The High Court held that the standard method of calculating the applicable input tax deduction in respect of construction work on a school sports complex produced a fair and reasonable apportionment which reflected the economic use made of it by the school.

Facts

The taxpayer school constructed a sports complex at a cost of £2.6m and applied for a partial exemption special method which gave a VAT recovery rate of 54 per cent. That method was based on the number of hours that the complex was let to a subsidiary (SHEL), as a proportion of the total of the hours let plus the hours used by the taxpayer. The Revenue and Customs Commissioners (‘Customs’) refused the application and the taxpayer submitted a revised application, seeking permission to use a ‘standard override method’ under reg. 107 B of the Value Added Tax Regulations 1995 based on hours of actual use, which was also rejected.

Consequently the taxpayer was forced to use the standard partial exemption method based on the proportion of taxable income to total income. That produced a recoverable input tax figure of one percent. The taxpayer contended that the standard method was grossly unfair and unreasonable. Customs argued that the sports complex was constructed by the taxpayer for the purpose of education, in accordance with the business plan and planning permission, with other uses being only ancillary. They maintained that the construction costs were to a very limited degree a cost ingredient of the standard-rated licence granted by the taxpayer to its subsidiary; those construction costs could never have been covered by the licence income.

The VAT and Duties Tribunal ([2006] BVC 4,061) held that the terms of art. 2 and 17(2) of Directive 77/388 (‘the sixth directive’) were relevant in two ways in considering whether the proposed special method was reasonable. First, those provisions concerned the requirement that supplies to the taxable person be used by that person for the purpose of his taxable transactions. A method that brought the use by a third party for the purpose of that party's taxable business into the apportionment calculation went beyond what was authorised. Secondly, in identifying what cost components qualified for input tax relief, there was a requirement for a ‘direct and immediate link’. The taxpayer would not have granted a licence to the subsidiary, which in turn could not have used the complex to make supplies, but for the fact that it had built the complex. That did not equate to the ‘direct and immediate’ link and ‘cost component’ tests. The expenditure provided the taxpayer with the means to make its supplies of education and the grant of the licence, but the licence was the limit of the school's standard-rated supply and the licence fee was the limit of the consideration obtained for that supply. The costs of construction were directly and immediately linked to the grant of the licence, but not to the use made by the subsidiary of the complex. Thus the taxpayer's proposal of a use-based special method went beyond the permitted limits ([2006] BVC 4,061; Decision No. 19,449). The taxpayer appealed to the High Court.

Issues

Whether the standard method and the special method proposed by the taxpayer each resulted in a fair and reasonable attribution; and, if so, whether the proposed special method was the fairer and more reasonable alternative.

Decision

Warren J (dismissing the appeal) said that the search in the present case was for a fair and reasonable proxy for the ‘use’ of the sports complex by the school in making exempt and taxable supplies.

On the evidence, it was clear that, objectively assessed, the principal purpose of the school in building the sports complex was the furtherance of its educational activities carried out in connection with its business of making exempt supplies of education. The generation of income by out-of-school use was essentially a secondary consideration, albeit that the benefit thereby produced was an aspect of the whole project from the beginning. For VAT purposes, the provision of an exempt supply of education was the principal use of the sports complex and the taxable supply of the licence to SHEL was a secondary use. Any method of allocation between the exempt and taxable supplies made by the taxpayer had to reflect that use. Given the approach of the court in Banbury Visionplus Ltd v R & C Commrs [2006] BTC 5,482, the questions for the court were whether the standard method and the taxpayer's proposed special method each produced a fair and reasonable attribution, and, if so, whether the taxpayer's method was more fair and reasonable than the standard method.

In all the circumstances, the standard method, whatever its shortcomings, produced a fair and reasonable apportionment which reflected the economic use which was made by the taxpayer of the sports complex. Further, without saying that the taxpayer's proposed special method was not a fair and reasonable method, the standard method produced an allocation which was more fair and reasonable. Moreover Customs’ rejection of the ‘standard method override’ would be upheld. Regulation 107B was applicable where the attribution being applied produced a result which ‘differs substantially’ from one which represented the extent to which the goods or services were used by the taxable person in making taxable supplies. In the present case, the standard method could not be said to produce a result which differed substantially from the one which represented the extent of the taxpayer's economic use of the sports complex in granting the licence. In any event, the way in which the taxpayer sought to calculate that difference did not represent a proper calculation of any such difference and was to be rejected.

Chancery Division.
Judgment delivered 20 December 2006.