VAT - Entitlement to recover
Jan Garioch CA discusses a recent case, HMRC v Frank A Smart & Son Ltd, which saw the Supreme Court delve into the jurisprudence of the ECJ to find the answer.
There can be no doubt that the judges at the Supreme Court enjoyed hearing the case of HMRC v Frank A Smart & Son Ltd. Their judgement, released on 29 July 2019, smacks of legal brains relishing forensic analysis of the law. The mood music was just right because they were able to praise the representatives for both appellant and respondent for skilful and succinct submission of the arguments. Following this propitious start, they concluded that the answer to the dispute lay in analysis of the jurisprudence of the ECJ in relevant cases. Therefore, their fun continued as they revisited old ‘chart topper’ cases from the ECJ.
VAT on single farm payment entitlements
The question raised with them was whether Frank A Smart Ltd (FASL), a company carrying on a farming business in Aberdeenshire, could reclaim the VAT incurred on purchasing Single Farm Payment Entitlements (SFPEs) to access agricultural subsidies which between 2005 and 2014 were paid to farmers who had eligible land at their disposal and who met the requirement of maintaining it in good agricultural and environmental condition.
HMRC said there should be no recovery because the receipt of SFPs is a non-economic activity and outside the scope of VAT. The acquisition of the SFPEs has a direct and immediate link between that expenditure and the receipt of the SFPs and was not a general overhead of FASL. HMRC said the FTT, Upper Tribunal and Inner House were all wrong in taking into account the consideration that the funds generated by SFPs were to fund the development of FASL’s taxable supplies in future.
The taxpayer’s view
FASL said that under the principle of neutrality a fully taxable trader (which they are) has the right to recover all input VAT incurred in raising finance for their business, so long as the finance raised is spent on funding the business which goes on to make more taxable supplies, and so long as the financing exercise remains outside the scope of VAT. FASL recognised that in future it might have an obligation to repay a portion of any deduction if it ultimately used funds on activities that were not taxable.
The Supreme Court’s review of relevant case law
The Supreme Court boiled this down to one central question: whether the receipt of SFPs prevented FASL from deducting the VAT paid on purchase of the entitlements to SFPs. Their path to an answer took them through a beauty parade of ECJ judgements.
They started with the BLP case, where a management company sold shares in a subsidiary and sought to recover VAT on professional services relating to the sale. The ECJ denied this, but it was noted that judgement related only to the use of services on an exempt transaction, not an outside the scope transaction.
Next stop was Midland Bank. The nugget extracted from this was that entitlement to deduct, once arisen, is retained even if the economic activity envisaged does not give rise to taxed transactions. Also, a taxable person who carries out both taxable and non-taxable transactions can deduct the entirety of input VAT only if it could objectively show the expenditure was a cost component of the taxable output transaction.
The Abbey National case, and the Advocate General’s opinion, was scrutinised because (like FASL) it involved a claim to deduct input VAT incurred on a transaction which was outside the scope of VAT. The AG opined that it was inherent that an exempt transaction broke the chain between a supply and the taxable person’s taxable activities whereas a transaction outside the scope of VAT does not break that chain. Although the ECJ did not find a direct and immediate link between professional services and one or more taxable outputs in this case, they did find the costs at issue in the case were part of Abbey National overheads and as such were cost components of the products of the business.
The Supreme Court shoved the Kretztechnik case under their magnifying glass and again saw a share issue being outside the scope of VAT, with the ECJ supporting the right to deduct the VAT charged on the supplies acquired in connection with the share issue. The ECJ saw the increase in capital as benefiting its economic activity in general and thus the costs form part of its overheads and are component parts of the price of its products.
By the time Skatteverket was reached, the ECJ called into question its ruling in BLP in light of developing jurisprudence. It now recognised the need to avoid discriminatory fiscal treatment by extending the reasoning in cases where share disposals are outside the scope of VAT to share disposals which are exempt. To avoid discrimination, the ECJ moves on from the bald statement that ‘breaking the chain’ prohibits recovery. Instead, it requires an examination of whether the costs of the input services are incorporated into the price of the shares sold or whether they are incorporated into the prices of the taxable person’s products downstream.
A testament to the passion for studying every relevant case comes from the fact that the University of Cambridge judgement from the ECJ was considered although it was not released until after a draft judgement for FASL had been prepared. The university wanted to reclaim VAT on management fees for a fund which holds and invests charitable donations and endowments. Income from that fund is used to finance the whole range of the University’s activities. The ECJ has held that VAT is not deductible, with the reasoning that the collection of donations and endowments is not an economic activity and thus outside the scope of VAT. Although the ECJ recognised that recovery is not precluded by the fact the costs are incurred in a non-economic activity provided they were cost components of particular transactions or overheads, they found this was not the case here. Instead, they held the university generated resources to allow the price of its goods and services to be reduced.
Suitably braced by this intent study of ECJ jurisprudence, the Supreme Court held that FASL was not prevented from deducting VAT incurred on acquiring the SFPEs provided the objective purpose of the fundraising was to develop the business of providing taxable supplies. The Court found no reason for distinguishing a fundraising which involves receipt of subsidy. The FTT found as fact that in purchasing the SFPEs, FASL was acting to support its current and planned economic activities. On that basis, it has an immediate right to deduction. On the facts found, FASL does not propose to carry out downstream and non-economic or exempt transactions so no question of apportionment arises. HMRC’s appeal was dismissed.