Twycross Zoo East Midland Zoological Society v Revenue & Customs [2006] UKVAT V19548 (18 April 2006)

                                                                                                                                            19548
	VAT – input tax – zoo – whether expenditure on keeping animals in zoo attributable not only to exempt admission charges but also to various taxable supplies – held applicable only to admission charges – input tax in question attributable exclusively to exempt supplies -  appeal dismissed 

MANCHESTER TRIBUNAL CENTRE

 
 	
	TWYCROSS ZOO EAST MIDLAND ZOOLOGICAL SOCIETY	Appellant

	- and -

THE COMMISSIONERS FOR
	HER MAJESTY’S REVENUE AND CUSTOMS	Respondents

				Tribunal:	David Demack (Chairman)
						Peter Whitehead (Member)

Sitting in public in Manchester on 22 and 23 February 2006

Leslie Allen of Messrs Dorsey & Whitney, VAT consultants, for the Appellant 

Valentina Sloane of counsel, instructed by the Acting Solicitor for HM Revenue and Customs for the Respondents 

	© CROWN COPYRIGHT 2006

DECISION

1.	In May 2004, following the decision of the Court of Justice of the European Communities (“the ECJ”) in Commissioners of Customs & Excise v Zoological Society of London [2002] STC521, the Commissioners for Her Majesty’s Revenue & Customs (“the Commissioners”) accepted that the appellant, Twycross Zoo East Midland Zoological Society (“the Society”), met the conditions for exemption in item 1 of Group 13 to Schedule 9 to the Value Added Tax Act 1994 in respect of admission charges to its zoo.   
2.	The Society then sought to recover the tax it had overpaid in the years since 1990 and made certain residual and other input tax claims. The Commissioners accepted its output tax claims and some of its input tax claims, but not its residual input tax claims. In relation to the last mentioned category the Society argued that expenditure on keeping the animals in the zoo was attributable both to its exempt admission charges and to its taxable supplies of catering, merchandising, ‘animal adoptions’ and ‘animal encounters’.  The Commissioners rejected that argument by letter of 27 August 2004, and it is against that rejection that the Society now appeals.   (We need not deal with animal adoptions and animal encounters as they remain the subject of discussions between the parties, and it is agreed that they should not be included in our decision).   
3.	It is common ground that, for the appeal to succeed it is not sufficient for the Society to show that there is a general commercial link between the keeping of the animals and its subsidiary commercial activities, but it must also show that there is a “direct and immediate” link between its animal keeping costs and its taxable supplies. 
4.	The case for the Society was presented by Leslie Allen of Messrs Dorsey & Whitney, VAT Consultants, and that for the Commissioners by Miss Valentina Sloane of counsel.  Mr Allen called as witnesses for the Society, Mrs Suzanne Isabelle Boardman, the director of the Society and a qualified veterinary surgeon, and Mrs Katharine Ann Marshall, the Society’s finance and administration manager. We were presented with three bundles of copy documents.  From that evidence we find the following facts to have been established. 
Facts
5.	As its name indicates, The Society is a zoological society. Its Memorandum of Association indicates that it was established for the public benefit for the following purposes:
(1) To educate the public in greater knowledge, interest and appreciation of fauna, flora and the natural kingdom.
(2) To promote, facilitate and encourage the study of biology, zoology, veterinary science, animal physiology, aviculture, aquaria, ichthyology, entomology, botany, agriculture, horticulture and kindred sciences and to disseminate the results.
(3) To provide and assist in the provision of facilities for recreation or other leisure time occupation in the interests of social welfare.
6.	Twycross Zoo was founded in 1963, and registered both as a limited company and as a charity.  Since then it has re-organised its affairs, so that the Society is now the representative member of a group consisting of itself and the zoo trading company, which gift aids all its profits to the Society.  Initially the zoo occupied 14 acres of land.  Over the years it has grown and now occupies 88 acres.   It attracts half a million visitors every year and its turnover is approximately £4.5 million per year.  It has 115 permanent staff and about 120 part time staff who work mainly in the summer season.  The zoo has one of the largest collections of primates in the world, and houses a number of species that are endangered or critically endangered.  
7.	The Society’s main business activity is animal viewing for which it charges admission. Apart from its animal enclosures, within the zoo are four cafes, two shops, two education buildings, an adventure play area, various ice cream and refreshment kiosks, a hotdog stand and a mini railway. 
8.	 Costs incurred on animals are one of the zoo’s core expenses.  Its main items of expenditure on animals are: 
(a)	capital expenditure on animal enclosures; 
(b) 	expenditure on welding the cages and other repairs;
(c)	veterinary services; 
(d)	cleaning and pest control; and  
(e)	food and bedding 
9.	The majority of expenditure on animal enclosures is for public safety purposes; care has to be taken to ensure that the animals and other creatures cannot escape, and that the public cannot approach them too closely
10.	Most visitors to the zoo travel by car because the public transport links to it are very limited.  There is a car park for visitors.  Until recently a charge was made for car parking, but the charge is no longer made.  Visitors enter the zoo itself via the ticket gate paying whatever price is appropriate to their individual status.  Parties of visitors (20 people or more) may obtain a package including reduced entrance fees and a meal for the members of the party.  
11.	An individual may purchase annual membership, which entitles him or her to visit on as many occasions and he or she wishes.  Such membership is paid for through a separate organisation called Twycross Zoo Association. 
12.	Quite frequently, free entry to the zoo is offered to visitors.  Free entry vouchers may be inserted in local newspapers allowing, e.g. two children to enter free when accompanied by a paying adult, or free vouchers might be given away as raffle prizes.  The Society reasons that if it can persuade people to enter the zoo, even though they may not be paying the entry fee, they will spend money elsewhere within the zoo, e.g. in the cafés, or gift shops.
13.	The entry fees charged to zoo visitors are not its only source of income.  It also receives income from its: 
(a)	adopt an animal scheme; 
(b)	animal encounters experience; 
(c)	kiosks;
(d)	cafés; 
(e)	gift shops; 
(f)	sales of guide books; 
(g)	fares for travelling on the mini railway; and
(f)	provision of conference facilities.
14.	Expenditure is attributable to each of those sources of income.  As each service is reliant on the zoo animals being there, the Society claims, and we accept, that any expenditure incurred on the animals is also related to its various sources of income.
15.	 Sales of food, minerals and other products commonly sold from its kiosks and cafés produce income for the zoo’s trading company. If the zoo were not there, the Society claims it is very unlikely that people would visit simply to patronise the cafés, kiosks or to buy merchandise from the gift shops.  Thus, it maintains, the cafés, kiosks and gift shops generate income as a direct result of the presence of the animals.  
16.	The vast majority of items on sale in the gift shops contain representations of the creatures to be found in the zoo.  They include toys, jigsaws, posters and postcards. Zoo guidebooks are sold from both the gift shops and in the cafés. The guidebooks are specific to Twycross Zoo and are not on sale elsewhere.  In 2005 the mini railway, which provides rides for pleasure only,  produced £52,935 in fares.

Legislation 
17.	Article 17 of the Sixth VAT Directive (77/388/EEC) provides for the deduction of input tax “in so far as the goods and services are used for the purposes of [the taxable person’s] taxable transactions” (Article 17(2)), and permits deduction where goods and services are used for taxable and non-taxable services, but of only such proportion of the tax “as is attributable” to taxable transactions (Article 17(5)).  Those provisions are implemented in domestic legislation in the form of section 26 of the Value Added Tax Act 1994 and Regulation 101(2) of the VAT Regulations 1995, which restrict recovery of input tax to that on supplies to be  “used” in the making of mixed supplies.  
Case Law on the correct interpretation of the legislation 
18.	The legislation referred to above has been considered by the courts and tribunals on a number of occasions, and from the case law it is common ground that the following principles can be distilled: 
(a)	It is not sufficient to show that the supplies on which tax is paid (in the instant case, the costs of keeping and displaying the animals) are “used” in a general sense to make the Society’s subsidiary commercial supplies.  “Use” in this context means specifically that the goods and 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”, (see the judgment of the Court of Justice of the European Communities (“the ECJ”) in BLP Group Plc v Customs & Excise Commissioners [1995] STC 424 at paragraph 19).
(b)	Moreover, the “direct and immediate” test has the following further, specific meaning: 
“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 costs components of the taxable transactions.  Such expenditure must therefore be part of the cost of the output transactions which utilise the goods and services acquired.” 
(paragraph 30 of the judgment of the ECJ in Midland Bank plc v Customs & Excise Commissioners [2000] STC 501)
(c)	Further, “the link must be identifiable according to objective criteria; that generally means that the link should reflect the normal relationship between the two suppliers”  (paragraph 31 of the judgment of the ECJ in Midland Bank) 
(d)	In considering whether there is an immediate and direct link, the transactions must be considered individually, “component transaction by component transaction”, rather than in a generalised way, per Jacob L J at paragraph 37 of his judgment in Customs & Excise Commissioners v Southern Primary Housing Association Limited [2004] STC 209.
(e) 	Importantly, the fact that a transaction is commercially necessary for the taxable supply does not create a direct and immediate link – that is a “but for” test.  The “but for” test is not the direct and immediate link /cost component test.  As Jacob L J explained at paragraph 32 in his judgment in the Southern Primary case: 
“The land purchase transaction was commercially necessary to make its performance commercially possible, but it was not a cost component of the contract itself in the same way as the costs of the materials used.  There is a link with the contract but the link was not direct or immediate.  The development contract would not have been made but for the associated land purchase and sale.  But ‘but for’ is not the test and does not equate to the ‘direct and immediate link’ and ‘cost component’ test”. 
(f) 	Further, in considering the link transaction by transaction: 
“What matters is whether there is a sufficient link of that kind with the relevant taxable supply and for the purpose of answering this question one has to take into account any intervening exempt transaction for which the same taxable services have been used.  If, as in BLP, the services were used for the purposes of an exempt supply it matters not that the same input might as a component part of that exempt supply also properly be treated as a cost component of the subsequent output supply.  Their use for the purposes of the exempt supply breaks the causal link for VAT purposes”
per Patten J in RAP Group plc  v Customs & Excise Commissioners [2000] STC 980 at paragraph 17).
(g)	The “chain-breaking effect” of an exempt transaction was correctly explained by the tribunal in Royal Agricultural College v Commissioners of Customs and Excise (2001) Decision No. 17508.  In that case, the tribunal was concerned with a claim by the college that expenditure incurred on advertising ‘the Cirencester experience” for students was attributable not only to its exempt supplies of education but also to the taxable supplies made through its bar and shop.  The tribunal rejected the claim, saying at paragraph 43 of it decision:  
“The marketing costs incurred by the Appellant have a direct and immediate link with the provision of the exempt supply of education to students who enrol in courses as a consequence of that marketing. There is not the same direct and immediate link to the subsequent provision of taxable supplies through the shop and bar.   The second step does not have a direct and immediate link; it has an indirect and subsequent link.  The tribunal finds therefore that the direct and immediate link required in order to allow the marketing costs to become a cost component of that subsequent taxable supply does not exist, the link being broken.  As Advocate General Jacobs said in the case of Abbey National plc v Commissioners of Customs and Excise [2001] STC 297: ‘Nevertheless, it remains clear from BLP that the “chain-breaking” which is an inherent feature of an exempt transaction will always prevent VAT incurred on supplies used for such a transaction from being deductible from VAT to be paid on a subsequent output supply of which the exempt transaction forms a cost component.  The need for a “direct and immediate link” thus does not refer exclusively to the very next link in the chain but serves to exclude situations where the chain has been broken by an exempt supply’ ”. 
(h) 	The test is a mixed question of fact and law, which is exceptionally fact sensitive.  As Jonathan Parker LJ explained at paragraph 72 of his judgment in Dial-A-Phone v Commissioners of Customs and Excise [2004] STC 987: 
“By its very nature the BLP test is fact-sensitive, in the sense that its application inevitably requires a qualitative judgment to be made on the basis of the facts (as found or admitted) relating to the transactions in question.”
19.	In summary, the cases: 
(a)  	require the transactions to be analysed on a transaction by transaction basis; 
(b)	require an analysis of whether the costs incurred are used in the supply, that is a determination of whether the costs are components of the cost of supply;  
(c)	require that examination to be factual and objective; 
(d) 	 indicate that where there is no direct link of a cost component nature, VAT on the supply is irrecoverable;  and 
(e) 	 also indicate that where there is an exempt transaction in the chain, the chain of recovery is broken. 
Submissions for the Commissioners 
20.	Miss Sloane observed that it was central to the Society’s argument that the animals were “exploited” in a variety of ways in order to generate income and that income could not be generated but for the animals.  It focused on a general “use” test.  Thus, the Society claimed that its aims were not simply entrance to a zoo, it having various aims and objects which needed income to meet them.  The Society further maintained that it generated income by using its assets in a number of ways, some taxable, some exempt, the animals generating both taxable and exempt income.  Miss Sloane maintained that the Society had to put its case in that way because, as a matter of fact, there was no direct and immediate link.  What was asserted instead was a generalised link (neither direct nor immediate) between maintaining the animals and making subsidiary commercial sales, e.g. selling animal related products in its shop. Thus, the Society exhibited animals (in return for ticket sales which granted a right to see those animals) and took that opportunity to generate additional income by selling merchandise and catering, and raising additional funds from adoptions and encounters.  
21.	Miss Sloane maintained that five points followed from the Society’s presentation of its case: 
(a)	To say that the animals were “exploited” in a variety of ways was not sufficient to enable recovery of the VAT incurred on maintaining the animals.  The Society’s argument, put at its highest, was that the animals were “used” in a general sense to generate income from taxable supplies.  She maintained that that was not the test: it ignored the requirement that “use” in that context needed a “direct and immediate link so as to be a cost component” between the animals and the subsidiary commercial activities;
(b)	To say that there would be no commercial sales (of merchandise, catering, and adoptions) without the animals was only to say that “but for” the existence of its principal business of exhibiting animals, the Society would not make those sales.  Again, Miss Sloane maintained that that was not the test
(c)	Nor, she claimed, was the commercial necessity of making taxable supplies to generate income the test
(d)	Further, the Society could not simply look at the sources of all of its income taken together and conclude that all its supplies had the animal costs as their cost components.  One must look at each supply made and ask which costs were (directly) its cost components
(e) 	That the Society could rely only on the generalised link was fatal to its claim.
22.	Miss Sloane therefore contended that Society had adopted the wrong test. Once a proper analysis was adopted, its case was bound to fail. She submitted that the following was such an analysis:  
(a)	The cost components of the catering and merchandising supplies were the costs of purchasing the stock, construction, repairs and maintenance of the retail and catering outlets. (The Commissioners had already recognised all those costs as directly attributable to the taxable supplies and so acknowledged that they were recoverable by the Society in full)
(b) 	The costs of keeping the animals was not associated in any way with the actual costs of, say, making the catering supplies or the animal adoption supply
(c)	The keeping of the animals might be commercially necessary in order to make performance of the subsidiary, commercial activities possible, but it was not a cost component of each of those commercial activities in the same way as, say, the cost of stock for the shop or the cost of producing an animal adoption certificate
(d)	There was a direct and immediate link between the animal costs and the exempt supply of admission to view the animals exhibited.  The link between those costs and the Society’s other commercial activities was indirect and subsequent 
(e) 	The commercial activities “piggy-backed” on the exempt supply of exhibiting animals.  That exempt supply had a “chain-breaking effect”
23.	Miss Sloane therefore submitted that, on a proper analysis, the expenditure incurred in maintaining the animals was part of the cost components only of the exempt supply of admission to view the animals. She accepted that there was a commercial link between the keeping of the animals and the Society’s subsidiary commercial activities, but maintained that the link was not direct and immediate. 
Submissions for the Society
24.	Mr Allen made his submissions under four separate headings. First, he observed that it was common ground between the parties that the supplies made from the cafés, kiosks and gift shops, at the zoo were taxable for VAT purposes.  Mr Allen contended that there was a direct and immediate link between those supplies and the “animal input tax” (i.e. the input tax attributable to the maintenance of animal enclosures, animal food stuffs and bedding, veterinary bills, livestock purchase, and maintenance of the grounds, gardens and walkways) so that it was residual and should be apportioned under the standard method..
25.	Secondly, Mr Allen submitted that individuals attending the zoo did so for a “zoo experience” and that it therefore followed that there was a direct and immediate link between the animal costs and all of the Society’s subsidiary commercial activities.  Confining the “but for” principle to the facts of the Southern Primary case, he claimed that the principle was confined to a situation where there were sequential supplies.
“thus Southern Primary is authority for the proposition that the mere fact that ‘but for’  the input costs in question taxable supplies would not have been made is not enough to establish the required “direct and immediate link” between the input costs and the taxable supplies”
26.	The third point made by Mr Allen was that in order to exploit the animals they must be kept in enclosures, the enclosures must be maintained, the animals needed to be fed, some had to be purchased , and they needed veterinary treatment”.  .
27.	Mr Allen’s final submission was that animal costs were properly classed as overheads since they were “essential” to the Society’s business as a whole and were expenditure arising from “general running costs, as distinct from particular business transactions”.  He maintained that the importance of the term was that expenditure which the courts defined as “overheads” was automatically considered by them to constitute non-attributable costs. For example, in the Abbey National case, the ECJ stated at paragraph 42 of its judgment:  
“the costs incurred by the transferor for services acquired in order to effect that transfer form part of the taxable persons overheads and thus in principle have direct and immediate link with the whole of his economic activity” 
28.	He therefore asked what the courts meant by the term “overhead” in that context, maintaining that the answer lay in the dictionary definition of “overhead”, and reference to whether the expenditure was “essential” to the day to day running of the business (see West Lothian College SPV v Commissioners of Customs and Excise (2004) Decision number 18133). He offered the definition of overhead given by the Concise Oxford Dictionary: “expenditure arising from general running costs, as distinct from particular transactions”, and maintained that, given that not only did the expenditure to which the animal input tax related fall within that definition but also, given that the business in question was a zoo, it would lead to a bizarre result if the expenditure to which the animal input tax related was not regarded as essential.
Conclusion
29.	Dealing with Mr Allen’s submissions seriatim, we observe of the first of them that, in failing to explain how the alleged link between supplies made by the Society from its cafes, kiosks, etc., and the “animal” input tax was “direct and immediate”, he was merely making an unsupported assertion. In the absence of an explanation, we cannot accept his assertion, and have no alternative but to reject his submission.
30.	In Mr Allen’s second submission, he simply restated the “general use or exploitation” argument, which is not the test we must apply in determining whether there is a “direct and immediate” link between the Society’s taxable supplies and the “animal” costs. We consider the link in question to be indirect and subsequent. And, in relation to Mr Allen’s claim that the “but for” principle is confined to sequential supplies, we consider that the Court of Appeal in its judgment in Dial-a-Phone was stating a principle of wider application. As Jonathan Parker LJ explained at paragraph 36 of his judgment in that case:
“Thus Southern Primary is authority for the proposition that the mere fact that  ‘but for’ the input cost in question taxable supplies would not have been made is not enough to establish the requisite ‘direct and immediate link’ between the input cost and the taxable supplies.”
31.	In our judgment, that passage is directly applicable to the point made by Mr Allen in his second submission, so that we reject his claim that the “but for” principle is confined to sequential supplies.
32.	Mr Allen’s third submission – that for the animals to be exploited they had to be kept in secure enclosures, and had to be fed and properly cared for – we regard as nothing more than repetition of the incorrect “ general use” and “but for” arguments which, as we have already explained, are not the tests we must apply.
33.	Of Mr Allen’s final claim – that the animal costs are properly classed as “essential” overheads – we would make a number of points. First, it is incorrect of the Society to assert that any expenditure which is “essential” is an overhead for, if it were, the “but for” test would have no application.  Secondly, overheads which are general expenses cannot be charged to any particular part of the Society’s operations. Thirdly, we observe that the animal costs are attributable to the specific output of admission tickets, and cannot be regarded as overheads in the same way as general expenses. Fourthly, we note that the Society does not claim that the animal costs are not cost components of its ticket sales. Finally, we hold that the costs of purchasing and maintaining animals are attributable to the particular supply of making admission ticket sales. We reject Mr Allen’s final submission.
34.	The essence of the Society’s case is that animal costs are used to generate other income such as catering and other sales. In our judgment, that shows that there is a commercial, or “but for”, link between the transactions. As that is the wrong test it follows that the appeal must fail.
35.	Although we have based our conclusion on rejecting the submissions of Mr Allen, we have not ignored those of Miss Sloane. In our judgment, her submissions are correct in every detail, and have been adopted and applied by us.
36.	Miss Sloane made no application for costs in the event of our dismissing the appeal, and we therefore make no direction in that behalf.

DAVID DEMACK 
CHAIRMAN
Release Date:
MAN/04/0682