Dial-A-Phone Ltd v Customs & Excise

This is an appeal by Dial-a-Phone Ltd (“DaP”) against an order made by Blackburne J on 13 December 2002 dismissing DaP’s appeal against a decision (“the Decision”) of the Value Added Tax and Duties Tribunal (Mr Rodney Huggins and Mr Kenneth Manterfield) (“the Tribunal”) promulgated on 1 March 2002. By the Decision, the Tribunal dismissed DaP’s appeal against a ruling by the Commissioners of Customs & Excise (“the Commissioners”), in a letter dated 18 January 2001, that valued added tax (“VAT”) paid by DaP on the supply by third parties to DaP of marketing and advertising services (that is so say, the ‘input tax’ in respect of such supply) was attributable, for the purposes of regulation 101(2) in Part XIV of the Value Added Tax Regulations 1995 (SI/2518) (“the Regulations”), to both taxable and exempt supplies made by DaP to its customers; and that accordingly only a proportion of such input tax was deductible against VAT charged by DaP to its customers (that is to say, against the ‘output tax’ charged by DaP). In so ruling, the Commissioners rejected DaP’s contention (repeated before the judge and in this court) that such input tax was attributable exclusively to taxable supplies made by DaP, and was accordingly deductible in full against output tax charged by DaP.

There is no issue as to the primary facts. The sole issue in the case is whether (as DaP contends) the supply of marketing and advertising services to DaP is attributable, for the purposes of regulation 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.

Permission for a second appeal was granted by Arden LJ on the papers on 15 February 2002.

In paragraph 2 of his judgment the judge summarised the undisputed facts, as found by the Tribunal, as follows:

To the above summary I add the fact that DaP’s entitlement to commission on insurance premiums received by Cornhill and to a share of Cornhill’s profit on customers introduced to it by DaP arose under the Heads of Agreement referred to in subparagraph xiii) above.

The starting-point is article 2 of EC Directive 67/227 (“the First Directive”), which provides in general terms for a deduction of input tax, as follows:

“. … On each transaction, value added tax, calculated on the price of the goods or services at the rate applicable to such goods or services, shall be chargeable after deduction of the amount of value added tax borne directly by the various cost components. ….”

Article 17 of EC Directive 77/388 (as amended) (“the Sixth Directive”) contains more detailed provisions for deduction of input tax, as follows:

“1.

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

2.

In so far 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 or 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 paragraphs 2 …., 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.”

Article 17 of the Sixth Directive was brought into effect in the United Kingdom by the Value Added Tax Act 1994 (“the 1994 Act”), the material provisions of which are as follows:

“4(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.

24(1) Subject to the following provisions of this section, “input tax”, in relation to a taxable person means the following tax, that is to say –

(a)

VAT on the supply to him of any goods or services …

being (in each case) goods or services used or to be used for the purpose of any business carried on or to be carried on by him.

(2)

Subject to the following provisions of this section, “output tax”, in relation to a taxable person means VAT on supplies which he makes …

25(1) A taxable person shall –

(a)

in respect of supplies made by him…

account for and pay VAT by reference to such periods (in this Act referred to as “prescribed accounting periods”) at such time and in such manner as may be determined by or under regulations and regulations may make different provision for different circumstances.

(2)

Subject to the provisions of this section, he is entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under section 26, and then to deduct that amount from any output tax that is due from him.

26(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 …

(3)

The Commissioners shall make regulations for securing a fair and reasonable attribution of input tax to supplies within subsection (2) above …

31(1) A supply of goods or services is an exempt supply if it is of a description for the time being specified in Schedule 9…… ”

Schedule 9 of the 1994 Act includes, in Part II, various groups of supplies. The relevant group for present purposes is ‘Group 2 – Insurance’. Item 1 under that heading includes a person permitted to carry out insurance business. Cornhill falls within that definition. Item 4 (the last item under that heading) relates to services provided by an ‘insurance intermediary’. There then follow a number of Notes, which form part of the Schedule. Note (1) defines the services provided by an insurance intermediary as (so far as material):

“…. the bringing together, with a view to the insurance or reinsurance of risks, of … persons who are or may be seeking insurance or reinsurance, and …. persons who provide insurance or reinsurance”.

It is common ground that DaP provided insurance intermediary services within that definition to Cornhill.

I should also refer to Note (7), which is relied on by Mr Rupert Anderson QC (for DaP). It provides as follows (so far as material):

“Item 4 does not include …. the supply of any … promotional or similar services”.

The Regulations were made pursuant to section 26(3) of the 1994 Act. Regulations 100 and 101 are in the following terms (so far as material):

“100 Nothing in this Part shall be construed as allowing a taxable person to deduct the whole or any part of VAT on the … acquisition by him of goods or the supply to him of goods or services where those goods or services are not used or to be used by him in making supplies in the course or furtherance of a business carried on by him.

101(1) …. 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 as the value of taxable supplies made by him bears to the value of all supplies made by him in the period….”

It is to be noted that in the Decision the Tribunal uses the expression ‘residual tax’ to refer to input tax which is not attributable exclusively either to taxable supplies or to exempt supplies, but which falls to be apportioned, pursuant to regulation 101(2)(d), to both taxable and exempt supplies. The expression ‘residual tax’ does not appear in the Regulations; it derives from Notice 706, issued by the Commissioners and containing guidance as to the operation of regulation 101.

In BLP Group plc v. Customs & Excise Commissioners (Case C – 4/94) [1995] STC 424 (“BLP”) the European Court of Justice (“the ECJ”), on a reference by the English High Court, held that the right to deduct under article 17(2) of the Sixth Directive arises only in respect of goods and services the supply of which has a ‘direct and immediate link’ with taxable transactions; and that the ‘ultimate aim’ of the taxable person is irrelevant in this respect.

In BLP, the taxpayer company (BLP) disposed of shares in a subsidiary company (an exempt transaction for VAT purposes). It sought to deduct the input tax on the cost of professional services supplied to it in connection with the disposal, on the basis that the purpose of the disposal was to raise funds to pay off debts which had arisen directly from its taxable transactions, and that the professional services should therefore be treated as having been ‘used for the purposes of [its] taxable transactions’ within the meaning of article 17(2) of the Sixth Directive.

In the course of his opinion, the Advocate-General (Lenz) said this:

“29.

According to art. 2(1) of the First Directive, the common system of VAT is based on the application to goods and services of a general tax on consumption exactly proportional to the price of the goods and services, whatever the number of transactions which take place in the production and distribution process before the stage is reached at which tax is charged. In order for the ‘number of transactions which take place in the production and distribution process before the stage at which tax is charged’ not to influence the amount of VAT ultimately due to the revenue authorities, art. 2(2) of the First Directive introduces the mechanism of deduction of input tax.

30.

A consideration of those provisions together shows that the Community legislature, proceeding from an ideal image of ‘chains of transactions’ …., intended to attach to each transaction only so much VAT liability as corresponds to the added value accruing in that transaction, so that there is to be deducted from the total amount the tax which has been occasioned by the preceding ‘link in the chain’ ….

31.

On the question whether the goods or services supplied to taxable persons, on which the input tax has been charged, can be attributed to a transaction by the taxable person in such a way that deduction of tax is justified, the Community legislature decided on a criterion corresponding to the system: the amount which is to be deducted as input tax must have been ‘borne directly by the various cost components’ (see art 2 of the First Directive).

32.

Article 17 et seq of the Sixth Directive lays down specific rules on the deduction of income tax, in so far as is relevant here, in two respects. Firstly, those articles take account of the circumstance that the Community legislature has in art. 13 et seq exempted certain transactions from VAT. Input tax in respect of exempt transactions is not deductible in the common system of VAT, because in such a case the taxable person acts as the final consumer, since he is unable to pass the VAT onto third parties (see the judgment in Becker v. Finanzamt Munster-Innenstadt (Case 8/81) [1982] ECR 53 para 44). Secondly, art. 17 et seq takes account of the fact that some goods and services are by their nature to be attributed to several transactions of the taxable person, and that attribution may relate to the group of taxable transactions and the group of exempt transactions at the same time.

33.

Those details logically do not change the fact that input tax can be deducted only to the extent that the goods or services on which it has been paid are ‘cost components’ of a taxable transaction. On the contrary, the identification of goods and services as such cost components becomes all the more important with the introduction of the category of exempt transactions, since those transactions do not give the right to deduct input tax ….

34.

It follows that, subject to divergent rules such as those in art. 17 et seq of the Sixth Directive, the different types of transactions by the taxable person must be distinguished as clearly as possible. In particular, as follows from the system which has been demonstrated, in applying art. 17(2)(a) goods or services which have been identified as cost components of a specific exempt supply of goods or services cannot be attributed to other supplies of goods or services which are subject to VAT. The term ‘purposes’ in art. 17(2) must be interpreted in that light. The term therefore does not permit the clear distinction between taxable and exempt transactions to be blurred on the basis of considerations which are outside the system.

35.

That conclusion is confirmed firstly by art. 17(5) of the Sixth Directive. That provision, without employing the word ‘purposes’, speaks merely of goods or services ‘used …. for transactions’. In the context of that provision, however, the same criteria – naturally – as in art. 17(2) apply for the attribution of goods and services on which input tax has been paid. Secondly, the above conclusion is confirmed by art. 17(3). Article 17(3)(c) in particular provides for a precisely defined exception to the rule that transactions which (like the disposal of the shares in this case) are exempted from VAT …. confer no right to deduct input tax. ….

36.

With respect to the present case, the High Court found …. that the services in question on which input tax had been paid were ‘used …. for an exempt transaction’ by the taxable person …. It is thus established that those services form a cost component precisely of the exempt supply (effected by the sale of the shares).

37.

That is not affected by the argument put forward by BLP at the hearing that the costs of the services on which the input tax has been paid …. are ultimately incorporated into the price of the goods and services which it sells by means of its taxable transactions. …. That circumstance does not make the services in question into cost components of the taxable transactions and cannot therefore alter the attribution stated above.

38.

On the basis of that attribution, the right to deduct input tax is excluded in the present case, it being of no relevance whether the sale of the shares was for the benefit of the taxable activity of the taxable person on the basis of the discharge of indebtedness intended and effected.”

Three points in particular are to be noted in the passage from the Advocate-General’s opinion quoted above.

In the first place, the Advocate-General explains the rationale for the requirement in article 17(2) that, to be deductible, input tax must relate to goods or services ‘used for the purposes of [the taxable person’s] taxable transactions’ by reference to the concept of a chain of (taxable) transactions ending with the final consumer, where VAT is charged on the value added at each link in the chain. In the case of an exempt supply, however, the chain of transactions necessarily ends with the making of that supply, since (as the Advocate-General puts it in paragraph 32 of his opinion, quoted in paragraph 16 above) in such a case the taxable person – i.e. the person making the exempt supply – “acts as the final consumer, since he is unable to pass the VAT onto third parties”. This in turn demonstrates the need to establish whether (and if so to what extent) a particular input cost is ‘used for’ a taxable supply, as opposed to an exempt supply.

In the second place, in the context of the application of that test the Advocate-General treats the expression ‘cost components’ in article 2 of the First Directive as synonymous with the expression ‘used for’ in article 17(2) of the Sixth Directive (see paragraph 33 of his opinion, quoted above). As will be seen, the ECJ endorsed this treatment in its judgments in BLP and in the later case of Midland Bank plc v. Customs Excise Commissioners (Case C – 98/98) [2000] STC 501 (“Midland Bank”), to which further reference is made below.

Thirdly, in paragraph 37 of his opinion the Advocate-General concludes that the expression ‘for the purposes of his taxable transactions’ in article 17(5) does not extend to the ultimate aim of the taxable person when incurring the relevant input costs (i.e., as in BLP itself, the making of its taxable supplies): rather, it refers to the purposes of particular transactions (note the use by the Advocate-General of the word “precisely” in the last sentence of paragraph 36 of his opinion, quoted above). Thus, in the opinion of the Advocate-General, the mere fact that the input costs in question may be reflected in the prices charged by the taxable person for his taxable supplies will not suffice to render the input costs ‘cost components’ of the taxable supplies.

In the course of its judgment in BLP, the ECJ said this:

“19.

[Article 17(5)] of the Sixth Directive lays down the rules applicable to the right to deduct VAT where the VAT relates to goods or services used by the taxable person ‘both for transactions covered by paragraphs 2 …., in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible’. The use in that provision of the words ‘for transactions’ shows that to give the right to deduct under para 2, the goods or services in question must have a direct and immediate link with the taxable transactions, and that the ultimate aim pursued by taxable person is irrelevant in this respect.

20.

That interpretation is confirmed …. by art. 2 of the First Directive….

21.

Article 2 of the First Directive states that only the amount of tax borne directly by the various cost components of a taxable transaction may be deducted.”

Rejecting BLP’s arguments based on the fact that the reason for the sale of the shares was to raise money to pay off debts incurred in the pursuit of its taxable activities, the ECJ said this (in paragraph 24 of its judgment):

“…. if BLP’s interpretation were accepted, the authorities, when confronted with supplies which, as in the present case, are not objectively linked to taxable transactions, would have to carry out inquiries to determine the intention of the taxable person. Such an obligation would be contrary to the VAT system’s objectives of ensuring legal certainty and facilitating application of the tax by having regard, save in exceptional cases, to the objective character of the transaction in question.”

The ECJ accordingly concluded (in paragraph 28 of its judgment) that:

“…. art. 2 of the First Directive and art. 17 of the Sixth Directive are to be interpreted as meaning that, except in the cases expressly provided for by those directives, where a taxable person supplies services to another taxable person who uses them for an exempt transaction, the latter person is not entitled to deduct the input VAT paid, even if the ultimate purpose of the transaction is the carrying out of a taxable transaction.”

It will be seen, therefore, that in its judgment in BLP the ECJ effectively adopted the reasoning and the conclusions of the Advocate-General.

In Midland Bank, the ECJ, in answer once again to a reference by the English High Court, reaffirmed that the use of the words ‘for transactions’ in article 17(5) of the Sixth Directive showed that for the right to deduct under article 17(2) to arise, the goods or services in question had to have a ‘direct and immediate link’ with the taxable output transactions giving rise to the right to deduct.

In paragraph 25 of its judgment in Midland Bank the ECJ said this:

“It is for the national courts to apply the ‘direct and immediate link’ test to the facts of each case before them and to take account of all the circumstances surrounding the transactions at issue.”

The ECJ continued (in paragraphs 29 and 30 of its judgment) as follows:

“29.

It should be borne in mind that, according to the fundamental principle which underlies the VAT system, and which follows from art 2 of the First and Sixth Directives, VAT applies to each transaction by way of production or distribution after deduction of the VAT directly borne by the various cost components ….

30.

It follows from that principle as well as from the rule enshrined in the judgment of [BLP] para 19, according to which, in order to give rise to the right to deduct, the goods or services acquired must have a direct and immediate link with the taxable transactions, that the right to deduct the VAT charged on such goods or services presupposes that the expenditure incurred in obtaining them was part of the cost components of the taxable transactions. Such expenditure must therefore be part of the costs of the output transactions which utilise the goods and services required. That is why those cost components must generally have arisen before the taxable person carried out the taxable transactions to which they relate.”

Hence, on the authority of BLP and Midland Bank, in applying the ‘used for’ test prescribed by article 17(2) of the Sixth Directive the relevant inquiry is whether there is a ‘direct and immediate link’ between the input cost in question and the supply or supplies in question; alternatively whether the input cost is a ‘cost component’ of that supply or those supplies. It is clear from the judgments of the ECJ in BLP and Midland Bank, as I read them, that there is no material difference between these alternative ways of expressing the basic test.

Also cited to us (by Miss Philippa Whipple, appearing with Miss Shaheen Rahman for the Commissioners) was the decision of the ECJ in Abbey National plc v. Customs & Excise Commissioners (Case C-408/98) [2001] STC 297 (“Abbey National”). Miss Whipple referred us in particular to paragraph 35 of the opinion of the Advocate-General (Jacobs), where he said this:

“…. The reference to cost components in BLP is a reminder of the basic principle set out in art.2 of the First Directive …. Thus, what matters is whether the taxed input is a cost component of a taxable output, not whether the most closely-linked transaction is itself taxable. As the Commission submitted at the hearing, the conclusion to be drawn from [BLP] is that the question to be asked is not what is the transaction with which the cost component has the most direct and immediate link but whether there is a sufficiently direct and immediate link with a taxable economic activity. Indeed, it may be stressed that in that case the court was concerned with supplies which were not objectively linked to taxable transactions …. Nevertheless, it remains clear from BLP that the ‘chain-breaking effect’ which is an inherent feature of an exempt transaction will always prevent VAT incurred on supplies used for such a transaction from being deductible from VAT to be paid on a subsequent output supply of which the exempt transaction forms a cost component. The need for a ‘direct and immediate link’ thus does not refer exclusively to the very next link in the chain but serves to exclude situations where the chain has been broken by an exempt supply.” (Emphasis supplied)

On that footing, the fact (if it be the fact) that in the instant case the link between the marketing and advertising costs and DaP’s taxable supplies may be more direct and immediate than the link between those costs and DaP’s exempt supplies does not serve to exclude the possibility that there may nevertheless be a sufficiently direct and immediate link between those costs and the exempt supplies.

So far as domestic authority is concerned, Mr Anderson cited the decision of this court in Customs & Excise Commissioners v. Southern Primary Housing Association Ltd [2003] EWCA Civ 1662, [2004] STC 209 (“Southern Primary”). In Southern Primary, this court held that the question whether there was a ‘direct and immediate link’ was not a pure question of fact, but a mixed question of fact and law and as such susceptible to appeal. It further held, allowing the Commissioners’ appeal, that on the facts the requisite ‘direct and immediate link’ was not established.

The facts in Southern Primary were, in summary, as follows. The taxpayer, a developer, purchased a piece of land, on which it paid VAT (the relevant input tax). It sold the land on to a housing association, and entered into an agreement with the housing association under which it was to develop the land by building houses on it. It was common ground that the transactions were commercially connected, and that the purchase of the land was a ‘supply’ for VAT purposes. The taxpayer contended that it was entitled to deduct the VAT which it had paid on its purchase of the land from its output tax, on the basis that there was a ‘direct and immediate link’ between the cost of the land and the taxable supplies which it made in developing the land. The Commissioners rejected that contention. The VAT Tribunal allowed the taxpayer’s appeal, and on the Commissioners’ appeal to the High Court Sir Donald Rattee (sitting as a High Court judge in the Chancery Division) upheld the Tribunal’s decision. This court allowed the Commissioners’ appeal.

The judgment of the court was delivered by Jacob LJ. In paragraph 28 of his judgment he rejected the taxpayer’s contention that the question whether there was a ‘direct and immediate link’ with taxable transactions was a pure question of fact, saying this:

“…. It is for the tribunal to determine the primary facts (i.e. the commercial transactions). That it has done here, and no one quarrels with its findings – which are set out immaculately and concisely. Whether or not those facts amount to a ‘use’ within the meaning of art. 17(2) as interpreted by the court is a question of law arising on those primary facts. …”

On the substantive issue, Jacob LJ said this (at paragraph 32 of the judgment):

“The land purchase transaction was commercially necessary to make its performance commercially possible, but it was not a cost component of the contract itself in the same way as the cost of the materials used [i.e. used in developing the land]. There is a link with the contract, but the link was not direct or immediate. The development contract would not have been made but for the associated land purchase and sale. But ‘but for’ is not the test and does not equate to the ‘direct and immediate link’ and ‘cost component’ test.”

Jacob LJ continued (in paragraph 37 of the judgment):

“Turning back to the tribunal, it concluded that there was a direct and immediate link between the land purchase and both the land sale and development contract, with both an exempt and a non-exempt transaction. VAT law does not work in such a generalised way. You have to look at transactions individually, component transaction by component transaction. They may be linked in the sense that one would not have happened without the other, but they remain distinct transactions nonetheless. Only if one transaction is merely ancillary to a main transaction can one disregard the distinct nature of each transaction …. If that were not so, the principle of neutrality would be violated. Moreover, there would be intractable problems as to which input was being attributed to which part of the ‘overall transaction’. You may find, as here, taxable and exempt transactions all mixed up in the same ‘overall’ transaction – which is illegitimate.”

Thus Southern Primary is authority for the proposition that the mere fact that ‘but for’ the input cost in question taxable supplies would not have been made is not enough to establish the requisite ‘direct and immediate link’ between the input cost and the taxable supplies.

Lastly, so far as the authorities are concerned, I should note the decision of a VAT Tribunal in Royal Agricultural College v. Customs & Excise Commissioners (decision no. 17508, unreported, 11 January 2002) (“Royal Agricultural College”), on which Mr Anderson also relied. In that case, the College contended that marketing expenditure which was primarily aimed at attracting students had a ‘direct and immediate link’ not only with its (exempt) supply of educational services, but also with its (taxable) supplies in providing conference facilities and in selling goods in its shop and bar. The VAT Tribunal rejected that contention, saying (in paragraph 42 of its decision):

“The direct and immediate link is clearly that of attracting students to the College. The link that thereby they contribute to the College’s taxable activities such as, for example, using the bar, is indirect and not immediate, in the sense in which that term is used. If it has no students it will not be successful in its wider activities.”

As indicated earlier, the only issue in the instant case is as to the application of regulation 101(2) to the undisputed facts. Specifically, the issue is whether (as DaP contends) the supply of marketing and advertising services to DaP is attributable exclusively to taxable supplies made by DaP (in which case the input tax on the supply of such services is deductible in full against output tax charged on taxable supplies made by DaP, pursuant to regulation 101(2)(b)); or whether (as the Commissioners contend) the supply of such services is attributable to both taxable and exempt supplies made by DaP (in which case the input tax on the supply of such services constitutes residual tax falling within regulation 101(2)(d), with the consequence that only a proportion of such input tax is deductible against output tax on taxable supplies made by DaP).

Miss Whipple accepts (rightly, in my judgment) that the issue is one of mixed fact and law, and that the Decision is accordingly susceptible to appeal on a point of law.

Having set out the undisputed facts (as summarised in paragraph 4 above), the Tribunal referred to the Sixth Directive, the 1994 Act and the Regulations, and to a number of authorities which had been cited to it (including BLP and Midland Bank).

In paragraph 43 of the Decision, the Tribunal described the issue for decision as hinging on:

“…. whether there is a direct and immediate link between the marketing and advertising costs and only the taxable supplies made by DaP or whether some part of the advertising costs can be said to have a direct and immediate link with the insurance intermediary [services] provided by DaP to Cornhill.”

In paragraph 46 of the Decision, the Tribunal restated the issue for decision as follows:

“…. whether the input tax in question [is] directly and immediately linked with the supply of insurance intermediary services.”

The Tribunal continued:

“47.

The tribunal has found that there was a supply of insurance intermediary services provided by DaP to Cornhill. The vital question is when did this occur?

48.

We find that the supply occurred upon conclusion of the negotiations with each customer. Mrs Brown contended the supply occurred some three months after the supply of the mobile phones and the associated connection to air time or indeed not at all. The evidence before the tribunal does not support this contention.

49.

The arrangements of insurance [sic] is not ancillary to the advertising. Free insurance is not used merely to attract customers to sign air time service contracts for the phones. It is clearly intended to attract new customers to Cornhill Insurance as well and the appellants have a direct financial interest in customers staying with Cornhill on completion of the three free months. It is for that reason that the appellant not the phone service providers are funding a proportion of the free three month insurance with Cornhill.

50.

In our view, a customer’s mobile phone insurance cover commences on submission by the customer to Cornhill of the direct debit mandate. The proper contractual analysis of the submission of the mandate is a promise to pay for mobile phone insurance subject to an option to cancel. This promise is consideration for the insurance cover which is then provided for three months without premiums being payable. Therefore, although we accept that a customer, under the terms of the individual certificate of insurance, is ‘free to cancel the insurance contract at any time and may revoke the direct debit prior to its (the direct debit’s not the contract’s) commencement’ the tribunal does not accept the appellant’s assertion that a customer does not enter into a contractual relationship with the Cornhill at the outset.

51.

The advertisements relate both to the appellant’s intermediary service introducing customers to mobile phone air time providers and to their insurance intermediary service introducing customers to insurance business with Cornhill. All insurance is paid for. The rate of the premium is set to include the ‘risk premium’ of a claim within the three month period.

……….

52.

Further the tribunal does not accept that the appellant does not derive income from the ‘free’ three month period, as asserted by the appellant. The service as an insurance intermediary is supplied at the time the direct debit mandate (or equivalent under the new paperless administration scheme) is submitted to Cornhill. This is at the outset of the three month period. There is one supply of insurance intermediary services and the appellant’s advertising costs are, in part, attributable to this exempt supply.

53.

The appellant is clearly engaged as an insurance intermediary by Cornhill within the meaning of Item 4 Group 2 Schedule 9 VATA. This arrangement is particularised contractually in the Heads of Agreement. The commissions earned from arranging insurance form a substantial part of the appellant’s income.

54.

The arrangement of insurance by intermediaries is an exempt supply and input tax cannot be claimed upon costs relating to such supplies. The input tax on costs of advertising taxable phones with exempt insurance is directly and immediately linked to both the exempt and taxable supplies as held in the BLP Group decision. Therefore it is residual for partial exemption purposes.”

The Tribunal accordingly concluded, dismissing DaP’s appeal, that the input tax on marketing and advertising services provided to DaP was to be treated as ‘residual tax’, falling within regulation 101(2)(d).

In paragraph 14 of his judgment, under the heading “Did the Tribunal misunderstand the issue for decision?”, the judge rejected a submission by Mr Anderson that the Tribunal’s formulation of the issue for decision in paragraph 43 of the Decision (quoted in paragraph 41 above), and in particular the Tribunal’s reference to “some part” of the relevant input costs, indicated that the Tribunal had misunderstood the issue which fell for decision and had thereby misdirected themselves in law.

In paragraphs 16 to 20 of his judgment, the judge recorded Mr Anderson’s further submissions to the effect that on the facts of the instant case there was no ‘direct and immediate link’ between the relevant input costs (that is to say, the costs of marketing and advertising services supplied by third parties to DaP) and the supply of insurance intermediary services by DaP to Cornhill. Those submissions included the following:

In support of the last of the above submissions Mr Anderson had contended that in relation to customers who did not take up the offer of insurance, or who took up the offer but subsequently cancelled their direct debits before any insurance premium became payable, there was no supply of insurance intermediary services for consideration; and that in relation to customers who became liable for insurance premiums after the expiry of the initial three-month period, the supply in question was temporally too remote to lead to the conclusion that the requisite ‘direct and immediate link’ with the marketing and advertising costs existed.

In paragraphs 23 to 26 of his judgment, the judge recorded the submissions of Miss Rahman, for the Commissioners. Miss Rahman had submitted (among other things):

In paragraphs 27 to 29 of his judgment, the judge expressed his conclusions as follows:

“27.

In my judgment, Miss Rahman is correct. The Tribunal’s conclusion that the advertising had this dual purpose or function and was directly and immediately linked to the supply of DaP’s supply of services as an insurance intermediary is not open to successful challenge. The fact that the sale of insurance cover was subsidiary, in the sense of being less important than the sale of mobile phones and ASAs, does not detract from this conclusion.

28.

Nor am I able to accept Mr Anderson’s separate ground of attack (the Tribunal’s failure to accept that unless and until a customer pays a premium (from which DaP receives a commission) DaP has made no supply at all (taxable or exempt) because a supply must be for a consideration). The supply by DaP of an insurance intermediary service is to Cornhill. Under the Heads of Agreement (to which the Tribunal referred in its decision) Cornhill and DaP have agreed that DaP will promote and sell insurance and, for this purpose, that DaP is appointed Cornhill’s agent. Attracting customers to sign up for insurance cover with Cornhill is the role that DaP undertakes in this regard. It is remunerated for the supply on the basis of a commission on the premium collected and, less directly, by sharing with Cornhill the premium fund used to pay claims. This is clearly a supply for a consideration. As Miss Rahman submitted, the precise manner in which and time when DaP is remunerated is irrelevant. The underlying service provided by DaP to Cornhill is not affected by whether particular customers do or do not sign up for insurance cover or, having signed up, cancel the cover before the free three month period has expired.

29.

In any event, as regards individual customers who do not cancel their cover and a premium becomes payable, the fact that it is not payable until the fourth month does not mean that there is no direct and immediate link between the advertising costs and that particular supply. As the Tribunal observed (in paragraph 52 of its decision):

“ The service as an insurance intermediary is supplied at the time the direct debit mandate (or equivalent under the new paperless administration scheme) is submitted to Cornhill. That is at the outset of the three month period. There is one supply of insurance intermediary services and the appellant’s advertising costs are, in part, attributable to this exempt supply.”

The fact that the premium becomes payable as a result of the customer’s failure (which may or may not be a conscious omission) to cancel his direct debit instruction is irrelevant to this analysis.”

The judge accordingly dismissed DaP’s appeal.

By its grounds of appeal, DaP repeats the contention that in paragraph 43 of the Decision the Tribunal misdirected itself in its formulation of the issue for decision. As to the existence or otherwise of a ‘direct and immediate link’ between the marketing and advertising costs and the provision of insurance intermediary services, DaP contends that in upholding the Tribunal’s conclusion that such a link existed in the instant case the judge overlooked the Tribunal’s findings of fact that the advertisements contain no reference to paid-for insurance; that the offer of free insurance is an inducement to customers to take up mobile phones; that customers can take up mobile phones and enter into ASAs without insurance (whether free or otherwise); and that no insurance is offered (free or otherwise) prior to the supply of a mobile phone and an ASA. DaP also repeats its contention that in any event there was no supply of insurance intermediary services for consideration, at least at the time when taxable supplies were made by DaP.

Save that Mr Anderson did not expand upon the submission (rejected by the judge in paragraph 14 of his judgment: see paragraph 45 above) that the Tribunal misdirected itself as to the issue for decision, the arguments presented on this appeal have, inevitably, reflected those which were presented to the judge.

On the substantive issue of ‘direct and immediate link’, Mr Anderson submits that the Tribunal made three fundamental errors, which ought to have led the judge to conclude that the Decision should be set aside.

First, he submits that the Tribunal erred in concluding that the time or times at which the taxable and exempt supplies were made by DaP was the “vital” consideration in determining whether the marketing and advertising services supplied to DaP were attributable to both taxable and exempt supplies or only to taxable supplies; and that in any event the Tribunal wrongly determined the time at which the (exempt) insurance intermediary services were supplied. He accepts that the question of timing is important, but he submits that it is not determinative. Thus he submits that even if, contrary to the facts, the supply of insurance intermediary services (i.e. the exempt supply) had taken place at the same time as the taxable supplies, that would not answer the question whether there was a ‘direct and immediate link’ between the marketing and advertising costs and the exempt supply. The question would still remain whether the exempt supply (the commission income from which accounted for only 6.5 per cent of DaP’s turnover) was secondary to the taxable supplies.

In any event, he submits, the Tribunal’s conclusion (in paragraph 48 of the Decision) that the exempt supply is made “upon conclusion of the negotiations with each customer” is both ambiguous and incorrect. He submits that, on a proper analysis of the transactions, there was a two-stage process. The first stage is concluded when a customer agrees to take up a mobile phone and to enter into an ASA. The question of insurance arises only after that supply has been made. Hence, he submits, there is no direct and immediate link between the marketing and advertising costs and the supply by DaP of insurance intermediary services.

In the course of oral argument, Mr Anderson made the further submission that since the provision of promotional services is not an exempt supply (see Note (7) in Schedule 9 to the 1994 Act, quoted in paragraph 11 above), and since the supply of insurance intermediary services included an element of promotional services, it followed that there was no ‘direct and immediate link’ between the marketing and advertising costs and the (exempt) insurance intermediary services supplied to Cornhill.

The Tribunal’s second fundamental error of law (as Mr Anderson submits) lies in its finding (in paragraph 49 of the Decision) that the provision of insurance intermediary services was “clearly intended to attract new customers to Cornhill Insurance as well”. Mr Anderson submits that in so finding the Tribunal erred in that it had regard to DaP’s ‘ultimate aim’, contrary to the principle enunciated by the European Court of Justice in BLP; and that in any event the Tribunal wrongly identified DaP’s ultimate aim. He submits that the fact that expenditure may be intended to facilitate further supplies is insufficient to constitute a ‘direct and immediate link’. In support of this submission he relies on Royal Agricultural College. He submits that in the instant case the Tribunal and the judge ought to have applied the rationale applied by the VAT Tribunal in that case. He further submits that in making the finding in question the Tribunal failed to have regard to unchallenged evidence before it to the effect that in taking decisions as to advertising DaP took no account of insurance commissions earned. He submits that this evidence was highly material.

Mr Anderson also challenges the Tribunal’s finding (in paragraph 51 of the Decision) that the advertisements relate both to DaP’s (taxable) supply in relation to mobile phones and ASAs and to its (exempt) supply of insurance intermediary services. He submits that there is no legitimate basis for that finding, given its earlier findings that the advertisements made no reference to paid-for insurance, that free insurance was an inducement to customers to take up mobile phones and ASAs, and that free insurance would only be offered after a taxable supply had first been made. He seeks to draw a parallel between the instant case and Southern Primary, submitting that, in effect, the Tribunal applied a ‘but for’ test in the instant case.

Mr Anderson accordingly submits that both the Tribunal and the judge failed properly to analyse the actual services provided by DaP, and in particular failed properly to distinguish between its taxable services and its exempt services.

He submits that the third fundamental error of law into which both the Tribunal and the judge fell was their conclusion that a supply of insurance intermediary services was made for a consideration at the stage when customers of DaP first agreed to take up mobile phones and to enter into ASAs, irrespective of whether they accepted the offer of three months’ free insurance and, if so, whether at the expiry of that period they became liable to pay insurance premiums. He submits that no consideration was provided to DaP in respect of such services unless and until an individual customer became liable to pay an insurance premium, and thereby generated commission entitlement on the part of DaP.

For the Commissioners, Miss Whipple submits that the application by national courts of the ‘direct and immediate link’ test established by BLP and Midland Bank involves a two-stage approach. The first stage is to analyse the transaction in question objectively, from a VAT perspective. That, she submits, is essentially a question of law. The second stage involves identifying the output (if any) of which the input in question is a cost component. That, she submits, is essentially a question of fact.

She submits that the Tribunal correctly analysed the transactions in question and that it was fully entitled to find, on the undisputed facts, that there was a direct and immediate link between the input tax and both the taxable and the exempt supplies made by DaP. She stresses, in particular, that without the advertisements DaP would not be able to fulfil its role as an insurance intermediary, introducing customers to Cornhill. She submits that Southern Primary is distinguishable on its facts from the instant case, and that in any event there is no basis for the submission that the Tribunal applied a ‘but for’ test in the instant case.

She submits (relying on the observations of the Advocate-General in Abbey National quoted in paragraph 29 above) that it is irrelevant that the exempt activity may be the lesser in terms of value of the categories of activity undertaken by the taxpayer, or that the advertisements in the instant case referred only to free insurance. She submits that on the undisputed facts it was part of the strategy of the advertising that the customer would be induced into purchasing insurance which he would start paying for only after the expiry of the initial three months, and that if he did so DaP’s income from its insurance intermediary services would thereby be increased.

As to timing, Miss Whipple submits that in relation to an individual customer insurance intermediary services were supplied (i.e. supplied to Cornhill) at the moment when DaP first advised the customer of the availability of insurance with Cornhill.

As to the existence of consideration, Miss Whipple submits that Mr Anderson is confusing the consideration passing from an individual customer to Cornhill for the provision of insurance services with the consideration passing from Cornhill to DaP for the provision of insurance intermediary services. She refers to the Heads of Agreement between DaP and Cornhill, submitting that the commission payable by Cornhill to DaP is consideration for the totality of the insurance intermediary services provided by DaP, irrespective of whether an individual customer of Cornhill becomes liable to pay an insurance premium to Cornhill. Accordingly, she submits, consideration is provided by Cornhill from the outset, and not at some uncertain date or dates in the future.

In summary, Miss Whipple submits that the Tribunal correctly directed itself as to the law; that on the undisputed facts its finding that the marketing and advertising costs were attributable both to DaP’s taxable supplies and to its exempt supplies is clearly correct; and accordingly that the judge was right to uphold the Decision.

I turn first to Mr Anderson’s submissions that the Tribunal misdirected itself in that (a) it mis-stated, and misunderstood, the issue for decision; and (b) it treated the supply of insurance intermediary services as a supply made for consideration at the time when the services are provided.

As to (a), I agree with the judge that there is no substance in Mr Anderson’s submission. The Tribunal’s formulation of the issue in paragraph 43 of the Decision (quoted in paragraph 41 above) does not in my judgment indicate any misunderstanding on the part of the Tribunal. In any event, any possible doubt about that is dispelled by the Tribunal’s restatement of the issue in paragraph 46 of the Decision (quoted in paragraph 42 above).

As to (b), once again I agree with the judge that this submission must be rejected, for the reasons which the judge gave. To my mind, the submission is patently hopeless. As Miss Whipple rightly submits, it confuses the consideration provided to DaP by Cornhill for DaP’s insurance intermediary services with the consideration provided to Cornhill by Cornhill’s customers for Cornhill’s insurance services. Under the Heads of Agreement between DaP and Cornhill, DaP is contractually entitled to a commission calculated by reference to insurance premiums received by Cornhill and to a share of profits. Those contractual entitlements plainly constitute consideration for the contractual obligation assumed by DaP to provide insurance intermediary services to Cornhill. In my judgment, the fact that under the terms of the scheme a customer of Cornhill who has been introduced to Cornhill by DaP will not be liable to pay an insurance premium to Cornhill prior to the expiry of the initial three-month period, and may never become liable to do so, cannot affect either the existence or the nature of the consideration provided by Cornhill to DaP under the Heads of Agreement. So far as DaP is concerned, the only consequence of such a customer not becoming liable to pay a premium at the end of the three-month period is that DaP will earn less by way of commission than it would otherwise have done.

I turn, then, to the substantive issue as to the application of regulation 101(2) to the facts of the instant case.

The word ‘attributable’ and ‘attributed’ in regulation 101 fall to be interpreted by reference to article 2 of the First Directive and article 17 of the Sixth Directive, and in accordance with the principles enunciated by the ECJ in BLP and Midland Bank. Those authorities establish that the appropriate test of attributability in this context is the ‘direct and immediate link’/‘cost component’ test referred to paragraph 28 above. For convenience, I will refer to it hereafter as “the BLP test”. Moreover, as the ECJ made clear in paragraph 25 of its judgment in Midland Bank (quoted in paragraph 26 above), it is for the national courts to apply the BLP test to the fact of the case, “and to take account of all the circumstances surrounding the transactions at issue”. That, therefore, was the task facing the Tribunal in the instant case.

By its very nature the BLP test is fact-sensitive, in the sense that its application inevitably requires a qualitative judgment to be made on the basis of the facts (as found or admitted) relating to the transactions in question. So whilst I accept that the question whether the BLP test has been correctly applied in any particular case is a question of mixed fact and law, the factual element in that question is bound to be a substantial one. And since the facts are essentially for the VAT Tribunal, it follows, in my judgment, that, absent any misdirection as to the BLP test itself, the scope for successfully challenging a VAT Tribunal’s decision in applying the BLP test is likely to be limited. Certainly that is so in the instant case, where the undisputed facts seem to me to point so strongly in the direction of the conclusion which the Tribunal reached as to lead more or less inevitably to that conclusion.

Thus, in my judgment, the findings of the Tribunal in paragraph 49 of the Decision and in the first sentence of paragraph 51 of the Decision (all of which are quoted in paragraph 43 above) seem to me to amount to no more than the drawing of well-nigh irresistible inferences from the undisputed facts. At all events, I can see no basis for challenging those findings on appeal. In particular, I reject Mr Anderson’s submission, relying on Southern Primary (see paragraphs 31 to 36 above), that it is somehow implicit in those findings that the Tribunal applied a ‘but for’ test. I can detect no sign that it did so. Nor, in my judgment, did the Tribunal fall into the error (see Midland Bank) of looking beyond the ‘purposes’ of the particular transactions in question and having regard to some ‘ultimate aim’ on the part of DaP. As I read the Decision, the Tribunal’s approach to the application of the BLP test was entirely in accordance with the correct principles, as enunciated by the ECJ in BLP itself and in Midland Bank.

As to Mr Anderson’s submissions directed at the factual relationship between the insurance intermediary services and the taxable supplies made by DaP (and in particular his submissions regarding timing), it is important to bear in mind that (as the Advocate-General observed in Abbey National (see paragraph 29 above)) a ‘direct and immediate link’ may exist between the marketing and advertising costs and the 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.

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.

In any event, however, I reject Mr Anderson’s submissions that from DaP’s point of view the provision of insurance intermediary services was secondary to the making of taxable supplies; and that in terms of timing such services were only provided after a taxable supply had been made.

As to the suggested ‘secondary’ nature of the insurance intermediary services, DaP’s entitlement to commission under the Heads of Agreement between DaP and Cornhill represented a substantial proportion of its income during the relevant period. Insurance with Cornhill was part of the package of services advertised by DaP. To my mind, the fact that the advertisements referred only to the intial free three-month period of insurance is hardly surprising, and says nothing as to the relative importance to DaP of the insurance element of the package as compared with the making of taxable supplies.

As to timing, I accept Miss Whipple’s submission that, viewed in the context of a particular individual responding to the advertisements, DaP began to provide insurance intermediary services at the point in time when the question of insurance was first raised by DaP in its initial contacts with that individual. But in my judgment that is not the correct way in which to view the situation. Insurance intermediary services fell to be provided by DaP to Cornhill on a continuous basis, pursuant to the Heads of Agreement. The precise order in which taxable and exempt services were supplied by DaP vis-a-vis any particular individual customer seems to me to be entirely beside the point for present purposes.

I also reject Mr Anderson’s submission that the facts of the instant case are on all fours with those of Southern Primary (see paragraph 32 above). In my judgment, the factual situation in Southern Primary is plainly distinguishable from the factual situation in the instant case. In Southern Primary the taxpayer subsold the land and entered into an agreement with the subpurchaser to develop it. That situation has no parallel in the instant case.

Nor, in my judgment, can Mr Anderson derive any support from Royal Agricultural College (see paragraph 37 above). In so far as the decision of the VAT Tribunal in that case has any bearing on the issue in the instant case, it seems to me to be against Mr Anderson rather than for him.

Finally, I reject Mr Anderson’s submission based on Note (7) in Schedule 9 of the 1994 Act (Note (7) is quoted in paragraph 11 above; Mr Anderson’s submission based on it is summarised in paragraph 56 above). I cannot see that the possibility (if there be one) that the insurance intermediary services may include an element of (non-exempt) promotional services has any bearing at all on the question whether the BLP test is satisfied in relation to such services.

Accordingly in my judgment, for the reasons I have given, the Decision was correct in law, and the judge was right to uphold it.

I would dismiss this appeal.

I agree.

I also agree.

Appeal dismissed

Appellant to pay the Respondent’s costs in the sum of £7,842.50