[2011] UKFTT 42 (TC)

								
TC00919

Appeal number:  TC/2009/14221
							      TC/2009/11692

FLAT RATE SCHEME – Relevant turnover – Exempt supplies - Bank interest – whether bank interest an exempt supply – In principle: Yes – Whether bank interest constitutes a receipt arising in the course or furtherance of any business carried on by Appellant – No – VAT Act 1994 s.26B – VAT Act 1994 Schedule 9 Group 5 Items 2 and 8

FIRST-TIER TRIBUNAL
TAX CHAMBER

	FANFIELD LIMITED 	First Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

	THEXTON TRAINING LIMITED 	Second Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS (VAT)	Respondents

				TRIBUNAL: 	 SIR STEPHEN OLIVER QC (Judge)
						 
Sitting in public in London on 1-3 November 2010

Keith Gordon, counsel, for the First Appellant 
Michael Thexton FCA CTA, director, for the Second Appellant

Jonathan Davey, counsel, instructed by the general counsel for HMRC, for the Respondents

© CROWN COPYRIGHT 2010

DECISION

1.	This decision covers two appeals.  I refer to these as (the “Fanfield Proceedings”) and (the “Thexton  Proceedings”).

2.	The Fanfield Proceedings arise out of a decision in a letter of 23 April 2009 declining Fanfield’s claim for a VAT refund in the sum of £4,553 (of which £3,710 relates to this appeal) in respect of interest earned on Fanfield’s bank accounts.  The basis for the decision was that such interest formed part of Fanfield’s relevant turnover for the purposes of applying the Flat Rate Scheme.  Fanfield’s notice of appeal dated 6 July 2009 states:

“Interest from the company’s bank accounts do not represent exempt business income and therefore do not need to be taken into account for the purposes of the fixed rate scheme.”

3.	The Thexton Proceedings arise out of an assessment to tax on 20 April 2009 in the sum of £250 together with interest.  The sum in question relates to interest earned on Thexton’s bank accounts, such interest not having been included in Thexton’s calculation of its relevant turnover for the purposes of calculating its VAT liability under the Flat Rate Scheme.  Thexton’s notice of appeal of 14 September 2009 states:

“HMRC believe that bank interests received by a small business on deposit and current accounts is consideration for an exempt supply and is therefore liable to Flat Rate Scheme VAT.  We believe that such interest is not consideration for a supply made by a small business but is incidental, non-business investment income.  It is therefore not exempt but rather outside the scope of VAT, and as such is not liable to the Flat Rate.”

The legislative provisions are contained in the Schedule to this Decision.

The Issues

4.	The two Appellants participate in the Flat Rate Scheme provided under section 28B VAT Act as amended.  Under the Flat Rate Scheme VAT liability is calculated by reference to a person’s “relevant turnover” (section 26B(1)).  A person’s relevant turnover is the total of  “(i) the value of those of his relevant supplies that are taxable supplies, together with the VAT chargeable on them, and (ii) the value of those of his relevant supplies which are exempt supplies” (section 26B(2)(c)).

The positions of the parties

5.	The Appellants’ cases, presented separately and with separate emphasis being placed on particular aspects, can be jointly summarised as follows:

•	“First, the bank interest received by both Fanfield and Thexton was outside the scope of VAT because the receipts did not arise in the course or furtherance of any business carried on by the company in question; in terms of the Principal Directive (2006/112/EC) the receipts were not consideration for the supplies of services by each of Fanfield and Thexton as “taxable persons acting as such”.  
•	Second, given that the receipts of bank interests were within the scope of VAT, they did not come within any of the definitions of “exempt” supplies in Group 5 of Schedule 9 of VAT Act 1994.
•	Third, neither of the Appellants was making any supply to its bank; instead, it was using the facilities of the relevant bank.  Consequently the receipts of interests did not amount to consideration for that Appellant’s supply.  Thexton described the payment of interest as “an incentive to customers to use the bank in preference to its competitors, similar to the reverse premium received in the case of Mirror Group Plc (Case C409/96)”.

6.	HMRC’s response is that in providing its bank with money each Appellant was making a supply in the course or furtherance of its business within section 4(1) VAT Act.  The supply in question involved the making of an advance or the granting of credit (item 2 of Group 5) as well as the operation of a current, deposit or savings account (item 8).  The supply in question was therefore exempt and its value as consisting in the interest paid by the bank constituted relevant turnover under the Flat Rate Scheme (Section 28B(2)(c)(ii)).

The facts

7.	Fanfield is a trading company.  Its business is the provision of specialist services in the field of computational electronic analysis.  Its annual turnover is in the range of £100,000 to £250,000.  It receives relatively modest sums of interests from bank accounts principally arising from money received in the course of its business or held on deposit.  The evidence of Andrea Weston shows that Fanfield retained such funds to enable it to present a better balance sheet to potential clients.  

8.	Fanfield has held a current account with its bank from which all bills are paid and into which all money is deposited.  For security reasons Fanfield has never left large sums of money in its current account.  Fanfield’s deposit account is fed from its current account and places money in the current account to meet bills when payable.  Fanfield holds fixed term deposits with its bank for periods of one month or longer.  On maturity the moneys are either transferred to the deposit account or put into another fixed term deposit.  For the period to which this appeal relates the largest part of Fanfield’s bank interest has come from fixed term deposits.

9.	These fixed term deposits are used to hold reserves to pay corporation tax (due at the end of each year).  The evidence shows that Fanfield retains a relatively large part of its balance sheet value in cash.  In the three years to 31 March 2009 “cash as percentage of balance sheet” is shown as 106%, 115% and 104% respectively.  

10.	Thexton has two shareholders and directors, Mike Thexton (a chartered accountant and a chartered tax adviser) and Kathy Thexton.  It provides training and updating to firms of accountants and others and some accountancy, tax advice and consultancy services.  The greater part of its supplies relate to the presentation of courses and written training materials.

11.	Since April 2003 Thexton has been authorised to use the Flat Rate Scheme.  It applies the Flat Rate Scheme rate for “business services that are not listed elsewhere”, which is currently at 10.5%.  

12.	Thexton has had three bank accounts.  Its current account is used to process payments to receive cheques and direct credit transfers.  Some interest accrued on the balance sheet until June 2008 when interest ceased.  Thexton continued to use its current accounts throughout and, Mr Thexton said, “we were not interested in interest income”.  Thexton has a “savings account” which holds the company’s tax reserves.  

13.	Thexton’s deposit account was operated in a passive manner.  Over a period of four years (covering the period to which this appeal relates) seven transfers were made out of that account.  Three such transfers were associated with the payment of corporation tax.  The directors took no steps to improve the interest returns by, for example, re-negotiating a better rate or changing bank accounts.  

14.	In its returns for the years to 30 November 2006, 2007 and 2008 Thexton did not include the interest earned on those accounts of respectively £700 (flat rate VAT on which would have been £77), £799 (on which flat rate tax would have been £87.84) and £782 (flat rate tax would have been £86.02).  Assessments were issued for £77, £87 and £86 respectively.  

15.	All trading receipts were deposited in the accounts; so far as funds were introduced from outside Thexton (by Mr Thexton), this was done to strengthen its balance sheet.  The interest paid on the accounts comprised just under 0.5% of the total trading receipts and 0.7% of profits before tax.  

Some general points

16.	The core businesses in the course of which the two Appellants made supplies to customers were, in the case of Fanfield, that of providing specialist engineering services for consideration and, in the case of Thexton, that of providing training and advisory services for reward.

17.	In common with virtually every business both Fanfield and Thexton have to have an arrangement with their banks to enable payments to be made (by cheques, credit cards, direct debits etc) to enable it to make its own business disbursements and to enable it to receive payments from customers. 

18.	So far as concerns the current account of each company, this is capable of giving rise to its supplies in both directions.  The bank makes a supply to the customer by providing it with all the facilities to enable the customer to make and receive payments.  The customer’s action of leaving moneys standing to its credit in return for payments of interests from the bank amounts to the customer, for reasons that I will explain below, in making a supply of services to the bank.  As I understand the positions of the current accounts of both Appellant companies, the interest receipts were small or negligible at all material times.

Can the receipt of interest on a bank account amount, in principle, to consideration for an exempt supply?

19.	I am satisfied that, when both Appellants provide the bank with money to be held on any of the three categories of account, each of them has effected an exempt supply falling within the scope of one or more of the items listed in Group 5 of Schedule 9 in return for which the bank in question has paid interest to the Appellant in question.  To the extent that that interest constitutes consideration for a supply made in the course or furtherance of the particular Appellant’s business, it is to be included as part of that Appellant’s relevant turnover for the purposes of calculating its liability to VAT under the Flat Rate Scheme.  That conclusion is well established by authority.  The relationship between account holder and bank is that of creditor and debtor, the former in effect providing the latter with a loan.  The speech of Lord Cottenham LC in Foley v Hill [1843-1860] All ER Rep 16 at 19 contains the following passage:

“Money, when paid into a bank, ceases altogether to be the money of the customer; it is then the money of the banker, who is bound to return an equivalent by paying a similar sum to that deposited with him when he is asked for it.  The money paid into the banker’s hands is money known by the customer to be placed there for the purpose of being under the control of the banker.  It is then the banker’s money; he is known to deal with it as his own; he makes what profit of it he can, which profit he retains to himself, paying back only the principal, according to the custom of bankers in some places, or the principal and a small rate of interest, according to the custom of bankers in other places.  The money placed in the custody of a banker is to all intense and purposes the money of the banker, to do with as he pleases.”

That principle remains good today.  On that basis, it seems to me, the placing of moneys on deposit amounts to either “the making of any advance or the granting of any credit” on the part of the particular appellant or the “operation of any current, deposit or savings account”.  See items 2 and 8 of Group 5.  In the words of the European Council Directive 2006/112 (“the Principal Directive”) these amount to “transactions … concerning deposit and current accounts ….”: see Article 135.1

Is the interest within the scope of VAT?

20.	The conclusion that the interest on the deposits is consideration for something that falls within the description of “exempt supply” in Schedule 9 Group 5 items 2 and 8 leads on the question of whether the interest receipts come within the Flat Rate Scheme calculations in section 26B.  For this purpose the supplies have to be “relevant supplies” of the taxable person in question, being supplies in respect of which he is liable to VAT (section 26B(1)).  The person will be “liable to VAT” when the supplies are made by him in the course or furtherance of any business carried on by him: section 4(1).  The Principal Directive defines the scope of charge to VAT as the supply for a consideration by a taxable person acting as such.  To be acting “as such” the taxable person must be carrying out an economic activity; and “economic activity” includes the exploitation by the person in question “of tangible or immovable property for the purpose of obtaining income therefrom on a continuing basis” (see Article 9.1).

21.	The Flat Rate Scheme provisions bring into the reckoning of “relevant turnover” the value of the “relevant supplies that are exempt supplies” of the taxable person: see section 26B(2)(c)(ii). For this purpose the requirement is to determine whether the interest receipts are within the scope of VAT as being business supplies, notwithstanding their exempt status.

22.	Some forms of supply, to use that word neutrality, are equally capable of being, on the one hand, supplies made in the course or furtherance of a business or by a person carrying out an economic activity as such or, on the other hand, supplies that are made outside the scope of VAT.  Some supplies are of their nature taxable supplies.  The core business of Fanfield, i.e. providing computational electronic analyses for reward, is an obvious example of a business making taxable supplies.  The same goes for the core business of Thexton.  But the supply made when a person places money with another for a period of time in return for interest is a prime example of the type of supply that is, depending on the circumstances, capable of falling on either side of the line.  That “activity” will at one end of the range be pure business as where a bank or a company with a group “treasury” function makes its mainstream profit from lending at interest.  At the other end of the range is the private individual who places and keeps cash on deposit; there could be no question of such a person carrying out an economic activity.  Between the two will be the case where cash receipts arising from a business activity are placed and kept on deposit.  Whether such receipts arose from an economic activity or were outside the scope of VAT was a question for the ECJ in Regie Douphinoise (Case C-304/94) [1996] STC 1176.  Much the same question had arisen twenty years earlier in the VAT Tribunal case of Hedges and Mercer v C&EC (1976) VAT Dec. 271.

23.	Regie’s principal business had been property agency and management for clients.  The clients funded its agency and management operations by making repayable cash advances to Regie.  The arrangement with the clients was that the moneys should be placed by Regie with financial institutions and that the interest would belong to Regie.  The interest received by Regie from those placements amounted to some 14% of its total annual receipts.  The placements giving rise to that interest, ruled the Court in paragraph 18 of the judgment, constituted the “direct, permanent and necessary extension of the taxable activity of” Regie as a property management company.  The interest in question was not to be left outside the scope of VAT; instead it was to be taken into account in determining the deductible proportion when applying its partial exemption formula.

24.	Hedges and Mercer was a four partner firm of solicitors.  It had several bank accounts, all in the firm’s name.  Some were “clients’ accounts”.  These held deposits of money that had been paid to the firm to cover the costs of performing particular legal tasks; for example, these held moneys paid on account of costs prior to the rendering of the bill to the client.  By convention and with the clients’ consent and with the approval of the Law Society the interest arising on clients’ account belongs to the firm.  The Tribunal decided that those deposits had been made in the course of carrying on its business by Hedges and Mercer, thus the interest arising from the deposits had been consideration for supplies made in the course of its business and was therefore within the scope of VAT.  Other accounts held by Hedges and Mercer had been deposit accounts held with building societies.  These accounts contained profits that had been earned by the firm in carrying on its solicitors business.  The funds were retained in these accounts because the tax liabilities of the partners were handled and discharged from within the firm.  The Tribunal records those accounts as having been used as an “ultimate and general reserve” and on rare occasions as having been drawn on to supplement cashflow deficiencies.  The Tribunal concluded that accounts of the latter type belonged to the four partners as individuals.  The making of those deposits had not therefore been supplies by Hedged and Mercer, the firm, in the course of its business.

25.	Had Fanfield and Thexton not been incorporated, the interest arising from their accounts and deposits would not have arisen in the course of furtherance of their businesses; nor would the placing of moneys such that interest was earned have amounted to the carrying out of economic activities by them.  The line drawn by the Court in Regie would have left those activities outside the scope of tax because, in contrast to the placement arrangements made with clients in that case and in Hedges and Mercer which were necessary parts of the business activities of both, the deposits made by Fanfield and Thexton were the results of decisions as to the investments of profits after they had been earned.  The activity that actually earns the interest for Fanfield and Thexton is the decision to leave the moneys on account for long enough to earn interest and that is in no sense a direct and permanent extension of those companies’ profits emphasises their status as funds withdrawn from the business.

26.	Because Fanfield and Thexton are incorporated their funds continue to belong to them and, in the case of Fanfield in particular, a deliberate decision has been taken to leave them in the company so as to present a strong balance sheet to its customers.  I do not see that feature as characterising the deposits as direct, permanent and necessary extensions of Fanfield’s business of providing computational electronic analysis services.  If anything, the moneys are left standing in the accounts of the company and earning interest so as to enhance the structure within which it carries on its business.

27.	HMRC placed reliance on a passage in the judgment of the ECJ in Empresa de Desenvolvimento Miniero SGPS SA (“EDM”) v Fazenda Publica (Case C-77/01) [2005] STC 65.  That case was concerned with financial transactions of EDM and whether receipts from those were to be brought into the reckoning in apportioning input tax between its exempt and its taxable transactions.  The range of EDF’s activities covered mineral prospecting, the selling of shares and the granting of loans to companies in which it had a financial interest.  The passage relied on by HMRC in support of its contention that the interest arising on the accounts and deposits of Fanfield and Thexton is in paragraph 69 where the Court said:

“Interest paid to an undertaking in consideration of bank deposits or placements in security such as Treasury notes of certificates of deposit likewise cannot be excluded from the scope of VAT since the interest paid does not arise from the simple ownership of the assets but constitutes the consideration for making capital available for the benefit of a third party (see, to that effect, Regie Douphinoise, paragraph 17).”

As I read it, the Court was there concerned with the different question of whether the lending activities of EDM, being one of its core activities, were economic activities.  Here by contrast the lending activities of Fanfield and Thexton are not, on any basis, parts of their core businesses.  They are satellite activities akin to the placements of funds by Regie, whose core business was property management, or the client accounts maintained by Hedges and Mercer, a firm of solicitors.  The question here is whether those satellite activities can be described as, to use the Court’s words in Regie, a direct, permanent and necessary extension of the Appellants’ business.  And, for the reasons I have given, I do not think they can.

Conclusion

28.	For those reasons I am satisfied that the interest on the bank deposits held by both companies is outside the scope of the VAT.  I am, in consequence, satisfied that the interest does not form part of the “relevant turnover” of either company for purposes of Flat Rate Scheme calculations. 

29.	I allow the appeals.

30.	This document contains full findings of fact and reasons for the decision. Any party dissatisfied with this decision has a right to apply for permission to appeal against it pursuant to Rule 39 of the Tribunal Procedure (First-tier Tribunal) (Tax Chamber) Rules 2009.   The application must be received by this Tribunal not later than 56 days after this decision is sent to that party.  The parties are referred to “Guidance to accompany a Decision from the First-tier Tribunal (Tax Chamber)” which accompanies and forms part of this decision notice.

SIR STEPHEN OLIVER QC

RELEASE DATE: 11 January 2011

THE SCHEDULE

UK Legislation

1.	The relevant statutory provisions in respect of both sets of proceedings are primarily contained in the Value Added Tax Act 1994 (“VATA 1994”).  Section 3 VATA 1994 is headed “taxable persons and registration” and provides so far as relevant:

“(1)	A person is a taxable person for the purposes of this Act while he is, or is required to be, registered under this Act.”

2.	Section 4 VATA 1994 is headed “Scope of VAT on taxable supplies” and provides:

“(1)	VAT shall be charged on any supply of goods or services made in the United Kingdom, where it is a taxable supply made by a taxable person in the course or furtherance of any business carried on by him.

(2)	A taxable supply is a supply of goods or services made in the United Kingdom other than an exempt supply.”

3.	Section 5 VATA 1994 is headed “meaning of supply: alteration by Treasury order” and provided:

“(1)	Schedule 4 shall apply for determining what is, or is to be treated as, a supply of goods or a supply of services.

(2)	Subject to any provision made by that Schedule and to Treasury orders under subsections (3) to (6) below – 

(a)	“supply” in this Act includes all forms of supply, but not anything done otherwise than for a consideration;

(b)	anything which is not a supply of goods but is done for a consideration (including, if so done, the granting, assignment or surrender of any right) is a supply of services.

…

(4)	Without prejudice to subsection (3) above, the Treasury may by order make provisions for securing, with respect to services of any description specified in the order, that where –

(a)	a person carrying on a business does anything which is not a supply of services but would, if done for a consideration, be a supply of services of a description specified in the order; and

(b)	such other conditions as may be specified in the order are satisfied,

such services are treated for the purposes of this Act as being supplied by him in the course or furtherance of that business.

4.	Section 26B VATA 1994 is headed “Flat-rate scheme” and provides so far as relevant:

“(1)	The Commissioners may by regulations make provision under which, where a taxable person so elects, the amount of his liability to VAT in respect of his relevant supplies in any prescribed accounting period shall be the appropriate percentage of his relevant turnover for that period.

A person whose liability to VAT is to any extent determined as mentioned above is referred to in this section as participating in the flat-rate scheme.

(2)	For the purposes of this section – 

(a)	a person’s “relevant supplies” are all supplies made by him except supplies made at such times or of such descriptions as may be specified in the regulations;

(b)	the “appropriate percentage” is the percentage so specified for the category of business carried on by the person in question;

(c)	a person’s “relevant turnover” is the total of – 

(i)	the value of those of his relevant supplies that are taxable supplies, together with the VAT chargeable on them, and
(ii)	the value of those of his relevant supplies that are exempt supplies.

5.	Schedule 9 VATA sets out those supplies which are exempt from VAT.  Group 5 of Schedule 9 lists, amongst others, the following items:

“1.	The issue, transferor receipt of, or any dealing with, money, any security for money or any note or order for the payment of money.

2.	The making of any advance or the granting of any credit.
…
8.	The operation of any current, deposit or savings account.”

European Legislation

6.	Article 2 of the European Council directive 2006/112 (“the Principal Directive”) provides;

“1.	The following transactions shall be subject to VAT:

…

(c)	supply of services for consideration within the territory of  Member State by a taxable person acting as such.”

7.	Article 9 of the principal Directive provides:

“1.	‘Taxable’ person shall mean any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity.

Any activity of producers, traders or persons supplying services, including mining agricultural activities and activities of the professions, shall be regarded as ‘economic activity’.  The exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis shall be regarded as an economic activity.”

8.	Article 135 of the Principal Directive provides:

“1.	Member States shall exempt the following transactions:

…

(b)	the granting and the negotiation of credit and the management of credit by the person granting it;

…

(d)	transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments, but excluding debt collection.”