20674

Value Added Tax – Input tax – Company making both taxable and exempt transactions – Company selling cars and car-related products and finance and financial products – Whether standard method secured fair and reasonable attribution – Whether standard method override applied – Value Added Tax Regulations 1995 SI 1995/2918 regs 101,102,
Value Added Tax – Input tax – Value Added Tax Regulations 1995 SI  1995/2518, regs 106 and 107 – Whether capable of application

LONDON TRIBUNAL CENTRE

	CAMDEN MOTORS (HOLDINGS) LTD	           Appellant

-	and –

	THE COMMISSIONERS FOR HER MAJESTY’S REVENUE & CUSTOMS 	 Respondents

				Tribunal:	MISS J C GORT (Chairman)
						MR CYRIL R SHAW FCA

Sitting in public in London on 29,30 31 January and 1 February 2008

Mr Andrew Hitchmough and Jonathan Bremner of counsel, instructed by PriceWaterhouseCoopers, for the Appellant

Mr David Manknell of counsel, instructed by the solicitor’s officer, for the Respondents

© CROWN COPYRIGHT 2008

DECISION

1.	This is an appeal against a decision by the Commissioners for HM Revenue and Customs (“the Commissioners”) notified to the Appellant in a letter dated 15 November 2005, to raise a VAT Notice of Assessment on the ground that the Appellant, Camden Motors (Holdings) Ltd (“Camden”) had attributed an excessive proportion of its input tax to use in making taxable supplies.  The decision was followed by the issue of an assessment dated 5 December 2005 in the sum of £903,944 plus interest in respect of tax years ending 31 March 2003 and 31 March 2004.  Following an internal reconsideration the decision was confirmed by a letter dated 10 May 2006.  

2.	At the outset of the appeal hearing the Commissioners withdrew the assessment for the tax year ending 31 March 2003 which was in the sum of £465,585.  Assessments were raised subsequent to the Notice of Appeal in respect of the year ending 31 March 2004 in respect of the years ending 31 March 2005 and 31 March 2006.  At the outset of the hearing a notice of appeal was issued in respect of those two assessments and, by agreement between the parties, the Tribunal directed that those appeals should be considered with this appeal. The basis for the appeal against those two subsequent years is the same as that for the appeal against the assessment in respect of tax year ending 31 March 2004.  There was no objection on behalf of the Commissioners to the Tribunal looking at the facts for the earlier period and then using those facts to decide the outcome in respect of the two later years.

3.	The grounds of appeal in the Notice of Appeal are as follows:

1.	The Respondents have erred in fact and law in deciding that the standard method does not result in a fair and reasonable attribution of input tax in respect of the Appellant’s business.  In particular, in determining the “use” to which the Appellant’s inputs are to be attributed, the Respondents have adopted a methodology which is wholly alien to the system of VAT.

2.	The Respondents have incorrectly interpreted Regulation 107B; which only applies where an attribution has been made under Regulation 107(1)(a), and does not apply where a taxpayer is “de minimis” under Regulation 106.

4.	The issue for the Tribunal is therefore whether the standard method does represent a fair and reasonable proxy of Value Added Tax-bearing overheads, and whether on the facts of this case it is appropriate to apply the override as in Regulation 107B of the Value Added Tax Regulations 2005 (see below), and, further, whether Regulation 107 is capable of application in the present circumstances (see preliminary point below).

The legislation

5.	The EC Council Directive 77/388 provides:

	Article 17

	Origin and scope of the right to deduct

1.	The right to deduct shall arise at the time when the deductible tax becomes chargeable.  

2.	Insofar as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:

(a)	value added tax due or paid within the territory of the country in respect of goods and services supplied or to be supplied to him by another taxable person;
…

5.	As regards goods and services to be used by a taxable person both for transactions covered by paragraph 2 and 3 in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions.

	This proportion shall be determined in accordance with Article 19, for all the 	transactions carried out by the taxable person.  

	…

Article 19

Calculation of the deductible proportion

1.	The proportion deductible under the first sub-paragraph of Article 17(5) shall be made up of a fraction having:

–	as numerator, the total amount, exclusive of value added tax, of turnover per year attributable to transactions in respect of which value added tax is deductible under Article 17(2) and (3),
–	as denominator, the total amount, exclusive of value added tax, of turnover per year attributable to transactions included in the numerator and to transactions in respect of which value added tax is not deductible.  The Member States may also include in the denominator the amount of subsidies, other than those specified in Article 11A(1)(a).

The proportion shall be determined on an annual basis, fixed as a percentage and rounded up to a figure not exceeding the next unit.

2.	By way of derogation from the provisions of paragraph 1, there shall be excluded from the calculation of the deductible proportion, amounts of turnover attributable to the supplies of capital goods used by the taxable person for the purposes of his business.  …

3.	The provisional proportion for a year shall be that calculated on the basis of the preceding year’s transaction. In the absence of any such transactions to refer to, or where they were insignificant in amounts, the deductible proportion shall be estimated provisionally, under supervision of the tax authorities, by the taxable person from his own forecasts.  However, Member States may retain their current rules.

Deductions made on the basis of such provisional proportion shall be adjusted when the final proportion is fixed during the next year.

	(Article 19 above is now Article 174 of the re-cast directive.)

6.	The Value Added Tax Act 1994 provides at section 26, where material, as follows:

(1)	The amount of input tax for which a taxable person is entitled to credit at the end of any period shall be so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below.  

(2)	The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business; - 

(a)	taxable supplies;
	…

7.	The standard method for deduction of input tax is contained in Regulation 101 of the Value Added Tax Regulations 2005 (“the Regulations”) which, at the relevant time, provided:

Attribution of input tax to taxable supplies

101 (1)	  Subject to Regulation 102 [and 103B], the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.

(2)       In respect of each prescribed accounting period –

(a)	goods imported or acquired by and, … goods or services supplied to, the taxable person in the period shall be identified, 
(b)	there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies, 
(c)	no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies, and
(d)	there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies as bears the same ratio to the total of such input tax of the value of taxable supplies made by him bears to the value of all supplies made by him in the period.

(3)	In calculating the proportion under paragraph (2)(b) above, there shall be excluded – 

(a)	any sum receivable by the taxable person in respect of any supply of capital goods used by him for the purposes of his business, 
(b)	any sum receivable by the taxable person in respect of any of the following descriptions of supplies made by him, where such supplies are incidental to one or more of his business activities – 

(i)	any supply which falls within Item 1 of Group 5, or 	Item 1 of Group 6, of Schedule 8 of the Act, 
(ii)	any grant which falls within Item 1 of Group 1 of 	Schedule 9 to the Act,
(iii)	any grant which falls within paragraph (a) of Item 1 of 	Group 1 of Schedule 9 to the Act, 
(iv)	any grant which would fall within Item 1 of Group 1 of 	Schedule 9 to the Act but for an election having effect 	under paragraph 2 of Schedule 10 to the Act, and 
(v)	any supply which falls within Group 5 of Schedule 9 to 	the Act …
…

(4)	The ratio calculated for the purpose of paragraph (2)(d) above shall be expressed as a percentage and, if that percentage is not a whole number, it shall be rounded up to the next whole number.  (The last five words were later deleted and the words ‘as specified in paragraph (5) below’ were added.)

(5)	The percentage shall be rounded up – 

(a)	where in any prescribed accounting period or longer period which is applied the amount of input tax which is available for attribution under paragraph 2(d) above prior to any such attribution being made does not amount to more than £400,000 per month on average, to the next whole number, and
(b)	in any other case, to two decimal places.
…

8.	The percentage of residual input tax which can be reclaimed is calculated as follows:

Claimable percentage =  value of taxable supplies in the period (excluding VAT)  x 100
			value of all supplies in the period (excluding VAT)

If the resulting percentage is not a whole number, it should be rounded up to the next whole number. In respect of VAT periods beginning on or after 1 April 2005 it should be rounded up to two decimal places.

9.	The standard method laid down in paragraph 101(2)(d) above may be overridden where the conditions of Regulation 107B are met.  

10.	Regulation 107(1) provides:

Where a taxable person to whom a longer period is applicable has provisionally attributed an amount of input tax to taxable supplies in accordance with a method, and where all his exempt input tax in that longer period cannot be treated as attributable to taxable supplies under Regulation 106, and save as the Commissioners may dispense with the following requirement to adjust, he shall – 

(a)	determine for the longer period the amount of input tax which is attributable to taxable supplies according to the method used in the prescribed accounting periods,
(b)	ascertain whether there has been, overall, an over-deduction or an under-deduction of input tax, having regard to the above-mentioned determination and to the sum of the amounts of input tax, if any, which were deducted in the returns for the prescribed accounting periods, and
(c)	include any such amount of over-deduction or under-deduction in a return for the first prescribed accounting period next following the longer period, except where the Commissioners allow another return to be used for this purpose.
…

Regulation 107A

(1)	This regulation applies where a taxable person has made an attribution under regulation 101(2)(b) and (d) and the prescribed accounting period does not form part of a longer period, and the attribution differs substantially from one which represents the extent to which the goods or services are used by him or are to be used by him, or a successor of his, in making taxable supplies.

(2)	Where this regulation applies, the taxable person shall calculate the difference and account for it on the return for the first prescribed accounting period next following the prescribed accounting period referred to in paragraph (1) above, except where the Commissioners allow another return to be used for this purpose.

(3)	But where a registered person has his registration cancelled at or before the end of the prescribed accounting period referred to in paragraph (1) above, he shall account for any adjustment under this regulation on his final return.

(Regulations 107A to 107E were inserted by the VAT (Amendment) Regulations), SI 2002/1074)

Reg 107B

(1)	This regulation applies where a taxable person has made an attribution under regulation 107(1)(a) according to the method specified in regulation 101 and that attribution differs substantially from one which represents the extent to which the goods or services are used by him or are to be used by him, or a successor of his, in making taxable supplies.

(2)	Where this regulation applies the taxable person shall – 

(a)	calculate the difference, and
(b)	in addition to any amount required to be included under regulation 107(1)(c), account for the amount so calculated on the return for the first prescribed accounting period next following the longer period, except where the Commissioners allow another return to be used for this purpose.

Reg 107C

For the purposes of regulations 107A and 107B, a difference is substantial if it exceeds – 

(a)	£50,000; or
(b)	50% of the amount of input tax falling to be apportioned under regulation 101(2)(d) within the prescribed accounting period referred to in regulation 107A(1), or longer period, as the case may be, but is not less than £25,000.

Reg 107E

(1)	Regulations 107A and 107B shall not apply where the amount of input tax falling to be apportioned under regulation 101(2)(d) within the prescribed accounting period referred to in regulation 107A(1), or longer period, as the case may be, does not exceed – 

(a)	in the case of a person who is a group undertaking in relation to one or more other undertakings (other than undertakings which are treated under sections 43A to 43C of the Act as members of the same group as the person), £25,000 per annum, adjusted in proportion for a period that is not 12 months; or
(b)	in the case of any other person, £50,000 per annum, adjusted in proportion for a period that is not 12 months.

(2)	For the purposes of paragraph (1) above, “undertaking” and “group undertaking” have the same meaning as in section 259 of the Companies Act 1985.

11.	Regulation 106(1) provides (so far as is relevant for present purposes) that:

“… where relevant input tax 

… 
(b)	in the case of a longer period, taken together with the amount of any adjustment in respect of that period under Regulation 107B – 

(i)	does not amount to more than £625 per month on average, and
(ii)	does  not exceed one half of all his input tax for the period 	concerned, 

all such input tax in that period shall be treated as attributable to taxable supplies.”

“Relevant input tax”, for these purposes, is defined as input tax attributed under the standard method to exempt supplies (Regulation 106(3)).  

12.	The application of the standard method by Camden results in a new attribution of input tax to exempt supplies, and it was agreed by the parties that the de minimis limits prescribed by Regulation 106 are satisfied by Camden.  The question is whether the standard method itself properly reflects use.

Preliminary point

13.	It was submitted by Mr Hitchmough on behalf of Camden that the result of Camden satisfying the de minimis limits prescribed by Regulation 106 is that all of the input tax in the longer period applicable to it shall be treated as attributable to taxable supplies, and it therefore followed that Regulation 107(1)(a), and therefore the standard method override, is incapable of application.  

14.	Whilst Mr Manknell on behalf of the Commissioners agreed that there was a circularity in the Regulations, in the Statement of Case it is argued that:

“As is clear from Regulation 106(1), read with Regulations 107(1)(a) and 107B, a taxable person to whom a longer period is applicable can only come within the de minimis exception provided for by Regulation 101(1) if he comes within the £625 per month limit taking account of any adjustment under Regulation 107B.”

At the hearing he submitted that the Regulations must have a meaning despite the ostensible circularity and it was possible to read them to make sense in the following way:  Regulation 106 must be applied in the light of any relevant override calculation, were it otherwise the reference in Regulation 106(1) to Regulation 107B would be deprived of any effect.  The Tribunal was obliged to prefer this reading which did not lead to the absurdity which Camden’s construction led to.

15.	Mr Hitchmough further submitted that a reference to Regulation 107B is incorporated into Regulation 106 in order to extend the scope (and benefit) of Regulation 106 to traders who would not otherwise comply with the prescribed de minimis limits, but are able to do so as a result of applying an override calculation.  In this way the legislation recognises that an override calculation can work in favour of a taxpayer, as well as the Crown, and such a construction accorded with the plain wording of the legislation.  With regard to Mr Manknell’s construction, he submitted that it was quite clear from the reference in Regulation 107B to the requirement for an attribution under Regulation 107(1)(a) that the override does not (and cannot have been intended to) apply to those traders (such as Camden) who are “de minimis” as a matter of general principle.

16.	We will return to this issue later, it being necessary to find the relevant facts before properly considering it.  

The background

17.	Camden’s principal business activity is the sale of new and used cars.  At all material times it made both fleet sales, as well as sales to retail customers (via dealerships, car supermarkets and similar outlets).  In each of the years 2003, 2004, 2005 and 2006, the Appellant’s fleet activities contributed over 60% (around £800m per annum) of Camden’s total turnover. Camden’s fleet activities generate exclusively standard rated income.

18.	Camden is a private limited company.  It is the representative member of a VAT Group.  Other members of the VAT Group at 1 April 2002 comprised:

(i)	Camden Motors Ltd 
(ii)	Charles H Allen Ltd
(iii)	Daventry Shopfitters Ltd

Group members added between 1 April 2002 and 31 March 2004 are:

(iv)	TMGL (1) Ltd (27.06.03)
(v)	Camden Renault/Nissan Ltd (01.01.04)
(vi)	Allen Ford (UK) Ltd (01.01.04)
(vii)	CarShop Ltd (01.01.04)
(viii)	Camden Corporate Fleet Services Ltd (01.01.04)

19.	Camden’s retail business comprises:

(1)	The sale of new and used vehicles.
(2)	The servicing and repair of vehicles.
(3)	The sale of spare parts.
(4)	The sale of other “add-ons” for vehicles.
(5)	Acting as agent in the sale of finance and insurance products on behalf of third party suppliers.

Activities 1 to 4 generate standard rated income for Camden.  When Camden acts as an agent in the sale of financial and insurance products the commission income it earns from such sales is exempt.  

20.	In the period covered by the initial appeal the exempt commission income represented less than 1% of Camden’s turnover, and no directly attributable input tax was identified by Camden in relation to its exempt agency activity.  Accordingly, Camden rounded the amount of input tax that it was entitled to recover under the standard method up to 100% in accordance with Regulation 101(4) of the Regulations.  

21.	Following meetings and lengthy correspondence over some seven months in 2005 the Commissioners determined that, for the longer periods 06/03 and 06/04, Camden was obliged to apply the standard method override.  (The decision in relation to the period 06/03 was later not pursued by the Commissioners.)  The Commissioners performed their own override calculation for those periods and based the assessment which is the subject matter of the first appeal, and, depending on the decision of the Tribunal in relation to that appeal, which is for the period 06/04, a similar process will be applied by the Commissioners to the periods the subject matter of the subsequent appeal.

The facts

22.	The Tribunal was provided with agreed bundles of documents and we heard evidence from Mr David Hammond, director of Camden, and from Mr Jimmy Smith, a VAT officer, on behalf of the Commissioners.  Mr Hammond was not only a director of Camden, but also of all the other companies within the Camden group of companies (“the Group”).  Between 2003 and November 2005 reorganisation took place and in January 2004 the various operating businesses were transferred into separate limited companies.  The reorganisation does not affect the point at issue in this case. 

23.	During the relevant periods the Group employed approximately 1,460 staff.  Of these approximately 564 were employed in administration in each of the dealerships or were head office staff and directors.  Some 164 were employed in Camden Corporate Fleet Services Ltd  (“CCFS”), including 12 salesmen and two business managers. There was 260 salesmen who worked in the franchised dealerships and the CarShop. Some 47 business managers were employed in the franchised dealerships and the CarShop. Of these people, the business managers, about half the salesmen, and most of the staff involved in administration and at the head office were principally employed in respect of the exempt activities.  Only the business managers had the authority to sell financial and insurance products to customers.  They also sold standard rated extended warranties and it was their job if possible to convert a potential car buyer into an actual car buyer by showing him various financial opportunities.  A very large proportion of the time spent by the head office staff was concerned with negotiating and dealing with the banks and insurance companies.

24.	The car salesmen would when negotiating a sale introduce the customer to the possibility of securing finance, but the negotiations themselves were completed by the business managers.  Some of the business managers would sell cars directly to customers. The business managers were individually regulated by the Financial Services Authority, and had to be specialists.  Each business manager had to report to somebody higher up.  All customers had to be seen by a business manager, even those who had expressed no wish to purchase finance.  This was in order that the manager might explore the possibilities of selling add-on products such as an extended warranty or insurance cover and it was also the business manager’s job to process the car sale.  The sale of warranties was not treated as exempt, the rest of the products with which he dealt were exempt.

25.	The head office staff were principally concerned with negotiations with the Capital Bank and First National motor finance, the two main providers for the CarShop and Camden Retail.  Ford Credit and Barclaycard were the main providers for Allen Ford.  The agreements with these companies set out the base rates at which the lender agreed to provide finance, together with other terms and conditions.  The Group senior management also negotiated the terms and the rate of commission.  For example, the Capital Bank agreement provides that it shall pay to Camden £75,000 as a contribution to Camden’s marketing costs.  Commission is either on a standard or a scale basis, depending on the age of the vehicle.  Camden sells a car to a customer at a rate it itself decides, the bank having set a maximum rate, and Camden then takes 100% of the difference.  A volume bonus is paid on each transaction, which depends on the amount of the loan, although not all loans qualify.  A volume bonus is also paid on the total quantity of vehicles sold.  This commission bonus is a consequence of the work of the senior management in conducting negotiations with the lenders, not the business managers.  A commission is also paid in respect of the insurance products sold, and with Capital Bank the agreement is that the commission is 45% of the gross premium, net of insurance premium tax. The agreement with Capital Bank was a three year agreement, the agreements with other banks were negotiated annually. All agreements have to be signed off by key board members.

26.	Whilst all the business managers have their own offices, cars and computers it was Mr Hammond’s opinion that the primary cost involved in the exempt aspect of the business was the labour cost; any involvement the salesmen had in selling finance was only at a basic level.  Some 35% to 45% of all customers bought some type of finance.  The staff generally had company cars, including some of the head office staff.  

27.	The Group was divided into various divisions according to the franchised car dealerships.  Each franchise operated from various locations.  The principal franchises were with Vauxhall, Ford and Renault.  Each franchised dealership sold new vehicles of a particular single manufacturer, along with a number of its used vehicles.  The manufacturers laid down strict conditions under which the dealership could operate, which included obligations in terms of branding, advertising, internet sites, minimum vehicle stock requirements and minimum standards at the premises.  In general all the vehicles on a franchised site are owned by the Group.  These will include new vehicles, demonstrator vehicles and used stock.  There is an obligation on the Group to stock a certain number of demonstrator and display vehicles per site.  

28.	Each dealership imposed different conditions, and required significant investment in terms of premises, stock maintenance and staffing.  In addition there has to be a facility for servicing the vehicles and fitting them out.  If a dealership did not meet the manufacturer’s standards, there would be a reduction in the level of incentive payments received from that manufacturer, and hence in the profitability of that dealership.  Camden had to meet the cost of acquiring and/or developing a new site, and also of upgrading those sites as the manufacturers changed their requirements.  

29.	The principal divisions of the Group are Allen Ford, which deals primarily with Ford franchises, Camden Retail, which operates primarily Renault and Nissan franchises, Camden Corporate Fleet Services, which also operates Vauxhall franchises and the CarShop which sells used cars from a number of sites.  These are not franchises.  Of the 16 Allen Ford sites, 11 were capable of generating exempt income.  Of the 6 Camden Retail sites 4 were able to generate exempt income.  The service and repair customers and the fleet activities did not generate any exempt income.  Of the 4 CarShop sites, 3 generated exempt income.  In 2004 Camden generated £11,393,000 worth of exempt income.  Of this around 55% to 60% came from vehicle sales from the franchised dealerships, and 40% to 45% from vehicle sales from the CarShop.  Of this total the scale finance commission and commission from sale of credit amounted to £6,109,000 in 2004.  The volume bonuses and extra commissions generated £3,752,000 of income, and insurance and vehicle replacement insurance commission amounted to £1,532,000.  The scale commissions are directly attributable to the business managers’ work, whereas the volume bonuses and some of the extra commissions, depend on the negotiations at head office.  The level of competition in the retail finance market place is such that Capital Bank paid Camden £8m in advance commissions at the commencement of the agreement.  In addition to the primary lenders, there are also second and occasionally third string lenders, who may only be offered the opportunity to lend after the first and second string have declined.  

30.	The different car manufacturers operate differently in terms of when title to the vehicles passes and payment is required.  With Renault Camden places an order and when it receives these cars orders it is obliged to pay for them and title passes to it.  Thus the cars are purchased at Camden’s risk.  In addition Camden is obliged to hold a certain number of cars in its showroom and a number of demonstrators. Whilst the Renault display cars held in Camden’s showrooms, are, in accordance with its agreement with Renault, owned by Renault, Camden is in fact obliged to purchase those cars  With Fords, the cars are invoiced to Camden as soon as they leave the factory, and Camden is obliged to pre-order a certain quota of cars and it is invoiced when those cars leave the factory.  For the first 100 days thereafter, if the cars are not registered there is no penalty, but after that Camden has to pay Fords for the cars.  This means that Camden is always left with some unsold cars.  

31.	The CarShop buys a large number of cars on sale or return, buying cars which have been used as part of a fleet.  Whilst Camden has the right of rejection, commercially it tries to reject as few as possible.  There is a quick turnover in the CarShop, but there is not always a right of return.  The benefit of a quick turnover is that Camden does not have a lot of money invested in car stock, but it does have the cost of preparing the car for sale.  Realistically it is not in a position to return most of the cars.  In respect of the franchise dealerships the cars in the showroom are owned by the manufacturer, but Camden ultimately has to buy and sell all of those cars.  Whilst Vauxhall see Camden as an agent in the selling of its vehicles, it was not as a matter of fact possible to return any of the Vauxhall cars once they had been received by Camden.

32.	The commission on the sale of cars was about the same as that on finance.  In 2004 56% of all vehicles (new, used and wholesale) sold by Camden were fleet vehicles.  Because the fleet sales did not require so many people, a similar proportion of costs could not be attributed to fleet sales.  However the fleet activities did contribute over 60% (around £800m per annum) of Camden’s total turnover.  It was not Camden’s case that, although less than 60% of the total costs went to fleet, the fleet activities should be disregarded for the purposes of  this appeal.

33.	A large proportion of Camden’s overhead expenditure is in respect of advertising.  In 2004 about £5½ m was spent on advertising, of which over £3½m was in respect of newspaper or trade magazine advertisements, nearly £500,000 represented point of sale and direct mailings and £400,000 was in respect of radio advertising.  The majority of its advertisements are focused on the vehicles which Camden sells, in particular through the CarShop which generates a significant proportion of Camden’s commission income. Some advertisements are placed to promote a particular finance offer, for example where a manufacturer offers 0% finance.  In such circumstances Camden will not receive any exempt income where a new car is involved.  If the dealership promotion is for used cars, a subsidy payment has to be made by that dealership to the finance company, although volume bonuses are still earned.  It is possible for an advertisement promoting finance to generate no or even a negative commission for Camden, and usually generates little commission income. Although a majority of the advertisements we saw made some reference to finance, it was evident that even those advertisements were aimed principally at selling cars.

34.	The issue of whether the override should be applied first arose in January 2005 when Jimmy Smith, who is a Partial Exemption  Sector Leader in the Anti Avoidance and Partial Exemption Group of HMRC, contacted the national business manager for Camden to request a meeting in order to confirm that the partial exemption method being used was fair and reasonable.  There followed a meeting at Camden in March 2005 followed by a further meeting on 17 May at which David Hammond, who had not been at the March meeting, was present.  Mr Smith was concerned about the fairness of the standard method calculation in Camden’s case and outlined his concerns in a letter dated 19 May 2005.  By that letter he requested copies of Camden’s management accounts. At that time Grant Thornton were Camden’s advisers, and in his letter of 19 May Mr Smith had asked Grant Thornton for a breakdown of (1) how the income was recorded and costs allocated within the registration, particularly in the dealerships and between the various activities undertaken there, and (2) how central costs were allocated between the various profit-generating areas.  Grant Thornton replied by a letter dated 8 June 2005 in which they referred to the fact that a VAT officer, Andrew Madden of the Oxford large business group, had on 16 September 2004 confirmed that the group was de minimis for the tax years ending 2001 and 2003. They also informed Mr Smith that the partial exemption method and the allocation of input tax had been reviewed only nine months previously and nothing materially had changed within the business since that date.  It had been established during Mr Madden’s review that for the tax year ending 2002 the difference in the residual input tax was £31,004.  Grant Thornton confirmed that nothing materially had changed within the business since Mr Madden’s review.  

35.	Because the possible need to apply the override had not been considered in relation to Camden previously, Mr Smith thought it appropriate to do so.  There was further correspondence between Mr Smith and Grant Thornton in which Grant Thornton provided certain details of Camden’s business and supplied certain calculations. This correspondence is not relied on by Camden. Mr Smith subsequently wrote that he intended issuing an assessment applying the standard method override adjustment. However, in August 2005 PriceWaterhouseCoopers took over from Grant Thornton and therefore the issuing of the assessment was delayed.  PriceWaterhouseCoopers informed Mr Smith inter alia that the taxpayer was reliant on the guidance issued by HMRC in Information Sheet 4/02.  That Information Sheet, which was issued consequent to the announcement of the introduction of the override in the Budget of 17 April 2002, explained how the standard method override affected businesses using the standard method to determine the VAT they can deduct.  It states inter alia that very few businesses will be affected by the changes and that the standard method over-ride is targeted primarily at aggressive VAT avoidance by large businesses that used the standard method to deduct exempt input tax.  It states: “Other than avoidance, very few businesses will be required to make an adjustment, and those that are would be as likely to benefit as to lose.”  Under paragraph 5 which is headed ‘in what circumstances will the override apply?’ it states as follows:-

“The override will only apply where the standard method fails to provide a fair and reasonable deduction of input tax given the extent to which purchases are used, or are to be used, to make taxable supplies.  

The standard method fails where purchases are:

•	incurred in one tax year but used in a different tax year in which the proportion of deductible VAT is very different; or
•	not used in proportion to the value of taxable and exempt supplies made.

Examples of where the standard method breaks down and the override may apply are:

•	…
•	exceptionally high value transactions are undertaken which do not consume input to an extent significantly greater than transactions of lower value;
•	the pattern of business is such that inputs are simply not consumed in proportion to the value of output.

All tax avoidance schemes which exploit the standard method to deduct more input tax than relates to taxable supplies are likely to trigger the override but very few other cases will.”

The override applied to input tax incurred on or after 18 April 2002.  

36.	Grant Thornton had attempted in their correspondence to run a parallel special method calculation to show that the standard method was fair and reasonable in Camden’s case.  Those calculations had been criticised by Mr Smith on various bases.  The approach of PriceWaterhouseCoopers was that it was not appropriate even to try to carry out such a calculation. A common sense business decision had to be made that simply required Camden to determine what it actually cost to carry out the additional business which, although substantial in value, was not a primary activity of the business.  

37.	In a letter dated 1 September 2005 Mr Smith informed PriceWaterhouseCoopers inter alia that traders on the standard method with over £50,000 of non-attributable input tax must consider whether a use-based calculation varied from the standard method substantially. He intended issuing an assessment based on the standard method not reflecting use. In his opinion the standard method assumed that use of non-attributable inputs varied with income. It followed that the  standard method suggested that a £40,000 new car sold by a dealer used four times as much non-attributable inputs (overheads) as a £10,000 new car.  It also suggested that a £5,000 old car uses twice the amount of non-attributable inputs as an older model of the same car sold for £2,500. It further suggested that the £40,000 new car uses sixteen times the non-attributable input tax of the £2,500 used one. Mr Smith suggested that prima facie, any car sale uses fairly similar non-attributable inputs, and it therefore followed that the standard method did not reflect use. This was because cars are high value transactions where the non-attributable costs are a small fraction of the sales price.  The non-attributable costs are not significantly greater for a higher value transaction than a lower value transaction. The relationship between the price and the use of non-attributable costs varied considerably. Mr Smith asked himself whether the standard method and override calculation completed by Camden substantially differed from a use-based calculation. If it did, then he was obliged to make an assessment using a calculation that did reflect use. That assessment would be valid as long as (a) an override adjustment should have been made and (b) the method used provided a fair and reasonable reflection of use.  

38.	Further correspondence ensued between Mr Smith and PriceWaterhouseCoopers and a meeting took place in September 2005.  Subsequently Camden was advised not to provide Mr Smith with copies of their management accounts. After consultation with the partial exemption policy team, Mr Smith issued an assessment for periods 06/03 and 06/04 on 5 December 2005 in the sum of £903,944. On 3 February 2006 PriceWaterhouseCoopers sent him a set of management accounts for the year ending 31 December 2004, and, in analysing the accounts Mr Smith considered that they confirmed his opinion that the override should have been applied and his calculation reflected use.

39.	In his initial analysis Mr Smith noted that Camden’s accounts for 2002 showed that exempt income was around £10.7m, whereas the overall pre-tax profit was only around £5.8m.  He took account of the fact that Camden used the standard method for partial exemption and that they had made no restriction of input tax as they considered themselves de minimis, that is the input tax on goods and services used wholly and partly to make exempt supplies was less than £7,500 a year. This was compared to the total non-attributable input tax of around £3m. Mr Smith was concerned that a partial exemption method which suggested that there were practically no costs used in a part of the business which generated over £10m of income might not be accurately reflecting the actual use of those costs.  Given that Camden’s overall pre-tax profit was around £5.7m, this suggested to Mr Smith that the taxable activities of selling new cars, selling used cars, the selling of parts and servicing of vehicles were together making a large loss, which was not realistic, and the standard method calculation was not attributing costs in a realistic way. He originally performed the standard method calculation relying on the post-tax profit figure which affected his calculation, but not his conclusion. Using the correct figures he concluded that if the standard method calculation correctly allocated costs, the taxable activities lost money for Camden.

40.	In Camden’s case Mr Smith considered that the selling price of a car reflected the cost of buying the car, overheads incurred in selling the car and a profit margin.  The majority of the selling price reflected the cost of buying it and only a small fraction of the selling price reflected the non-attributable costs which are apportioned in a partial exemption calculation. He contrasted this with the fee received for arranging finance which only reflected the overheads and a profit margin. He therefore considered the two prices did not compare on a like for like basis, the price of finance having no capital element. He therefore considered that the standard method calculation did not give a result that was fair and reasonable. As the non-attributable input tax was greater than £50,000, he concluded that Camden should, under the terms of the standard method override, have calculated the input tax that would be recoverable using a use-based partial exemption calculation.  Mr Smith then completed a use-based calculation using the information available to him.  

41.	At the time Mr Smith made his assessment, he did not have the management accounts. He had the suggested method calculations submitted by Grant Thornton (which Camden disavowed) and a summary of the sales and cost of sales for 2002, 2003 and 2004.  He used the financial information he had available in ascertaining use.  He considered that because of the distorting effect of the capital cost of the car, the inputs were not consumed in proportion to the outputs.  He therefore removed the capital element of the cost of the cars from the sales value of the cars in order to provide a similar relationship to that between the cost of the commission and its value.  Having amended the standard method calculation in that way to reflect use, and as the difference between input tax recovery under the standard method calculation and a use-base calculation was greater than £50,000, he decided to issue an assessment.  

42.	Mr Smith’s original assessment was calculated using the figures provided by Grant Thornton for the year 2003.  In his calculations he removed the capital element of the price of cars from the standard method calculation which he considered provided a fair and reasonable proxy for use.  This gave a revised taxable income of £65,864,000.  The exempt income was £10,783,070, so he calculated a use based recovery by dividing £65,864,000 by £65,864,000 plus £10,783,070 which gave a percentage of 85.94%.  He applied this percentage to the non-attributable input tax for 2003 and arrived at an amount of £488,330 that a use-based method would attribute to exempt supplies. He did a similar calculation for 2004, again based on Grant Thornton’s figures with some adjustments. He did not have a breakdown for the operating income total which was the source of the exempt income figure, so he was unable to recalculate the standard method for 2004.  He therefore applied the same taxable percentage as in 2003 which gave a figure of  £438,359 as the exempt element of the £3,113,335.  

43.	Mr Smith subsequently recalculated the assessment for 2003 because he had initially failed to take account of the fact that the standard method override had only been brought into effect from 18 April 2002, but the revised figures are irrelevant as the assessment for that year is no longer being pursued by the Commissioners.

44.	Further to the receipt of the management accounts for the year ending 31 December 2004 Mr Smith made further calculations.  He initially allocated costs in accordance with the standard method calculation treating the new and used car sectors as the only ones with exempt activities.  He allowed full recovery of input tax in the remaining seven sectors. The central overheads incurred by Camden in the management accounts totalled £24,053,509, the new and used car sectors brought in 91.25% of the income, accordingly he allocated 91.25% of the central costs, £21,948,089, to them.  He then undertook an analysis of the combined new and used car sectors looking at the taxable and exempt activities.  The non-attributable costs he again allocated in the same manner as the standard method.  He concluded that the standard method calculation allocated costs in a way which suggested Camden was selling cars for over £6,000,000 less than it cost to buy and sell them.  He did not consider that a calculation that suggested that the cost components of selling cars exceeded their selling price by such a large margin was credible.  He was therefore satisfied that the standard method was not fair and reasonable.  

45.	Mr Smith then did a second analysis allocating costs using an amended standard method calculation similar to that used for the assessment, the difference being that, rather than apportioning all non-attributable costs by a single fraction, he used the accounts to allocate the costs to either car sales or after sales.  He treated the after sales costs as fully attributable to taxable supplies. The car sales costs he apportioned using an income-based calculation and in calculating the taxable car sales income figures he removed the capital element within the car sales values.  Doing this and applying an income-based apportionment suggested new and used car sectors should receive 69.65%, or £16,433,184 of the £24,053,509 central overheads.  There were £28,318,880 of overheads allocated directly to the new and used car sectors.  Mr Smith’s analysis suggested that of these £52,372,389, £8,160,663 related to exempt activities.  This represented an apportionment of 84.42% taxable and 15.58% exempt.  The assessment had been raised on the basis of 85.94% taxable and 14.06% exempt.  Mr Smith did not amend the assessment as a consequence of this further analysis, not considering the difference substantial.

46.	At the hearing of the appeal Camden produced a revised version of a table which Mr Smith had included at paragraph 46 of his witness statement, having removed certain salary costs. Camden’s workings resulted in the total net profit (before salary costs) of £13,241,911, rather than the £2,215,808 that Mr Smith had arrived at.  The net profit of the taxable activities, before salary costs, was £4,468,669 rather than a loss of £6,332,346.  The net profit for the exempt activities before salary costs was £8,773,242, rather than a profit of £8,548,154.  Mr Smith had attributed only £456,000 of the business managers’ salary costs to exempt activity, and £2,044,000 of those costs was attributed to taxable activities.  

47.	In the course of the hearing Mr Smith had recognised that his allocation of £59,000,000 of costs to the taxable side of the business was too high and revised that figure to £56.973m.  He acknowledged that the standard method was concerned only with VAT bearing costs, and assumed that all costs were used in the same way and in his initial calculations he had made the assumption that the salary costs burdened the taxable and the exempt side of the business in the same way as the VAT bearing costs.  At the time he made the assessment Camden had given him no information as to how the salary costs were treated.  In the course of the hearing Mr Smith produced three hand-written and confusing pages which showed his revised figures taking account of the salaries of salesmen, management and clerical staff and other staff, derived from the management accounts subsequently supplied to him.  He also used figures provided by Mr Hammond in his witness statement.  Mr Smith did not alter his conclusion that the standard method was flawed because the result obtained from his standard method calculations did not reflect the reality of the business.  He did not accept that it was wrong to apply the standard method calculations to the salary costs, considering that he had to ask whether the standard method produced a reasonable result for all costs, and that, even using his calculations produced at the hearing excluding certain of the staff costs, he still concluded that the tax-bearing side of the business made a loss.    

The Respondents’ case

48.	The starting point for the Commissioners was to consider whether the attribution made according to the standard method differed substantially from one which represented the extent to which the goods or services were used by Camden or were to be used by it in making taxable supplies. Based on figures supplied by Camden, the Commissioners took the view that the attribution made according to the standard method did differ substantially from one based on a “use-based” calculation as required by Regulation 107B.  It was submitted that a substantial difference arises in this case because the trading pattern of Camden involved an unusual juxtaposition of very high value/very low margin car sales with high margin commissions with practically no direct costs.  This put Camden in the small subset of standard method users where the standard method does not fairly represent the extent to which the goods and services are used.  

49.	Because only limited calculations which it was maintained were use-based were submitted to the Commissioners by Grant Thornton on behalf of Camden, and because there was no clarification of those calculations despite requests from the Commissioners, the Commissioners had had to make an assessment as to the attribution that should have been made under Regulation 107B based on their own use-based calculation. This calculation was made on the basis that it was the capital, direct cost element included in the price of cars caused a distortion, therefore removal of that element would achieve a fair result.  

50.	The Commissioners took the view that the input tax recoverable under the standard method was substantially different from an attribution based on the use of goods and services, primarily because of the distorting effect of including the selling of cars which have very high direct costs and very low margins, alongside finance commissions, which have very low direct costs and very high margins, in a single calculation.  

51.	The Commissioners concluded that the input tax recoverable under the standard method was substantially different from an attribution based on the use of goods and services because:

(i)	The standard method suggested that there were practically no costs used in part of the business which generated over £10m in income.

(ii)	The standard method suggested that the exempt activity generated over £10m of profit whereas, given that Camden’s pre-tax profit was around £5.7m, this suggested that the taxable activities of selling new cars, selling used cars and servicing were together massively loss-making, which was considered to be unrealistic.

(iii)	The selling price of a car reflects the cost of buying the car, overheads incurred in selling the car and a margin.  The vast majority of the selling price reflects the cost of buying it.  Only a small fraction of the selling price reflects the non-attributable costs which are apportioned in a partial exemption calculation. By contrast the fee received for arranging finance only reflects the overheads and a profit margin.  The price of a car with capital, overhead and profit element does not therefore compare on a like for like basis with the price of the finance which have no capital element.

52.	The Commissioners’ primary submission is that Camden was obliged to consider the use of the 107B override, that the standard method produces a result that differs substantially from use, that the method adopted by the Commissioners clearly produces an attribution which substantially better represents the extent to which the goods or services are used by Camden, and Camden has proposed no other valid methodology.  

53.	In the Commissioners’ calculations over 85% of the cost of overheads was ascribed to the making of taxable supplies. In relation to advertising, the Commissioners referred the Tribunal to the case of Dial-a-Phone Ltd v Customs and Excise Commissioners [2004] STC 987.  The sole issue in the case was (as per paragraph 2, Jonathan Parker LJ):

“… whether (as DaP contends) the supply of marketing and advertising services to DaP is attributable, for the purposes of reg.101(2), exclusively to taxable supplies made by DaP; or whether (as the Commissioners contend and as the tribunal found) the supply of marketing and advertising services is attributable to both taxable and exempt supplies made by DaP.”

54.	The original decision of the tribunal in that case that the supply of such services was attributable to both taxable and exempt services made by the company was upheld both by the High Court and subsequently by the Court of Appeal.  The Court of Appeal emphasised (paragraph 74 and 75):

“74. 	… it is important to bear in mind that (as the Advocate General observed in Abbey National …) a ‘direct and immediate link’ may exist between the marketing and advertising costs and insurance intermediary services despite the fact that there may be an even closer link between those costs and DaP’s taxable supplies.  In other words the quest is not for the closest link, but for a sufficient link.

“75.	It follows that it matters not that the insurance intermediary services may be viewed as being in a commercial sense secondary to the making of the taxable supplies, or even that they may be provided only after a taxable supply has been made, provided that a sufficient ‘direct and immediate link’ exists between them and the marketing and advertising costs.”

55.	It was submitted that in the present case there was a direct and immediate link between the advertising and the supply of finance as any advertising which referred only to cars in its text was plainly designed to attract customers who potentially bought both cars and finance from Camden.

56.	The use of costs implied by the recovery generated by the standard method would have the taxable supplies made at a loss, which was not the case.  It was the Commissioners’ contention that all activities of Camden make a positive contribution to overhead costs and that both taxable and exempt supplies are profitable.  However, this conclusion does not result if the standard method is applied which supports the Commissioners’ contention that the attribution made according to the standard method differs substantially from that which represents the extent to which the goods are used by Camden.

57.	In respect of Camden’s argument that it was not a principal in the supply of finance, but an agent on behalf of the finance company, and that the finance company incurred all the attributable costs, and bore all of the risks and rewards of the capital element of the financial supplies, and the commission is a very profitable area of Camden’s business as it consumes only a very small amount of Camden’s overall costs to secure, the Commissioners submitted that this was to misapply the principal/agent relationship. Camden were agents between the finance house and the customer, and were acting as principals when they provided the service to the finance providers.  Whilst Camden’s overheads were not used to build cars, they were partly used to sell cars built by someone else and partly to arrange for finance provided by someone else. Effectively to include all the car manufacturers’ costs in Camden’s calculations but not the finance providers’ costs, meant that the calculation was not comparing like with like. To be consistent, the costs of the finance provider and the manufacturer should be included, or the costs of neither should be.

58.	It was the Commissioners’ position that volume bonuses in finance were similar to the manufacturer’s bonuses received for reaching the required volume sales of cars, and in both cases the income was in respect of the respective supplies of selling cars and selling finance.  Although the car bonus and the finance bonus  payments are not negotiated by the salesmen, they nevertheless are consideration for the work done by them.  On the Commissioners’ analysis, it did not matter how the finance commission arose. 

59.	As a matter of fact the Commissioners’ calculations did attribute the overwhelming majority of Camden’s overhead costs to their main activity of selling cars.  The standard method and the Commissioners’ alternative only applied to residual input tax.  The Commissioners’ method attributes 99.7% of Camden’s taxpaying costs to taxable supplies and only 0.3% to the exempt supplies. Less than 15% of the residual input tax is attributed to generating exempt commissions.

60.	It was submitted by Mr Manknell that it was not a relevant consideration for the Tribunal whether the method favoured by the Commissioners produced the best representation of the extent to which the goods or services are used by Camden.  There will be a range of calculations that could be said to be fair and reasonable and all that is required of the Commissioners when a taxpayer has made no calculations of their own is to be within that range. In the present case no alternative, use-based calculations had been put forward by Camden.  The situation in the present case is that the attribution made according to the standard method differs substantially from one which represents the extent to which the goods or services are used by Camden, and removing the capital element included in the price of cars produced a better, and fairer representation of the extent to which the goods or services are used by Camden.

The Appellant’s case

61.	On behalf of Camden the principal arguments were that Camden was entitled to determine the amount of input tax it recovers by using the standard method and it was not under an obligation to recalculate its entitlement to recover input tax in accordance with Regulation 107B because:

(i)	On its true construction, Regulation 107B does not apply to a “de minimis” trader falling within Regulation 106.  

(ii)	The “trigger conditions” prescribed by Regulation 107B are not satisfied in this case: i.e. the application of the standard method does not produce an attribution of inputs to taxable supplies which differs substantially from one which represents the extent to which those inputs are used by Camden in making its taxable supplies.

(iii)	Camden is therefore entitled to recover input tax in accordance with a straightforward application of the standard method.

62.	Camden’s approach was that the override only applies if the attribution produced by the standard method differs substantially from one which represents the extent to which inputs are “used” in making taxable supplies.  Accordingly, in order to determine whether the override applies, one must first identify some alternative to the standard method which more accurately reflects the way in which inputs are actually “used” in the business.

63.	It was submitted by Mr Hitchmough that “use” should be applied in the way referred to in the judgment of Warren J in St Helens School Northwood Ltd v HMRC [2007] STC 633.  At paragraph 76 he said:

“… the ‘use’ referred to in Reg 101( as elsewhere) is not physical use but some special VAT use.  It is, I think, the same as what [counsel for the Commissioners] terms ‘economic use’.”

64.	It was Camden’s case that because of the nature of its business it was far more costly to generate £1 of taxable income then it was to generate £1 of exempt income, a fact which was ignored by the Commissioners but which, on a strict application, worked to the Commissioners’ advantage. Any deficiency caused by the fact that the standard method does not allocate enough to the cost of supplying a car, which is expensive to make, is cured by the rounding mechanism. In excluding the capital value of the cars, the Commissioners had failed to appreciate the importance of the fact that Camden sells cars and car-related services as a principal, but is not a principal in the supply of finance to customers, where it is an agent of the relevant finance company.  Camden incurs all the costs and bears all the risks (and rewards) in supplying cars and car-related services.  By contrast, in relation to the sale of finance and insurance, it is the finance and insurance companies themselves that incur all the costs and bear all the risks (and rewards) associated with the transaction.  Officer Smith had sought to defend his view by reference to the fact that Camden is a principal for VAT purposes when it makes supplies of intermediary services relating to finance companies.  Whilst this is true, it is irrelevant.  That Camden is a principal for VAT purposes in this regard does not alter the fact that much of the cost burden relating to the finance is borne by the finance company itself.  The Commissioners’ approach, in failing to recognise the agent/principal distinction, ignored economic reality, and the clear guidance which emerges from the case of St Helens (supra) where at paragraph 79 Warren J said that:  

“In terms of VAT, the provision of an exempt supply of education was the principal use of a sports complex and the taxable supply of the licence to SHEL of a secondary use.  

“80.	Any method of allocation between the exempt and taxable supplies made by the School must, in my judgment, reflect that use.  Given the approach of Etherton J in Banbury Visionplus Ltd v Revenue and Customs Commissioners [2006] STC 1568, the question for me are whether the standard method and the School’s proposed special method each produce a fair and reasonable attribution and if so whether the School’s method is more fair and reasonable than the standard method.  In my judgment, the standard method, whatever its shortcomings, does produce a fair and reasonable apportionment which does reflect the economic use which is made by the School of the sports complex.  Further without saying that the School’s proposed special method is not a fair and reasonable method, the standard method produces, in my judgment, an allocation which is more fair and reasonable than the School’s proposed special method.

…

83.	For the same reason as I have given in deciding that the School’s proposal of the special method is not to be preferred to the standard method, I do not consider that the standard method, whatever its shortcomings, can be said to produce a result which differs substantially from the one which represents the extent of the School’s economic use as a sports complex in granting the licence.  Certainly, the way in which the School seeks to calculate that difference does not, in my judgment, represent a proper calculation of any such difference and is to be rejected.”

65.	The commercial reality of Camden’s case was ignored by the Commissioners.  If Camden decided to stop selling finance, it would have a negligible impact on its VAT bearing overheads, the impact would be on the turnover.  The primary cost in generating the exempt income was the labour cost which was not VAT bearing.  The consequence of the Commissioners’ approach would be that no loss-bearing business would be able to recover its input tax.  The Commissioners’ approach was also criticised for its equating the ability to recover VAT with profit, whereas VAT is a tax on turnover, not on profit, other than in exceptional cases where the tax is applied by reference to the margin.  When Camden bought a car it paid VAT on the full cost, it reimbursed the manufacturer for the full cost of the manufacture, it did not pay VAT on the margin. 

66.	The Commissioners had wrongly assumed that the personnel costs (which they had taken from the 2002 account) of £20m were used by the business in the same way as the other costs.  In fact the personnel costs burdened the exempt business more than the taxable business because more time was taken by the personnel talking about finance than in selling cars.  Because the personnel costs were not VAT bearing, they should not be taken into account.  The Commissioners had introduced a concept which was alien to the standard method to discredit the result produced by the standard method.  The Commissioners’ key assumption that the costs were used to add value in proportion to the value added was wrong.  Mr Smith had concluded that, because using the standard method as he had showed a loss, this was confirmation that the standard method broke down, which was not the case.  The reality was that the exempt business was more burdened with the personnel costs and if that exercise is properly done then the Commissioners whole premise is shown to be wrong.  

67.	With regard to whether the standard method accorded with the principal of use, it was Camden’s case that it did.  The Commissioners had taken 85.94% as relating to taxable expenditure and the remainder to the exempt part.  Instead of relating it to the total turnover, they had applied it to the gross margin.  The effect of this was to attribute far too much of Camden’s VAT bearing expenditure to the exempt part of the business.  The effect of factoring in expenditure on personnel was that the exempt activity went into the red whereas in reality it was a very lucrative side of the business.  This effect is not arrived at if the standard method is applied using the turnover and not the margin as the basis.    

68.	It was accepted on behalf of Camden that the sale of a £40,000 car did not use more inputs than the sale of a £20,000 car, but equally the arrangement of £40,000 worth of finance did not use more inputs than arranging £20,000 finance. Mr Hammond’s evidence had been that the ‘physicality’ involved in supplying the exempt activity was a negligible part of the total.  If Camden were unable to supply finance, that would not change the physicality (i.e. the cost) of running the business.  The Commissioners had assumed that all the costs should be allocated on the standard method basis, then put to each sector and fully absorbed, which was not how the business was run.  It was in fact impossible to allocate the costs specifically.  There was a degree of uncertainty as to how the staff spent their time, therefore it was unsafe to bring them into any calculation and it was wrong to allocate the cost arbitrarily.  Because of this uncertainty, it was wrong to say that the staff costs followed the VAT costs.  On the further calculations produced by Mr Smith it was assumed that 98.77% of salary costs burdened the taxable business, a proposition with which Mr Hammond had disagreed.  The sale of finance involved the higher paid employees and therefore Mr Smith’s approach did not reflect reality.  Mr Smith had said that you would have to allocate £4.2m to make the taxable business break even, but this was irrelevant.  Given the salary costs of £20m in 2002, an allocation of 25% of the salary bill to the exempt activity was not excessive and was more than sufficient to remove the loss.

69.	It was Camden’s case that the standard method did not produce an attribution of input tax to taxable supplies which differed substantially from an attribution which represented the extent to which Camden used the inputs in making taxable supplies.

Decision

Preliminary point

70.	We accept Mr Hitchmough’s argument that the override in Regulation 107 VATA is only in point where a trader has made an attribution under regulation 107(1)(a), which itself depends upon the trader having incurred input tax which cannot be treated as attributable to taxable supplies under regulation 106.  ‘Relevant input tax’ is defined in regulation 106(3) as input tax attributed under the standard method to exempt supplies.  Since the application of the standard method by Camden results in a nil attribution of input tax to exempt supplies, the de minimis limits prescribed by regulation 106 are satisfied by Camden.  The result is that all of the input tax in the longer period applicable to Camden “shall be treated as attributable to taxable supplies” (regulation 106(1)) and therefore regulation 107(1)(a), and hence the standard method override, is incapable of application.  

71.	In our judgment regulation 107B only applies where there is an attribution under regulation 107(1)(a), and regulation 107(1)(a) only applies if regulation 106 does not apply in the first place, which we find to be the case.  There is no requirement for Camden to make an annual adjustment under regulation 107(1)(a).  To answer Mr Manknell’s question as to when regulation 106(1)(b) could ever apply, we again accept Mr Hitchmough’s argument that a trader whose relevant input tax exceeds the de minimis limit in regulation 106 is a trader who is required to make an annual adjustment under regulation 107(1)(a) and in that case the trigger condition for regulation 107B is satisfied.  This ensures that regulation 106 can apply to a trader who only satisfies the de minimis limit because of an annual adjustment.

72.	From the above it follows that we do not accept the Commissioners’ argument that it was necessary to decide whether an adjustment had to be made under regulation 107 before deciding whether a taxpayer is over the de minimis limit.  Mr Manknell had accepted that there was an ostensible and unavoidable circularity in that regulation 107 is on its face subject to regulation 106 which sets de minimis limits in relation to input tax ‘taken together with the amount of any adjustment in respect of that period under regulation 107B’.  On this basis Regulation 106 thus requires consideration of whether a regulation 107B adjustment applies.  On the other hand, regulation 107B states that it applies where an attribution has been made under regulation 107(1)(a), whereas regulation 107(1)(a), in turn states that an adjustment shall be made where the exempt input tax cannot be ignored under the de minimis limits in regulation 106.  We do not accept Mr Manknell’s solution which was that one must make the annual calculation under regulation 107 first (without making a conclusive attribution), then see whether the resulting figure is below the regulation 106 de minimis level, which in turn requires prior examination of whether the regulation 107B override needs to apply.  He submitted that ‘attribution’ in regulation 107B should be understood as hypothetical, not actual, and that this required no distortion of the words used and resulted in the only logical reading of the regulations that is possible if they were to have any meaning.  The Commissioners accepted that both Camden’s and its readings were possible, but submitted that its own was to be preferred because Camden’s reading led to absurdity and would prevent the Commissioners from stemming abuse, which was the purpose of the regulations.  We do not accept that this is the case.  We do not consider it consistent with the principle of statutory interpretation to ascribe a hypothetical meaning not an actual one to a word used in a statute as suggested and we consider the whole argument to be unnecessarily complicated; Camden’s simpler solution is to be preferred.  Furthermore the trigger for the application of regulation 107B is regulation 107(1)(a), which deliberately restricts its use.  Regulation 107A specifically refers to a situation where a taxpayer does not have a longer period applying.  Regulation 106 is applicable where a trader is not on the face of it de minimis (and we note that a trader is entitled to arrange his affairs so that he is) which leads to regulation 107(1)(a).  If that applies, then the trigger condition in regulation 107B is satisfied so that the override must be considered.  If a taxpayer is de minimis when the adjustment in regulation 107 is taken into account, then the taxpayer is entitled to benefit.  There is in our judgment a statutory purpose, albeit a restricted one, and we therefore find that the application of the statutory override provided for by regulation 107B is not applicable in this case and for that reason alone this appeal is allowed.

73.	However, if we are wrong in our conclusions as to the above point, then it is incumbent upon us to set out our reasoning in respect of the substantive appeal which we now do.  The principal issue is whether the standard method in Camden’s case does produce a fair and reasonable apportionment which reflects Camden’s economic use.  Does the standard method differ substantially from one which represents the extent to which the goods or services were used by Camden, or were to be used by it, in making taxable supplies?  Does Camden use more overheads to generate £1 of the exempt income than to generate £1 of standard rated income?  The Commissioners arrived at the conclusion that it does having taken the decision to exclude the capital cost of the cars and also, initially, to include the wages’ cost.   Applying the standard method on this basis, the Commissioners’ figures show that the car-dealing business is apparently making a loss, whereas the exempt, financial side of the business is making a significant profit.  Since this would not appear to reflect the reality of the situation, the Commissioners concluded that the standard method does not reflect use.

74.	In our judgment the Commissioners are wrong to discount the capital cost of the cars: in Camden’s hands the cars are stock-in-trade and are properly to be taken into account applying the standard method.  It is the sale of cars which is the economic driver of Camden’s business.  In its car-dealing Camden incurs all the costs and bears all the rewards, which is not the case in relation to its sale of finance.  We do not accept the Commissioners’ argument that Camden is acting in the same way when selling cars as it is when selling financial products.  Camden is, although by differing contractual terms imposed by the different manufacturers, obliged to buy the cars it sells through its showrooms.  It does not incur capital costs in relation to its sale of finance.  Whilst it is the case that both the car manufacturers and the finance providers incurred capital costs which Camden does not, in relation to the cost of the cars any deficiency caused by the fact that the standard method does not allocate enough to the cost of supplying a car, which is expensive to make, is cured by the rounding mechanism.  

75.	It is evident that a far greater infrastructure is needed to sell and service the car than is required for the sale of the financial product.  There is a contractual obligation on Camden that it should provide an attractive showroom, as well as space for matters such as pre-delivery inspection and a body shop, all of which incur running cost.  A far higher proportion of Camden’s costs are expended in respect of the car sales than in the sale of finance, notwithstanding that the business managers are provided with offices, cars, computers etc.  Whilst the showroom is also used to facilitate the sale of finance, it cannot reasonably be said that the expenditure in respect of it is used more extensively for the sale of finance than for the sale of cars.  The effect on Camden’s overheads would not be very considerable if it decided to stop selling finance, its wages bill, which is not VAT bearing, would still be its most significant expense.  It is a fact that only 35% to 45% of Camden’s customers buy finance, and the primary cost of the exempt business is labour.  It is also the case that Camden’s income derived from the sale of finance represents less than 1% of its turnover.

76.	We do not consider it appropriate for the Commissioners to include non VAT-bearing costs such as labour costs.  The effect of their doing so was to distort the picture, given that the major cost of providing finance is represented by the salaries of the staff involved at head office and the business managers, and such salaries are higher than those paid to the salesmen and others connected with the car side of the business; these costs are not VAT-bearing.  It was accepted by Camden that, if the method adopted by the Commissioners is applied, the result produced by it does differ substantially from that produced by a straightforward application of the standard method.  We do not accept that the Commissioners’ method is an accurate reflection of the way in which the inputs in question are used by it for the purpose of making taxable supplies in the course of its business.  Not only does it ignore the central feature of the Appellant’s business which is selling cars, and fails to take account of the fact that it is more expensive for Camden to earn taxable income than exempt income, it also placed reliance on the relevant profitability of Camden’s taxable and exempt activities which is contrary to basic principles of VAT.  VAT is a tax on turnover, not on profit.

77.	We do not understand why the Commissioners stressed the relative profitability of the two areas of Camden’s business.  It is not a necessary precondition of recovering input tax that a taxpayer makes a profit, or at least breaks even, on the taxable transactions for which he uses the relevant inputs.  By Article 17(2) of the Sixth Directive taxable persons are to attribute VAT on overheads (like other inputs) in accordance with how they are used, not how they are paid for.  A taxable person may recover input tax on inputs he uses to make taxable supplies even if the ultimate commercial result is that the taxable person makes a loss, or, indeed where his intended taxable supply is frustrated (see Belgium v Ghent Co Terminal NV (Case C-37/95) [1998] STC 260).  Arriving at the conclusion that the standard method shows that the Appellant’s car and car-related (taxable) activities are loss-making, the Commissioners failed to exclude from the exempt activities the salaries of the business managers who are the only employees able to sell finance, and which are overwhelmingly attributable to the exempt side of Camden’s business.  It was in fact accepted by the Commissioners that the exempt side of the business is very lucrative to Camden and indeed that was one reason why the Commissioners concluded that the standard method did not reflect use.  Whilst it is open to the Commissioners to look at the effect on profit of applying the standard method to see if it is a good proxy for use, it was the failure of the Commissioners properly to apply the standard method that caused  the distortion.

78.	This business is not run on the basis that the relative costs are fully absorbed into each sector.  This is evident from the management accounts.  We do not consider it possible to allocate specific costs to the specific areas in the way the Commissioners suggest should be done.  The advertising costs are a case in point.  Whilst it is clear that a proportion of the money spent on advertising is for the benefit of the exempt side of the business, it is not possible to identify specifically what proportion of the cost should be so attributed.  The evidence shows that in many cases where advertisements do have a specific reference to finance, Camden takes no, or very little, commission in such cases.  Its only effect is on the amount of volume bonus.  Just as it is not possible specifically to allocate the advertising costs, it is equally difficult properly to allocate the staff time, which renders it unsafe to bring staff costs into any calculation, even assuming it is correct to do so; it would not be correct to allocate their time arbitrarily.  In the additional sheets produced by Mr Smith he had assumed that 98.7% of the salary costs burdened the taxable business.  This is simply not the case on the evidence.  The sale of finance involved the higher paid employees and therefore this method does not reflect reality.  Finally, with regard to the Commissioners attempting to exclude the capital value of the cars because they distort the figures, it might be expected that there would be a specific statutory provision to deal with this, which is not the case.  This is a fundamental and important principle which could have been included in regulation 101(3) but it is not.  

79.	We do consider that in this case the standard method does give a fair result, and for this and for all the above reasons we allow this appeal and award Camden its costs.  Those costs to be agreed between the parties, or in the failure of agreement, to be referred back to this Tribunal.

MISS J C GORT
CHAIRMAN

RELEASED: 21 May 2008

LON 2006/0579
LON 2008/0235