Goldmax of Marwood House from Abbotsdale Homes, pursuant to the option granted by Abbotsdale in April 2001.  That purchase attracted tax at the standard rate.  The second was the sale by Goldmax of Marwood House, also on 4 March 2002, to Signpost.  It is contended by Goldmax that there then followed, on 7 March 2002, a contract between it and Connaught under which Connaught agreed to pay management fees to Goldmax, subject to certain conditions.  There was also a contract between Signpost and Connaught under which Connaught was to carry out the building works.  

29.	The arrangement between Goldmax and Connaught was an unusual one, and deserves a close look.  Mr Morrison referred to the arrangement as a contract.  Mr Taylor referred to it in his letter of 25 September 2002 as a contract, and said that, 

“The basis for the contract, or contracts, for the management services is found in three letters.  There is no other documentation.”  

Those letters, he stated, were those from Signpost to Goldmax of 20 August 2001 (paragraph 6 above), from Connaught to Signpost of 7 March 2002 (never produced), and from Connaught to Goldmax of 7 March 2002 (paragraph 7 above).  In his letter of 26 July 2002 to the Commissioners (paragraph 9 above), Mr Taylor said that the contract was contained only in Connaught’s letter of 7 March 2002 to Goldmax.  The letter from Signpost of 20 August 2001, on the face of it, contains no suggestion of contractual terms or agreement.  In any event, if the contract was between Goldmax and Connaught one would not expect there to be.
  
30.	The wording of Connaught’s letter of 7 March 2002 does not look like a contract.  It begins by referring to a revised proposal made by Connaught to Signpost, in which there is a reference to a fee to be paid to Goldmax.  Nowhere in the letter does it say for what consideration that fee is to be paid; there is merely a hint in classifying the fee as a management fee.  The letter goes on to set out certain conditions under which the management fee will be reduced, and the procedure for doing so.  All of this has the appearance of a proposal for contractual terms, save, again, for a want of consideration.  The letter ends by inviting Goldmax’s agreement.  It would appear that at that date no agreement had been entered to between Goldmax and Connaught.  There is no other document, not even a letter from Goldmax to Connaught agreeing or disagreeing with Connaught’s proposal.  There was no evidence of any kind that there had been agreement to that proposal, nor when nor in what manner that agreement (if any) was concluded.  Nor, again, was there any evidence of agreement between Goldmax and Connaught as to what Goldmax was obliged to do in consideration of the management fees.  Nor was there any evidence of any obligation between Goldmax and any other person that Goldmax was obliged to carry out any of the building works, nor that Goldmax was properly, and contractually, obliged to meet any of the costs of any of the building works. There was, on the contrary, evidence that, not being a member of Construction Line, Goldmax was not eligible to carry out any of the construction work. All there was was a statement by Mr Morrison that Goldmax had negotiated the agreement between Signpost and Connaught: there was no evidence from anyone on behalf of Signpost that Goldmax was acting as negotiator or facilitator, nor on whose behalf it was so acting; nor was there any such evidence from Connaught.  Miss Rahman, rather to our surprise, said that Goldmax had agreed to stand down from carrying out the construction work in return for consideration from Connaught.  But, in the first place, there was no evidence of any such agreement; and in the second, Goldmax really had no choice but to stand down, since Signpost could not, under the Housing Corporation rules, employ it to do the building work.  It appears to us, therefore, on the evidence before us, that there was actually no concluded agreement at all between Goldmax and Connaught.  At the most, there was a proposal, upon which no agreement was concluded, and that proposal contained no reference to any consideration moving from Goldmax.

31.	If there was no contract under which Goldmax agreed to make taxable supplies in consideration of the management fees, it seems to us that there could have been no taxable supplies.  The result must, therefore, be that the costs of the standard-rated purchase of Marwood House could only be attributable to the exempt sale of Marwood House to Signpost.

32.	However, we will assume that Mr Morrison’s evidence was correct, that there was an agreement of some kind between Goldmax and Connaught, as the Commissioners appeared to have accepted, under which Goldmax made taxable supplies of services to Connaught in consideration of the management fees.  It is not impossible, though no evidence was produced, that Connaught may have been obliged under the contract with Signpost to pay the management fee to Goldmax, though that still leaves a gap in the evidence as to the obligation of Goldmax to make taxable supplies to Connaught.

33.	We must then proceed to the second of the three stages, and look to see if there was a direct and immediate link between the purchase of Marwood House and the supply of services to Connaught.  The original purpose of the purchase of Marwood House was so that Goldmax, a property development company, could sell the building to Signpost having itself carried out the conversion work.  That being impossible because of the rules of the Housing Association, Signpost had to find another builder, and entered into a contract with Connaught.  That contract had nothing to do with Goldmax, in that Goldmax was not a party to it.  That contract could not take effect until after Goldmax had sold the property to Signpost.  In fact, once Goldmax had sold Marwood House to Signpost, Goldmax had no further legal interest in the property.  If Goldmax acted as negotiator of the contract between Signpost and Connaught, it must have been as agent for one or the other.  It would appear not to have been Signpost, since the management fees were to be paid by Connaught.  It was never said by Mr Morrison that the cost of purchasing Marwood House was incurred in order to make such supplies to Connaught, nor do the facts of what actually happened suggest that that was the case.  The contract between Signpost and Connaught was entered into after the sale of the property by Goldmax to Signpost, and the agreement between Goldmax and Connaught, if agreement there was, took place as an adjunct to the agreement between Signpost and Connaught.  There was no tripartite deal, as Mr Morrison termed it: Goldmax was a party only to the agreement to sell to Signpost; as Mr Morrison said, Goldmax had to generate some income having sold at a loss.  But such supplies (if there were any) as may have been made to Connaught were the product of Goldmax’s ineligibility to carry out the construction works.  It does not appear to us that there was any direct and immediate link between the purchase of Marwood House and the supplies under an agreement with Connaught.

34.	For the same reasons, in our view, the purchase of Marwood House was not a cost component of the supplies made to Connaught.  The cost was not incurred in order that such supplies of services could be made to Connaught, nor was there any evidence that they were incurred in order to make such supplies to whichsoever builder might contract with Signpost.  They were incurred, as Mr Morrison said, so that Goldmax could sell the building to Signpost and carry out the building work.  That did not happen.  If, as Mr Morrison suggested, Goldmax had had contractual responsibility arising out of its contract with Signpost for the carrying out of any of the building work, it may be that the purchase of Marwood House was a cost component of the making of such supplies.  But there was no evidence, except in the most vague and general of terms, that Goldmax did any such thing.  It cannot be said, in our judgment, that the expenditure on Marwood House was “part of the cost components of the output transactions which utilise the goods and services acquired”.  The services, if any, supplied to Connaught by Goldmax cannot in our view be said to have utilised Marwood House; any such services were, so far as the evidence reveals, connected with the terms and particulars of the contract between Signpost and Connaught.

35.	We should add that we considered the application contended for by Goldmax of the decisions in Wiggett and Southern Primary Housing.  Those two cases differed from the present in the essential feature that the taxpayer, having purchased the property, both sold it and carried out the building work to the same person.  That being the case, we took the view that those two decisions did not assist Goldmax.

36.	For the above reasons, we have concluded that the cost of purchasing Marwood House was attributable only to the exempt sale of that property to Signpost, with the single and limited reservation mentioned in paragraph 34.  We reach this conclusion first, on the basis that there was not in fact a contract between Goldmax and Connaught (see paragraphs 28 to 31 above); and secondly, and in case we are wrong as to the relationship between Goldmax and Connaught, for the reasons given in paragraphs 33 and 34 above.

37.	Accordingly, this appeal must be dismissed.

38.	No application for the costs of this hearing was made by the Commissioners, and accordingly we give no direction as to costs.  However, in case either party wishes to be heard as to costs, we give liberty to each to apply to the Tribunal.  Any such application should be made not later than 42 days after the date of release of this decision.

ANGUS NICOL
CHAIRMAN

RELEASED:

LON/01/1138