VAT: Entitlement to deduct
Jan Garioch CA discusses a recent case involving a dispute between HMRC and a company over VAT recovery on legal fees relating to the defence of civil proceedings brought against a sole director.
Praesto Consulting Limited v HMRC concerns input VAT deduction regarding legal fees relating to the defence of civil proceedings brought against that company’s sole director, Mr Ranson. Initially, he was employed by Customer Systems plc (CSP), an IT consultancy. He subsequently resigned in order to become sole director of Praesto Consulting UK Ltd (Praesto), which was a competitor to CSP and employed three others who had also resigned as CSP employees.
CSP issued proceedings against Mr Ranson but not Praesto. It contended that Mr Ranson breached terms of employment in setting up Praesto to compete with CSP and claimed damages.
The High Court trial
In 2011, the case went to trial at the High Court. It is pertinent to the subsequent VAT case that at the outset of the trial the judge raised the issue of CSP’s hope of making a claim on Praesto’s profits in light of the fact that Praesto was not a party. CSP's counsel stated that in the event that it was found that Mr Ranson owed a fiduciary duty and was in breach of that duty then CSP was likely to seek to join Praesto in relation to the claim. The result of the case was that initially the High Court held against Mr Ranson, but his appeal was allowed at the Court of Appeal.
The VAT issues arose when Sintons, solicitors who acted for Mr Ranson and Praesto, issued nine invoices and Praesto reclaimed the VAT involved. The first invoice, which covered costs up to the point that proceedings commenced, was not disputed by HMRC. However, they raised an assessment for the input tax credit of £79,932 claimed for the remaining eight invoices which had all been addressed to Mr Ranson.
That assessment was appealed to the First Tier Tribunal which considered two questions:
- Do the invoices relate to services provided by Sintons to Praesto?
- If so, do the services have a direct and immediate link to Praesto’s taxable activities? It answered yes to both.
On question 1 it reasoned that CSP would have sought to join Praesto as a party if it succeeded in showing Mr Rankin breached a fiduciary duty. On question 2 it reasoned that Praesto had a direct interest in the appeal being dismissed to avoid it having to account for its profits made in competition to CSP.
The legal rollercoaster continued when HMRC appealed to the Upper Tribunal. It allowed HMRC’s appeal. Its reasoning was that FTT had made an error in approach by failing to find if Praesto was contractually entitled to legal services provided by Sintons. Moreover, even if the services were provided to Praesto, they were not used by it for the purposes of its business.
A majority verdict
The legal battle rolled on further when permission was given to appeal the Upper Tribunal decision to the Court of Appeal. In March 2019, by a majority verdict, it overturned the Upper Tribunal judgement. The majority judgement was that Sintons made supplies to Praesto on the following reasoning; Mr Ranson instructed throughout on behalf of himself and Praesto, Sintons acted on behalf of both, all work done was on behalf of both and both were jointly liable for the fee.
As a matter of economic reality, there were good reasons for the FTT to consider that throughout Praesto was a main target of the litigation. There was also a majority judgement that the services supplied by Sintons had a direct and immediate link to Praesto’s taxable activities. The consequence of finding a liability on the part of Mr Ranson would have produced a real risk that consequential proceedings brought against the company would severely impact the company's taxable activities or put it out of business.
Entitlement to VAT credit
For those who enjoy the game of predicting the outcome on cases before reading the full judgement, no doubt some will have anticipated the judgement would go the other way. Therefore, it is of interest that there was a dissenting view. The view of Sir Terence Etherton was that entitlement to VAT credit depended upon three things.
Firstly, there must be a direct and immediate link between an input transaction and one or more output transactions, or secondly, they must be part of general costs and have a direct and immediate link with the economic activity as a whole. Thirdly the direct and immediate link must be established objectively as set out by the ECJ in Finanzamt Koln-Nord v Becker EU:C:2013:99 (C-104/12).
Praesto did not contend that there was any direct link between the supply of services in the invoices addressed to Mr Ranson and one or more particular output transactions of Praesto. Nor could Sir Terence be satisfied that, objectively, there was a direct and immediate link between the supply of the solicitor services and Praesto's economic activity as a whole.
There would have been such a direct and immediate link if Praesto itself had been sued, but that did not happen. The fact that the board of directors of Praesto may have thought subjectively that it would be generally in Praesto's best future economic interests if the claim against Mr Ranson failed did not satisfy the condition of an objective direct and immediate link. Therefore, Sir Terence would have dismissed the appeal.