M Barton Consultancy Ltd v Customs & Excise [2003] UKVAT V18233 (18 July 2003)

INPUT TAX – Motor cars – VAT (Input Tax) Order 1992 Art 7(2G) – Whether car leased for consideration less than monetary consideration for a commercial arms length transaction – Appeal dismissed

LONDON TRIBUNAL CENTRE

	M BARTON CONSULTANCY LTD	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	Respondents

				Tribunal:	MR PAUL HEIM CMG  (Chairman)

Sitting in public in Cardiff on 4 March 2003

Mr A Haythorne, tax consultant, for the Appellant

Mr R Hill, counsel, for the Respondents

© CROWN COPYRIGHT 2003

DECISION

1.	M Barton Consultancy Ltd appeals against the decision of the Commissioners to disallow a claim to a sum of £4,339.26 as input tax, that tax relating to the purchase by the Appellant on 8 November 1999 of a BMW motor car registration number 1 DKD for the sum of £29,135, including the VAT of £4,339.26. 

2.	The Appellant was represented at the hearing by Mr A Haythorne, tax consultant and the Commissioners by Mr R Hill of counsel.

3.	There is no dispute between the parties about the facts of the matter, save insofar as the second-hand value of the motor car is concerned.  

4.	The facts arise from the documents before the Tribunal and from the evidence of Mr John Porter, VAT assessment officer of the Cardiff Value Added Tax office.  

5.	It is not in dispute that M Barton Consultancy Ltd provides consultancy and car leasing services to associated businesses.  Mr Martin Barton is the company secretary and also a director of the Appellant.  He was until April 1997 a partner in the firm Bartons Chartered Accountants, and still works for them.  

6.	On 8 November 1999 the Appellant purchased the car in question, and on the same day leased it to the firm Bartons Chartered Accountants for the sum of £160 monthly plus VAT.  This made the gross rental £188 per month, thus for the 36 months of the rental agreement £6,368.  

7.	Mr Porter said that he was the officer entrusted with the verification of the Appellant’s repayment claim made in respect of the purchase of this car.  He visited Mr Barton and inspected his books and records about VAT claims up to January 2000, and in particular the claim regarding this motor car which was the major part of that VAT claim.  He saw the purchase invoice for £29,135 including within that amount £4,339.26 of value added tax.  He saw the invoice for monthly lease payments of £160 plus VAT but he did not see a lease agreement at that time.  He discussed the value of the car and the lease agreement with Mr Barton.  He saw that the lease was to a subsidiary with which Mr Barton was involved.  He thought it was not a commercial transaction.  Mr Barton said that he had made a personal contribution of £5,000 towards the car.  No value added tax had been declared on that amount.  Mr Porter said that £160 per month plus VAT did not cover the loss in value to the car over three years.  There was no commerciality.  There was no significant profit element to make it a commercial transaction.  He asked for advice from colleagues at headquarters.  He sent them details.  He received a reply and then sent the letter the subject of this appeal, disallowing the value added tax of £4,339.26 claimed on the car under the Value Added Tax (Input Tax) Order 1992  article 7(2G)(a).  

8.	On these facts the Appellant says that the matter is one of construction of the relevant article of the 1992 Order, in the light of the Appellant’s intention as envisaged in paragraph 7(2G)(a). Similarly the reference in the Order to “commercial transaction” and “arms length” had to be considered subjectively.

9.	The Appellant says that the matter hinges on the residual value of the motor car after the elapsing of the hire period.  

10.	The Appellant here relies first on a letter from a sales executive of the dealer who originally sold the car, dated 18 July 2000 in the following terms:

“Dear Mr Barton

Further to our telephone conversation early today, I would like to confirm that at the time of the purchase of your BMW 523 ISE automatic, we did indicate a future value to be in the region of  £22,000 within three years.  This was in consideration of  very low mileage and current high market value.

…”.

11.	The Appellant also relies on a schedule showing the cost of the car, reduced by the value added tax paid upon it, reduced by the £5,000 contribution made by Mr Barton, reduced by the market value cost given in the letter earlier quoted, that also being reduced by value added tax to produce a depreciation of £1,072.  Adding to that the funding cost of 8% per annum of £4,631 produced an amount of £5,703, from which was to be deducted the monthly rental of £160 over the three year period to show a profit of £57.  

12.	The Appellant says that it was relying on the statement made by the dealer, so that Mr Barton was acting on professional advice.  If the funding cost of 8% used in the Appellant’s schedule was put aside because no funding was required that would be a part of the profit.  The evidence which the Appellant relied was that letter from the selling agent.  On the basis of this Mr Barton believed that this was a commercial transaction.  Even if hindsight showed that it was not a good transaction it was still a commercial transaction and still at arms length.  To sell something cheap did not mean that it was not a commercial transaction.  

13.	The Commissioners say that the matter is covered by article 7(1) of the Value Added Tax (Input Tax) Order 1992 (SI 1992/3222) which in the following terms excludes motor cars from any credit under section 25 of the Value Added Tax Act 1994:

“7(1)	Subject to paragraph (2) [to (2H)] below tax charged on –

(a)	the supply … to a taxable person;

… of a motor car shall be excluded from any credit under section [25] of the [Value Added Tax] Act [1994]”.

14.	Article 7(2) of the same Order provides:

“Paragraph (1) above does not apply where –

(a)	the motor car is –

(i)	a qualifying motor car;
(ii)	supplied … to a taxable person; and
(iii)	the relevant condition is satisfied;”

15.	Article 7(2E) of the same Order provides:

“For the purposes of paragraph (2)(a) above the relevant condition is that the letting on hire, supply, acquisition or importation (as the case may be) is to a taxable person who intends to use the car either –

(a)	exclusively for the purpose of a business carried on by him, but this is subject to paragraph (2G) below; …”.

16.	Article 7(2G) provides:

“A taxable person shall not be taken to intend to use the motor car exclusively for the purpose of a business carried on by him if he intends to –

(a)	let it on hire to any person either for no consideration or for a consideration which is less than that which will be payable in money if it were a commercial transaction conducted at arms length”.

17.	The Commissioners therefore say that the principle of the exclusion of a motor car from credit under section 25 of the Value Added Tax Act 1994 applies, as the conditions for the application of the exceptions allowed to the exclusion do not apply  The taxable person, here the Appellant, could not be taken to intend to use the motor car exclusively for the purpose of a business where he intended to let it on hire to any person, here Bartons Chartered Accountants, at a consideration which was less than that which would be payable if it were a commercial transaction conducted at arms length.

18.	The Commissioners say that a commercial transaction conducted at arms length would be one which produced a profit, that is to say that the hire charges over the period of the hire would exceed the depreciation of the vehicle over that same period, so that a profit ensued.  

19.	The Commissioners say that the element of commerciality is excluded by the fact that according to the evidence of their disposal, which they submit to the Tribunal, a motor car of this type would depreciate by about 50% over a period of three years, while the hire charge paid by Bartons Chartered Accountants, being £6,768 over the three years would only be a commercial compensation for a much lesser depreciation.  The possibility of profit on the sale of the car after three years was therefore excluded.  

21.	The Commissioners say that the requirement that the transaction be at `arms length’ had to be considered with care, in view of the fact that Mr Barton was company secretary and a past director of the Appellant, and an employee of Bartons Chartered Accountant.  The fact that he had made a personal contribution of £5,000, not declared for value added tax, showed that the transaction was not at arms length.  The Commissioners rely for their conclusion that no claim for input tax can be allowed in respect of this transaction on four decided cases.

22.	The first is the appeal of Tamburello Ltd v Commissioners of Customs and Excise (14305).  The Tribunal there considered the terms of article 7(2G) of the Value Added Tax (Input Tax) Order 1992, and in particular the requirement that the consideration meet the test of being not less than that of “a commercial transaction conducted at arms length; …”.

23.	In paragraph 28 of this decision the tribunal said:

“28.	It seems clear to us that the test in (2G)(a) is applied by comparing the consideration under two leases of the particular motor car.  (2G) refers to an intended hiring.  In the normal case, as here, the vehicle would be leased on the same terms as were intended when it was acquired.  The first of the leases that is to be compared therefore is the lease of the vehicle actually entered into.  The second lease to be looked and compared is a hypothetical hiring of the vehicle for the consideration in money that will be payable under a commercial transaction entered into and performed at arms length.  The comparison is not to be made with the profit to be earned under the hypothetical transaction but with the consideration that will be payable in money under the hypothetical transaction.  If the first actual lease were itself a commercial transaction entered into at arms length it is likely to be the best evidence of what the terms of the second hypothetical lease would be, so that in effect no comparison need be made.  (2G)(a) refers to the consideration that will be payable in money. The hypothetical arms length lease is therefore to be assumed to be for a consideration payable in money. On the other hand (2G)(a) simply refers to the consideration for the intended hiring. It seems clear therefore that one is to be compared as on the one hand the amount of any money to a consideration plus the value of any other consideration for the actual or intended hiring as against on the other hand the money to a consideration payable under a hypothetical commercial hiring at arms length”.

24.	The Tribunal agrees that the comparison set out above requires to be made.

25.	In the appeal of  Orin Engineering (UK) Ltd v Commissioners of Customs and Excise (15254) a motor car was let on hire by the trader to its managing director and the question was whether the letting was for a consideration less than that of a commercial arms length transaction.  The facts were that the managing director of the appellant inspected the vehicle and paid the dealer a deposit for it.  The trader purchased the vehicle on hire purchase.  The vehicle was at all times used by the managing director for his private purposes.  The lease document was signed by the managing director as the hirer and by him on behalf of the trader.  The tribunal said:

“If the Company is to succeed in its appeal I must be satisfied that the credit to input tax under section 25 of the VAT Act 1994 is not blocked by the provisions of article 7 of the Value Added Tax (Input Tax) Order 1992.  If I am to be satisfied on this I must, in the circumstances of this appeal, be satisfied that at the material time the [vehicle] was let on hire to [the managing director]. If I am satisfied on that point (and assuming that such a letting would be a use of the vehicle by the company for the purposes of its business) I must also be satisfied that the terms of the letting at the material times was for a consideration which was not less than would be payable in money if it were a normal commercial transaction.  Put the other way, I must be satisfied that the terms of the letting at the material time were not more favourable to Mr King than the amounts that would have been payable by him if the letting had been a normal commercial transaction.  …  It … seems to me that the material time at which the nature of any letting needs to be considered is when the vehicle is acquired, or at the latest when the input tax credit is claimed …”.

26.	The third case to which the Tribunal was referred was the appeal of  West Midlands Motors Ltd v Commissioners of Customs and Excise (16512).  The issue again was whether hire transactions were commercial transactions at arms length.  The tribunal relied on the decision in Orin Engineering (UK) Ltd, as quoted above.  It found that “so-called rental agreements” were vague, and not in the format one would expect in transactions of this nature.  The Tribunal agreed with the submissions of the Commissioners that the so-called hire agreements did not evidence agreements intended to create binding legal commitments and that the Appellant had not been able to demonstrate that transactions were commercial and at arms length nor that the hire rate was a commercially acceptable rate.

27.	The fourth case to which the tribunal was referred was the appeal of Mrs A C S Nightingale t/a Arrowe Rental v Commissioners of Customs and Excise (17750) the issue was again whether a vehicle was let on hire for a consideration which was less than that payable in money if it were a commercial transaction conducted at arms length.  In the facts before the tribunal in that appeal the agreement in issue did not give a date for the commencement of hire and it was common ground that the intention of the parties was that the first twelve months of hire would constitute a payment holiday.  In fact no payments of rental appeared to have been made.  The Tribunal adopted the approach of the tribunal in the appeal of Tamburello Ltd that the test was the comparison on the one hand of the amount of any monetary consideration plus the value of any other consideration for the actual or intended hiring as against on the other hand the monetary consideration payable under a hypothetical hiring at arms length.  It found that the effective consideration under the hire agreement was far below the monetary consideration which would be payable if it were a commercial transaction conducted at arms length, although a specimen contract hire quotation produced by the Appellant showed that the monthly average charge over the first ten months of those agreements would be very much higher than the possible monthly average payment under the agreement in issue.  The Appellant submitted that it could charge much less under the agreement and that the agreement could nevertheless still be commercial. The Tribunal found in its judgment that the combined effect of the twelve months payment holiday and the ability of the hirer to terminate the agreement within that period by paying a penalty of three months rental, the consideration payable under the hire agreement was substantially less than would be payable where it a commercial transaction conducted at arms length.  Even the argument that the agreement was commercial because any loss of income would have been more than made up for by a profit from other contracts did not convince the Tribunal.  It would, in the Tribunal’s view, help to justify the claim that it was in the business interests of the Appellant, but hope, even confident hope, of future benefits to flow from the activities of the hirer, was not consideration for these purposes.  

28.	In the present case before the Tribunal the Commissioners ask the Tribunal to consider the value of the car before the hire agreement and the probable value of the vehicle at the end of it, so as to assess whether the monthly payments represented a realistic commercial relation to the depreciation in value.  In other words if at the end of the hire period the car was worth less than its original value less the hire charges, those hire charges would not represent a commercial transaction.  The Commissioners say that the Appellant has produced figures to show that the leasing transaction would produce a profit of £57 over the three years of the agreement, those calculations being based on the basis that the car could have been resold for £22,000 after three years.  The evidence of this was the letter dated 18 July 2000 from the vendor of the car stating that at the time of purchase the vendor did indicate a future value of the car to be in the region of £22,000 within three years and that this was in consideration of  very low mileage and current high market value.  The Commissioners say that “very low mileage” cannot realistically be applied to a vehicle which was leased for three years and where the lease agreement allowed an annual mileage of  12,000 miles.  Further, the industry guidelines produced by the British Road Vehicles Licensing Association and submitted to the Tribunal suggested an annual residual value for a three year old car of this kind with 60,000 miles on the clock of approximately £13,997.

29.	The Commissioners also obtained and produced figures from a vehicle price monitoring fund called CAP indicating that in November 1999 the expected gross second hand selling price of the relevant model after three years and 36,000 miles was £14,300.  This was the equivalent to a net price of £12,170.  No other figures have been produced. 

30.	It is for the Appellant, M Barton Consultancy Ltd to show that it is entitled to credit for input tax in respect of the purchase of this vehicle, that is to say that the provisions excluding the vehicle from credit do not apply because under paragraph 7(2E) of the Order “the letting on hire, supply acquisition or importation” (as the case may be) is to a taxable person who intends to use the motor car either – (a) exclusively for the purpose of a business carried on by him.  However this condition allowing a taxable person to claim credit in respect of a motor vehicle is subject to the conditions of paragraph 7(2G) quoted above, that a taxable person shall not be taken to intend to use a motor car exclusively for the purpose of a business carried on by him if he intends to let it on hire to any person either for no consideration or for a consideration which is less than that which will be payable in money if it were a commercial transaction conducted at arms length.

31.	The Tribunal therefore asks itself whether the taxable person, here the Appellant, intended to let this car for a consideration which was less than that which will be payable in money if it were a commercial transaction conducted at arms length.  

32.	The relevant facts are the personal contribution of £5,000 made by Mr Barton, the amount of the monthly hire charge in relation to the value of the vehicle before the start of the transaction of hire and at the end of the three years period of that transaction.  The Appellant’s intention must be deduced from those facts.  

33.	The Tribunal finds as a fact that the personal contribution of £5,000 made by Mr Barton necessarily affects the transaction, and that such a personal contribution, not brought to account for value added tax, would not normally have a place in the commercial transaction conducted at arms length.

34.	The Tribunal further finds, using the test set out in paragraph 7(2G) of the Order in the way in what it was expressed in the appeal of Orin Engineering, that it must be satisfied that the terms of the letting at the material time were not more favourable than the amounts which would have been payable if the letting had been a normal commercial transaction.  The Appellant relies on the question of its intent, to suggest that this was intended to be a commercial transaction conducted at arms length. The Tribunal considers that that intent must be examined in the light of the special position of Mr Barton, of the payment of the £5,000 by Mr Barton, and of the absence of all but the minimal profit of £57 over three years, even on the Appellant’s calculations.  These indicate that this was not a transaction at arms length.

35.	Further the Tribunal finds that the suggestion that the vehicle would have depreciated within three years from £29,135 to £22,000 to be too optimistic to be helpful to the Appellant. This represents depreciation of £7,000, that is to say less than 25% over three years. The figures before the Tribunal as produced by the Commissioners are closer to 50%. These figures come from independent sources and the Tribunal takes them to be realistic.  If therefore the expected depreciation of the vehicle over that period was closer to 50% than 25%, it follows that the hire charges made by the Appellant could not represent a commercial return on the hire or compensate for the normal loss in value of the vehicle over the period of the hire.  A commercial transaction is one which follows normal commercial rules, that it is in the commercial interest of the trader, and that a profit element is least in mind.  This was a transaction which, on a realistic assessment produced income over three years of £6,368 against likely loss in depreciation of over twice that amount, that is, the difference between the purchase price of £29,135, and the residual vale of between £1,200 to £14,055 approximately.  Even if the Appellant had taken into account as consideration the £5,000 personal contribution, and relied on the possibility of reclaiming input tax, the transaction at best breaks even, and thus does not satisfy the test set out, in that the hiring was intended to be for a consideration less than that which would be payable if it were a commercial transaction conducted at arms length. For these reasons, the Tribunal finds that the condition set out in paragraph 7(2G) of the Value Added Tax (Input Tax) Order 1992 have not been satisfied and that the Appellant is not entitled to treat the hire as a taxable transaction within the meaning of the Order.

36.	This appeal is dismissed.

PAUL HEIM CMG
CHAIRMAN

RELEASED:

LON/00/865