Centralan Property Ltd. v Commissioners of Customs & Excise

Part XV of the Value Added Tax Regulations 1995 SI 1995/2518 makes provision for adjustment to the deduction of input tax on capital items. Such items include land where the value of the interest supplied by way of a taxable supply is not less that £250,000 excluding so much of its value as consists of rent. In such a case Regulation 114 provides for adjustments over a 10 year period in accordance with the method prescribed in Regulation 115. In each of those years, called intervals, the owner of the land may deduct one tenth of the input tax subject to adjustment by reference to the adjustment percentage as defined in regulation 115(5). Broadly speaking that percentage represents the ratio of the use in that interval attributable to taxable supplies when compared with the use so attributable in the first such interval.

So far as material Regulation 115(3) provides

“(3)

where the whole of the owner’s interest in a capital item is supplied by him.....during an interval other than the last interval applicable to the capital item, then if the supply....is

(a)

a taxable supply, the owner shall be treated as using the capital item for each of the remaining complete intervals applicable to it wholly in making taxable supplies, or

(b)

an exempt supply, the owner shall be treated as not using the capital item for any of the remaining complete intervals applicable to it in making any taxable supplies,

and the owner shall calculate for each of the remaining complete intervals applicable to it, in accordance with paragraph (1) or (2) above, as the case may require, such amount as he may deduct or such amount as he shall be liable to pay to the Commissioners, provided that the aggregate of the amounts that he may deduct in relation to a capital item pursuant to this paragraph shall not exceed the output tax chargeable by him on the supply of that capital item.”

On 14th September 1994 the appellant Centralan Properties Ltd (“Centralan”) bought from the University of Central Lancashire Higher Education Corporation (“the University”) the Harrington Building, Adelphi Street, Preston for £6.5m and VAT of £1,370,500 and leased it back to the University (“the Lease”) for a term of 20 years at an annual rent of £300,000 plus VAT. In the third interval after its acquisition Centralan disposed of its whole interest in the Harrington Building so that Regulation 115(3) had to be applied.

Such disposal was effected by two transactions. The first was the grant on 22nd November 1996 of a 999 year lease (“the Reversionary Lease”), subject to the existing lease in favour of the University, to Inhoco 546 Ltd (“Inhoco”) at a premium of £6.37m and a nominal rent if demanded. The second was the transfer on 25th November 1996 (“the Transfer”) of the freehold reversion to the University for £1,000. Both Centralan and Inhoco were wholly owned subsidiaries of Centralan Holdings Ltd which was itself wholly owned by the University. The supply constituted by the Reversionary Lease was an exempt supply because Centralan and Inhoco were connected persons within Para 2(3A) Schedule 10 VAT Act 1994. The supply effected by the Transfer was standard-rated because, notwithstanding that the University and Centralan were connected persons, the provisions of Item 1(a)(ii) of Group 1 of Schedule 9 to VAT Act 1994 precluded an exemption.

The question arose how to apply Regulation 115(3). The respondent Commissioners of Customs & Excise (“Customs”) contended that the relevant supply was the Reversionary Lease and the Transfer should be ignored as de minimis. In the alternative they claimed that there should be an apportionment, based on their respective values, between the supplies constituted by the Reversionary Lease and the Transfer. The first contention would give rise to a liability of Centralan to Customs of £796,250, the second of £796,090. Centralan disagreed. It claimed that it disposed of its whole interest in the Harrington Building by the Transfer alone so that its liability to Customs under Regulation 115 did not exceed £943.93.

The VAT and Duties Tribunal (Mr J.Demack and Mrs Ainsworth) rejected the contention of Centralan and the first claim by Customs. They concluded that the Reversionary Lease and the Transfer were “pre-ordained” in that there was no likelihood that the Transfer would not be concluded once the Reversionary Lease had been granted. In those circumstances they considered that the proper application of Regulation 115(3) required an apportionment between them. On that basis they confirmed the liability of Centralan to Customs as £796,090. This is the appeal of Centralan from that decision. There is no cross-appeal by Customs from the Tribunal’s rejection of the argument that the Transfer should be ignored on the basis that it is de minimis. Thus the issue for my determination is the proper construction and application of Regulation 115(3) in the circumstances of the two supplies made by Centralan in November 1996.

The starting point for the consideration of the issue is the Sixth Council Directive (77/388/EEC) whereby Member States of the European Union were required to modify their value added tax systems so as, by 1st January 1978 at the latest, to give effect to the provisions therein contained. Those provisions are well known and do not require detailed explanation from me. For present purposes it is sufficient to note some of them. By Article 5 member states are entitled to treat land as tangible property so that references to a supply of goods includes the transfer of land. Article 10 provides that the events chargeable to VAT are constituted by and occur when “the goods are delivered or the services performed”. Article 13 contains the exemptions from liability which member states are allowed to permit. One of them, Article 13B(b) is “the leasing or letting of immovable property” but subject to such exclusions as member states may apply. Article 13C permitted member states to give taxpayers the option for taxation in cases of letting and leasing land subject to such restrictions and such details as member states might impose.

Article 17 confers the basic right to deduct from tax payable the input tax incurred. It is clear from paragraphs 2 and 3 that the right to deduct arises and is commensurate with use of the goods or services for the purpose of taxable transactions. Article 17(5) provides for apportionment where the goods and services are used for the purposes of both taxable and exempt transactions in the following terms:

“As regards goods and services to be used by a taxable person both for transactions covered by paragraphs 2 and 3, in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions. This proportion shall be determined, in accordance with Article 19, for all the transactions carried out by the taxable person.”

The remainder of the paragraph sets out the areas in which member states have autonomy. They include the ability “(c) to authorise or compel the taxable person to make the deduction on the basis of the use of all or part of the goods and services”.

Article 19 contains provisions to enable the calculation of the proportion which may be deducted in accordance with Article 17(5). Article 20 makes provision for the subsequent adjustment of that proportion. Paragraph 1 covers cases of deduction over or under the person’s entitlement and with changes of circumstance. Paragraphs 2 to 4 make special arrangements for capital goods in the following terms:

“2.

In the case of capital goods, adjustment shall be spread over five years including that in which the goods were acquired or manufactured. The annual adjustment shall be made only in respect of one-fifth of the tax imposed on the goods. The adjustment shall be made on the basis of the variations in the deduction entitlement in subsequent years in relation to that for the year in which the goods were acquired or manufactured.
By way of derogation from the preceding subparagraph, Member States may base the adjustment on a period of five full years starting from the time at which the goods are first used.
In the case of immovable property acquired as capital goods the adjustment period may be extended up to 10 years.

3.

In the case of supply during the period of adjustment capital goods shall be regarded as if they had still been applied for business use by the taxable person until expiry of the period of adjustment. Such business activities are presumed to be fully taxed in cases where the delivery of the said goods is taxed; they are presumed to be fully exempt where the delivery is exempt. The adjustment shall be made only once for the whole period of adjustment still to be covered.
However, in the latter case, Member States may waive the requirement for adjustment in so far as the purchaser is a taxable person using the capital goods in question solely for transactions in respect of which value added tax is deductible.

4.

For the purposes of applying the provisions of paragraphs 2 and 3, Member States may:

- define the concept of capital goods,

- indicate the amount of the tax which is to be taken into consideration for adjustment,

- adopt any suitable measures with a view to ensuring that adjustment does not involve any unjustified advantage,

- permit administrative simplifications.”

These provisions are implemented by VAT Act 1994 and the VAT Regulations 1995 SI 1995/2518. Part XIV thereof, comprising regulations 99 to 111, deals with input tax and partial exemption. Accordingly by Regulation 101(1) deductible input tax is limited to that “which is attributable to taxable supplies”. The point is emphasised in Regulation 101(2)(a) to (c). Sub-paragraph (d) provides that

“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.”

Regulation 102 authorises the Customs to use other methods of apportionment. Regulation 107 allows for the adjustment of attributions made by those methods or any of them.

As I have already indicated Part XV, comprising Regulations 112 to 116, deals with adjustments to the deduction of input tax on capital items. I need not add to the summary I have given in paragraph 1 above. But for completeness I should set out the terms of Regulation 115(1) and (2) and the definition of “the adjustment percentage” in Regulation 115(5). They are

(1)

Where in a subsequent interval applicable to a capital item, the extent to which it is used in making taxable supplies increases from the extent to which it was so used in the first interval applicable to it, the owner may deduct for that subsequent interval an amount calculated as follows—

(a)

where the capital item falls within regulation 114(3)(a) or (b)—

Total input tax x the adjustment %

5

(b)

where the capital item falls within

regulation 114(3)(c)—

Total input tax x the adjustment %

10

(2)

Where in a subsequent interval applicable to a capital item, the extent to which it is used in making taxable supplies decreases from the extent to which it was so used in the first interval applicable to it, the owner shall pay to the Commissioners for that subsequent interval an amount calculated in the manner described in paragraph (1) above.

[(3) and (4)]

(5)

For the purposes of this regulation—

"the adjustment percentage" means the difference (if any) between the extent, expressed as a percentage, to which the capital item is used (or is regarded as being used) in making taxable supplies in the first interval applicable to it, and the extent to which it is so used or is treated under paragraph (3) above as being so used in the subsequent interval in question.”

The conclusion of the VAT and Duties Tribunal, contained in paragraph 88 of their decision, was that

“...It is plain from the EU legislation applicable in this instant case, as confirmed by ECJ case law, that the purpose of reg.115(3) is to give an accurate reflection of the use of a capital item, so that it is necessary to construe it as implying apportionment. And, in the absence of any challenge whatsoever by [the barrister appearing for Centralan], we accept the correctness of the Commissioners approach to the analysis of the purpose of reg.115(3), ([as set out in paragraph 57 of the Tribunal’s decision]). We therefore conclude that art.20(3) of the Sixth Directive, and by necessity reg.115(3)...must be read as making implicit provision for apportionment in a case where capital goods were sold by way of a two stage transaction involving two supplies, one exempt and the other taxable.”

Centralan submits, for a number of reasons, that this conclusion is wrong in law. It contends, first, that it ignores the structure, wording and clear meaning of Regulation 115(3). Counsel for Centralan points out that the paragraph contemplates only one supply which is either taxable or exempt. He submits that the words “if” and “or” in that context are incompatible with an apportionment between two or more supplies. Second, Centralan suggests that if the regulation contemplates an apportionment between two or more supplies it may give rise to excessively complicated calculations and anomalies if one or more of the relevant supplies occurs in the succeeding interval. By contrast if only the ultimate supply is considered then it focuses on the time when economic exploitation by the owner ceases altogether.

Centralan claims that its arguments on Regulation 115(3) are supported by the terms and purpose of Article 20(3) of the Sixth Directive. Reliance is placed on the antithesis between “fully taxed” and “fully exempt” and the concept of the “delivery of goods” being incompatible with the progressive disposition of the whole of or all interest in the land. Counsel for Centralan emphasised that this case concerned two bona fide supplies made on different days to different persons.

Customs do not contend that the two supplies can or should be coalesced into one. Nor do they suggest that the principles of W.T.Ramsay Ltd v IRC [1981] STC 174 and subsequent cases in that line are relevant to the issue. They claim that on the true interpretation of Article 20(3) and Regulation 115(3) the adjustment to be made must be ascertained from an apportionment in accordance with the relative values of the supplies where three conditions are satisfied. Those conditions are (1) the whole of the interest in the land is supplied by way of more that one supply, (b) not all such supplies attract the same VAT liability but (c) all such supplies are made in the same interval.

The Customs submit that each of those conditions is satisfied in this case so that the conclusions of the VAT Tribunal are right. With regard to the wording of the Regulation they contend that the word “if” should be read as meaning “if and insofar as”. They suggest that such a construction is justified by and consistent with Article 20(3). They rely on the decision of Neill J in National Water Council v Customs and Excise [1979] STC 157 and of the Court of Appeal in Thorn Emi plc v Customs & Excise [1995] STC 674.

Neither party invited me to make a reference to the European Court of Justice under Article 234 EU Treaty. I understood both parties to recognise that that was a matter for me. It is common ground, as is plainly established in Marleasing SA v La Comercial International de Alimentacion SA [1990] ECR I 4135, 4160, that Regulation 115(3) must, if reasonably possible, be construed in the light of and so as to be consistent with the wording and purpose of Article 20(3). To that extent a question does arise within the jurisdiction of the European Court of Justice. If the purpose and meaning of Article 20(3) is clear then no reference is required. But it is also common ground that there is no decision of the European Court of Justice which throws any light on the true interpretation of Article 20(3). If the meaning of Article 20(3) is unclear then I should consider whether to make a reference even though not asked to do so.

Article 20(3) is couched in terms appropriate to a supply of goods susceptible of delivery. Evidently it is not intended to be so confined because, by Article 5, “supply of goods” includes the transfer of the right to dispose of tangible property as owner and member states are entitled to treat immovable property as tangible goods. The article contemplates a supply of the capital asset such that it ceases to be applied for the business use of the former owner. The purpose of the article is to attribute a use for the remainder of the adjustment period by reference to whether or not the supply by virtue of which it ceased to be applied in the former owner’s business is or is not taxable. In this context it is necessary to consider what is meant by “the delivery of the said goods”.

The proper interpretation and application of Article 20(3) in relation to immovable property must accommodate the various and varied systems of land law applicable in individual Member States. Not all of them differentiate between immovable property and estates or interests in it. And even if they do should the retention of a reversion on a 999 year lease affect the taxable status of immovable property based on its current use? This is essentially a question for the European Court of Justice.

The correct approach of this court has been clearly expressed by Sir Thomas Bingham MR in R v International Stock Exchange, ex p. Else [1993] QB 534, 545 in the following terms:

“I understand the correct approach in principle of a national court (other than a final court of appeal) to be quite clear: if the facts have been found and the Community law issue is critical to the court's final decision, the appropriate course is ordinarily to refer the issue to the Court of Justice unless the national court can with complete confidence resolve the issue itself. In considering whether it can with complete confidence resolve the issue itself the national court must be fully mindful of the differences between national and Community legislation, of the pitfalls which face a national court venturing into what may be an unfamiliar field, of the need for uniform interpretation throughout the Community and of the great advantages enjoyed by the Court of Justice in construing Community instruments. If the national court has any real doubt, it should ordinarily refer. I am not here attempting to summarise comprehensively the effect of such leading cases as H. P. Bulmer Ltd. v J. Bollinger S. A. [1974] Ch. 401, C.I.L.F.I.T. (S.r.l.) v Ministry of Health (Case 283/81) [1982] E.C.R. 3415 and Reg. v Pharmaceutical Society of Great Britain, Ex Parte Association of Pharmaceutical Importers [1987] 3 C.M.L.R. 951, but I hope I am fairly expressing their essential point.”

It is also necessary to bear in mind the reminder of Chadwick LJ in Customs & Excise v Littlewoods Organisation plc [2001] STC 1568, 1613, to which I recently drew attention in Customs & Excise v BAA plc [2002] EWCA Civ 1814 para 48

“But it is, we think, important to have in mind, also, the observations of the Advocate General (Mr Francis Jacobs QC) in Wiener S I GmbH v Hauptzollamt Emmerich (Case C-338/95) [1998] CMLR 1110. A measure of self-restraint is required on the part the national courts, if the Court of Justice is not to become overwhelmed. A passage at paragraph 61 of his opinion is of particular relevance in the present context:

“. . . another development which is unquestionably significant is the emergence in recent years of a body of case law developed by this Court to which national courts and tribunals can resort in resolving new questions of Community law. Experience has shown that, in particular in many technical fields, such as customs and value added tax, national courts and tribunals are able to extrapolate from the principles developed in this Court’s case law. Experience has shown that that case law now provides sufficient guidance to enable national courts and tribunals – and in particular specialised courts and tribunals – to decide many cases for themselves without the need for a reference.”

Ultimately there are two questions. First, in the words of Article 234, do I consider that “a decision on the question [concerning the interpretation of Article 20(3) of the Sixth Directive] is necessary to enable me to give judgment” on this appeal? Second, if so should I refer it to the European Court of Justice for a ruling on it. My answer to both questions is in the affirmative.

It is clear that the true construction of Regulation 115(3) depends on the true interpretation of Article 20(3). There is no decision of the European Court of Justice as to how it is to be applied to supplies of immovable property either directly on the point or from which this court might extrapolate with any degree of confidence. It would be open to me to decide as best I might how Regulation 115(3) should be construed and leave it to a higher court to determine whether a reference should be made but such a course seems to me to be likely to increase both delay and expense before this dispute is finally resolved. Customs have procured amendments to Regulation 115(3) so that the scheme used by Centralan in this case is unlikely to be repeated. But, I understand, there is at least one other case which raises the same point, the amount involved in this case is large and the true interpretation of Article 20(3) in relation to supplies of immovable property is of general importance.

Counsel for Customs helpfully produced a draft question for my consideration. Counsel for Centralan had only one comment on its form. Taking account of that comment the question I would propose to refer is in the following terms:

“Where:

During the period of adjustment provided for in article 20(2) of the Sixth VAT Directive a taxable person disposes of a building which is treated as a capital good; and

The disposal of the building is effected by way of two supplies, being (i) the grant of a 999 year lease of the building (an exempt transaction under article 13(B)(b) of the Directive) for a premium of £6 million, followed three days later by (ii) the sale of the freehold reversion (a taxable transaction under article 13(B)(g) and article 4(3)(a) of the Directive) for a price of £1,000 plus VAT and which either are or are not pre-ordained in the sense that once the first had been carried out there was no chance that the second would not be,

is article 20(3) of the Sixth VAT Directive to be interpreted so that:

(a)

the capital good is regarded until the expiry of the period of adjustment as if it had been applied for business activities which are presumed to be fully taxed;

(b)

the capital good is regarded until the expiry of the period of adjustment as if it had been applied for business activities which are presumed to be fully exempt; or

(c)

the capital good is regarded until the expiry of the period of adjustment as if it had been applied for business activities which are presumed to be partly taxed and partly exempt in the proportion of the respective values of the taxed sale of the freehold reversion and the exempt grant of the 999 year lease?”

Subject to further argument on the form of the question or otherwise I will make a reference to the European Court of Justice in that form and stay all further proceedings in this appeal in the meantime.