The issue was whether the value of securities should be included in the fraction used within the appellant's partial exemption method to determine the deductible proportion of residual input tax. The subject of the appeal was the decision of the commissioners to deny the appellant input tax credit on supplies made to it which were used for the purpose of making supplies of securities outside the member states, referred to as ‘specified supplies’.

The appellant was a life assurance company and subsidiary of Lincoln International (UK) plc, part of a US corporation. It was the principal trading company of the group in the UK and was the representative member of the group for VAT purposes. The appellant made three main types of supply. First, it supplied insurance policies to policyholders for which it received premium income. Most of the policyholders were resident in the UK and these were exempt supplies. A few policyholders belonged in other member states and a very few policyholders belonged outside the member states; these latter supplies were specified supplies. Secondly, the appellant let out its investment properties and received rental income; these supplies were either taxable or exempt. Thirdly, the appellant sold securities in the course of managing its investments. Securities were sold to persons in the UK, in which case the supplies were exempt, to persons in other member states, or to persons outside the member states and these were specified supplies. Until the end of 1995, the appellant used a special partial exemption method under reg. 102 of the Value Added Tax Regulations 1995 (SI 1995/2518) to attribute its residual input tax between taxable and exempt supplies. On 1 January 1996, the commissioners withdrew the special method and from that date the appellant used the standard method under reg. 101 and the same method for specified supplies. On 17 March 1999, the Court of Appeal decided in C & E Commrs v Liverpool Institute for Performing Arts [2001] BVC 333 that, for the purposes of the standard method, taxable supplies did not include foreign supplies. As a result, the commissioners published Business Brief 8/1999 and on 26 April 1999 wrote to the appellant with their disputed decision. Since the disputed decision, the appellant used the standard method to attribute its residual input tax between taxable and exempt supplies under reg. 101.

However, since then it appeared that the appellant received no credit for input tax in respect of specified supplies. In the years that followed the disputed decision, discussions took place between the appellant and the commissioners in an attempt to agree a special method under reg. 102 which would also deal with specified supplies under reg. 103, but agreement could not be reached. In August 2001, the appellant suggested that the group's activities could be divided into business sectors as opposed to using the companies in the group, but the proposal was not accepted by Customs. In January 2002, the appellant proposed a revised method, which was the one argued for in the present appeal. It involved attribution of residual input tax in two steps:

Step 1-the reg. 103 calculation-Calculate the recoverable amount of residual input tax that relates in part to making specified supplies by using the fraction:

Total value of specified supplies

Total value of all supplies

Step 2-the reg. 101 calculation-Calculate the recoverable amount of residual input tax that relates in part to making taxable supplies by using the following fraction:

Total value of taxable supplies

Total value of all supplies except specified supplies

Agreement was still not reached and on 2 October 2006 the commissioners wrote to the appellant saying that they wished to make interim payments pending the outcome of this appeal and suggested an outline basis of a calculation involving allocation of residual input tax directly to ‘Life and Pensions’ and ‘Unit Trust Management Business’ sectors where it was wholly used in those sectors, and allocation of remaining residual input tax to those two sectors according to the allocation of costs within the appellant's internal cost accounting system used for its management and statutory accounts. Further allocations were included in the commissioners’ proposals. At the appeal hearing, the commissioners put forward the view that this method was more appropriate than the one suggested by the appellant which was based on values.

The appellant argued that it should be able to calculate the input tax attributable to specified supplies by reference to values as that was a fair proxy for use within the meaning of reg. 103. Because the appellant had to use the standard method for attributing input tax between taxable and exempt supplies under reg. 101, the value of (exempt) securities was used in that calculation to its detriment; it followed that values should also be capable of use in the reg. 103 calculation. The appellant submitted that the commissioners’ method did not recognise that the company had a unitary business model and that the insurance element and the investment element of each insurance policy were inextricably linked. The appellant cited art. 17 and art. 19 of Directive 77/388, the sixth VAT directive, relied on in National Provident Institution [2005] BVC 2,398.

The commissioners argued that a values-based method was not a good proxy for use in this case, because the use of the values of securities produced a distortive effect by implying that a substantial proportion of supplies to the appellant was used in making supplies of securities when in fact a relatively small proportion of such supplies was used for this purpose. The commissioners had suggested a method of sectorisation based on customer-facing activities, the costs of which were directly related to the sale of the policy. It may be the case that the sale of a policy and the sale of securities might be linked in the sense that one would not have happened without the other but they remained distinct transactions. When a customer purchased a policy, he received a supply of insurance and investment services. In the commissioners’ view, there was no sufficient link between the sale of a policy and some future disposal of the securities purchased with the premium money. The commissioners further argued that the use of values did not create distortion in the standard method calculation because there was such a large amount of exempt supplies and such a small amount of taxable inputs that the result would always be a rounding up to one per cent of recoverable input tax. They believed that the potential distortion in reg. 103 was much greater.

Having considered various authorities, the tribunal turned its mind to the question of whether the commissioners’ 2006 method more closely identified the use to which the appellant's inputs were put. It noted that sectorisation had advantages in some cases but, in this case, it decided that the appellant operated a unitary business; the making and management of investments, including the regular sale and re-purchase of securities, was an integral part of the whole supply of long-term insurance cover including life policies and pensions business. The tribunal also noted that the commissioners’ method continued to use values, albeit'ring-fenced values’, which indicated that the use of values could have advantages. However, a disadvantage of the commissioners’ method was that, within the Life and Pensions sector, the residual input tax, not otherwise allocated, was allocated on the basis of the costs of expenditure whether or not subject to tax and this did not adequately address the wider question of the allocation of the indirect overheads. A major disadvantage of the commissioners’ method was that it combined the attribution of residual input tax between taxable, exempt and specified supplies in one calculation and this was not approved by the House of Lords in C & E Commrs v Liverpool Institute for Performing Arts [2001] BVC 333. On the other hand, a major advantage of the appellant's method is that it did comply with the judgment in Liverpool Institute for Performing Arts because there were separate calculations under reg. 101 and 103. It also accorded with the spirit and purpose of the sixth directive which indicated that values could be a good proxy for use for the purpose of attributing input tax between taxable, exempt and specified supplies. The method also had the merit of simplicity; it was reasonable for the appellant to operate, did not involve disproportionate or unreasonable resources and was capable of being checked by the commissioners without unreasonable effort.

The tribunal allowed the company's appeal.

1. The method chosen by the appellant attributing its residual inputs to specified supplies was a rationally fair method that corresponded with the use of those inputs.
2. The attribution of input tax to specified supplies under reg. 103 could, in this case, be made by reference to the proportion which the value of specified supplies bore to the value of total supplies.
3. The company's appeal was allowed.