19188
	VAT — INPUT TAX — deductibility of input tax — construction costs of extension to amusement arcade providing both taxable and exempt supplies — whether input tax wholly deductible or to be apportioned — VAT Regulations 1995 Reg 101

MANCHESTER TRIBUNAL CENTRE

 
 	LYNDON JAMES MULHEARN
	trading as SANDANCER AMUSEMENTS	Appellant

	- and -

	HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

				Tribunal:	Lady Mitting (Chairman)
						Susan C Stott FCA ATII	

Sitting in public in Manchester on 20 June 2005

Alan Rashleigh, VAT Consultant, for the Appellant 

Jonathan Cannan, counsel, instructed by the Acting Solicitor for HM Revenue and Customs, for the Respondents 

	© CROWN COPYRIGHT 2005

DECISION

1.	The decision under appeal is that of the Respondents to assess the Appellant in the sum of £9,969 (plus interest) for the period 1 September 2002 to 31 August 2003, the assessment being notified on 5 November 2004.
2.	Mr Mulhearn owns and operates an amusement arcade, Sandancer Amusements, from which he generates both standard rated supplies (example gaming and amusement machines) and exempt supplies (prize bingo).  The appeal arises out of an extension which Mr Mulhearn carried out to the arcade and concerns the amount of input tax which he is entitled to recover on what were globally referred to before us as “the construction costs” of the extension.  
Legislation
3.	Bringing into effect Article 17 of EC Council Directive 77/388, Sections 25 and 26 VAT Act 1994 provide as follows:
	“25	Payment by reference to accounting periods and credit for input tax against output tax
(1)	A taxable person shall —
(a)	in respect of supplies made by him ….
account for and pay VAT by reference to such periods (in this Act referred to as “prescribed accounting periods”) at such time and in such manner as may be determined by or under regulations and regulations may make different provision for different circumstances.
(2)	Subject to the provisions of this section, he 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	Input tax allowable under section 25
(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 within the 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 …
(3)	The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above …”
4.	The applicable regulations are contained in Regulations 100 and 101 Value Added Tax Regulations 1995:
“100	Nothing in this part shall be construed as allowing a taxable person to deduct the whole or any part of VAT on the … acquisition by him of goods or the supply to him of goods or services where those goods or services are not used or to be used by him in making supplies in the course or furtherance of a business carried out by him.
101(1)	… 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 imported or acquired by and 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 or to be used by him exclusively in making exempt 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.”
5.	It is open to the Respondents to agree an alternative method of attribution to the standard method set out in Regulation 101(2)(d) but in this case no application had been made to adopt anything other than the standard method and the particular method to be used was not an issue in the case before us.
6.	The input tax which falls to be apportioned pursuant to Regulation 101(2)(d) is commonly referred to as residual input tax or “the pot” and the sole issue before us was whether the construction costs, either in total or in part, were attributable to Mr Mulhearn’s taxable supplies as he contended or, as was contended by the Respondents, to both his taxable and exempt supplies in which case the input tax would fall to be apportioned in accordance with Regulation 101(2)(d) and only part would be deductible.  The case was not presented on the basis on individual invoices of which we saw none, but we were asked to make a decision in principle which the parties would then apply to each individual supply.  
Evidence
7.	We heard oral evidence from Mr Mulhearn who told us he had been running Sandancer Amusements since 1991.  It is situated on a road leading to the beach, adjacent to a couple of holiday camps and although there is some passing trade, the main trade is from holidaymakers.  The dates and times of opening vary according to seasons, weather and school holidays. 
8.	The building which houses the Arcade is prefabricated and owned by Mr and Mrs Mulhearn.  Prior to the extension, it was a rectangular building, the entrance to which was along one of the short walls.  Mrs Mulhearn operates a hot food takeaway which, again prior to extension, was situated at the front of the building to the left of the entrance (this was a separate business to that of the Arcade and recognised as such by the Respondents for VAT purposes).  To the right of the entrance along the entire length of the long wall was situated the bingo area which consisted of a bank of seats facing boards which come down electronically.  At the end of the bingo bank and secreted in the top right hand corner of the building was Mr Mulhearn’s office and along the far short wall, opposite the entrance, were a couple of interconnected store rooms, one of which housed the staff WC.  There was no public WC as there was a council run block just outside.  The remainder of the premises was taken up with various amusement, gaming and video machines which ran the length of the remaining long wall to the left of the entrance.  Down the middle of the building were a series of concrete pillars which supported the roof.  This then describes the building in its original form.  
9.	The popularity of bingo had been gradually declining over the years.  Originally, Mr Mulhearn had operated 42 boards but in recent years turnover had reduced and he had reduced the number of boards by a few each time, until now he is operating just 29.  The space was better utilised, he told us, by profit generating arcade machines.  There had been a bingo outlet just across the road from Sandancer but this had closed down, leaving Sandancer the only arcade in the immediate area offering prize bingo.  Although declining in popularity, bingo was an attraction which Mr Mulhearn was anxious to keep.  He saw the bingo as giving him a competitive edge because no-one else within a two mile radius offered it.  Also he told us the market he was aiming for was the entire family and with the bingo often being popular with mothers, he was able to provide a sufficient variety of amusements for the whole family.  People who came in for one activity, he told us, often ended up playing another.  
10.	Mr Mulhearn gave a number of reasons behind his decision to extend the premises.  It was an old building, “On its last legs”, which needed revamping.  He wanted to create more space inside the building, both to give easier access to the attractions and to increase the number of gaming machines he could house.  Some modern machines are so large that prior to extension, he could not physically get them through the doors into the building.  He was also acutely aware of competition.  His closest competitor, Parkers, was situated just next door and was rather larger than Sandancer.  Mr Mulhearn felt he had to increase the size of his premises to remain competitive and to avoid being swallowed up.
11.	The extension achieved all Mr Mulhearn’s objectives, giving him substantially more space, increased ease of access and specifically greater access for pushchairs and wheelchair users.  It became far easier to move around the machines.  The extension had enabled him to provide, we were told, a wider choice of things to do in greater comfort. 
12.	The work carried out involved the removal of the external long wall to the left of the entrance (i.e. the non bingo wall) and the construction of a new external wall some feet out.  The exact position and measurements of the extension were never made clear to us as the only plans which we saw appear not to have been entirely accurate.  The building remained rectangular, except for an indent at the rear.  The enlargement of course also involved the lengthening of the two short walls.  Along the back short wall, the additional space was taken up with an extended staff WC.  The entrance was extended to cover the entire width of the newly enlarged building and the old wooden entrance doors were replaced with wall to wall electrically operated roller shutters, thus giving an enormously enlarged access area for customers and for the movement of machines.  What had previously been just a canopy over the entrance was now enclosed.  The pillars down the centre of the original building were removed and the new enlarged building was entirely re-roofed.  As the ground on which the arcade stands is not completely level, the re-roofing also involved building up and raising the level of the bingo wall by the construction of new steel cladding.  A new fire escape was constructed on the back wall.  There was a complete electrical rewiring involving the replacement of the lighting system and virtually all sockets and the introduction of overhead conduits and strips.
13.	The layout of the new enlarged building differed slightly from that of the previous smaller building.  The bingo remained along the original right hand wall and its position and layout remained unchanged (although a new modernised unit has since been installed but this has no relevance to the appeal).  Mrs Mulhearn’s food outlet was moved down from its original left hand corner position of the original building to the same left hand corner position of the newly enlarged building.  It is thus housed completely in the newly created space.  Some children’s amusements have been installed in the newly enclosed area under the canopy and new fruit and amusement machines have been introduced and run the entire length of the newly constructed outside wall.  
14.	It was agreed by both parties that 94.2 per cent of the overall construction costs should be treated as referable to Mr Mulhearn’s business purposes and 5.8 per cent being treated as non-business, this being the approximate percentage of space occupied by Mrs Mulhearn’s business.  
Submissions
15.	We were referred by Mr Cannan to the case of Dial-a-Phone Limited v Commissioners of Customs and Excise [2004] EWCA Civ 603.  In Dial-a-Phone, Jonathan Parker LJ, at paragraph 71, approved as the test to be applied by the tribunal, the test propounded in BLP Group v Customs and Excise Commissioners [1995] FTC 424 as “… the relevant enquiry is whether there is a ‘direct and immediate link’ between the input cost in question and the supply or supplies in question; alternatively whether the input cost is a ‘cost component’ of that supply or those supplies”.  To succeed, therefore, in his appeal, contended Mr Cannan, Mr Mulhearn would have to show that the construction costs of the extension had a direct and immediate link with his taxable supplies and no such link with his exempt supplies (the bingo).  It was Mr Cannan’s case that the direct and immediate link was to both the taxable and exempt supplies.  The result of the work has been, in effect, to provide a larger more attractive environment for all Mr Mulhearn’s customers to enjoy a wider range of amusements – both on the gaming machines and playing bingo.  In his submission, the work served the entire arcade, not just that part which provided the amusement machines.  
16.	Mr Rashleigh, in his closing submissions, conceded that the work to the roof, the entrance and the staff WC were in fact attributable to both taxable and exempt supplies and the input tax on these costs rightly fell into the pot.  The works which remained in issue were therefore the electrical works and the demolition of the original external wall and the construction of the new.
17.	Mr Rashleigh implied he accepted the BLP test put forward by Mr Cannan and contended that in both these remaining areas, the necessary link could be established.  Bingo was a declining activity and what Mr Mulhearn wished to do and had achieved was to increase the space available for his amusement machines.  It was these which attracted the customers to the arcade, not the bingo, which was merely a minor part of a much larger overall activity.
Conclusions 
18.	We say at the outset that we have no hesitation in accepting Mr Mulhearn’s evidence, as given.  We found him to be an honest and straightforward witness and we have no reason to doubt any of the evidence which he gave us.
19.	We accept that the BLP test is the test which we should apply to those two areas of dispute left upon which we were asked to adjudicate. 
20.	It cannot be said, in our view, that the demolition of the old external wall and the construction of the new has a direct and immediate link only to Mr Mulhearn’s taxable supplies.  It was this work which was the crux of the extension and the extension created a revamped, enlarged and modernised arcade in which customers could engage in the pursuit of their choosing in a more spacious and comfortable environment.  More of them may have played on the amusement machines than the bingo but that is immaterial.  In any event, Mr Mulhearn’s evidence was that once he had attracted customers into the much improved arcade, he was providing activities for the entire family and he clearly hoped that the various types of activity would feed off each other, with customers coming in to play on perhaps the gaming machines but ending up playing bingo and vice versa.  As Mr Cannan pointed out, in the activities on offer, Mr Mulhearn sought to make no distinction between the bingo and amusement machines.  The only distinguishing feature of the bingo was that it was a unique attraction in the immediate area.  What shone through Mr Mulhearn’s evidence was his aim to provide entertainment for the whole family; whatever they chose to do he could and did provide.  His was the only arcade in the vicinity where the family could play bingo and gaming machines under one roof.  We accept that the increased space provided additional space for standard rated amusement machines and that this was the element of his business to which he applied much of the space.  We also accept that in the newly created space, only amusement machines were situated so that if one were to look at that space in total isolation, no exempt activity would be taking place within it.  This, however, is a totally artificial separation which does not, in any practical sense exist and that is not the way in which one single building and one single business, which this is, can be viewed.  The works created an enlarged single space and an environment in which both taxable and exempt supplies could flourish.  All customers, regardless of the activity they are pursuing, can move freely and with increased ease around the entire building.  We find that the input tax incurred on the costs of the demolition of the old wall and erection of the new falls to be dealt with as residual.  It is not attributable only to taxable supplies but to both exempt and taxable.
21.	The electrical work may not be quite so clear cut depending on the nature of the work undertaken and how it was invoiced.  In principal, the bulk of the electrical work clearly served the entire business.  As part of the new modernised, enlarged arcade, the entirety was rewired.  This can be seen in no other way than as a benefit to the whole – the whole building and the whole business.  Improved lighting would, for example, serve those playing bingo as it would those on the amusement machines.  The input tax on the rewiring must therefore be treated as residual.  However, we can see the possibility that an analysis of the invoices for the electrical work may reveal some works which were related only and exclusively to the gaming and amusement machines and which could be for no other purpose and which would otherwise have been unnecessary.  Is it possible, for example, that certain of the gaming machines required their own specialised cabling?  We would not include within this exception the provision of any sockets or any of the overhead electrical strips or conduits.  We see both of these items as part of the provision of enhanced and improved electrical supplies to the whole, regardless of whether or not they were situated in part of the extension or part of the original, and clearly attributable to all of Mr Mulhearn’s activities.  We apologise for the vagueness of these comments but can do no better in the absence of any technical evidence as to what was actually done and without sight of the individual invoices which would have to be the starting point of any claim by Mr Mulhearn that some aspect of the electrical work, separately invoiced, had a direct and immediate link only to his amusement machines and none to the bingo.  The best we can do is enunciate the principle and hope the parties can resolve the details between themselves but if not, we give them liberty to reapply to us, the same tribunal, to adjudicate further on any outstanding points of difference.
22.	Subject therefore to this possible exception, in principle Mr Mulhearn’s appeal is dismissed and we find the input tax on those works that have been described to us throughout the hearing to be attributable to both taxable and exempt supplies and thus to fall for apportionment within Regulation 101(2)(d).
23.	Mr Cannan indicated that he would make no application for costs but Mr Rashleigh would have done.  We were, however, asked to make no direction as to costs but to give the parties liberty to apply in case of need, which we do.

LADY MITTING
CHAIRMAN
Release Date: 6 July 2005

MAN/04/0691