GSTS Pathology LLP & Ors, R (On the Application Of) v Revenue & Customs

MR JUSTICE LEGGATT: The claimants have applied to the court on an urgent basis for an interim injunction to prevent the Commissioners for HM Revenue & Customs (HMRC) from implementing on 1 May a decision to treat supplies of pathology services by the first claimant, GSTS Pathology LLP (GSTS), as exempt from value added tax. It may at first sight seem surprising that a claimant should be seeking to challenge a decision that the services which it supplies are exempt from tax. But it is the claimants' case that if implemented this exemption will, for reasons I shall explain, be highly damaging to them and to their delivery of pathology services to hospitals.

GSTS is a joint venture between the second claimant Serco Ltd and two NHS Trusts. Serco is a subsidiary of Serco Group PLC (a private company). The two trusts are Guy’s and Tomas’ NHS Foundation Trust (Guy’s), the third claimant, and King’s College NHS Trust (King’s), not a party to this claim. The joint venture is thus a form of public private partnership. GSTS was established as a limited liability partnership on 1 February 2009. Initially it had two members, Serco and a subsidiary of Guy's. On 1 October 2010 a subsidiary of King's became a member. The three members each owned one-third of the shares of GSTS.

GSTS was established against the background of a review of NHS pathology services carried out at the Government's request by Lord Carter of Coles. Lord Carter published two reports, the first in September 2006 and the second in December 2008. Pathology encompasses a number of different areas of medical science, including clinical bio-chemistry, haematology, histo-pathology and cellular pathology and cytology, immunology, microbiology and biology. An important part, but by no means the only part, of pathology services consists of testing in laboratories of blood samples and other specimens taken from patients. Historically, pathology services have been provided at hospitals with each hospital carrying out all its own laboratory testing. The principal recommendation made by Lord Carter was that pathology services should be consolidated by creating what he called "managed pathology networks". This would involve establishing freestanding organisations to provide laboratory testing services for a group of hospitals. Lord Carter considered that such arrangements would be more efficient and would potentially lead to a variety of benefits. He also envisaged an increased role for the private sector in providing investment and managerial skills.

In line with these recommendations Guy's began in 2007 to investigate the idea of forming a joint venture with a partner in the private sector to provide laboratory testing services. Following a tender process, Serco was identified as a suitable partner and Guy's entered into discussions with them. Advice was also sought from accountants to determine the best structure for the proposed joint venture from a financial and tax point of view. An important consideration in the joint venture was the impact of VAT. One of the key questions in this regard was whether or not the pathology services which the proposed joint venture would provide would be exempt from VAT.

To understand why the answer to that question mattered, it is necessary to understand certain aspects of the VAT regime as it applies to health services - the VAT treatment of health services. As a general rule, a person who supplies goods or services in the United Kingdom must charge VAT to its customers on the goods or services supplied. A trader will also have to pay VAT on goods or services purchased from others for the purpose of its business. At the end of each accounting period the trader must account to HMRC for the VAT charged on goods or services which it has provided; this is known as output tax. However in so doing the trader is entitled to deduct tax incurred on goods or services purchased; this is known as input tax – if those goods and services have been used for making taxable supplies. If, at the end of the period, the amount of input tax exceeds the amount of output tax the trader does not have to pay any VAT to HMRC but is instead entitled to receive a repayment.

Certain activities are exempt from VAT on the ground that they are considered to be in the public interest. The ability of Member States of the European Union to grant such exemption is regulated by a Directive of the European Council. The Directive currently in force is Council Directive 2006/112/EC of 28 November 2006. Article 1-321 of this Directive, previously Article 13 of Council Directive 77/388/EC, requires Member States to exempt, among other transactions, "(b) hospital and medical care and closely related activities undertaken by bodies governed by public law or, under social conditions comparable with those applicable to bodies governed by public law, by hospitals, centres for medical treatment or diagnosis and other duly recognised establishments of a similar nature." I shall refer to this exemption for short as "the medical care exemption".

Article 132 1 (b) is implemented in the United Kingdom by Section 31 and Schedule 9 of the Value Added Tax Act 1994 (VATA) which specifies supplies of goods and services that are exempt from VAT. Group 4 - or 7 (it can be corrected) - of Schedule 9 is concerned with health and welfare. Item 1 of Group 4 is -

A critical question in this case is whether the pathology services supplied by GSTS represent "provision of care in a hospital or state-regulated institution" so as to fall within this description.

Another feature of the VAT regime is also relevant for present purposes. Under Section 41 (3) of the VATA, where a Government department has to pay VAT on certain goods or services supplied to it, the Department can recover the amount from HMRC. For this purpose, the definition of a "Government department" includes a NHS Trust or NHS Foundation Trust (see Section 41 (6) and (7). Rules are published by the Treasury known as the Contracted Out Services provisions (COS) which specify services to which this provision applies. Such services include "laboratory services".

Guy's sought advice from the accountancy firm KPMG, the VAT consequences of the proposed joint venture. It was envisaged that a joint venture vehicle, which was intended to be a limited liability partnership, would incur VAT on certain goods and services which are purchased. On the preferred model, these would include staff costs because there were advantages if the LLP did not employ all its staff but had them seconded to it. It was anticipated that VAT would be chargeable on the supply of staff seconded to the LLP.

A key question was the question I have mentioned already, namely whether the pathology services supplied by the LLP to its customers would be exempt from VAT. If the services were exempt and VAT was therefore not chargeable on the supply of services by the LLP to its customers, the LLP would not be entitled to deduct the input tax paid to its suppliers. The LLP would thus have to bear the input tax as a cost of its business. If, on the other hand, the pathology services supplied by the LLP were not exempt, the LLP would have to charge VAT to its customers. The LLP would be able to deduct the input tax payable to its suppliers in full. As the prices charged to the LLP's customers would include VAT, prima facie, the customers would incur this tax as an additional cost. However the intention was that the customers of the LLP would be Guy's and potentially other NHS Trusts which would fall within the definition of a government department for the purposes of Section 41 (3) of the VATA. As the services supplied would be "laboratory services", it was envisaged that the NHS Trust customers would be able to recover from HMRC the tax which they had to pay on services purchased from the LLP.

If the various assumptions about VAT treatment were correct, then the proposed joint venture structure would be efficient from a VAT point of view.

When planning commercial ventures it is of obvious importance to be able to know in advance what the tax consequences of proposed arrangements and commitments will be. If the law or its application to particular facts is uncertain, parties may be deterred from embarking on or investing in a new venture. The risk may be all the greater where the venture is of an innovative kind. Uncertainty in the tax system can therefore discourage enterprise and innovation and potentially have heavy economic and social costs. HMRC is alive to this danger. To reduce uncertainty, it is the practice of HMRC to give guidance to taxpayers on how it interprets tax legislation. Such guidance may be general or it may be specific to a particular transaction.

Thus where there is material uncertainty on how tax law will apply to a commercially significant transaction HMRC may be willing to give a ruling which states its view in advance of what the correct tax treatment is. This facility is plainly of great public benefit. It goes without saying however that in order to achieve this benefit, such a ruling when given must be one on which the taxpayer can rely.

Because of the importance of knowing how VAT would apply to the proposed joint venture, Guy's requested a ruling from HMRC before entering into any contractual commitment. The request was made by KPMG on behalf of Guy's in the letter dated 19 May 2008. The letter was addressed to Mr Henry Hoad (?), a Higher Officer in the HMRC NHS Compliance Team. The introduction explains the purpose of the letter as follows:

The letter then set out at some length the background to the request, different options which Guy's had considered, the nature of the joint venture proposal and the services which it was intended that the new LLP would supply.

Three questions were then posed on which a ruling was sought from HMRC. The first question concerned VAT treatment of staff costs if staff were (a) transferred under TUPE or (b) seconded to the LLP. The second question was whether the pathology services to be supplied by the LLP would be exempt from VAT. The third question was whether, if VAT was chargeable on the services supplied to Guy's and other NHS Trust customers of the LLP, the Trusts would be entitled to recover the VAT under Section 41 (3) of the VATA and costs.

I have already indicated that it is the second question which has given rise to controversy in this case. I must explain why the answer to the question is uncertain. The pathology services which it was intended that the new LLP would supply, as described in the letter from KPMG, consisted of laboratory testing and provision of laboratory test reports to Guy's and other Trust customers. It was not envisaged that the LLP would have any contact with patients, would undertake any diagnosis or would make any decision about a patient's treatment or care.

In determining whether such services fell within the scope of Schedule 9 Group 7 Item 4 of the VATA, the essential question was and is whether they constitute "care". Because the domestic legislation is intended to implement a European Directive, it must be construed, so far as possible, to achieve conformity with the Directive. Thus, where the same word or phrase is used in both the Directive and the domestic provision - and where it appears in the Directive that it has been given a particular interpretation by the ECJ - the corresponding domestic provision should be interpreted in the same way (see, eg, Vodafone 2 v Revenue & Customs Commissioners [2010] Ch 77, 90).

In interpreting the term "medical care", as it is used in the medical care exemption in the Directive, two principles are (and were when a request for a VAT ruling was made) clearly established by the case law of the ECJ. The first is that it is the principal purpose of a medical service which determines whether it should be exempt from VAT. The second is that to constitute the provision of "medical care", a service must have a therapeutic aim. That is, it must have as its purpose the diagnosis, treatment and, insofar as possible, cure or prevention of disease or health disorder. (see, eg, D'Ambrumenil v Customs & Excise Commissioners (Case C-307/01), [2004] QB 1179, paragraphs 57-60).

In the United Kingdom tribunal case of InHealth Group SA Public Body, Decision No 19593, decided on 25 May 2006, it was held that the provision of an MRI scanning service by the appellant did not constitute provision of medical care and was therefore not exempt from VAT. The tribunal's reasoning was that what the appellant did was to perform scans and provide data resulting from the scans to the NHS Trust with which it had a contract. It would then call radiologists and others employed by the Trust to use the data or not as they saw fit. The tribunal found that in these circumstances the provision of the data did not have a therapeutic purpose. It was, at the most, preparatory to diagnosis by someone else.

This reasoning seems to me persuasive. If applied to the facts of the present case, as described in the letter from KPMG, it indicates that the principal purpose of the pathology services to be provided by the joint venture should not be characterised as therapeutic but as the provision of information which Guy's and other Trust customers could use for therapeutic purposes. On that analysis, the supply of the proposed laboratory testing services would not constitute the "provision of medical care" so as to be exempt from VAT.

Very shortly after InHealth Group was decided however, the ECJ gave judgment in L.u.P. GmbH v Finanzamt Bochum-Mitte (Case C-106/05), [2006] ECR 1-5213. L.u.P. was a private company which carried out medical laboratory tests ordered by GPs. The ECJ was asked to give a preliminary ruling on whether the Directive allowed the Member State (Germany) to impose certain conditions on the grant of VAT exemption for medical testing services provided by private laboratories to GPs. The question referred to the ECJ assumed that such services fell within the medical care exemption. The ECJ first considered whether this assumption was correct. In that context, the court held that the medical tests carried out by a private laboratory such as those at issue in the proceedings, which have as their purpose the observation and examination of patients for prophylactic purposes, may constitute "the medical care" within the meaning of the medical care exemption.

I must say that I find the reasoning and conclusion of the ECJ on this point opaque. Reference is made in paragraph 31 of the judgment, as authority for the proposition stated, to the earlier ECJ decision in Commission v France (Case C-76/99), [2001] 1 CLLR 48, paragraph 30. However the issue in that case was whether the transmission of a sample from one laboratory (where the sample was taken) to another laboratory (where the sample was to be analysed) was a distinct act from the subsequent analysis, such that it did not fall within the phrase "closely related activities" in the medical care exemption.

The court concluded at paragraph 30 of its judgment in Commission v France that the taking and transmission of the sample were services which were closely related to the analysis and must therefore be treated in the same way as the analysis for fiscal purposes. The court did not have to decide whether the analysis itself was exempt from VAT although it was common ground between the parties that it was (see paragraph 20).

In these circumstances I find it impossible to see how Commission v France could be regarded as authority for anything decided in L.u.P. In terms of principle, the Court of Justice in L.u.P. noted at paragraph 29 of its judgment the point made in earlier cases that the therapeutic purpose necessary for a supply to constitute medical care may be prophylactic in nature and may include the protection or maintenance, as well as the restoration, of human health. At paragraph 30 of the judgment the court then stated as follows:

It was "in those circumstances" that the court found in paragraph 31 that -

There is no difficulty with the proposition stated in paragraph 30 of the judgment that medical laboratory tests prescribed by GPs may contribute towards maintaining human health. So, for that matter, may many other services such as running a gym or a health food shop. Those plainly do not constitute provision of medical care. When the court goes on to state that medical tests "allow for the observation and examination of patients before it becomes necessary to diagnose, care for or heal a potential illness" this statement seems to me to gloss over the distinction between making a clinical judgment about the state of a person's health and whether any medical intervention or advice is appropriate, which may be made at a time when no sign of illness is apparent, and providing data in the form of test results which may be used by clinicians in making such a judgment. The ECJ does not explain whether it considers that distinction to be relevant and, if so, why.

Counsel for HMRC on this application - Miss Alison Foster QC - submitted that the effect of the judgment in L.u.P is clear and that the case establishes that, as a matter of law, carrying out medical laboratory tests ordered by a medical practitioner constitutes the provision of medical care.

I am unable to accept that submission. I agree that L.u.P. provides the basis for a substantial argument to that effect for which, as Miss Foster pointed out, paragraph 37 of the judgment provides further support. However it seems to me at least arguable that the Court of Justice decided only that if medical tests do have a therapeutic purpose they may constitute medical care and that a prophylactic purpose is, in principle, sufficient to satisfy this requirement. Arguably at least, it remains a question of fact for a national court or tribunal to determine what the principal purpose of a particular medical testing service it is and to distinguish, if on the facts it thinks it appropriate, between a therapeutic purpose (which may be prophylactic) and a purpose which is not itself therapeutic but only ancillary or preparatory to provision of services which have a therapeutic purpose by another person.

I note that HMRC does not appear to have interpreted the L.u.P. decision at the time it was given as having the effect contended for by counsel for HMRC on this application. It is reasonable to draw that inference from the publication in February 2007 of VAT Notice 701/31 Health Institutions. The notice which was replaced in 2011 in materially identical terms and is still current, gives guidance on the interpretation of the medical care exemption as enacted in the United Kingdom by Schedule 9 Group 7 Item 4 of VATA. Section 3 of the Notice is concerned with "supplies made by providers that are not qualified institutions". Section 2.1 explains that an institution is qualified if it is a hospital or it is either a hospice or nursing home which meets certain conditions. It is therefore clear that the LLP, with which the present case is concerned, is not a qualifying institution.

Section 3.1 of the Notice explains that:

The Notice states:

An example given of a service which does is -

Laboratory testing services provided by an independent contractor of the kind that were at issue in L.u.P. would not satisfy the court of these conditions even if provided at the hospital, assuming they do not involve direct contact between the provider and the patient. They would also not satisfy the fifth condition if they were supplied in the hospital for reasons of geographical convenience only. A fortiori, they could not qualify for exemption under the guidance if the service was not supplied on the hospital premises. Since HMRC must have been aware of the L.u.P. case when formulating this guidance, it is reasonable to infer that HMRC did not consider that L.u.P. precluded the legal analysis reflected in the notice.

In response to the request from KPMG, HMRC gave a ruling on the questions raised in KPMG's letter. The ruling was given in a letter dated 28 May 2008 addressed to KPMG on behalf of Guy's. The letter stated that its purpose was "to confirm the VAT liabilities and recovery position with regard to the various supplies relating to the proposed pathology services joint venture between Guy's and Serco.”

In answer to the second question - regarding the VAT treatment of the provision of pathology services by the proposed LLP - HMRC stated:

After this ruling was given the joint venture went ahead as planned. On 22 December 2008 the Pathology Services Agreement was concluded between Guy's and the new LLP (ie, GSTS). In February 2009 GSTS starting trading. In support of the present application, the claimants have served a number of witness statements which contain unchallenged evidence that in proceeding with the joint venture Guy's and Serco relied on the VAT ruling. For example, Martin Shaw (the financial officer at Guy's) at paragraph 16 of his witness statement dated 21 March 2013 said:

Before King's joined the joint venture in 2010, HMRC was asked to confirm its VAT ruling for the benefit of King's. A request was made in an e.mail from Brendan McGowan of Serco to Paul Sheffield, who had taken over from Henry Hoad (?) as responsible officer with HMRC. Mr McGowan explained that GSTS was now negotiating with King's to provide the same pathology services to them as were being provided to Guy's. Although King's had been shown the earlier HMRC ruling, they were "insisting that they had a similar letter confirming the liabilities themselves". In response to this request, Mr Sheffield sent a letter dated 29 April 2010 to GSTS confirming that:

On 30 April 2010 further confirmation of the position was given by HMRC, NHS Compliance Team, this time in a letter to a company called Accounting for VAT Ltd which I understand to have been acting for King's. This letter similarly stated that provided pathology services being supplied under the joint venture were the same as before, then "it is confirmed that the VAT treatment would be exactly the same".

The decision which is the subject of these proceedings is contained in a letter from HMRC to GSTS dated 17 January 2013. The letter states:

It is clear from the evidence filed by the claimants that if the HMRC decision to treat the services supplied by GSTS as exempt from VAT is implemented on 1 May 2013, in accordance with the decision letter, the consequences for the claimants will be very serious indeed. As set out in a witness statement dated 22 March 2013 from Mr David Brown, the Chief Financial Officer of GSTS, GSTS has only just reached the point where it was starting to generate an operating profit.

Substantial costs have been incurred in setting up GSTS, particularly putting in place the necessary IT systems. In the year ended 31 December 2012 the LLP achieved a break-even result for the first time with - based on its unaudited accounts - a net profit of £303,000 on net turnover of £87.6 million. That brought the cumulative retained losses since the joint venture was started to £8.1 million. For the current year, GSTS has set itself the target of achieving turnover of £90.6 million with a net profit of £2.8 million. As at the end of the 2012 year, GSTS owed a total of £20 million to its members in the form of loans and working capital invested. This breaks down into £10 million owed to Serco, £7.8 million to Guy's and £2.5 million to King's. GSTS currently incurs approximately £13 million of input VAT per annum. Of this figure, approximately £6.1 million is attributable to payments for seconded staff, approximately £5.6 million to purchases of equipment, reagents and other laboratory supplies, and approximately £1.3 million to facilities provided by Guy's and King's.

To date, HMRC has given no definitive confirmation that it will not seek to implement its decision retrospectively so as to claim back input tax previously deducted by GSTS from VAT charged on the services it has supplied to its customers. The total amount involved if GSTS were required to make such a repayment is in the order of £50 million. It is clear that such a liability would render the LLP immediately insolvent. Even if the HMRC decision were to be implemented only prospectively, it would result in an additional cost to GSTS of over £1 million per month. This cost would quickly deplete the cash reserves of the business. The result would be that unless it received additional support from its members, GSTS would only be able to carry on business for three to four months before it would have to cease trading.

Since the HMRC decision letter was received GSTS and its members have been considering potential options available to them if the decision is implemented. Their current thinking is set out in the second witness statement of Richard Jones, the Chief Executive Officer of GSTS, dated 2 April 2013 which supersedes some of the earlier evidence served by the claimants on this issues. In this witness statement Mr Jones says that it is inconceivable that GSTS and its members would allow the LLP to become insolvent or unable to operate because of the catastrophic effect that this would have on hospital care. According to Mr Jones, if the HMRC decision is implemented, GSTS would look to restructure itself within the NHS as a partnership between King's and Guy's. This would avoid the costs of VAT on staff and the facilities provided by King's and Guy's although input VAT would continue to be occurred on the purchase of reagents and other laboratory supplies which might not be recoverable under COS.

This restructuring would require Serco to leave the joint venture which, in turn, would require Guy's and King's to buy out Serco. This would be a matter for negotiation. But the amount of Serco's investment, which it would obviously be looking to recoup, currently stands at £10 million. There would also be significant overhead costs of restructure in this way, including legal costs, employment costs and possibly other tax costs. If Serco leaves the joint venture, its departure will, in practice, be irreversible.

Such restructuring would have three major detrimental consequences. First, it would be very costly, running into millions of pounds. That money would have to come out of NHS funds, thus reducing the amount available to be spent by Guy's and King's on health care. Second, it would deprive the joint venture of the investment and management expertise of Serco, thus negating the benefits of collaboration with the private sector which the Carter Report envisaged. Third, the unwinding of the GSTS would also be - in Mr Jones's description - a "colossal public policy failure" which, among other foreseeable consequences, would be likely to discourage future private investment in the health sector.

GSTS has exercised its right to appeal against the HMRC decision to the First Tier Tribunal. The notice of appeal was filed on 15 February 2013. GSTS has been attempting to expedite the appeal and has invited HMRC to agree directions for a hearing in the week beginning 29 July 2013, which is the earliest date the tribunal has been able to offer. It is to be expected that the tribunal would hand down its decision within a month or so of the hearing.

These proceedings were begun on 22 March 2013 seeking judicial review of the HMRC decision and interim relief. The grounds of the claim for judicial review are that the claimants have a legitimate expectation that the supplies of services by GSTS to its customers will be treated as subject to VAT at the standard rate. The claimants contend that this legitimate expectation extends not only to all past suppliers but to future suppliers, at least until after the VAT appeal has been decided, and, if the appeal is unsuccessful, until after the claimants be afforded a further reasonable period to re-organise their affairs. The parties are agreed that in the interests of good case management the claim for judicial review should not proceed until after the tribunal appeal has been determined, apart from the present application for interim relief. That is because if GSTS succeeds on its appeal to the tribunal, the judicial review claim will fall away.

On this application the claimants seek an injunction to restraint HMRC from implementing its decision until the date falling three months after the decision of the First Tier Tribunal is handed down. The hearing of the application was fixed with a time estimate of one-and-a-half days and directions for it given by an order of Mrs Justice Nicola Davies dated 25 March 2013.

In their detailed grounds of resistance to the application for interim relief served pursuant to that order, HMRC, as well as setting out their grounds for contesting the application, offered to engage in what was described as a "stand still", such that although the change of VAT treatment would be implemented on 1 May 2013, as stated in the decision letter, no tax would actually be collected by HMRC until after the tribunal appeal had been decided. GSTS say that such an arrangement would not assist as it would still have to provide for the tax in it accounts, and, unless it immediately embarked on a restructuring, would expose it to an unacceptable financial risk with effect from 1 May 2013.

At the hearing of this application the claimants have been represented by Miss Philippa Whipple QC and Miss Andrea Lindsay Shrugo, and HMRC by Miss Alison Foster QC and Mr Peter Mant. I am indebted to counsel on both sides for their excellent written and oral submissions.

The general principles applicable to the grant of interim relief are those established by the decision of the House of Lords in American Cyanamid v Ethicon Ltd [1975] AC 396. They require, first, the claimant to show a serious question to be tried or, in other words, a real prospect of succeeding in its claim for a final injunction at the trial. Second, if that requirement is met the court must determine where the "balance of convenience" lies. This requires the court to assess what, if any, injury will be sustained which cannot adequately be compensated in damages if (a) an interim injunction is granted but the claim fails at trial and (b) an interim injunction is refused but the claim succeeds at trial, and then to weigh the one against the other and decide where the balance lies. In private law cases the focus is on injury likely to be suffered by the parties to the action. But in public law cases matters of wider public interest also need to be considered.

The principle that on an application for interim relief the court should not consider the merits of claim beyond asking whether the claimant has shown a real prospect of success is by no means inflexible. The fundamental requirement is that the court should do what appears just and convenient. There are cases in which the court has considered that justice requires it to examine the strength of each party's case in more depth before deciding whether to grant or refuse an injunction (see eg. Cayne v Global Natural Resources Plc [1984] 1 All ER 225).

Two particular features of the present case persuade me that I ought to adopt this course.

The first one is that as counsel for HMRC rightly emphasised the "interim" relief sought by the claimants, were it granted, would be equivalent in its effect to final relief. That is because the claimants are seeking an injunction to prevent HMRC from implementing its decision for a period which is likely - if the tribunal appeal is unsuccessful - to be around seven months.

It has been agreed by both parties that, save for this application, the claim for judicial review should not proceed until after the tax appeal has been determined if the claim then is relevant. That means that even if the hearing were then expedited, by the time any hearing of the claim for judicial review takes place, if it ever does, most of the period for which the claimants are seeking the injunction will have elapsed. If the injunction is granted and the claimants lose the tax appeal, they will therefore obtain most, if not all, of the substantial benefit which is the subject of their claim for judicial review. Nor do they propose that the benefit should be relinquished if the claim for judicial review proceeds to a hearing and is dismissed. The claimants do not offer any cross-undertaking in damages in this case. The explanation given is that to do so would be to expose them to the same financial risk which it is the object of their application to the court to avoid. Granting the injunction sought by the claimants would amount go giving judgment against HMRC on the claim for judicial review. I do not think it would be just to follow that course unless I can be satisfied at this stage that the claim for judicial review has not just a real prospect of success but is likely to succeed.

The second reason why I think that I should consider the merits of the claim more closely on this application is because I can. The rationale of the American Cyanamid principle is that the court should not attempt to resolve disputes of fact without adequate evidence, nor to decide points of law without hearing sufficient argument; neither of which is generally practical or desirable on an interim application. That is not this case. In this case, pursuant to directions given by the court, a substantial body of evidence has been served and full trial bundles of documentation - most of it not relevant - have been placed before the court. The claimants have served ten witness statements and HMRC has served six witness statements. There are however very few, if any, relevant disputed matters of fact. I have also had the benefit of extensive skeleton arguments (in the case of the claimants' skeleton argument running to some forty pages) and oral argument from leading counsel over the day-and-a-half which was provided for the hearing. Given the importance of the issues, the sums at stake and the fact that I am being asked to grant what would be effectively final relief, I do not think any of this unjustified.

The upshot is that I am in almost as good a position to form a view of the merits as I would be if this were the final hearing of the claim for judicial review. Moreover it would be wasteful and positively unhelpful to the parties in the circumstances if I were to limit myself to expressing a view only on whether the claimants have shown a real prospect of success, and put the parties to the trouble and expense of rehearsing their arguments again, no doubt over another hearing of similar length before another judge, if they wish to obtain a view on whether or not the claim is actually well founded.

Miss Foster QC submitted that there is one significant gap in the evidence currently before the court. She argued that in order to test the reasonableness of the reliance placed by the claimants on the 2008 and 2010 rulings, HMRC is entitled to disclosure of any advice received by the claimants from professional advisers about whether or not the services to be supplied by GSTS would be exempt from VAT. Even however if there is merit in this point, it can be no disadvantage to HMRC if, before granting an injunction, I require to be satisfied to a higher standard than the ordinary American Cyanamid test of the merits of the claimants' case.

I accordingly think it just and convenient in the circumstances of this case to adopt the course of considering whether, on the basis of the evidence which is now before the court, if this were the hearing of the claim for judicial review, it would be right to grant a final injunction in the same terms as the interim relief sought. I believe this approach to be within the broad discretion which the court has on an application for interim relief, to take the course which seems most likely to produce a just result or at least to minimise the risk of injustice. Of course nothing that I say in this judgment will create any issue estoppel or prevent the parties from adducing further evidence or re-arguing any point of fact or law if they choose to do so in the event that the claim does proceed to a final hearing.

I turn to consider the legal basis of the claim for judicial review.

The principle that legitimate expectation should be protected is now well established as a ground for judicial review. For this principle to apply, the general requirements are: (1) the claimant has an expectation of being treated in a particular way favourable to the claimant by the defendant public authority; (2) the authority has caused the claimant to have that expectation by words or conduct; (3) the claimant's expectation is legitimate; (4) it would be an unjust exercise of power for the authority to frustrate the claimant's expectation. Although it has sometimes been said to be a requirement also that the claimant has relied to its detriment on what the public authority has said, the law now seems to be clear that such detrimental reliance is not essential but is relevant to the question of whether it would be an unjust exercise of power for the authority to frustrate the claimant's expectation (see, eg, R (On Application of Bancoult) v Secretary of State for Foreign & Commonwealth Affairs (No 2) [2009] AC 413, paragraph 6, per Lord Hoffmann).

As originally developed, the doctrine protected legitimate expectations of a procedural kind, in other words, expectations that a particular procedure would be followed, for example, that the claimant would be consulted or given a hearing before the public authority takes a decision. But it is also now established that English law will sometimes protect a substantive legitimate expectation, that is an expectation that the claimant will receive a particular substantive benefit. One area in which that principle is clearly recognised is tax law. It is well established that a taxpayer who receives a ruling from HMRC as to the application of the law to his or her particular case may acquire a substantive legitimate expectation to be taxed according to that ruling.

The leading case is R v Inland Revenue Commissioners ex p MFK Underwriting Agents Ltd [1990] 1 WLR 1545. In that case, Lloyd's underwriters had purchased certain bonds for investment purposes. Before the bonds were issued the Revenue had given certain assurances as to how part of the investment proceeds of the bonds would be taxed. Although the Divisional Court found that on the facts the assurances given did not establish a legitimate expectation, the court accepted that in principle a ruling given by the Revenue could create a legitimate expectation that the taxpayer would be taxed in a particular way but by which the Revenue would be bound.

In reaching that conclusion, the court had to confront an argument that a taxpayer could have no legitimate expectation to be taxed other than in accordance with the law. At least as it currently stands, English law does not recognise the possibility that a person could have a legitimate expectation which it would be unlawful to fulfill. In MFK, the Revenue invoked this principle. It relied upon the fact that the statutory scheme governing the Inland Revenue imposed a duty upon it to collect all tax properly due. It argued that it could not, without breach of that duty, agree or indicate in advance that it would not collect tax which, on a proper construction of the legislation was lawfully due.

The Divisional Court (Lord Justice Bingham and Mr Justice Judge, as they then were) rejected that argument. They did so on the basis that the Revenue has a managerial discretion to decide on the best way of carrying out its duty to collect tax and that it is within the scope of that discretion for the Revenue to give advice and guidance to the public as to what it believes the tax position to be, by which the Revenue may be bound even it if results in the Revenue forgoing tax which is legally due. Lord Justice Bingham stated (page 1568):

Lord Justice Bingham set out (page 1569) two conditions which he considered that it would ordinarily be necessary for the taxpayer to have satisfied before the Revenue could be required to forgo tax:

MFK has been treated as good law in later cases, including recently by the Supreme Court in R (On Application of Davis and Another v Revenue & Customs Commissioners [2011] 1 WLR 2625. In that case Lord Woolf also cited with approval the following statement of Lord Justice Moses at the Court of Appeal which emphasised the fundamental utility of co-operating with taxpayers in this way:

On behalf of HMRC, Miss Foster QC did not dispute these principles. She accepts that HMRC has a statutory discretion in circumstances similar to the present case to mitigate any unfairness caused by a change in tax treatment of a trader pursuant to its general powers of care and management. She submitted however that the discretion is very limited. Miss Foster QC relied on F & I Services v Commissioners of Customs & Excise [2001] EWCA Civ 762, and in particular on the passage at paragraph 71 in that case where Lord Justice Sedley rejected a submission that "the mere fact that advice turns out to be wrong in law does not ..... entitle the Commissioners to go back on it". Lord Justice Sedley said:

Miss Foster QC submitted that the exercise of the managerial discretion may allow HMRC to agree to treat that period of time covered by an erroneous ruling binding in the past and not subject to the new corrected ruling. It may, very exceptionally, extend to a short time for practical implementation of the new ruling. But it is necessarily a very narrow discretion in the present circumstances as it allows for the perpetuation of a position inconsistent with the true position in tax law.

I will make two observations about the citation from F & I Services and the submissions made by Miss Foster on this point. First, the passage quoted from the judgment of Lord Justice Sedley does not cast any doubt on the correctness of the legal principles stated in MFK. Indeed, he expressly refers to that decision with approval.

Second, there seems to me to be a significant distinction between the situation where the law is clear that the Revenue in the exercise of its managerial discretion declines to enforce and a situation where, as in this case, the true position in tax law is uncertain. There is no doubt that the managerial discretion of the Revenue may extend even to agree not to collect tax which, as a matter of law, is undoubtedly payable if it considers this to be in the overall interest of good administration and maximising the collection of Revenue. I would agree however that the discretion of the Revenue in such a case must be a very narrow one. But that, in my view, is very different from a case in which (1) the Revenue has given advice or guidance which it believed to be correct at the time that the advice or guidance was given, and (2) what has happened since is not that there has been any material change in the law but simply that the Revenue has changed its view as to what it believes to be the correct tax position.

Miss Foster submitted, and I accept, that it is the general duty of HMRC to enforce the law as, exercising its best judgment, it currently believes it to be (see Section 73 of the VATA). But it seems to me that this still leaves room for recognition that on a question where there is scope for reasonable difference of opinion the view of HMRC may be wrong. Ultimately, the arbiter of what the law requires must be the judgment of the court or tribunal.

Until such a judgment has been obtained, it begs the question to describe what HMRC is doing, if it does not enforce the law as it now believes is to be, as allowing the perpetuation of a position inconsistent with the true position in tax law.

Applying the legal principles which I have outlined to the present case, it is clear that the claimants had an expectation in the light of the ruling given by HMRC in May 2008 and re-affirmed in April 2010 that the pathology services supplied by GSTS would be treated by HMRC as subject to VAT at the standard rate. It is also clear that this expectation was legitimate. The two conditions identified by Lord Justice Bingham in MFK are met.

It is not suggested that the claimants withheld any relevant information or failed to put their cards face up on the table when they requested a ruling. The letter from KPMG explained in detail the background to it and reasons for the request, the particular ruling sought and its commercial significance, the reasons why the law was considered to be uncertain, referring to the relevant legislation, case law, the published HMRC guidance and KPMG's own analysis of the issues. It was quite clear from the request what reliance would be placed on a favourable ruling. The reliance that would be placed on the ruling that HMRC was later asked to give in April 2010 before King's joined the joint venture was made equally clear. Nor was there anything ambiguous or qualified in the ruling given by HMRC. They were clear and categorical.

It is quite clear from the evidence, and is not disputed by HMRC, that the claimants relied on the rulings. Given the terms of the rulings and the open and proper way in which they were obtained, such reliance was plainly reasonable.

As I have mentioned, Miss Foster submitted that in order to assess fully the reasonableness of the reliance placed by the claimants on the ruling, it is relevant to know what independent professional advice they received about whether or not the services to be supplied by GSTS would be exempt from VAT and that the failure to disclose such advice is a significant gap in the claimants' evidence. Although I do not suggest that they are entirely irrelevant, I cannot see that any view that might have been expressed by the claimants' professional advisers as to what they believed the appropriate interpretations of the legislation to be are likely to be of much significance. Whatever the advisers themselves thought, it was the ruling of HMRC on how HMRC interpreted the law - and therefore intended to apply it - which was critical.

The more difficult question is to determine the scope of the legitimate expectation. For how long could the claimants reasonably expect that the tax treatment stated in the rulings would continue? Or, put another way, in what circumstances would it be fair to the claimants for HMRC to adopt a different tax treatment? Although not expressly stated, it was clearly implicit that the rulings were based on the law as it stood at the time when they were given. If therefore the relevant legislation changed or if a subsequent court or tribunal decision changed the interpretation of the law on which the rulings were based, the claimants could not legitimately expect that HMRC would remain bound by the rulings. A reasonable person in their position would anticipate that in such circumstances HMRC would be obliged to reconsider the tax position and to enforce, at least prospectively, the new law or the court's interpretation of the existing law. All that the claimants could legitimately expect in such circumstances it seems to me is that the change in tax treatment would be managed fair and sufficient notice of its implementation given to allow the claimants a reasonable time in which to re-organise their affairs.

That was the approach which HMRC took and which the court endorsed in R (On Application of Cameron) v Revenue & Customs Commissioners 2012 EWHC 1174 Admin, paragraph 71. In this case however the relevant legislation has not changed since the rulings were given and it is not suggested that there has been any court or tribunal decision which has changed the proper interpretation of the law. All that has happened is that HMRC has changed its view of how the law should be interpreted.

On behalf of HMRC, Miss Foster stated at the start of her argument that HMRC acknowledged having made a number of errors in this case, one of which was that the 2008 and 2010 rulings did not even reflect its view of the law at the time they were given. I cannot accept that statement. The only evidence put forward to support it in the witness statement served by HMRC was a bare assertion by one official, Mr Lee Nichols, that it is his understanding that the ruling given in 2008 "was in fact given in error". However Mr Nichols does not explain the basis for this understanding which, since his own involvement began only in September 2012, cannot be based on any personal knowledge. Mr Nichols also gives no explanation of how the alleged error is supposed to have come about, nor does he identify whose views within HMRC the ruling in 2008 allegedly failed to reflect.

I would, in any event, find it difficult to accept that any error was made in circumstances where the ruling given in 2008 was, and indeed remains, consistent with the guidance published by HMRC in VAT Notice 701/31 Health Institutions. By the same token, the new decision seems to me to be inconsistent with their guidance. I was told that HMRC is currently considering whether to withdraw the notice. I cannot however accept - and certainly not without evidence - the suggestion that HMRC has left guidance in place for the last five years which does not reflect its official view.

There is in any case a more fundamental reason why I cannot accept that the 2008 and 2010 rulings did not reflect HMRC's view when they were given. It is not suggested that the officers who issued the ruling lacked the authority to do so. It is of course entirely conceivable that in an organisation such as HMRC different individuals or even different departments within it may hold different views on a particular question of tax liability at any given time. But, for the purposes of legal attribution, it seems to me that the view which is to be treated as that of HMRC as a corporate body must be the view which is communicated on its behalf either to the public at large or to the particular taxpayer in relation to whom the question arises by a responsible officer acting within his or her authority. If two or more views are certainly indicated, there might be ambiguity about what HMRC's view should be taken to be. But that did not happen in this case.

As a matter of law therefore, HMRC's view on the question of whether the pathology services to be supplied by GSTS were exempt from VAT or were taxable at the standard rate was the view stated in the rulings.

I, accordingly, consider that the correct description of what has happened in this case is that following, as it would appear, a change in the personnel within HMRC responsible for dealing with GSTS, the relevant question upon which the rulings were given have been reconsidered and a different view has been taken of the answer to that question.

What is the claimants' legitimate expectation or what does fairness require from HMRC in these circumstances? On the one hand, it can be said that if tax treatment stated by HMRC in a ruling to be correct can change - not as a result of any change in the law but just because HMRC has changed its view - the value of such rulings and the practice of giving them will be very substantially undermined. The taxpayer is surely entitled to expect consistency and not that a public authority will change its mind without any objective change in circumstances.

The counter argument is that HMRC cannot reasonably be obliged to perpetuate indefinitely what is now considered to be a mistaken interpretation of the law. To do so would be inconsistent with its duty to collect what it believes to be the correct amount of tax required by law.

Where the balance is struck between these competing arguments may depend on the particular facts of the case. A number of features in the present case - in combination - have led me to conclude that HMRC cannot, without unfairness to the claimants, impose a different tax treatment from that stated in the rulings without any objective change in circumstances.

These features are: (1) the extent of the reliance which the claimants have placed on the rulings in setting up and investing in their business and the very serious and damaging consequences the proposed change in tax treatment will have if implemented; (2) the fact that the extent of the reliance which would be placed on the rulings was made clear to HMRC when the rulings were sought; (3) the fact that the rulings were and remain consistent with the general published guidance issued by HMRC in VAT Notice 701/31; (4) the fact that the point on which the rulings were given was and remains, in my view, an arguably correct interpretation of the law; (5) the fact that it is very unlikely on the current state of the law that the claimants will be entitled to recover compensation for losses suffered as a result of their reliance on the rulings if they are now subjected to a different tax treatment; (6) the fact that if the claimants are required to adopt the new tax treatment before the issue on which the rulings were given has been authoritatively determined by the tribunal they may feel compelled to restructure their affairs in a way which would be costly and detrimental and, in practice, irreversible and yet to turn out to have been unnecessary if the tribunal finds that the rulings were legally correct.

In these circumstances it seems to me wholly unreasonable to expect the claimants to restructure their business before the true legal position has been established by the decision of the tribunal.

If the claimants succeed in the tribunal proceedings that will be the end of the matter. If, on the other hand, they lose their appeal against the HMRC decision, it seems to me that the claimants are clearly entitled to expect that they will be given a reasonable time in which to carry out restructuring after that decision has been given before they are taxed on the new basis. It is to be expected that - given the notice that they will by then have had of what the tax position will be if the tribunal decides against them - the claimants will by then have their contingency plans in place. How long they should reasonably be allowed to implement those plans before the new basis of taxation is applied is impossible at this stage accurately to judge. Three months seems to me to be a reasonable time however on the present state of the evidence.

On the basis of the evidence which is now before the court, I therefore consider that if this were the hearing of the claim for judicial review the claimants would have succeeded in establishing the legitimate expectation that HMRC's decision to treat the supplies of pathology services by GSTS as exempt from VAT will not be implemented until three months after the decision of the First Tier Tribunal is handed down.

Is it just to frustrate the claimants' expectation? This conclusion is not decisive of the case however because even where a claimant has a legitimate expectation, which it would be unfair to the claimant for the public authority which produces that expectation to frustrate, it is nevertheless permissible for the authority to do so if there is an overriding public interest that requires it.

In R v North East Devon Health Authority ex p Coughlan [2001] QB, the Court of Appeal held that where the legitimacy of the claimant's expectation is established, that the defendant asserts that there is a sufficient public interest to justify overriding the expectation, the role of the court is not limited to reviewing the rationality of the defendant's decision. Rather, it is for the court to weigh the requirements of fairness to the claim against the overriding interest relied upon by the public authority and to determine whether it is just exercise of power for the authority to frustrate the claimant's legitimate expectation. In Coughlan, the Court of Appeal indicated that the test which the court should apply in making its determination is whether the frustration of the claimant's expectation will be so unfair as to be an abuse of the authority's power (see paragraphs 81 to 82).

In Nadarajah and Abdi v Secretary of State for the Home Department [2005] EWCA Civ 1363, Lord Justice Laws suggested for this purpose a proportionality test should be used. Is acting in a way which defeats (?) the claimant's legitimate expectation a proportionate response, having regard to the legitimate aim pursued by the public body in the public interest?

In this case HMRC has argued that the claimants' expectation to be treated in accordance with the rulings given in 2008 and 2010 is overridden by the public interests in collecting the correct amount of tax and in treating taxpayers fairly by not favouring one taxpayer over another. Once it is accepted that the claimants have a legitimate expectation to be taxed in accordance with the rulings issued to them by HMRC however, I do not consider that either of the competing public interests relied on by HMRC can properly justify the unfairness involved in frustrating that expectation.

The weight reasonably to be accorded to the first interest, significant as it is, seems to me to be somewhat diminished where, as here, the effect of collecting the additional VAT will - except to the extent that it benefits Serco (?) - be that of transferring money from one area of Government expenditure (the NHS) to the general public purse.

As to the fairness to other taxpayers, HMRC has asserted that similar supplies by other traders are being treated as exempt from VAT. No further details have been divulged however and HMRC say that it is unable to give any further information because of its duty of confidentiality to other taxpayers. The claimants, on the other hand, say that there is only known competitor to GSTS which itself is believed to have an appeal against the decision by HMRC to treat supplies as exempt pending the First Tier Tribunal. On any view, the issue is not one of wide effect on taxpayers.

In these circumstances it seems to me that little weight can be given to treating all taxpayers alike. I also consider that VAT Notice 701/31 is relevant in this context. So long as that guidance is made publicly available, as it is at present, I find it difficult to see how it can be said to be unfair to taxpayers generally if HMRC treats an individual taxpayer - GSTS - in the sway required by that guidance.

I therefore conclude, on the basis of the evidence currently before the court, for HMRC to implement its decision before the end of a period for which an injunction is sought would not be a proportionate or just exercise of power.

I have so far been considering the merits of the claim but I arrive at the same conclusion if I follow the approach of assessing the balance of convenience. If interim relief is granted, if the claimants' tax appeal fails and the claim for judicial review is ultimately held to have been unfounded, the claimants will have received the benefit of standard VAT rating of the services which GSTS supplied for several months longer than legitimate.

I ignore for this purpose the possibility that HMRC might be entitled to apply its decision to periods before 1 May 2013 though notwithstanding the terms of the decision letter. I regard any such contention as so plainly unsustainable that it can properly be discounted altogether whatever approach is adopted to the grant of interim relief. It is, on any view, unnecessary to consider the balance of convenience insofar as there is no arguable defence to a claim (see, eg, Official Custodian for Charities v Mackey [1985] Ch 168). The result of that will be that the public revenue is permanently deprived of several million pounds of tax it ought to have received.

Against that however must be weighed irreparable injury to the claimants and to the wider public interest that is to be caused if interim relief is refused, and the claimants - in order to avoid the financial risk of an adverse outcome in the tribunal proceedings of the current proceedings - are driven to restructure GSTS in the way described by Mr Jones in the near future, even though, as is to be assumed for this purpose, their tax appeal is well founded and/or they have a good claim for judicial review. The consequences would be particularly catastrophic if the claimants are entitled to succeed on their tax appeal so that the restructuring should never have been necessary.

If the alternative assumption is made - that the tax appeal will fail but that the claim for judicial review is well founded - there will still be irreparable injury caused by the cost of disruption involved in undertaking a hasty restructuring and in Guy's and King's having to provide financial support to GSTS to prevent it from becoming insolvent, which may be avoided if more time is allowed to plan and execute a restructuring. That will also divert resources from other areas of operation, potentially affecting patient care.

When the disadvantages on each side are weighed against each other, I consider that the balance of convenience clearly favours granting an interim injunction so as to preserve the status quo in terms of tax treatment until after the tax appeal has been determined and, if necessary, the claimants have had a reasonable further period to re-organise the delivery of pathology services.

Even if I thought that the extent of the irreparable damage on each side of the scale did not differ widely, it would, on conventional American Cyanamid principles, be appropriate to bring into the balance at that point the relative strength of each party's case on the claim for judicial review. Given my conclusions on that issue, that factor would in any case tip the balance decisively in the claimant's favour.

For these reasons I would grant the interim relief sought on this application. I have indicated that whether the period for which the injunction should continue beyond the date of the tribunal's decision is difficult to assess on the current state of the evidence, in the event HMRC succeeds at the tribunal and wishes to argue for a shorter period than three months or the claimants wish to argue, in that event, for a longer period, either party will be at liberty to adduce further evidence and to apply to the court to vary the order.