The Royal Bank of Scotland Group PLC v Revenue & Customs [2007] UKVAT V19983 (19 January 2007)

19983

Input Tax – Hire Purchase contract –Partial Exemption – attribution – proposed revisal of agreed special method –refusal by HMRC – at Tribunal the formerly agreed special method not supported by either party – proposed method on its face fair and reasonable – appeal allowed – VATA 1994 s.26(3) Schedule 9, Group 5, Item 3 – Regulation 1996, 101 and 102, EC. 6th Directive.

EDINBURGH TRIBUNAL CENTRE

THE ROYAL BANK OF SCOTLAND GROUP PLC     	Appellant

- and -

THE COMMISSIONERS FOR
HER MAJESTY’S REVENUE & CUSTOMS	       Respondents

Tribunal:	 T GORDON COUTTS, QC (Chairman)
K W PRITCHARD, OBE.,BL., WS (Member)
I R WELCH, CA., JP (Member)

Sitting in Edinburgh on 8th and 9th January 2007.

for the Appellant(s)		Colin Tyre, QC

for the Respondents		Heriot Currie, QC

© CROWN COPYRIGHT 2007.

DECISION

INTRODUCTORY
	As originally presented this appeal raised various questions but by the stage of the hearing the only issue and therefore the only question for determination was whether the Respondents’ rejection of the method proposed for partial exemption by the Appellant should be supported.    The appeal relates to that proportion of input tax paid by companies within the Lombard Finance Group (Lombard) which is part of the Appellant’s VAT Group, on general overheads which is allocated to instalment credit business and to the method proposed by the Appellant for measuring use of that input tax for the purposes of determining a recoverable fraction.

The Appellant led as evidence Mr Robert Dagg, Lombard’s Director of Asset Finance, Fiona Stuart, the Appellant’s VAT Group Compliance Manager while the Respondents led Callum Melville a Higher Officer employed at the Large Business Office in Edinburgh.  Mr Melville  had been since August 2004 the Lead Higher Officer for HMRC dealing with Lombard North Central PLC.  

Mr Dagg’s evidence related substantially to potentially disputed facts.    The other witnesses basically sought to explain their respective contentions.   Mr Melville in particular gave valuable evidence about the policy considerations which had to some extent motivated HMRC’s  response.

In addition a considerable bundle of correspondence was produced to which reference was made.   In the main, however, that dealt with parties previous contentions and assertions and was only of some historical interest for the Tribunal.

The issue for the Tribunal was the analysis of the current business operation of Lombard.   The prior communings were of little relevance to our decision.                                                                                                                      

THE STATUTORY BACKGROUND
The UK legislation implements the provisions of the First Council Directive (67/227/EC) of 11 April 1967 and the Sixth Council Directive (77/388/EC) of 17 May 1977 and must be construed in the light of those Directives.

The First Directive, Article 2, includes the following:
	“On each transaction, value added tax….shall be 			chargeable after deduction of the amount of value 			added tax borne directly by the various cost 				components.”

The Sixth Directive, Article 2, subjects to value added tax “the supply of goods or services effected for a consideration…by a taxable person acting as such”.  Under Article 4(1), a taxable person is a person who independently carries out any economic activity within Article 4(2) whatever the purpose or results of that activity.   The economic activities referred to comprise, under Article 4, all activities of producers, traders and service providers.

Article 17(2) allows deduction in respect of inputs used for the purpose of the trader’s taxable transactions;  and under Article 17(5), there is to be an apportionment in the case of mixed use both for transactions in respect of which VAT is deductible (ie taxable transactions) and transactions in respect of which VAT is not deductible.   It then provides that “such proportion…shall be deductible as is attributable to the [taxable] transactions”.

The default method of attribution is found in Article 19(1).   

However, Article 17(5) also provides that Member States may make certain other specified provisions as set out in paragraphs (a) to (e):  paragraph (c) provides that a Member State may authorise or compel a taxable person to make the deduction on the basis of the use (a term which is not defined) of all or part of the goods or services.

The relevant domestic legislation is found principally in sections 24, 25 and 26 Value Added Tax Act 1994 (“VATA”) and in Regulations 101 and 102 of the Value Added Tax Regulations 1996 (SI 1995 no 2518) (“the Regulations”).   

Section 24 defines input tax on the supply to a taxable person of goods or services used for the purposes of a business carried on or to be carried on by him.    Section 24(5) provides for apportionment in cases of mixed use for business and non-business purposes;  only so much as is referable to business purposes counts as input tax.   The section uses the concept of business whereas the Sixth Directive talks of economic activities.

Section 25 provides that a taxable person is entitled, at the end of each accounting period, to credit for so much of his input tax as is allowable under section 26.  Section 26 contains the provisions which describe the input tax allowable under section 25 and makes it clear that the only input tax allowable is that which is attributable to taxable supplies made by the trader in the furtherance of his business and not to exempt supplies.  Section 26(3) provides in effect that, where a taxable person makes both taxable and exempt supplies, the Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to taxable supplies.   They have done so in Regulations.

Regulation 101 provides a standard method for apportioning “residual” input tax between taxable and exempt supplies.   Residual tax is the tax on supplies to the trader used by him to make both taxable and exempt supplies.

Regulation 102 provides for the use of methods of attribution other than the standard method.  HMRC may either approve or direct the use of such an alternative method which, in accordance with the statutory objective under section 26(3), is directed at achieving a fair and reasonable attribution when the standard method does not do so, or at least a fairer and more reasonable attribution than the standard method.   If an alternative method fails the fair and reasonable test another method or a return to the standard method can be suggested for approval.

In relation to exempt and taxable supplies VATA Schedule 9 Group 5 specifies the exemptions.    Item 2, exempts “the making of any advance or the granting of any credit.”  By Item 3 it is provided “the provision of the facility of instalment credit finance in a hire purchase, conditional sale or credit sale agreement for which facility a separate charge is made and disclosed to the recipient of the supply of goods.”

The provision in Item 3 make it clear that it is only the facility of credit finance that is exempt and only if a separate charge is made for the facility.   It has no application to the goods sold or hired.

However it should also be noted that by Article 13(b)(1) of the Sixth EC Directive debt collection is excluded from exempt supplies of finance and it would accordingly be a taxable activity.

THE BUSINESS OF LOMBARD
Underlying the Respondents approach appeared to be the premise that Lombard were only supplying finance.   For example an assertion was made by them in a letter dated 24 June 2000 that Lombard’s business is the provision of credit not the buying and selling of goods.   While this may look supportable superficially it is not an appropriate overall term to describe Lombard’s business activities, as it  ignores the vital matters of title and ownership of the goods which underlie the transaction and the consequences therein.  A better description from what evidence we heard is “asset finance”.

In simple terms we find that the transaction undertaken by Lombard is the purchase of an asset be it motor car or business machine, by Lombard from a supplier and the hiring of that asset to Lombard’s customer on terms which provide for the transfer of the title of the asset from Lombard when all payments on the hire purchase agreement have been made.   Lombard supplies the customer with an asset at a price which is paid in instalments and includes the cost to the customer of obtaining credit for the purchase but also recognises the assumption by Lombard of the cost of hiring the goods and ultimately disposing of them either to the customer or to a third party in the event of repossession or as part of a transaction to upgrade the customers asset with a new or better model.   In order to achieve a satisfactory transaction various activities are undertaken by Lombard but ultimately the object is the provision of a sound asset at a price which includes the cost of delayed payment.

Superimposed upon this comparatively simple legal and business concept has been the requirement for VAT purposes in Item 3 of Group 5 referred to above which involves the sub-division of the total transaction into the facility of finance for which a separate charge is made and the hiring acquisition or sale of the asset itself.

Mr Dagg’s evidence explained the various matters which could and usually did arise in progressing a transaction.    He described Lombard’s interest as differing from that of a bank who provide money in that Lombard also has an interest in the assets in question which they require to understand in order to fulfil the position of the owners of the moveable assets.    Part of the requirement for Lombard that they understand the assets is that they require to be satisfied as to their durability, identity and saleability.    That involves contact with the customer by way of several telephone or face to face meetings in order to understand the customers’ business to be in a position to advise.   Most customers he said, do not buy assets, they make things.   The credit worthiness of the customer requires to be ascertained.  While some customers know what they want, many seek and obtain advice about what is the best machine, what deals are available and whether any tax advantages can be obtained in relation to the timing of purchase.   Lombard must also contact the supplier;  inspect and check the viability of the supplier and the machine, all with a view to making certain that the asset was not worthless at the end of the transaction with the customer.  They may take guarantees and require insurance.   In particular they have to take steps in relation to the possibility of a machine becoming a landlord’s fixture and seek appropriate waivers if necessary.   They would investigate the supplier in relation to the warranties available.  When the customer signs the finance agreement Lombard are invoiced by the supplier.  If all is in order the machine can be delivered direct to the customer.

Additionally there could be payments for maintenance.  There requires to be contact with the customer on a regular basis to avoid defaults.     Lombard have a definite interest in the quality of the goods because if they turned out not to be fit for the purpose it is Lombard that will be left with and require to deal with the defective machinery because they are the owners.

At the end of the payment period title to the goods will normally be transferred to the customer but Lombard may require to confirm to interested parties that this has been done.

There may be variations on the simple transaction above noted in adjusting the payment and choice of the customer.

In an attempt by the Respondents to sub-divide the above transaction into “processes” a document was produced and spoken to by Mr Melville.    While the narration therein of what could be done was accepted as broadly correct, its relevance and the attribution of various items as a “process” were disputed.     Cross-examination of Mr Melville by Mr Tyre was destructive of virtually all Mr Melville’s conclusions and attributions.

Mr Tyre was able in his final submissions virtually to reject  the whole attribution by Mr Melville, although Mr Tyre stressed that he was not to be taken as agreeing that the consideration of “processes” was relevant or the correct way to proceed.

Mr Melville in his evidence asserted that the Respondents’ Policy Unit were of the view that in the present circumstances the recovery rate should be zero.   Mr Melville being a sensible and realistic person did not seek to support that.   However on the basis of his understanding and analysis thereafter of Lombards various activities he produced a calculation based upon “processes” which he suggested (in para 22 of his written statement) that there were 30 processes, 3 represented the supply of goods, 19 the supply of credit and the balance of 8 were mixed.   From that he stated that a recovery rate of 13.63% was appropriate.    As noted above he was unable to support that calculation after cross-examination.   Mr Tyre produced a document which asserted that there were two exempt processes, 5 taxable processes and 18 mixed.   That would give a recovery rate of above 70%.

Mr Tyre’s main contention however was that the attempt to isolate processes was of no assistance in achieving a proxy for use.  It took no account of time which the previous agreement in 1984 had but which in any event would itself not be an appropriate basis.    A comprehensive list of overheads by way of an extract from an oracle chart of accounts for accounting purposes was one of the productions.   From that it could be seen that a substantial number of items were involved in general office overheads which it would be difficult or impossible to sub-divide.

THE PREVIOUS AGREED SPECIAL METHOD
This derived from a negotiation between the Respondents and the Finance Houses Association (FHA) in 1984 agreeing a recovery fee of 15% of general business overheads as being attributable to instalment credit business.    That agreement appeared to proceed on some time basis but specific detail is not clear.  Subsequently a Tribunal in Sovereign Finance plc v C&E Commissioners (1998) Decision No. 16329 cast doubt upon the basis of the agreement as anything other than an arbitrary figure.    The Tribunal Decision, one which resulted from a typically careful and perceptive analysis of the legislation and the transaction in the hire purchase contract by the Chairman, Mr A W Simpson, which seems to have led to the FHA withdrawing their support from the Agreement.    That appears to have led to a flurry of activity around 2000 in which the Respondents recognised that a new agreement required to be achieved and they put forward various suggestions most of which from the correspondence produced appeared to have been directed towards promoting the idea that the entire activity of a hire purchase company had to do with the provision of credit.   That of course was in the teeth of the reasoning in Sovereign Finance and was resisted by Lombard who, for reasons which no doubt appeared to them to be good at the time, sought to maintain a 15% figure.     Further and better consideration of matters by the Appellant’s  VAT staff resulted in the present proposal, the subject of the appeal.

It should be noted that at no stage in the course of the appeal did the Respondents attempt to support or justify 13% or any other figure contenting themselves with the proposition that the Appellant had not provided sufficient evidence to justify their contention.

The Tribunal was accordingly left with the situation that neither party sought to support the status quo and the inevitable inference from that is  that the status quo is neither fair nor reasonable.

SUMMARY OF CONTENTIONS BY APPELLANT
The method proposed by the Appellant acknowledges that Lombard’s overheads, in so far as allocated to instalment credit business, are used in an undifferentiated and indistinguishable way for its business activity of the hiring of assets to customers at a price which takes account of the provision of credit and of the ultimate transfer of title.   There is a direct and immediate link between the overhead expenditure and that activity.   Since the activity falls to be regarded as two transactions for VAT purposes, it is appropriate when attributing input tax for VAT purposes, to do so on the basis of a transaction count.    The method proposed is therefore fair and reasonable.   The Respondents’ refusal to allow its use is unreasonable.

SUMMARY OF CONTENTIONS BY RESPONDENT
The Respondents did not take issue with the proposition that instalment credit business may comprise a taxable supply of goods and an exempt supply of credit.   It is not however fair and reasonable to treat 50% of the overhead input tax allocated to instalment credit activity as attributable to exempt supplies.   They contended that it is for the Appellant to demonstrate that the method proposed would produce a fair and reasonable result and the Appellants have not provided such evidence.  Auchterarder Golf Club 2007 No 19907 was cited as emphasising the need for the Appellants to do so..  The facts in the present case are not the same as in Sovereign Finance which turned upon a proper construction of a particular special method and did not lay down any general principle.    The analysis carried out by Mr Melville, it was submitted, confirmed that a percentage in excess of 15% would not result in a fair and reasonable apportionment.  It is not for a Tribunal to stipulate a method which would produce a fair and reasonable result, see St Helen’s School Northwood Limited v Commissioners HMRC [2006] EWHC 3306.

DECISION
In the first place the Tribunal had no hesitation in deciding as a matter of fact that the 15% figure operated at present did not produce a fair and reasonable attribution and was not of itself either fair or reasonable.   That was clearly confirmed by the analysis conducted, whether misconceived or otherwise, by Mr Melville when viewed after cross-examination.  In the light of that the Tribunal considered the Appellant’s proposal, which since it had no competitor, fell to be judged as whether it of itself could be regarded as a fair and reasonable result.   Whether or not other methods might produce a fair and reasonable result did not enter into the Tribunal’s consideration since there was no other method proposed which made any sense.    So for example a method based on value would produce a high rate since the goods will almost invariably cost substantially more than the credit facility.
In these circumstances the Tribunal in  determining whether or not to allow the appeal bore in mind the dictum of Warren J in St Helen’s School Northwood Limited v the Commissioners and in particular at paras 26 and 27 in which he said.
26. “The decision of Customs refusing to approve a proposed partial exemption special method or to apply a standard method override can be appealed to a tribunal under section 83 VATA (see paragraph (e) of that section).    The nature of such an appeal was considered by Etherton J in Banbury Visionplus Ltd v Revenue and Customs Commissioners [2007] STC 1568.    He concluded that an appeal was not “limited” in the sense identified by him (ie an appeal where the tribunal is confined to considering whether Customs decision was reasonable, in the sense that they did not take into account any irrelevant matters, they took into account all relevant matters and made no error of law and reached a decision which they could properly have reached);   instead, the appeal was “full” in the sense that, “even if the disputed decision was a reasonable one, the tribunal should itself decide whether it secured a fair and reasonable attribution of input tax within the meaning of [section 26VATA]”.   In other words, the tribunal can substitute its own view of what is fair and reasonable, in the context of the question before it, for that of Customs notwithstanding that Customs decision was within the range of decisions which a body properly directing itself could reach.  I propose to follow that approach without any further discussion.
27.  This is not to say that the tribunal is able to put forward its own version of a more reasonable special method (if there is one).   It cannot do so, as the Tribunal recognised in paragraph 43 of the Decision.    Accordingly, a tribunal can substitute its own view for that of Customs in deciding whether a proposed special method is fair and reasonable.  If on an appeal by a taxable person from a refusal of Customs to allow a proposed special method the tribunal decides that the method is fair and reasonable and also that it is more fair and reasonable than the method in operation (be it the standard method of some other special method), the appeal should be allowed.   But if the tribunal thinks that both the existing method and the proposed method are unfair or unreasonable, it could not allow the appeal even if it considers that the proposed special method is less unfair and unreasonable than the existing method.”

Following that approach and considering the facts in the present case we have decided that the proposed special method on a transaction based approach is fair and reasonable and that it is more fair and reasonable than the method in operation.  No other method was suggested to replace the unfair and unreasonable method currently operated.   The Tribunal must not substitute its own views. Accordingly we allow the appeal.

It was a matter of agreement that any new method would only apply from 1 January 2005.

The Appellant moved for expenses in the event  of success.   The Appellant has had success.  The Tribunal accordingly awards it expenses to be agreed failing which to be taxed in terms of Rule 29.

T GORDON COUTTS, QC

CHAIRMAN

EDN/05/95
RELEASE:  19 JANUARY 2007.