20531

INPUT TAX – Shop-fitting of premises carried out over an extended period prior to registration – Whether goods or services – Exercise of discretion – Regulation 111 of VAT Regulations 1995 – Whether Regulation 111 compatible with EC Directive 77/388 – Whether appeal brought under s.83(c) or 83(e) of the Value Added Tax Act 1996 – Appeal  dismissed

LONDON TRIBUNAL CENTRE

	KEVIN & MARY LAI T/A THE RICE BOWL	           Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Tribunal:	MISS J C GORT (Chairman)
						MISS ANGELA WEST FCA

Sitting in public in Plymouth on 25 & 26 October 2007

The Appellant appeared in person

Miss J Connors of counsel for the Respondents

© CROWN COPYRIGHT 2007

DECISION

1.	The appeal is against a decision of the Commissioners contained in a letter dated 16 January 2006 to disallow the sum of £19,464.03 (subsequently corrected to £18,912.86) claimed as input tax in the Appellant’s 10/05 VAT return on the basis that it was incurred outside the pre-registration time limit.

The background

2.	The Appellant is the leaseholder of a property in Margate which had previously belonged to his father.  In 2002 the Appellant (“Mr Lai”) employed a firm of chartered surveyors, Geoff Oliver & Associates, to oversee the refurbishment and fitting out of the premises as a Chinese restaurant.  Substantial work was carried out to the premises over a period of nearly three years.

3.	Mr Lai was the sole proprietor of another Chinese restaurant and a takeaway in Torquay that was separately registered for VAT with effect from 4 July 2004.  On 14 July 2005 Mr Lai applied to register the premises in Margate for VAT and submitted a form VAT 1 seeking voluntary registration with effect from 25 May 2005.  The business was so registered.

4.	Further to registration of The Rice Bowl, a VAT return dated 15 November 2005 was submitted in respect of the period 10/05.  This was a repayment return in the sum of £42,528.90.  Following receipt of this repayment claim, a visit was arranged to the premises by Mr Paul Darler, an officer of Revenue & Customs.  This visit took place on 1 December 2005 where Mr Lai was seen and the premises inspected.   Following this meeting both Mr Lai and Mr Darler went to the offices of Mr Lai’s accountants, Alexander Baker.  Mr Darler ascertained that the majority of the VAT claimed as input tax related to the refurbishment and re-fitting of the premises, and that approximately half of this had been incurred more than six months before the Effective Date of Registration (“EDR”).  

5.	Mr Darler examined the accountant’s spreadsheet of purchases and the relevant invoices.  In particular he examined those relating to a time before 25 November 2005, i.e. more than six months before the EDR.  

6.	The VAT on such of those invoices as were issued before 25 November 2005 amounted to a total of £19,604.35.  Of this £140.32 related to building materials for which there were receipts for small cash purchases.  These were treated by Mr Darler as supplies of goods and allowed as having been received within three years before the EDR and assumed to be on hand at the EDR.  Mr Darler allowed Mr Lai’s claim in respect of various items such as the purchase of furniture, kitchen equipment and carpets.  He disallowed invoices which totalled £18,912.86 (wrongly referred to in Mr Darler’s witness statements and on the assessment as amounting to £19,464.03) which related to Mr Oliver’s professional services as a surveyor in part, in part to the fixing of security cameras and the majority relating to payment to the builder, via the surveyor, for refurbishment of the premises.  At no point did Mr Darler see the contract with the builder, nor did he see any breakdown of the matters which constituted the payments to the builder. There was a charge of £73.35 by EDF Energy, but there was no available invoice for this sum. In his witness statement Mr Darler records: “This would be either goods (power) consumed before the EDR or services more than six months before the EDR.”  In either case this amount would also be disallowed.  We were uncertain as to why he considered that the EDF charge should be disallowed if it were treated as goods.  Mr Darler treated all the supplies to the builder, Angelo Tripodi, as being a supply of construction services. Mr Darler in his witness statement, having found that they were supplies of construction services, said:  “Any goods used in making the supply form part of an overall supply of services.”  However earlier he had in the same witness statement allowed the sum of £142.32 on building materials and treated them as supplies of goods, rather than treating the whole supply as one of services. 

7.	There was consideration at the time of Mr Darler’s meeting with the accountant of the possibility of backdating the EDR.  It was decided that the EDR could not be backdated, there having been neither a genuine error by Mr Lai in completing the VAT 1 application form, nor by the Commissioners.  There was no appeal against that decision.

The Legislation  

8.	Section 3 of the Value Added Tax Act 1994 (“VATA”) provides:
“(1) 	A person is a taxpayer person for the purposes of this Act while he is, or is required to be, registered under this Act. 

(2)  	Schedules 1 to 3A shall have effect with respect to registration.

Section 24(6) VATA provides:
	
“Regulations may provide –

		(a)  …

(b)	for a taxable person to count as his input tax, in such circumstances, to such extent and subject to such conditions as maybe prescribed, VAT on the supply to him of goods or services or on the acquisition of goods by him from another Member State or paid by him on importation of goods from places outside the Member States notwithstanding that he was not a taxable person at the time of the supply, acquisition or payment.”

Schedule 1 paragraph 9 VATA provides:

“Where a person who is not liable to be registered under this Act and is not already so registered satisfies the Commissioners that he –

	(a)	makes taxable supplies; or

(b)	is carrying on a business and intends to make such supplies in the course or furtherance of that business,

they shall, if he so requests, register him with effect from the day on which the request is made or from such earlier date as may be agreed between them and him.”

The Value Added Tax Regulations 1995 provide under Regulation 111:

“(1)  	Subject to paragraphs (2) and (4) below, on a claim made in accordance with paragraph (3) below, the Commissioners may authorise a taxable person to treat as if it were input tax –

(a)	VAT on the supply of goods or services to the taxable person before the date from which he was or was required to be, registered or paid by him on the importation or acquisition of goods before that date, for the purpose of a business which either was carried on or was to be carried on by him at the time of such supply or payment … 

(2)  No VAT maybe treated as if it were input tax under paragraph (1) above –

	(a)	In respect of –

		(i) 	goods or services which had been supplied, or

(ii)	save as the Commissioners may otherwise allow, goods which had been consumed, 
  
By the relevant person before the date with effect from which the taxable person was, or was required to be, registered;

	(b)  	…

(c) 	In respect of services performed upon goods in which sub-paragraph (a) or (b) above applied; or

(d)  	In respect of services which had been supplied to the relevant person more than six months before the date with effect from which the taxable person was, or was required to be, registered.”

Section 24(1) of VATA provides: 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;

(b)  	VAT on the acquisition by him from another Member State of any goods;

(c)  	VAT paid or payable by him on the importation of any goods from a place outside the Member States, 

(Be 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.”

Section 25(2) VATA provides:

“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 import tax as is allowable under Section 26, and then to deduct that amount from any output tax that is due from him.”

Regulation 111(4) provides:

“A taxable person making a claim under paragraph (1) above shall compile and preserve for such period as the Commissioners may require –

(a)  	in respect of goods, a stock account showing separately quantities purchased, quantities in the making of other goods, date of purchase and date and manner of subsequent disposal of both such quantities, and 

(b)  	in respect of services, a list showing their description, date of purchase and date of disposal, if any.”

Article 4 of the Sixth Directive provides:

“(1)	“Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.”

(2)	The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services, including mining and agricultural services and activities of the professions.  The exploitation of tangible or intangible property for the purpose of obtaining income there from on a continuing basis shall also be considered an economic activity.

….”

The evidence

9.	We heard evidence from both Mr Lai and Mr Darler.  The Commissioners produced a bundle of documents for the hearing which was made up without any cooperation from Mr Lai who had not responded to requests by the Commissioners to supply any documents in support of his appeal.  On no occasion did he return their telephone calls.  The consequence was that the contract with Angelo Tripodi, which it was accepted by Miss Connors was relevant to the appeal, was not available on the first day of the hearing.  Mr Lai did produce some relevant documents on the second day of the hearing, but at no time did either the Tribunal or the Commissioners see either the original contract or many of the documents relating to the particular performance of that contract.  It was acknowledged by Mr Darler at the hearing that he had not asked to see it at the time he visited the accountants’ premises.  

10.	Following Mr Darler’s visit to the premises, there was considerable confusion as to the relevant legislation.  It appears that Mr Darler misunderstood the situation initially and believed that in order to reclaim the input tax the Appellant had to own the premises in question to obtain a refund.  This confusion apparently lasted until about September 2006.  Unfortunately the Commissioners did not see fit to include in the bundle of documents any correspondence prior to 5 September 2006.  In that letter the Commissioners set out the terms of regulation 111 of the Value Added Tax Regulations.  The writer of that letter, a Mr Steve Braeger, continues:

“Regrettably, previous correspondents have incorrectly indicated that VAT could be recovered on services where those services were performed on goods that had been acquired no more than three years before VAT registration.  As a result of this misunderstanding of the conditions you have been given the impression that if you were the owner of the property you would be able to recover the VAT incurred on refurbishment work carried out to the property within the three years prior to your VAT registration.”

In the final paragraph Mr Braeger apologises for any confusion.  It is evident from this that for a considerable period of time Mr Lai was pursuing an appeal against a decision which had been made on a completely erroneous basis.  He had spent a considerable amount of time submitting documents to the Commissioners establishing the nature of his interest in The Rice Bowl.  Whilst this is not a matter which is justiciable in this Tribunal, it seems to us that it was incumbent on the Commissioners to set out the facts in full for the benefit of the Tribunal, particularly in a case which involves the exercise of a discretion on the part of the Commissioners, albeit there was some dispute as to the applicability of that concession in this case.  It was not apparent to the Tribunal from the documents before us, including Mr Darler’s witness statement, what the basis of the assessment was when it was initially made.

11.	In the course of the hearing it became apparent that the contract with Mr Tripodi was an important document. The case was adjourned in order for that contract to be produced. Unfortunately Mr Lai at no point appeared to understand the importance of the distinction between goods and services, and he did not supply the Tribunal with a copy of the original contract, but produced a variety of documents relating to the performance of the contract. These documents did show some items, including the supply of a boiler which had cost £2,200, which the Commissioners informed the Tribunal they were prepared to accept were goods, and therefore the VAT on them should be refunded.

Reasons for decision

12.	The first issue to be decided by the Tribunal is whether this appeal is brought under section  83(c) or section 83(e) of the VATA.  Section 83(c) allows an appeal in relation to: `The amount of any input tax which may be credited to a person’.  Section 83(e) allows an appeal to be brought against: `The proportion of input tax allowable under section 26’.  It was the Commissioners’ case that section 83(c) was the relevant basis for this appeal.  Mr Lai did not argue that s.83(e) was the relevant section.  In the absence of full argument on the point, the Tribunal accepts that  s.83(e) is the appropriate section.

13.	An issue was raised by a differently constituted Tribunal of its own motion as to whether regulation 111(2) was compatible with European law. This was not a point taken by the Appellant and he addressed no argument as to it.

14.	Miss Connors, however, set out a full and detailed skeleton argument on the point, as had been previously directed by the Tribunal.  We set out in full that argument, as it was uncontested, and appears to us to be correct.  

15.	Paragraph 1 of Schedule 1 to VATA 1994 provides that an unregistered person who makes taxable supplies is required to be registered once the monetary value of his supplies exceeds certain minimum thresholds.  These thresholds are increased from time to time in line with inflation, and now stand at £61,000. Therefore, an unregistered trader who is making taxable supplies with an annual value of (say) £50,000 will not be a “taxable person” for the purposes of the UK Value Added Tax Act 1994.

16.	This UK concept of a “taxable person” is narrower than the EC concept of a “taxable person”, as defined in Article 4 of EC Directive 77/388/EEC (“the Sixth Directive”).  Therefore, an unregistered trader who is making taxable supplies with an annual value of (say) £50,000 will be a taxable person within the meaning of Article 4 of the Sixth Directive, although he will not be a taxable person within the meaning of s.3 VATA 1994.

17.	The reason why the UK definition of “taxable person” in the VAT Act 1994 is narrower than the EC definition is that the UK has taken advantage of Article 24(2) of the Sixth Directive, which provides that Member States may (in the words of Article 24(2) “apply an exemption from tax to taxable persons” whose annual turnover is less than the equivalent in national currency of 5,000 European units of account (at conversion rates applying on 17 May 1977 when the Sixth Directive was adopted), increased in order to maintain the value of that sum in real terms.

18.	The Article 25(2) sum of 5,000 European units of account, converted to sterling at 17 May 1977 rates, and increased in line with inflation to give the same real value in present day terms, is approximately £61,000.

19.	Article 24(6) of the Sixth Directive provides that taxable persons who are eligible for exemption from tax may opt for the normal value added tax scheme if they so wish.

20.	A taxable person’s right to “opt in” to the normal VAT scheme, as set out in Article 24(6) of the Sixth Directive, is implemented in UK legislation by paragraph 9 of Schedule 1 to VATA 1994.

21.	A taxable supply is a supply of goods or services made in the UK other than an exempt supply; s.4(2) VATA 1994.

22.	Therefore, at any given time, any person who is carrying on a business and intends to make, or is making, non-exempt supplies of goods or services in the UK will be either:

(1)	already registered (whether mandatory under para 1, Sch.1 or voluntarily under para 9, Sch.1); or

(2)	liable to be registered under para 1, Sch.1 (because his taxable supplies are above the threshold level); or

(3)	entitled to his option to be registered under para 9, Sch.1 (because his taxable supplies are below the threshold level).

23.	The first two categories of person are “taxable persons” for the purposes of UK VAT legislation as well as for the purposes of EC legislation.

24.	The third category of person is a “taxable person” in the EC law sense, but has by definition not “opted in” to the normal VAT scheme (i.e. out of the Article 24(2) exemption).  Consequently, he is not a “taxable person” in the UK sense, although he could become so simply by applying for registration under paragraph 9, Sch.1 VATA.

25.	If a person who is not registered or liable to be registered does not “opt in” to the normal VAT scheme as contemplated by Article 24(6) and para. 9, Sch. 1 VATA, then this has certain consequences (both in EC law and in UK law) for his right to deduct input tax, as is explained below.

The right to deduct input tax

26.	Article 17 of the Sixth Directive provides:
“(1)	The right to deduct shall arise at the time when the deductible tax becomes chargeable.

(2)	In so far as the goods and 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 county in respect of goods or services supplied or to be supplied to him by another taxable person; ….”

27.	Article 10 of the Sixth Directive provides for a primary rule as to when the deductible VAT “becomes chargeable”, which may be displaced by special rules made by Member States as set out in the Article 10(2) derogation.

28.	Article 18(1)(a) of the Sixth Directive provides that in respect of deductions pursuant to Article 17(2)(a), a taxable person must hold an invoice drawn up in accordance with Article 22(3).

The Article 24(5) exception to the right to deduct

29.	Article 24(5) of the Sixth Directive provides an exception to the Article 17 right to deduct, as follows (emphasis supplied):
“Taxable persons exempt from tax shall not be entitled to deduct tax in accordance with the provisions of Article 17, nor to show the tax on their invoices.”

30.	The reference in Article 24(5) to “taxable persons exempt from tax” is a reference back to Article 17 and to Articles 24(2) and 24(6) – i.e. “taxable persons exempt from tax” means, in effect:

‘those who are exempted by a Member State under Article 24(2) and who – at the time when the tax in question became chargeable in accordance with Article 17 – have not opted in to the normal VAT scheme under Article 24(6).’

31.	Therefore, reading Articles 10, 17, 18 and 24(5) together, in order for an (EC law sense) taxable person “A” to have an EC law right to deduct tax due or paid within the UK on a supply made to him:

(1)	That tax must be in respect of goods or services supplied, or to be supplied, to A by another (EC law sense) taxable person “B”;

(2)	Taxable person B must not have been “exempt from tax” at the time when the tax which A wishes to deduct became chargeable (because then he would not be entitled to show VAT on his invoices); and

(3)	Taxable person A must not have been “exempt from tax” at that time either.

32.	It will be seen from the above that no EC law right of a taxpayer is breached when the UK, or any other Member State, limits or restricts the rights of a taxable person (in the EC law sense) to deduct tax in respect of goods or services which were supplied to him at a time when either he or the supplier was exempt from tax.  On the contrary:  Article 24(5) contemplates just such limitations or restrictions.  Therefore regulation 111(2) of the Value Added Tax Regulations 1995 is indeed compatible with European law. 

The domestic legislation in more detail

33.	In UK terms the requirement that both supplier and recipient of supplies should not have been “exempt from tax” means that both must have been either:

(1)	registered for VAT (either compulsory under para 1 of Sch.1 or voluntarily under para 9 of Sch.1); or

	(2)	liable to be registered for VAT under para 1 of Sch.1,

	at the time when the tax sought to be deducted became chargeable.

34.	In order to determine what was “the time when the tax sought to be deducted became chargeable”, it is necessary to look at s.6 of VATA 1994 (“Time of supply), by which the UK has implemented Article 10 and the derogation contained in it.

35.	Section 6 provides that VAT becomes chargeable on the earliest of these three dates (if indeed they are different dates):

	(1)	the date when the goods are delivered or the services are performed;
	(2)	the date when payment is made for the goods or services; and
	(3)	the date when an invoice is issued in respect of the goods or services.

36.	In UK legislation, both:

	(1)	the primary right to deduct, set out in Article 17; and
	(2)	the exception to the right to deduct, set out in Article 24(5),
	are implemented by Sections 24 – 26 VATA 1994.

37.	This is because – as a result of the particular UK definition of “taxable person”, described above – the scope of the right to deduct in ss.24-26 (and regulations made under them) is confined to those taxable persons (in the EC law sense) who are not exempt from tax, as follows.

38.	So far as is presently material, Section 26 VATA provides that the amount of input tax for which a “taxable person” is entitled to credit at the end of any period shall be so much input tax on supplies, acquisitions and importations in that period as is allowable by or under regulations as being attributable to taxable supplies made by him or to be made by him in the course or furtherance of his business.

39.	Therefore, the general rule is that input tax cannot be deducted by a person who was not, when he received the supply in question (or was invoiced for it or paid for it, if earlier), either registered or liable to be registered for VAT.

40.	There is one exception to this, however, as set out in regulation 111(1) of the Value Added Tax Regulations 1995.

41.	Regulation 111 is made under s.24(6) VATA.  In this (UK) context, “taxable person” means a person who is, or is liable to be, registered.  Therefore, s.24(6) is saying that regulations may provide for a person who is registered or is liable to be registered to be permitted to exercise his right of deduction in relation to tax which was paid or became due before he was registered or became liable to be registered.

42.	However, HMRC’s power to authorise such VAT to be treated as input tax is limited by regulation 111(2).

43.	There are therefore two types of services which cannot give rise to a claim to deduct input tax, when supplied to a person “A” who is at the relevant time neither registered nor liable to be registered:

(1)	Services of any kind, if supplied to A more than 6 months before A was registered or became liable to be registered (see regulation 111(2)(d)); and

(2)	Services – whether supplied to A more than 6 months or less than 6 months before A was registered or became liable to be registered – which were performed on goods supplied to A more than 3 years before A was registered or became liable to be registered (see regulation 111(2)(c)).

44.	We turn now to the question of whether in the circumstances of this case there is a discretion to be exercised under regulation 111(1).  That regulation, unusually, makes a prior condition of the initial exercise of the discretion by the Commissioners that the conditions of regulation 111(2) and (4) are satisfied.  The services which were disallowed in the present case fell within regulation 111(2)(d) in that they had been supplied to Mr Lai more than six months before the date with effect from which he had been registered, and would therefore on the face of it not be subject to any exercise of discretion under s.111(1).  However, the Commissioners had by their own admission in the course of the hearing, included in the assessment items which were now recognised by them to be properly described as goods in respect of which they were prepared to allow the claim for input tax.  This raises the question as to whether there was any proper exercise of the discretion in respect of those goods at the relevant time, in particular since a further discretion is given the Commissioners by regulation 111(2)(a)(11).

45.	It is however not necessary for us to consider the issue of the Commissioners’ discretion, since regulation 111(4) was clearly not complied with by Mr Lai, and by virtue of it he is precluded from claiming as input tax the supply of any amounts which may relate to goods encompassed in the Tripodi accounts, since he did not keep a stock account in respect of the goods or a proper list in respect of the services.

46.	It was submitted on behalf of the Commissioners in the alternative that the supply by Mr Tripodi to Mr Lai was a supply of services, and that any goods which Mr Tripodi supplied were ancillary to the supply of services and should be subject to the same VAT treatment.  We accept that any supply of goods where there is shop-fitting maybe incidental to a principal supply of shop-fitting, and that the relative values of the materials used and the goods are an important consideration in some circumstances, in the present case there is simply not sufficient evidence of the cost of any goods, and at the time the assessment was made the Commissioners did not have to hand any proper breakdown of the respective costs, and so were entitled to treat the entire supply as one of services.   They did, as stated above, make an allowance in respect of a few items for which there were invoices, and also in respect of those further items where invoices were produced at the hearing.

47.	Mr Lai’s case was that he could have registered earlier than 25 May 2005, and if he had done so he would have been allowed to claim all the disputed input tax, therefore the Commissioners ought to allow him to backdate the registration further.  He also submitted that, since he had paid out sums in excess of the £61,000 registration limit at the time, therefore he ought in any event to have been registered at an earlier date.  This latter argument was based on Mr Lai’s confusion between takings and expenditure when determining a person’s liability to be registered.  He was also, not surprisingly, confused both by the error made by the Commissioners in quantifying the assessment, and by their earlier having based their decision on his not being the owner of the premises.  He also made the point that it was unfair that he should be penalised for not having understood the requirements of value added tax, whilst the Commissioners, who similarly had misunderstood the relevant provisions, were not penalised.  Whilst Mr Lai is justified in some of his complaints against the Commissioners, it is not for this Tribunal to deal with those issues, however Mr Lai may like to consider approaching the adjudicator who has power to deal with some of the matters of which he complains.  

48.	We do not accept Mr Lai’s case that, because he could have registered earlier than the 25 May 2005, therefore the Commissioners ought to allow him to backdate the registration. There was no application by Mr Lai to backdate his registration before us, although it was a matter that was considered very thoroughly by Mr Darler, as he explained to us in his evidence, and in any event Mr Darler was correct to decide that no such backdated registration could be made because there had been neither a genuine error made by Mr Lai when he completed his VAT 1 application form, nor had the Commissioners made an error with regard to that aspect.  Although there have been many confusions in this case, not just on the part of Mr Lai but also on the part of the Commissioners, this appeal is concerned with the amount of any input tax which may be credited to Mr Lai, and Mr Lai has produced no evidence of any further goods obtained by him within the three years prior to his registration and therefore this appeal is dismissed.

49.	There is no order for costs.

MISS J C GORT
CHAIRMAN

RELEASED: 9 January 2008

LON/ 2006/698