University of Southampton v Revenue & Customs

This is an appeal from the decision dated 8 March 2005 (“the Decision”) of the VAT & Duties Tribunal (Dr AN Brice and Professor RG Spector) sitting in the London Tribunal Centre dismissing an appeal from a decision of Customs and Excise contained in a letter dated 21 October 2003 and an assessment for tax of £1,598,366 in respect of six consecutive accounting periods from that ending in October 2001 to that ending in January 2003. As the Tribunal state, the disputed decision and the assessment were made because Customs and Excise were of the view that Publicly Funded research (“PFR”) undertaken by the Appellant University of Southampton (“the University”) was not a “business” activity and so the University was not entitled to input tax credit in respect of tax on the supply of goods or services to the University which were used for the purposes of PFR. By PFR is meant research funded in whole or in part by way of a grant provided by one or more “public sponsors” for which the University has applied for the purposes of carrying out a particular research project; these include the Research Councils, charities and the UK government.

The University argued that its PFR is an integral part of its overall business, which includes (as was accepted by the Tribunal at paragraph 58 of its decision) the supply of education, undertaking research for commercial sponsors, the exploitation of intellectual property, an active conference trade, publishing and consultancy. The Tribunal rejected that argument. They held that PFR is “completely distinct” from the University’s other activities. That conclusion is challenged by the University; and it is argued that, if that conclusion is wrong as the University argues, then the University is entitled to input tax credit in respect of supplies used for the purposes of PFR just as it is entitled to input tax credit for any other supplies used for the purposes of its business, for instance VAT charged on advertising commercial conference facilities.

In making that challenge, the University is saying that the Tribunal were wrong in their conclusion of fact that PFR is a completely distinct activity of the University. Since an appeal from the Tribunal lies only on a point of law, the University has to show that the case falls within the principles expounded in Edwards v Bairstow [1956] AC 14 to which I will come in due course. In essence, the University submits that the conclusion which is challenged is inconsistent with the findings of primary fact which the Tribunal made and that they therefore erred in reaching the conclusion which they did.

The UK legislation to which I come in a moment implements the provisions of the Sixth Council Directive (77/388/EC) of 17 May 1977 and must be construed in the light of that Directive.

Article 2, so far as relevant, subjects to value added tax “the supply of goods or services effected for a consideration….by a taxable person acting as such.”. Under paragraph 1 of Article 4, a taxable person is a person who independently carries out any economic activity within paragraph 2 whatever the purpose or results of that activity. The economic activities referred to comprise, under Article 4, all activities of producers, traders and service providers. The exploitation of intangible property (such as IP) for the purposes of obtaining income on a continuing basis is considered an economic activity. Articles 5.6 and 6.2 concern self-supply of goods and services respectively. Deduction is dealt with under Article 17: it allows, by paragraph 2, deduction in respect of inputs “used for the purpose of his taxable transactions”; and under paragraph 5, there is to be an apportionment in the case of mixed use both for transactions in respect of which VAT is deductible (ie taxable transactions) and transactions in respect of which VAT is not deductible (“such proportion….shall be deductible as is attributable to the [taxable] transactions”).

The Tribunal identified the relevant UK legislation in paragraphs 3 to 7 of the Decision and which, for completeness, I repeat here:

I also mention section 5(2), reflecting Article 2, which provides that “supply” does not include anything done otherwise than for a consideration. This is important in the case of PFR. PFR does not give rise to any supplies (it is common ground, there is no supply to the funder in return for the funding which it provides). Viewed in isolation, PFR is not an economic activity or a business for VAT purposes. The position is therefore different from that of commercial research. In that case, a supply is made to the commercial sponsor for a consideration: the University carries out, for a fee or sponsorship, research, the fruits of which it delivers to the commercial sponsor. This generates outputs and a corresponding right to deduct input tax. It is worth noting, however, that both types of research produce the same product, namely the research results and papers; but in one case that result is an output, in the other it is not.

It can be seen from the summary of VATA 1994 above that there is a two-stage approach to the identification and quantification of the VAT charged on inputs which are recoverable by a taxable person.

The only definition of “business” is to be found in section 94 which provides in subsection (1) that “business” includes any trade, profession or vocation”. The word “business” in its ordinary use can have a wide meaning: see the observation of Lord Brightman in Customs & Excise Commissioners v Apple and Pear Development Council [1986] STC 192 at p197d. In that colloquial sense the business of the University no doubt includes PFR as well as the other activities which I have already mentioned. But “business” for the purposes of VAT is something different, equivalent to “economic activity” in the Sixth Directive.

Not everything which a taxable person does is necessarily done by him “as such” so that what is done outside the scope of his economic activity is not in principle within the scope of VAT. An example of this distinction can be seen in Wellcome Trust Ltd v Commissioners of Customs & Excise (Case C-155/94) [1996] STC 945. The Trust sought to recover a proportion of the VAT which it had paid on professional services in connection with the sale of shares (by way of by “bookbuilding” as described in the judgment) which it held as an investment. The Trust was a registered trader by virtue of other activities such as selling books, medical photographs and photocopies (see the paragraph 5 of the Opinion of the Advocate General (Lenz) at p 948b). But the activity of selling shares was not an “economic activity” and was therefore outside the scope of VAT so that there was no entitlement to deduct input tax on the costs incurred on that activity. In cases where a person carries on a number of different activities it will be important to establish which of those activities are “economic activities” since it is only the VAT on supplies used in the course of such activities which are capable of qualifying as input tax and thus deductible (insofar as used in producing taxable supplies).

An analysis of the definition of taxable person and economic activities shows that the scope of the term activities is very wide and that the term is objective in character in the sense that the activity is considered per se without regard to its purpose or results: see the judgment of the ECJ in Halifax plc v Customs & Excise Commissioners (Case C-255/02). Having said that, activities which are apparently very similar may, in their objective context, be economic activities in one case but not in the other. For instance, the nature of a particular piece of PFR as an economic activity or not may depend on whether the research institution conducting it is doing so with a genuine view to commercial exploitation of IP rights.

Once it is established that a person carries on activities some of which are economic activities and some of which are not (and which do not, by being taken together, in their totality constitute economic activities), VAT on supplies to the taxable person which are used for both economic and non-economic activities needs to be dealt with. An analysis of how this is done helps to throw light on the underlying concepts and thus, in my view, on how to answer the question of whether different activities are to be viewed together or separately in determining the extent of the relevant economic activities (the language of the Sixth Directive) or business (the language of VATA 1994). I therefore embark on what may be seen as a rather lengthy digression (see paragraph 13 to 17 below) but which ultimately helps, I think, in answering the question in hand.

In domestic law, mixed use for business and non-business purposes is dealt with expressly in section 24(5) VATA. Where goods or services are used or to be used partly for the purposes of a business carried on or to be carried on by the taxable person and partly for other purposes VAT on supplies is apportioned “so that only so much as is referable to his business purposes is counted as his input tax”. There is no provision of the Sixth Directive which is directly implemented by this provision of domestic law. But section 24(5) is grounded in the underlying principles of the European VAT legislation.

Some, at least, of those principles are summarised by the Advocate General (Jacobs) in his Opinion in P Charles and TS Charles-Tijmens v Staatssecrfetaris van Financien (Case C-434/03) at paragraphs 51 to 61. Two routes or systems are identified.

However, (see paragraph 59) “both systems apply only where taxed supplies are acquired within the business sphere. Articles 5(6) and 6(2) concern goods forming part of business assets or services supplied by a business. Article 17(5) concerns goods or services used by a taxable person for both taxed and untaxed – that is to say, exempt – transactions. Neither set of provisions can apply where a taxable person acquires goods in a private capacity or uses them for transactions outside the scope of VAT. [My emphasis] In such cases input tax can never be deductible, and the transactions are excluded from the calculation of the deductible portion”. Translating that into domestic law, section 24(5) concerns business/non-business apportionment; section 26 and Regulation 101 reflect the apportionment between taxable and exempt transactions.

In the judgment in that case, the Court puts it this way at paragraphs 23 and 30:

“23

It is settled case-law that, where capital goods are used both for business and for private purposes the taxpayer has the choice, for the purposes of VAT, of (i) allocating those goods wholly to the assets of his business, (ii) retaining them wholly within his private assets, thereby excluding them entirely from the system of VAT, or (iii) integrating them into his business only to the extent to which they are actually used for business purposes (see, to that effect, in particular, Armbrecht, paragraph 20; Bakcsi, paragraphs 25 and 26; Seeling, paragraph 40; and Case C-25/03 HE [2005] ECR I-0000, paragraph 46).

…….

30     Accordingly, a taxable person has, first, the right to choose to allocate wholly to his business capital goods which he uses in part for the purposes of the business and in part for purposes other than those of his business and, where appropriate, the right to immediate deduction in full of the VAT due on the acquisition of those goods and, second, the corresponding obligation to pay VAT on the amount of expenditure incurred for the use of those goods for purposes other than those of the business (see, to that effect, Seeling, paragraph 43).”

Accordingly, one solution open to a taxable person who makes use of a supply both for the purposes of his economic activity and also for other purposes is to allocate the whole to his business/economic activity in which case he can deduct the whole or part of the input tax depending on whether or not he makes exempt as well as taxable supplies. Articles 5(6) and 6(2) then come into play in relation to non-business use. But another solution in the case of mixed use is to carry out a business/non-business apportionment along the lines of section 24(5). In the present case, the University has not sought to use the first route or system. It does not seek to allocate to its business the whole of the goods and services supplied to it and used partly for PFR and partly for other, economic, activities and then acknowledge the presence of a self- supply where those goods or services are used for PFR. Rather, it says that PFR is part of its VAT business so that no question of allocation or self supply arises.

After that digression on how VAT operates in respect of supplies used for both business and non-business purposes, a further question is what inputs can be said to be used for the purposes of the business. In domestic law, section 26 and regulations 100 to 102, and in EU law, Article 17(2), might give the impression that it is only VAT on supplies to a trader which are actually used in making his own supplies which can count as input tax. For instance, a product might comprise many physical components. The VAT paid by the trader on acquiring each component is clearly input tax. It is not immediately obvious, however, that VAT on a supply to the trader which is not directly reflected in the product also counts as input tax, for instance VAT on fees paid to an advertising agency; nor is it obvious that VAT on services acquired in the general administration of the business (ie general overheads), for instance VAT on an auditor’s fees, count as input tax. However, it well established that such items are capable of giving rise to input tax and, indeed, it would hardly make for a rational tax if VAT on the indirect costs of making a taxable supply and overheads in running the business, as well as the direct costs, could not be counted as input tax.

In this context, the decision of the ECJ in Kretztechnik AG v Finanzamt Linz (Case C-465/03) [2005] STC 1118 is of relevance. In that case, Kretztechnik (a company limited by shares established in Austria) had incurred VAT on supplies linked with its admission to the Frankfurt Stock Exchange, a process which had included an increase in its capital. This raised the questions (i) whether a company which issues new shares, and becomes listed on the stock exchange for that purpose, is to be regarded as making a supply for a consideration for VAT purposes (ii) if yes, whether all services obtained in connection with the listing are to be attributed to an exempt supply and that for that reason there is no right to deduction of input tax and (iii) if no (to the first question) whether there is a right to deduct input tax on the ground that the services in respect of which the deduction of input tax is claimed are used for the purposes of the undertaking’s taxable transactions. Both the Advocate General (Jacobs) and the Court held, in answer to the first question, that there was no supply (and thus the relevant services were not attributable to an exempt supply).

The Advocate General then dealt with the third question in paragraphs 70 to 77 of his Opinion. He concluded that the input tax was deductible to the extent that the company charges VAT on its output transactions. He reached that conclusion by addressing the question whether the capital raised by the share issue was used for the purposes of one or more taxed output transactions as to which he said this at paragraphs 76 and 77:

“76.

It seems likely that the use of the capital – and the services connected with the raising of that capital – cannot be linked to any specific output transaction, but must rather be attributed to the company’s economic activity as a whole. There can be no reasonable doubt that a commercial company which raises capital does so for the purposes of its economic activity. [My emphasis]

77.

It appears to be common ground that Kretztechik makes only taxed output supplies, so that it raised the capital in its capacity as a taxable person acting as such. In that case, VAT on inputs attributable as overheads to its whole economic activity will be wholly deductible, in accordance with the case-law summarised in point 27 above. If however, it were also to make other supplies, only a proportion would be deductible……”

In order for VAT to be deductible, the relevant input transaction must have a “direct and immediate link” to the taxed output transaction: see paragraph 35 of the Judgment of the Court (set out in paragraph 23 below) restating this proposition and identifying relevant case-law. Paragraph 27 of the Advocate General’s Opinion also refers to that case-law (BLP Group PLC v Customs & Excise Commissioners (Case C-4/94) [1995] STC 424 at paragraph 25 and Abbey National plc v Customs & Excise Commissioners (Case C-08/98) [2001] STC 297 at paragraphs 35, 36 and 40) which demonstrates that a person’s general overheads are in principle cost components of, and thus have a direct and immediate link to, the whole of that person’s economic activity. Input tax on those overheads may thus be deducted to the extent that output supplies are taxed.

In Abbey National, the issue was whether the tax on the cost of services used to transfer a going concern (not a supply of goods) was deductible. The ECJ held that the costs incurred formed part of the taxable person’s overheads and thus in principle had a direct and immediate link with the whole of its economic activity. No doubt “overheads” (or “overhead expenditure”) has a wide meaning. Certainly it can include start-up costs: see paragraph 43 of the Opinion of the Advocate General (Jacobs) in Abbey National where reference is also made to Gabalfrisa SL v Agencia Estatal de Administracion Tibutaria (AEAT) (Joined Cases C-110/98 to C-147/98) [2000] ECR I-1577 [2002] STC 535. In that case, at paragraph 30 of his Opinion, the Advocate General (Saggio) recognised that

“….the concept of ‘economic activities’ for the purposes of the directive also includes activities prior and ancillary to those that directly constitute the commercial or professional activity.. Consequently, they must in principle be treated in the same way for tax purposes.”

I note, however, that the inputs under consideration in Abbey National formed part of Abbey National’s overall activity (see paragraph 35 of the judgment) and that Abbey National had no activity which was not an economic activity. It is not, therefore, surprising to find that services provided were held to be part of Abbey National’s economic activity.

The Court in Kretztechnik dealt with the question of overheads and the requirement for a direct and immediate link between inputs and outputs in paragraphs 30 to 38 of its Judgment. I quote paragraphs 34 to 38:

“34.

The deduction system is meant to relieve the trader entirely of the burden of the VAT payable or paid in the course of all his economic activities. The common system of VAT consequently ensures complete neutrality of taxation of all economic activities, whatever their purpose or results, provided that they are themselves subject in principle to VAT (see, to that effect, Case 268/83 Rompelman [1985] ECR 655, paragraph 19; Case C-37/95 Ghent Coal Terminal [1998] ECR I-1, paragraph 15; Gabalfrisa and Others, paragraph 44; Midland Bank, paragraph 19, and Abbey National, paragraph 24). [I note here an observation made by Mr Lasok, which seems to me to be correct, that the first sentence is not strictly correct: it is really a mantra derived from earlier decisions of the Court which ignores the fact that economic activity can include the making of exempt supplies and that input tax having a direct an immediate link with such supplies is not recoverable.]

35.

It is clear from the last-mentioned condition that, for VAT to be deductible, the input transactions must have a direct and immediate link with the output transactions giving rise to a right of deduction. Thus, the right to deduct VAT charged on the acquisition of input goods or services presupposes that the expenditure incurred in acquiring them was a component of the cost of the output transactions that gave rise to the right to deduct (see Midland Bank, paragraph 30, and Abbey National, paragraph 28, and also Case C-16/00 Cibo Participations [2001] ECR I-6663, paragraph 31).

36.In this case, in view of the fact that, first, a share issue is an operation not falling within the scope of the Sixth Directive and, second, that operation was carried out by Kretztechnik in order to increase its capital for the benefit of its economic activity in general, it must be considered that the costs of the supplies acquired by that company in connection with the operation concerned form part of its overheads and are therefore, as such, component parts of the price of its products. Those supplies have a direct and immediate link with the whole economic activity of the taxable person (see BLP Group, paragraph 25; Midland Bank, paragraph 31; Abbey National, paragraphs 35 and 36, and Cibo Participations, paragraph 33).

37.It follows that, under Article 17(1) and (2) of the Sixth Directive, Kretztechnik is entitled to deduct all the VAT charged on the expenses incurred by that company for the various supplies which it acquired in the context of the share issue carried out by it, provided, however, that all the transactions carried out by that company in the context of its economic activity constitute taxed transactions. A taxable person who effects both transactions in respect of which VAT is deductible and transactions in respect of which it is not may, under the first subparagraph of Article 17(5) of the Sixth Directive, deduct only that proportion of the VAT which is attributable to the former transactions (Abbey National, paragraph 37, and Cibo Participations, paragraph 34).

38.The answer to the third question must therefore be that Article 17(1) and (2) of the Sixth Directive confer the right to deduct in its entirety the VAT charged on the expenses incurred by a taxable person for the various supplies acquired by him in connection with a share issue, provided that all the transactions undertaken by the taxable person in the context of his economic activity constitute taxed transactions.”

One sees in paragraph 36, as with the Advocate General, a reference to the purpose for which the share issue was carried out. From that one can conclude, I consider, that although an objective approach must be adopted in relation to what is and what is not an economic activity, the purpose of particular activities which are not, by themselves, economic activities can be looked at to see if they qualify as overheads. If the purpose, at least if it is the sole purpose, of an activity is to benefit the other, economic, activities of the taxable person, then the costs of that first activity can be regarded as overhead costs so that the input tax is deductible (either in whole or in part depending on whether outputs include exempt, as well as taxable, supplies).

I will need to return to this case later. At this point, I simply observe that in Kreztechnik there were two factors identified in paragraph 36 which led to the conclusion that the cost of the supplies to Kretztechnik formed part of its overheads and, as such, part of the component parts of its products: first, that the share issue was an operation not falling within the scope of the Sixth Directive (if it had done, there would have been a supply); and secondly, that that operation was carried out in order to increase its capital for the benefit of its economic activity (in the sense in which those words are used in the Sixth Directive).

The second factor is important: it was no doubt factually correct to describe the operation in that way (ie as being for the benefit of its economic activity) because economic activity was what Kretztechnik carried out and all that it carried out. It did not carry out other, non-commercial, activities having an object separate from that of the company’s business: raising capital by issuing shares cannot sensibly be viewed as being an activity carried out, even in part, for its own sake. The costs of the operation (of issuing shares) were in those circumstances part of the company’s overheads and “therefore, as such, component parts of its products” (see Judgment paragraph 36). This makes perfectly good sense. If the company were asked “Why are you spending this money on fees etc?” the answer would come “In order to increase the capital, issue more shares and become listed”. That could prompt another question “Why are you increasing capital, issuing more shares and becoming listed?” to which the answer would be “Because we see that as the way to benefit our business” where the business referred to is the economic activity (in the sense of producing outputs) within the Sixth Directive. The answer would not be along the lines “Because we see doing so as a worthwhile activity in its own right”. The position is really no different, in that sense, from internal marketing costs, for instance, the production in-house of advertising brochures. Although there is, in one sense, a separate activity – the production of brochures – that production is effected for the benefit, and only for the benefit, of the business; the cost of production is an overhead cost and therefore “as such a component part” of the product’s production. The advertising brochure is not something which is prepared for its own sake.

I do not read the decision in Kretztechik as establishing any general proposition which goes further than this: that a cost will be an overhead where it is incurred solely (as was the case on the facts) for the benefit of the trader’s economic activity in general. I add that, in principle, it should be possible to treat in the same way an apportioned part of a cost incurred partly in connection with business activities and partly in connection with non-business activities. But in that situation, the part of the overhead apportioned to the non-business activities does not come into account in the subsequent partial exemption calculations under Articles 17/19 or Regulation 101.

The analysis, therefore, is this in relation to costs which are not directly reflected in the output (costs directly reflected in the output being eg typically costs of component parts of a manufactured goods). Those costs are incurred in relation to an activity which by itself does not produce a supply but produces some other result (eg in Abbey National, the transfer of the going concern, in Kretztechnik the issue of shares and listing on the Frankfurt stock exchange). Since the purpose of achieving that result was (only) to benefit the economic activity in general of the taxable person, the cost incurred in producing that result is an overhead and therefore a component cost of the outputs. In this context, “economic activity in general” must mean the making of taxable or exempt supplies. It is clear that the Court in Kretztechnik was using the phrase to mean economic activities which stood apart from the activities under consideration (ie the activities resulting in the share issue and listing). The question was whether the activity under consideration could be regarded as an overhead of something else (ie economic activities in general); it is meaningless to ask whether something is an overhead of itself.

Kretztechnik, however, has nothing to say about the position where the activities to which the inputs relate have a result which is achieved for its own sake but which, at the same time, benefit the taxable person’s other, economic, activities. Nor does it have anything to say about the question whether an activity forms part of a taxable persons economic activity in the first place.

Before leaving Kretztechik, I should note one further point. If the court had concluded (in accordance with the submissions of a number of governments excluding the UK) (i) that the share issue was not a taxable transaction, (ii) that the expenses did not form part of the overall economic activity but were linked only the admission to the stock exchange and (iii) that those expenses had no direct link with the general business, then it would follow that VAT was not deductible. That accords with the general principles which I have considered above; but Article 17(5) would not come into play. The same would, of course, apply if the case had been an English VAT case in relation to an English company. The share issue would not have been part of the business of the English company so that the supplies would not be input tax as defined in section 24 VATA 1994 because those supplies would not be used for the purposes of any business carried on by the company. Regulation 101 would not come into play.

The next case to which I refer is Customs & Excise Commissioners v Yarburgh Children’s Trust [2002] STC 207 which is relied on by Mr Milne QC for the University. At paragraph 23 of his judgment, Patten J clearly holds that the motive of a person in making a supply is not relevant to, and cannot dictate the correct tax treatment of, a transaction. This is perhaps another way of saying what the ECJ said in Halifax (see at paragraph 11 above). But, as the judge says, the exclusion of motive or purpose does not allow the tribunal to disregard the observable terms and features of the transaction and the wider context in which it came to be carried out. The transaction looked at in isolation will not usually enable the court to decide whether it was carried out in the course or furtherance of a business (the test under section 4 VATA 1994) or a supply by a taxable person acting as such (see Articles 2 and 4 of the Sixth Directive). The question of the correct tax treatment cannot, the judge explained, be answered by reference to the fact that a service was provided at a price: that was the beginning not the end of the enquiry. It should be noted that Yarburgh concerned an activity which involved a supply in the ordinary sense of that word and the question was whether that amounted to an economic activity. It is not, I think, a particularly helpful authority when it comes to determining whether activities which do not produce a supply are either economic activities or overhead activities of other, economic, activities.

In order to succeed in its appeal, the University needs to show that the Tribunal were wrong in concluding that PFR was a wholly distinct activity and has to bring the case within the principles explained in Edwards v Bairstow [1956] AC 14. That is a case which is well-known to all practitioners who work in the field of taxation. It is, nonetheless, important to remember precisely what it does decide; and since there is some difference of emphasis in the submissions of Mr Milne and Mr Lasok QC,for the Commissioners, I think I should go back to the decision itself.

Viscount Simonds says this at p 29:

“…..though it is a pure finding of fact, it may be set aside on grounds which have been stated in various ways but are, I think, fairly summarized by saying that the court should take that course if it appears that the commissioners have acted without any evidence or upon a view of the facts which could not reasonably be entertained…”

Lord Radcliffe puts the point at greater length at p36 in the oft-cited passage:

“…..it may be that the facts found are such that no person acting judicially and properly instructed as to the relevant law could have come to the determination under appeal. In those circumstances, too, the court must intervene. It has no option but to assume that there has been some misconception of the law and that, this has been responsible for the determination. So there, too, there has been error in point of law. I do not think that it much matters whether this state of affairs is described as one in which there is no evidence to support the determination or as one in which the evidence is inconsistent with and contradictory of the determination, or as one in which the true and only reasonable conclusion contradicts the determination. Rightly understood, each phrase propounds the same test. For my part, I prefer the last of the three, since I think that it is rather misleading to speak of there being no evidence to support a conclusion when in cases such as these many of the facts are likely to be neutral in themselves, and only to take their colour from the combination of circumstances in which they are found to occur.”

And at the end of his speech he says this:

“Their [the courts] duty is no more than to examine those facts [ie the facts found by the commissioners] with a decent respect for the tribunal appealed from and if they think that the only reasonable conclusion on the facts found is inconsistent with the determination come, to say so without more ado.”

I would only add that, where a tribunal has taken into account evidence which it should not have taken into account, its findings of fact may be open to challenge on that ground as well.

Mr Milne submits that the present case is such a case. In particular, he says that, in arriving at its conclusion that PFR is a “completely distinct” activity of the University, the Tribunal appears to have accepted, but then ignored in its entirety, clear evidence given on behalf of the University that PFR is not separate but is integral (and indeed vital) to the University’s business as a whole.

Although the University wishes to establish that its PFR is carried on by it as part of its overall business for VAT purposes in order to be able to deduct input tax on supplies made to it and used in the course of its PFR, not all universities wish to be treated in a similar way. Perhaps the most important reason for a university to wish to establish a different treatment from that which the University wishes to establish is to be able to claim zero-rating for a purpose-built research centre under Item 2(a) of Group 5 of Schedule 8 VATA 1994, on the ground that the centre is to be used for a relevant charitable purpose otherwise than in the course of furtherance of a business.

Cambridge University, for instance, wishes to treat its own PFR as entirely separate, although this is a position which it says it has consistently taken even before the introduction of the zero-rating for purpose-built research centres just mentioned. Evidence was given by Mr Sykes to explain Cambridge’s approach; but in doing so he was careful to restrict himself to Cambridge and expressly acknowledged that some other universities might have a different approach which might lead to a different VAT treatment.

There is, it is accepted by the Commissioners, no reason in principle why the treatment of PFR for VAT purposes has to be the same for every university. Whether a particular activity is or is not carried out as part of a university’s overall business for VAT purposes is a question of fact. The factual matrix might vary between universities and the VAT treatment may therefore differ. However, there are bound to be similarities across all research institutions in both the purposes of PFR and the motives for carrying it out. It is important not to draw artificial distinctions in reaching one conclusion in relation to one university and the opposite conclusion in relation to another. There is, it can be seen, a tension facing the Commissioners who wish to see as consistent an approach as possible applied across the board with different results, if there are to be differences, being clearly justified on the facts of each case.

The Commissioners themselves have changed their approach over time. This can be seen from the external and internal guidance which they have produced between 1997 and the present time, an aspect dealt with in paragraphs 42 to 51 of the Decision. Having historically treated PFR as a business activity, the Commissioners reviewed their position following on from some universities challenging that treatment. Guidance produced in 2002 distinguished between (i) commissioned research (eg for a sponsoring commercial organisation for a fee) where the client received the right to exploit the outcome of the research and (ii) university-led research which was initiated by the university itself and was funded in whole or in part by research grants. Commissioned research was regarded as a business whereas university-led research was not necessarily so regarded. The only research which could categorically be viewed as a non-business activity was research (i) which was solely grant funded (ii) where there was clearly no intention to produce exploitable intellectual property rights (iii) where there was no discernible student involvement (ie professional researchers only) and (iv) where the outcome of the research was not intended to further directly the university’s other business activity. The relevance of (ii) and (iv) to negating business use is obvious; the relevance of (iii) is based on the proposition that student involvement (particularly by graduates in the furtherance of work on a higher degree) could be viewed as part of the university’s supply of educational services. The guidance concluded that non-business research was the exception rather than the rule. It showed, however, that the Commissioners regarded the question as one of fact in any particular case.

Mr Milne emphasises, and agrees almost entirely with, paragraphs 12, 13 and 16 of the Guidance (paragraphs (i) to (iv) above reflecting paragraph 16 of the Guidance). In particular:

In May 2003, further Guidance was prepared. This represented a change of position from accepting that PFR was likely to be a business activity to a position where the more likely position was that it was not a business activity. But, consistently, one there sees a recognition that there is no hard-and-fast rule and the question is ultimately one of fact. The Guidance repeated that grant funding did not of itself make the research a non-business activity, repeating in substance the examples provided in the earlier Guidance. However, the Commissioners stated that it was no longer the position that they would take at face value without investigation claims that PFR is undertaken with a view to developing exploitable IP rights. Further they addressed the argument that, where research was intended to be used internally to further additional research or to improve the provision of education, the activity remains a business activity because it is carried out in furtherance of the overall business of the university. The Commissioners were “no longer inclined to accept this argument unless clear business imperatives can be demonstrated” a matter enlarged on in paragraph 18 of the Guidance.

Further, as to student participation in research, the Commissioners were no longer willing to treat PFR as a business activity “solely by virtue of the fact that fee paying students are involved”. This followed from a change in their understanding of how students actually participate in research. That would not preclude, I think, any particular university from establishing that its own students participated in such a way that a relevant business link existed.

The Commissioners were no longer prepared to take claims that PFR constituted a business without supporting evidence. Accordingly, if a university claimed that its research was driven by business imperatives, they required evidence to support that contention on a project by project basis. Indicators would include (i) whether the PFR is of a type which would produce commercially exploitable IP rights (ii) what evidence is available to support the contention that the exploitation of IP rights was a specific reason for the research (iii) whether there was an intention to publish in the public domain the results of the research (iv) whether the IP rights were to be passed on to a third party or to belong to the researcher and (v) the university’s record in exploiting IP rights from PFR.

The differences between the two Guidance notes mark a shift in practice. But I doubt they indicate any, or any significant, change in principle or view of the law. Whether PFR generally, or a particular PFR project, is or is not an economic activity or a business remains a question of fact. Whereas, in the past, the Commissioners were prepared to accept at face value claims that the university intended to exploit IP rights (and thereby to establish the relevant PFR as a business activity), for the future it would require evidence, and would do so on a case by case basis. The potential for commercial exploitation, and the intention to exploit any such potential, are no doubt factors, and important factors, in the overall picture. Whether or not there is such potential and whether there is such intention are not matters on which it is possible to draw an a priori conclusion either way but no doubt the factors adumbrated by the Commissioners in the Guidance will be highly relevant in reaching a conclusion. However, the question whether a particular piece of PFR is a business activity or not must be answered (whether by the Commissioners or the Tribunal) in the light of all the facts before them.

As a matter of principle, the Commissioners must surely be correct in saying, as they do in the later Guidance, that whether or not a project is business or non-business must be determined by the facts of the case in point ie on a project-by-project basis. No doubt, for any given university, there will be factors which apply to each and every one of its projects; but there are bound to be factors which are unique to individual projects, and in particular, the potential for exploitation of IP rights may differ significantly between projects. The status of a particular project must be assessed by reference to the facts relevant to that project albeit in the context of the activities of the university concerned as a whole, although it may be that included in the relevant factual matrix will be facts relating to other PFR projects (as indeed the Commissioners seem to recognise in the fifth factor mentioned at the end of 43 above).

Whether it is correct to look, as the Commissioners suggest in the Guidance, at the intention of a university in relation to the exploitation of PFR might be open to question in the light of the approach in Halifax. However, if the result of PFR is, in a particular case, exploited so that there is clearly economic activity at the end of the day, an objective assessment of the facts might be made at an earlier stage to show that the PFR is part of a larger activity intended to extend into the future.

Mr Milne points out that there were 5 witnesses called on behalf of the University and that there was nothing which any of them said with which the Tribunal disagreed. That evidence, and indeed the Tribunal’s findings, establish he says that PFR is not “completely distinct” from the University’s other activities but is integral (and indeed vital) to its business as a whole. Their evidence, and the findings which they made, lead, he submits, to only one conclusion, namely that PFR formed part of the overall business of the University for VAT purposes. However, instead of reaching that conclusion, the Tribunal reached the opposite conclusion because, according to Mr Milne, the Tribunal took account of statements from other witnesses and other material which were irrelevant to the present case, for instance the evidence of Mr Sykes about how Cambridge viewed its PFR and why. The Tribunal, Mr Milne says, went “hopelessly wrong by veering away from the evidence”. It is necessary to consider that findings of fact in some detail to see whether that submission is correct.

The Tribunal’s findings of fact are contained in paragraphs 16 to 57 of the Decision. I note the following, which include particular paragraphs on which Mr Milne and Mr Lasok rely:

Paragraph 17: the University is a charity and carries on business making supplies of education and undertaking commercial research. It has nearly 20,000 students and 5,000 staff of which 1,000 are research staff. Its total income in 2002/3 was £250 million. This included Funding Council grants of £85 million, academic fees of £50 million, research grants and contracts of £71 million with the rest being other operating income. Of the research grants and contracts, approximately one quarter (ie about £18 million) came from commercial sponsors and the rest from public funds. Only £95,000 or thereabouts came from the sale of IP rights. One can see, therefore, that PFR was a significant part of the University’s overall activities and that a tribunal might start with an initial impression that PFR had a life of its own and was not merely an overhead activity of the University.

In that context it is worth remarking that everyone concerned in the present case has referred to PFR as something which it is possible to identify. This is not surprising. PFR relates to defined projects, identified in the funding applications which are made for finance. It is carried out with a particular objective. And it results in an identifiable outcome, typically the research paper. Whilst there was evidence before the Tribunal to establish that some, at least, scientific research is carried out at the same time, by the same people and using the same facilities as other research, the results are entirely separate. Compare a manufacturer, say a skilled cabinet maker who, as a hobby, makes model aeroplanes using the same workbenches, the same tools and even the same sort of wood as he uses to make his furniture for sale. He even carries out his model-making activities at the same time as his professional activities, using glue he has mixed for one in the course of carrying out the other. It makes perfectly good sense to refer to his model-making activity as a separate activity notwithstanding the identity of the tools, the facilities and the personnel (the cabinet maker himself) involved in both activities. And in relation to input tax on any items used for both activities it would either have to be apportioned under section 24(5) or appropriated to the trade with use for model-making being treated as a self-supply.

Paragraph 18: The University treats all research as a serious activity and is held accountable by its sponsors for the use of research funds. It is in competition with other research establishments for the limited funds available and so seeks to ensure that the results of its research are of high quality and are good value for money. Published findings are peer-reviewed and scrutinised and measure the University’s reputation as a research institution. [I add here that it is implicit in that finding that the results of research are, on occasions, published - indeed, one would expect this to be the case with PFR.] The University regards it as important that it should achieve high rankings in published research in order to support its reputation. Successful research can lead to more grants which promote further research. I note that this is not a finding – and there is no such finding elsewhere in the Decision – that PFR projects, or indeed commercially sponsored projects, are selected solely or mainly for financial advantage to the University.

Paragraph 19: A research grant (the Tribunal is here looking at PFR) is applied for by a member of staff who has an interest in a particular field, putting forward a proposal for funding. The proposal might be tailored to meet the specific programme of funding of an individual sponsor. Mr Milne criticises the Tribunal for relying on the evidence of funders about their criteria for and purposes in providing funding, saying that what is relevant for VAT purposes is what the University, not the funders, considered to be the purpose of the funding it receives for PFR. However, as Mr Lasok observes, it is understandable that the Tribunal considered the views of funders to be relevant when the University itself was tailoring its proposals to meet the requirements of funders. I agree with Mr Lasok: it is unrealistic, in my judgment, to think that such evidence is irrelevant. Indeed, I consider that the requirements of funders are part of the wider context which, as Patten J says in Yarburgh, the Tribunal was obliged to take into account.

Paragraph 21: Although undergraduate teaching can be successfully delivered in a university which does not undertake a great deal of research, postgraduate teaching usually relies upon academic staff who conduct research and who are up to date with research techniques. It does not, of course, follow from that finding that research is carried out with a view to attracting graduate students any more than it follows that graduate students are attracted in order to facilitate research. It would not be at all surprising to discover that good graduate students follow good research and that good research is assisted by good graduates; but whether there is a “direct and immediate” link between the two activities (graduate teaching and research) for VAT purposes is a different question.

Paragraph 22: This deals with research assessment. A research assessment exercise is carried out approximately every 5 years by government to assess the research carried out by individual university schools. It is quality based and there are two critical factors taken into account: First, results in terms of peer-reviewed publications. Secondly, the strategic statement which links together (i) research aims and objectives (ii) the way in which research is integrated and (iii) how the research is exploited. One of the main results of publicly funded research is the report which is produced at the end of the research and there is a strong co-relation between high performance in PFR and ratings in the research assessment exercise. The ratings affect the overall success of the University and its ability to attract high quality staff and students.

Paragraph 27: The direct costs of a research project are always recovered in full regardless of the sponsor. The only exception is that some public sponsors do not always pay for the cost of supervising staff or existing permanent staff. The overhead costs of a research project are normally recovered in full from commercial sponsors but are not normally paid in full by public sponsors. However, a public sponsor will normally allow the recovery of overhead cost on a “cost plus” basis, namely a fixed percentage of the direct costs. The shortfall in the recovery of the overhead costs from a public sponsor is met by the grant from the Higher Education Funding Council for England (“HEFCE”). Thus ultimately the overhead costs of both commercially sponsored research and PFR are recovered in full.

Paragraphs 28 and 29: [28] Infrastructure and equipment which has been purchased for a research project can be used for future commercial or publicly funded research projects or for teaching or consultancy work regardless of whether it was paid for by a public or commercial sponsor. [29] Every research project, whether commercially or publicly funded, is carried out at the same time, in the same manner, often by the same staff, using the same equipment infrastructure and departmental space and within the same guidelines. Reading that last finding in context, what the Tribunal is saying, I think, is that there is overlap in the use of facilities and staff when different research projects in similar fields are being carried on simultaneously. Mr Milne points out that these findings mean that equipment and facilities, including laboratories and other buildings, can be used for other aspects of the University’s activities including carrying on its parts of its VAT business such as teaching and consultancy. He draws a distinction with some other universities (eg Cambridge) which, he suggested, used some of their new buildings solely for PFR. There was no evidence before the Tribunal that that was the case. Nor is it an inference which can be drawn from the fact that certain new buildings are zero rated for VAT in the light of an extra-statutory concession which permits zero rating to be claimed when the non-charitable use does not exceed 10%. In reaching its conclusions, I note that that Tribunal expressly referred to, and therefore had well in mind, their findings in paragraph 29.

Paragraphs 30 and 31: These deal with the commercial exploitation of research. [30] Each sponsor has its own rules about who owns the IP which a research project generates. Where research is commercially funded, a supply of IP is almost always made to the commercial sponsor. In the case of PFR, no supply of IP is made to the funding body; the University retains the IP to exploit or use as it sees fit. [31] The University’s policy is to maximise the commercial exploitation of all research. IP rights can be exploited through direct sale or through licensing in return for royalties, or by means of a number of patents being packaged together for use by a spinout company (an aspect dealt with in paragraphs 32 and 33 of the Decision). IP derived from research also contributes towards the University’s consultancy activities and its future research collaboration with both commercial and public sponsors. One must be careful about the finding in paragraph 31. Mr Milne submitted that the University’s policy is to use PFR to exploit IP rights by which I understand it to be suggested that exploitation of IP is the driver for the selection of projects for which application for public funding is made. Mr Lasok says that there is no evidence for that assertion: what the Tribunal is saying is no more than that if and to the extent that IP rights arise as a result of PFR, the University’s policy is to exploit those rights. That, he says, is a very different thing from saying that the selection of projects is driven by the potential for exploitation. I agree with Mr Lasok.

Typically, however, the fruits of a research project are published in the public domain – in practice for the public good and in the advancement of knowledge whatever may have been the motivation for the project in the first place. PFR is, indeed, sometimes referred to as “blue sky” research just because it is open and has no application in view. It should also be remembered that PFR, generally and in the University, is not restricted to laboratory based scientific work: it can include other types of research with its results being published in a learned journal.

Paragraph 34: This deals with the development of research from grant to spin-out company. PFR or commercially funded research which does not produce any exploitable IP may lead to further research which may produce exploitable IP. Thus all research projects may eventually lead to the creation of exploitable IP. One sees the use by the Tribunal of the word “may” three times; equally, any given research project may eventually not lead to exploitable IP and, unfortunately, one cannot know in advance which research will be successful and which will not. As a matter of fact, it is a minority of research projects which do lead to exploitable IP. Examples are given of two success stories in paragraphs 35 and 36.

Paragraph 38: This deals with financial management of the University. Each academic school is treated as a separate accounting centre rather than each activity undertaken by the University being treated as the primary basis for financial reporting. Thus each academic school manages itself as a business unit. [The Tribunal is not here using the word “business” as meaning a VAT business but is, rather, referring to the entire activity of a particular school as its “business”.] Each school is provided with about half of its budget by the University (out of central sources of income including grants from HEFCE) and then has to make up the balance from PFR, commercially funded research and consultancy services. In this way, all research activities are seen as part of each school’s budgeted activity and heads of school are charged with delivering a financially sustainable portfolio of activities allowing more or less profitable activities to coexist side by side. Mr Lasok makes two observations about this. First, he says, and I agree, that this simply means that each school has to be self-sufficient and that these findings add nothing to the debate about whether PFR is part of a VAT business: we all have to balance our books, as he puts it. Each activity, in that sense, supports the other but in the real, in contrast with the VAT, world, PFR is no more an overhead cost of education than is commercially sponsored research; indeed, given that PFR is such a significant part of the University’s overall activity, there is no more reason to view, in the real world, PFR as an overhead of education rather than vice versa. Secondly, he says that PFR is effectively self-funding and is by its nature already in balance: as to that, I am not sure that that is the position since overhead costs are not necessarily recovered in full and it is necessary for those to be covered by other sources such as the HEFCE grant.

Paragraph 39: It is one of the University’s overall objectives that the activities of each school should add to the University’s status as a research and teaching institution. No distinction is drawn here between PFR and commercially sponsored research and there is no reason to think that there is any distinction in the mind of the University. Again, this shows that PFR has, at least as one of its purposes, a purpose which goes beyond the University’s taxable activities, namely enhancing its reputation in the field of PFR: the University enhances its reputation in PFR not because it is an activity supportive of other activities but because it is an activity in its own right. Or perhaps I should say “not just because” rather than “not because” since each activity which enhances the University’s overall reputation can be said to support each and every activity of the Unviersity.

Paragraph 54: This sets out the view of Cambridge. Undisputed evidence was given by Mr Kerry Sykes, the Deputy Director of Finance of the University of Cambridge. Mr Sykes considered that it was important, in view of the potential impact of the decision for many universities, that opposing views within the sector should be heard and considered by the Tribunal. He set out the position of Cambridge:

Mr Milne does not dispute that these are the view of Cambridge in relation to the manner in which it carries out the activities which it does. He says, however, that it is irrelevant to the present case which concerns Southampton University (i) how Cambridge University views the activities which it carries out and (ii) what the correct treatment of those activities is. He draws attention to the qualification which Mr Sykes himself placed on his own evidence:

“…..it is important to remember that universities are separate independent institutions with their own procedures for governance. Whilst there are broad charitable and social aims applicant to the sector as a whole, each institution will have its own agenda and motivations for entering into transactions or undertaking particular areas of activity. It is therefore possible for me to comment on the policy and procedure of our own university; but not that of any other institution or the sector as a whole. Furthermore, I believe that it is entirely possible that the differing behaviour and approach of separate institutions may mean that it is possible that transactions which initially seem identical may incur a different VAT treatment when considered in the context of the individual institution’s behaviour.”

Mr Milne cries that “the Tribunal paid no heed to this warning”.

Paragraphs 55: This deals with the views of the research councils. The undisputed evidence on behalf of various research councils was that they awarded research grants in order to contribute to specific research projects which were likely to lead to an advancement of knowledge. [I observe that even the University must surely have that as one of its purposes in carrying out research.] Grant holders were expected to publish the results of their research and there was no requirement or expectation that results of industrial or commercial value should be obtained. If such results were obtained, the research institution would be encouraged to exploit them or make them available for commercial exploitation for the benefit of the UK economy. Normally, the IP would vest in the research institution which was entitled to retain any income arising from any exploitation arrangements. Mr Milne points out that even the councils recognise the potential for commercial exploitation. But that does not, I consider, assist Mr Milne since, to the extent that it is relevant at all, their evidence is to the effect that the councils actually fund research for the (non-business) purpose of the advancement of knowledge and not for commercial exploitation.

Paragraph 56: This deals with the views of the Wellcome Trust. This is an independent research funding charity promoting biomedical research with the aim of improving human and animal health. It funds research which will advance knowledge but will not have as a primary aim the development of a therapy or diagnostic device. Any useful results from the research which it funds are to be disseminated for the public good. It is only very occasionally that the research will result in a discovery with the potential for therapeutic or diagnostic development. IP rights, when they are produced, cannot be exploited without the consent of the Trust. Consent is given in return for a share of the potential income. The University has been in receipt of grants from the Wellcome Trust for many years.

Mr Milne says that the views of the funding councils and of the Wellcome Trust are irrelevant. I disagree. As I have already observed, [see 52 above] research projects are selected by staff, and proposals are put forward taking account of the funding criteria of the funders. There is no point in making a proposal which is known is unlikely to attract funding. The views of the funders in respect of the type of research which they will fund, and their reasons for doing so, must therefore be relevant to the process of selection by staff. It is necessary to look at the type and inherent nature of the projects which the funders are willing to fund and their purpose in funding. The Tribunal was right to consider this evidence although it is, of course, not determinative in any way of the question whether the research is, or is not, a business activity.

Before the Tribunal, the University argued that the entirety of its PFR was a business activity and that the entirety of the VAT on supplies used for PFR fell to be included in the partial exemption calculation as residual tax. The Commissioners did not, before the Tribunal, take the opposite extreme that none of that VAT could be included. Whilst the skeleton argument from Counsel (not those appearing before me) stated that the Commissioners considered it unlikely that all the research activity inputs of the University were used exclusively for economic activities, their position was that it had always been open to the University to seek to satisfy the Commissioners on the basis of evidence (ie evidence directed at each project) that all its research inputs are in fact actually used for business purposes; but the University had consistently refused to carry out a business/non-business apportionment.

There can be no doubt, in my judgment, that the University could, if it wished, conduct some of its PFR in such a way that it is a non-business activity. The question must be, therefore, in relation to each separate PFR project whether that project is a business activity. General evidence about how the University perceives its PFR activities in general is not conclusive in any particular case. The University decided to pursue its appeal on the basis of the evidence which it produced: from what I have seen of it, it deals in generalities and the Tribunal’s findings, too, are general. In the absence of specific evidence (eg that a particular piece of PFR was carried out with a view to exploitation of IP rights and thus as an economic activity) the question for the Tribunal was whether general evidence about how the University conducted research was enough to establish, in effect, that all PFR was a business activity. The Tribunal decided that PFR was not, on the basis of that evidence, a business activity but was a separate and distinct activity.

The Tribunal give their reasons for their decision, and reach their conclusion, in paragraphs 60 to 95 of the Decision. In paragraphs 62 to 74, they consider the authorities (mainly national) between 1979 and 1992; in paragraphs 75 to 87 they consider the decisions of the ECJ between 1995 and 2002; and in paragraphs 88 to 94 they consider the recent authorities (but not Kretztechnik the judgment in which was delivered on 26 May 2005 after the handing down of the Decision).

The Tribunal refer in paragraph 72 to the decision in Imperial War Museum v Customs & Excise Commissioners (1992) Tribunal Decisions 9097, a decision of the VAT tribunal. There the museum normally charged entrance for admission but allowed some categories of visitors, and all visitors on Fridays, to enter free of charge. The issue was whether the museum should restrict its claims for input tax. The tribunal found that the activities of the trustees of the museum in running the museum amounted to a business. The business activities included the main activity of admitting paying visitors and the predominant concern was that of making taxable supplies. The trustees were still carrying on a business when they admitted non-paying visitors even though such admissions were not taxable supplies. Later, in paragraph 73, they say that they found this the most favourable authority to the University: but they distinguish it on the basis that they do not “see [PFR] as being subsidiary to a main function of providing commercial research. About three-quarters of all research activity is PFR and one quarter commercial….the predominant concern of [the University] is not making taxable supplies as most of its activities are funded by grants”. And they end paragraph 73 by saying that the University undertakes both business and non-business activities.

In paragraphs 75 to 87 of the Decision, the Tribunal consider the more recent jurisprudence of the ECJ. Reference had been made earlier to the decision of the ECJ in BLP Group plc v Customs & Excise Commissioners (Case C-4/994) [1995] STC 424 (where the ECJ held that input tax could only be claimed in respect of goods or services which had a direct link with taxable transactions). Mr Milne had relied on [25] of the judgment where the ECJ made it clear that services whose costs form part of a taxable undertaking’s overheads, and hence cost components of its products, were also used by a taxable person for its taxable transactions. The Tribunal concluded that the principle in [25] did not assist the University. They did not regard the goods and services used in PFR as being part of the University’s overheads nor as part of the cost components of the University’s other products (education or commercial research). They were part of the cost components of what is essentially a separate non-business activity of the University which does not make any supplies. Mr Lasok submits that this is the only conclusion which the Tribunal could have reached given their findings in paragraph 27 of the Decision.

The Tribunal considered a number of cases to demonstrate what was, in any case, common ground namely that there was no direct and immediate link between the input transactions used in the PFR and any output transactions. But then the Tribunal went on, in paragraph 82 to say this: “Neither are the goods and services used in [PFR] part of the [University’s] general business costs. None of the supplies used to provide [PFR] are cost components of the other products of the [University], be they supplies of education or of commercial research or of intellectual property rights”. And, after considering Abbey National (which they found of assistance) in paragraph 84 they concluded that the goods and services acquired by the University for use in PFR have a direct and immediate link with what they called its non-business activities which is a clearly defined part of the activities of the University.

Mr Milne has a number of criticisms of the Tribunal which I summarise before turning to Mr Lasok’s responses and my own conclusions (although I make some comments as I go along):

Mr Milne developed his argument in relation to the interrelation and interlinking of commercial research and PFR. Relying on Imperial War Museum v Customs & Excise Commissioners (1992) Tribunal Decisions 9097 (which was a tribunal decision not a decision of the court) he says that any materially indistinguishable extension of an activity carried on by a trader in the course of his business will be part of the same VAT business even if it does not involve the making of supplies. He may be right in that but I do not think that that is quite what the Tribunal held. Rather, it said that in admitting members of the public free at certain times and in charging them at other times, it was carrying on only one business activity for the purposes of Regulation 30(1)(c) of the then General Regulations (now reflected in Regulation 101(2)(c)). But that was against the background of an overall business (carried on by the trustees of the museum) the success of which depended on getting as many people through the door as possible thus enabling them to increase merchandising turnover and the appeal of the museum to sponsors. The business activities “included the main activity of admitting paying visitors together with the related activities of exploiting the merchandising and catering opportunities and providing sponsorship facilities. The predominate concern is that of making taxable supplies”. Indeed, in that case, the Commissioners accepted that the Trustees continued their business throughout the year and were as much carrying on their business when the admitted paying visitors as when the admitted non-paying visitors. The reference to predominate concern would now appear to be inadmissible in the light of the more recent authorities which I have mentioned.

In the same vein, Mr Milne also sought to derive an apparently general proposition from Cumbrae Properties (1963) Ltd v Customs & Excise Commissioners [1981] STC 799 (at 804b) that this will be so where the activity in question is “interrelated to the overall objects” of the trader and “intrinsically part of” its overall business – in saying “this will be so” he is referring back to the proposition I have just attributed to him in relation to Imperial War Museum. In Cumbrae, a company had as its main purpose the holding and managing of let properties in the UK and Australia. Among its other business activities, the company paid all the expenses of the Marquis of Bute in connection with his activities in relation to the subsidiary companies. In order to take advantage of membership of a pension scheme provided for employees of that company, a number of employees of the Marquis of Bute (who owned 90% of the shares in the company) or of subsidiaries of the company resigned their employments and became employees of the company. The employees remained doing precisely what they had done before. The company paid their salaries and pension contributions; but the company was reimbursed by their previous employers. It was common ground that the company was a taxable person making a taxable supply for a consideration to the original employers. But it was said by the company that this supply was not made in the furtherance of its business in effect claiming that its business did not include this supply. Both the tribunal and the court dealt with the case without reference to EC legislation. The tribunal (whose reasons and conclusions were accepted without qualification by the judge) concluded that the services of the employees were supplied in the course of the company’s business “since by seconding them it is supplying services to facilitate the business activities of these subsidiary companies and it is employing them in order that they shall benefit from the [pension scheme]. In doing this we hold that there is a sufficient nexus between its acting as a holding company of the subsidiary companies and the services supplied”. It was to capture that same idea that the judge described the supply as “interrelated to the overall objects of the company in that it is intrinsically part of a normal business activity to make pension provisions”. I find that last statement difficult to understand and do not think it supports the wide general proposition which Mr Milne seeks to establish.

It is common ground that commercially sponsored research forms part of the University’s business, as Mr Milne points out. But I would point out that that (ie the common ground) is so because supplies are made for a consideration; it is not because this research is interrelated with other taxable transactions such as the provision of education. Then Mr Milne says (notwithstanding his rejection of aim and motive as of relevance) that PFR forms part of the University’s (VAT) business if the University can demonstrate a genuine intention that the research will lead to the creation of commercially exploitable IP rights. I am not sure that the Commissioners would accept the accuracy of that way of putting it, but it is not in dispute that if PFR is carried out with the principal aim of exploiting IP rights, then it forms part of the University’s VAT business. This will be, I think, not because the aim, or motive, of the University is to exploit the results of the PFR, but rather because the facts in relation to a particular piece of PFR, objectively viewed, lead to the conclusion that the PFR is a preliminary expense of a proposed business whose purpose will be the exploitation of the IP rights.

In relation to Mr Milne’s points about there being a single integrated business, Mr Lasok says that this is simply an assertion which seems to be based on the assumption that, if some part of the University’s activities can be characterised as a “business” activity, then to follows automatically that every other part must also be given the same characterisation. I agree that it does not follow logically, in the context of VAT, that whatever a taxable person does must be a business activity: that is clear in the light of the provisions of the VAT legislation which distinguish between situations in which a taxable person is acting “as such “(Sixth Directive Article 2(1)) or “in the course or furtherance of business” (section 4(1) VATA 1994) and situations in which he is not. However, I do not think that was what Mr Milne was saying. Rather, his submission was that the facts as found by the Tribunal could only lead to the conclusion that there was a single integrated business.

Mr Milne is no doubt correct in saying that PFR is capable of being included with the business of the University using the word “business” in one of its ordinary senses. And, had the Tribunal held that PFR was a wholly distinct activity - in the sense that it did not form part of the overall business of the University in that sense - he might well be right in saying that the conclusion was not one to which the Tribunal could properly have come. But I do not think that his criticism of the Tribunal is well founded since I do not think that that was what they were saying. Rather, what they meant (see further at 72 above) was that PFR was distinct in the sense that its PFR activities had no relevant relation to the other, economic, activities of the University.

Mr Milne placed considerable reliance on the value of PFR in enhancing the reputation of the University. The mere fact that an activity enhances the reputation of a trader’s business does not mean that that activity is a business activity. I for one would not quarrel with tribunal decisions such as Hubbard & Houghton Ltd LON/80/314 VTD 1028 and Fenwick Builders Ltd LON/90/928Z VTD 5801 where the purchase of high performance, prestigious motor cars, was not allowed as a business input even though use was made of them for enhancing the image of the business. In contrast, advertising which has no discernable purpose other than to enhance the reputation of the business or to sell its goods is clearly a cost giving rise to deductible VAT. It does not necessarily follow from the findings that PFR attracts good staff and students and that PFR is a reputation-enhancing activity, that it is part of the University’s business; it is, of course, a factor to be taken into account.

Mr Milne suggests that the Tribunal simply looked at PFR in isolation and thus fell into error. They certainly were aware that, viewed in isolation, PFR would not be a VAT business; but that is not, as I read the Decision, the basis of their conclusions. I reject any criticism of the Tribunal on this count.

Reliance has been placed by Mr Milne on the University’ charter which shows that the University is a teaching and examining body and shall further the prosecution of research. The same point is made by Professor Gregson when he says that the University’s “primary function is to create and translate knowledge for social, cultural and economic development. Research underpins the creation of knowledge, so research is at the cornerstone of the University”. No doubt that is true. But I fail to see why it helps to resolve the correct categorisation of PFR. It might equally well be said that it shows research to be a distinct activity which does not take its colour from any other activity; it is then a question of determining whether PFR is to be separately categorised from commercial research for VAT purposes.

Nor does it follow, in my view, from the finding that research, whether commercial or PFR, is carried on by the same people using the same infrastructure and to the same standards, that commercial research and PFR are therefore to be treated in the same way for VAT purposes. The context of each type of research is entirely different, not least because commercial research itself involves a supply and is for a consideration, whereas PFR has neither characteristic. The finding is, I do not dispute, a factor to be taken into account, but is certainly not conclusive and not, to my mind, particularly persuasive. As Mr Lasok says, a taxi driver taking his family to the cinema in his taxi is not carrying on a business activity notwithstanding that he is the same driver, using the same cab and driving with the same standard of care as when transporting a fare-paying passenger. And in similar vein, I have, at paragraph 50 above, considered the position of the cabinet maker who makes models as a hobby.

Similarly, I think that Mr Milne’s reliance on the Tribunal’s findings at paragraphs 18 and 31 of the Decision and on the evidence of Professor Gregson is misplaced. Indeed, I think that this reliance highlights what I perceive to be a misreading of what the Tribunal is really saying when it refers to PFR as being completely distinct. Returning to the cabinet-maker example, it makes perfectly good sense to describe his activity in making furniture as “completely distinct” from his activities in making model aeroplanes notwithstanding that the same skills and equipment are used in each activity: what such a description means is that there are distinguishing features between the two activities which constitute a valid reason for treating them completely differently in the particular context under consideration ie their VAT status. The position is the same in relation to PFR. There is nothing inconsistent, or to my mind even surprising, in describing commercial research and PFR as completely distinct in the context of the business/non-business context, although one can see from paragraph 18 of the Decision the importance of PFR to the University in terms of its reputation including – at least there is no reason to exclude - in particular its reputation as a research institute. But the totality of the findings in paragraph 18 are, in my judgment, entirely consistent with the finding of fact that PFR is a distinct activity of the University even if conduct of PFR enhances not just the research reputation of the University but also its profile generally making it more attractive to students and conference facility users alike. Further, it is not so easy to explain how the totality of these findings sits comfortably with the proposition that PFR is no more than a support activity of the University’s other activities (principally commercial research and education) and not an independent activity.

Mr Milne’s relies (see paragraph 54 above) on the fact that each University school is a self-contained accounting centre. That is certainly not a conclusive factor and, indeed, I think it carries very little weight, but I can see that it is a factor to be put in the balance and is of some small assistance to the tribunal charged with weighing the balance.

There can, I think, be no challenge to the Tribunal’s these findings in paragraph 64:

The Tribunal, as part of the finding at d. above, went on to say “but [PFR] is undertaken for the advancement of knowledge”, concluding that all these factors indicated that the carrying out of PFR is not a business (something which is now common ground in the sense that there is no free-standing business). As I have already remarked, not even the University could say that PFR as undertaken by it does not have as one of its purposes the advancement of knowledge; at the very least, the evidence is sufficient to allow that conclusion to be reached. Different question are, however, whether it is a predominate, motivating, purpose (although that is not a relevant question) and whether the PFR has a business purpose as part of the overall activities of the University.

In relation to finding a., I repeat what I have already said, namely that the evidence of the funders about what projects they fund and why they do so, and the evidence of Mr Sykes about how another leading research institution views its own PFR, are relevant factors in assessing the University’s activities. There is nothing which offends logic in holding that the purpose of the recipient of funds in receiving and applying those funds is different from the purpose of the provider in providing those funds in the first place. But it is important to examine critically why this should be so, especially when the recipient is well aware of, and indeed tailors its application for funds, to the requirements of the funders. In the absence of clear evidence leading to such a conclusion, the natural and perfectly proper inclination will be to think that there is no difference in purpose. Similarly, the evidence of another institution (ie Cambridge in the present case) explaining how it regards its PFR is not irrelevant, especially where its purpose coincides with those of its funders, although the Tribunal must bear in mind that the categorisation of the PFR is fact-dependent; it does not follow, either logically or necessarily as a matter of fact, that the correct approach for Cambridge is the correct approach for the University or vice versa.

I turn to Mr Milne’s particular criticisms of paragraph 70 of the Decision. The Tribunal stated, in the first sentence of paragraph 70, their view that the activity of the University in carrying out PFR “is an activity completely distinct from its other business activities of education and commercial research and it not part of one single business”. The Tribunal, by this stage of their decision, have clearly moved on from the question of the status of PFR viewed in isolation and are asking themselves whether PFR forms part of a larger business. In reaching that conclusion they expressly refer to the following:

Mr Milne says that the critical first sentence of paragraph 70 is inconsistent with the primary findings of fact and that the factors set out in a. to f. above (especially bearing in mind the error alleged in f.) do not justify the conclusion. Mr Lasok says that there are in fact no findings in the Decision which are inconsistent with that conclusion and submits that what Mr Milne is really saying is the University simply disagrees with the inferences which the Tribunal have drawn.

Mr Lasok submits that, in referring to “its primary aim” the Tribunal is here talking about the primary aim of the PFR not the primary aim of the University in carrying out the PFR. In the light of the Tribunal’s earlier discussion, it seems to me to be unlikely that, in paragraph 70, they were referring to the aims of the University rather than the object of the PFR itself. Viewing the PFR objectively in the light of its inherent nature (inherent nature being said by Mr Milne to be a relevant factor) the conclusion that PFR had as its principal aim the advancement of knowledge was a conclusion which the Tribunal were entitled to reach. Even if one were to disagree with that actual conclusion, it seems to me that it would be perverse to conclude that the advancement of knowledge was not either a significant purpose or a significant result of the PFR. I do not consider that there is any tension between, on the one hand, that conclusion or the conclusion that PFR is a distinct activity and, on the other hand, a finding that PFR leads to a number of benefits for the University.

At this point, I return to consider the relevance of Kretztechnik not only to the question of “overheads” but also to identifying “economic activity” in the first place. Mr Lasok says that the decision is irrelevant. He says that, where a person acquires goods or services which relate only to an activity which does not consist of the making of supplies for VAT purposes under the Sixth Directive (i) there is no direct and immediate link between those inputs and any taxable/exempt outputs and (ii) the inputs cannot be regarded as the overheads of any business/economic activity. That, he says, would be a Wellcome-type situation in which the taxable person was not acting “as such”.

I accept that latter may often be so, but it is not necessarily so. Kretztechnik itself was a case where the supplies related only to the (non-economic) operation of the share issue; but the supplies were nonetheless overheads of the company’s business so that a direct and immediate link was established.

In contrast with Mr Lasok’s submissions, Mr Milne relies particularly on paragraph 36 of the judgment in Kretztechnik, submitting that the position in the present case is in essence the same. He says that just as there was no supply in Kretztechnik on the issue of new shares, so there is no supply in the present case in carrying out PFR; and just as the operation was carried out by Kretztechnik in order to increase its capital for the benefit of its economic activity in general, so too, on the primary findings of the Tribunal in the present case, PFR is carried out for the benefit of the University’s economic activity in general (that is to say, economic activity within the meaning of the Sixth Directive). Accordingly, the cost of the PFR is to be treated as an overhead and is therefore a component part of the price of its supplies.

As to that, it is clear that Kretztechnik was addressing the question of overheads in a context where the share issue was not an economic activity; the costs of the share issue were an overhead of the economic activities ie the activities of what, apart from the share issue itself, was the company’s business. The fact that those costs were overhead costs did not convert the share issue into economic activities. That part of Mr Milne’s argument which is based on Kretztechnik must, in my judgment, rely on the cost of supplies for the purposes of PFR being overheads of the University’s other (economic) activity. It is no additional help to that part of his argument to say that the PFR is part of the University’s economic activity; although it would follow necessarily that PFR would be carried out for the benefit of the University’s economic activity in general (but only in the trivial sense that to carry out a PFR is for the benefit of PFR), it would not assist in establishing a direct and immediate link between inputs used in PFR and outputs. To establish that link requires the costs of supplies used for PFR to be an overhead of the University’s other (economic) activities.

The approach to the treatment of the costs of supplies for the purposes of PFR as an overhead cost of the University’s other (economic) activities informs, I consider, the approach to the question whether PFR is part of the University’s economic activity in the first place. In the decided cases which I have mentioned, the question whether activities amount to economic activities has been raised in a context where those activities involved something which would, by themselves have given rise to a supply if the activities were economic in nature. The cases dealing with the deduction, as overhead costs, of costs of inputs not having a direct and immediate link to outputs, have not needed to examine whether what I might call the overhead activity is itself already part of the economic activities of the taxpayer.

The present case, in contrast with those scenarios, is one where the activities in question do not directly, even if economic in nature, produce any output. It seems to me that, in those circumstance, the question whether PFR is part of the University’s economic activities and the question whether the costs of supplies used for PFR are overhead costs raise similar issues. Precisely the same factors which would lead one to the conclusion that PFR is part of the University’s economic activities are ones which would lead one also to conclude that the PFR costs are overhead costs; and, conversely, precisely the same factors which would lead one to say that the costs are not overhead costs are ones which would lead one to reject the proposition that PFR forms part of the University’s economic activities.

In that context, I do not see how the costs incurred in carrying out PFR can realistically be regarded as overhead costs in the present case – that is to say an overhead cost of activities producing taxable or exempt supplies – however wide a meaning is given to overheads. It is, I think, incontrovertible that (i) PFR produces an identifiable result (typically a research paper) and (ii) one, at least, of the purposes of PFR is to advance human knowledge – and objectively PFR does advance human knowledge whether or not that is a purpose and whether or not it is the motive of anyone (University or funders) to achieve that purpose. To be regarded as an overhead, it would be necessary to show that the PFR was carried out for “the benefit of its economic activity in general”. But as the evidence clearly shows, PFR in its own right is an important aspect of the University’s activities. PFR is no more carried out for the benefit of commercial research than vice versa; research generally is no more carried out of the benefit of education than vice versa. All activities (whether or not they are correctly classified as economic) are relevant and important to the University as an institution and to its reputation. It is artificial to regard one activity, on the evidence, as standing in such a relation to another activity, that the costs incurred on the one are to be viewed as overhead costs of the other.

I do not reject out of hand, however, the possibility of a particular piece of PFR standing in such a relation. I can see that the facts relating to a particular piece of research might establish that it is carried out in order, and only in order, to benefit some part of its economic activity; for instance, a particular piece of PFR might be undertaken reluctantly in order to attract an important and lucrative piece of commercial research. The incidental advancement of human knowledge might then be discounted in determining the status of the costs of that PFR as an overhead of the commercial research. The present case, however, is nowhere near that case.

Applying the legal principles discussed in this judgment at length, I conclude that the relevant decisions of the Tribunal (i) that PFR did not form part of the University’s VAT business and (ii) that PFR was not an activity the costs of which could be recovered as an overhead of the University’s VAT business, were, conclusions which the Tribunal could properly reach on the facts as found by them and in the light of those legal principles.

There is a subsidiary point which has been referred to as the “lurking final point”. It will be appreciated that there may be two apportionments which need to be carried out in ascertaining a trader’s VAT liability. The first is an apportionment under section 24(5) between business and non-business VAT on supplies to the trader used for both purposes. The second is an apportionment under regulations 101 and 102 pursuant to a trader’s partial exemption method. In the present case, the University’s partial exemption method is to ascertain the deductible element by applying to the total amount of input tax attributable to business activities (both taxable and exempt) the fraction. The subsidiary point relates to the first of those apportionments.

This point was mentioned by the Tribunal in paragraphs 96 to 98 of the Decision. The Tribunal record in paragraph 97 that the University’s case before it was that VAT paid by the University should be apportioned in accordance with paragraph 33 of the Commissioners’ Notice 700 in order to work out how much of the VAT was “input tax”. That notice prescribes an income based apportionment using the fraction

Mr Milne says that the Tribunal misunderstood the University’s case which was (and is) that in order to arrive at a fair and reasonable apportionment the teaching (“T”) element of the HEFCE recurrent grant should be included in both the numerator and the denominator of the fraction. He says that the University’s criticism of the Commissioners was that they had excluded the T Grant in their business/non-business calculation with the result that a smaller amount than was fair, according to the University, then went forward to the partial exemption calculation. He makes two points: first, that it is unreasonable for the apportionment between business and non-business use to be carried out on the basis of a fraction which includes the T Grant in the denominator but not also in the numerator; and secondly, (which is perhaps only part of the first point) that the partial exemption method should not be allowed to influence the proper way of effecting the earlier apportionment it being wrong to allow that apportionment to correct a perceived underestimate of the exempt portion of input tax under regulations 101 and 102.

The Tribunal released its Decision in draft to the parties on 8 March 2005. The University’s representatives wrote on 9 March 2005 to the Tribunal “explaining the above error”, as Mr Milne puts it, and asking that paragraph 97 be amended so as to include the T Grant in the numerator of the fraction which I have just set out. Notwithstanding that the Decision had been issued, the University’s advisers seem to have been expecting a further response to the letter of 9 March 2005 but there has been none.

Mr Milne further relies, in his skeleton argument, on a passage in paragraph 97 of a draft of the Decision which did not appear in the final Decision. I do not think that he can make any criticism of the Tribunal based on a passage which did not appear in their published Decision. In its final form, paragraph 97 simply stated that “….Customs & Excise agreed that the method in Notice 700 could be applied”. He refers to the Commissioners’ position as “set out with clarity” in their letter of assessment dated 21 July 20023 which provides:

“You will note that the HEFCE grand (T grant) has been excluded from the numerator………. If the University had (or does in the future) include the T grant in its partial exemption method to address the undervaluation of exempt supply of education in a values based method (ie treats it as if it were business income) I would allow the University to include it in the numerator/denominator of the business/non-business apportionment as well.”

To understand that, it is necessary to explain that the University’s partial exemption method effected an apportionment of residual input tax to business use using the fraction

The T Grant did not feature in either the numerator or the denominator of that fraction. The Commissioners’ position is that this undervalues the exempt supply of education. Mr Milne says that the Commissioners can correct this perceived defect under regulation 102(3) (for the future). Instead of doing that, they are, he says, attempting to remedy the perceived defect by an artificial manipulation of the quite separate non-business apportionment. He comments “As the Commissioners candidly point out, were it not for the error they say exists in the partial exemption method they would be prepared to accept that the non-business calculation should be carried out in the manner suggested by the [University]”.

Mr Lasok says, albeit he puts it more politely, that this is all rubbish. He draws attention to the origin of the apportionment point. The University contended that the disputed assessments were not made to “best judgment” and was based on two assertions in its response to the Commissioners’ Statement of Case: (i) that the Commissioners had ignored guidance given in Notice 700, paragraph 33 and (ii) that they had treated “other outside the scope income” as “non-business income”. But in the skeleton argument, there is a disavowal of any “best judgment” attack. This, says Mr Lasok , “left the point hanging in the air with no visible means of attachment to the issues in the appeal”.

Before the Tribunal the point featured in the cross-examination of Mr Dismore, one of the Commissioners’ officers. Mr Lasok says that the point seems to have reduced to the first of those two assertions. He says that Mr Dismore gave a convincing rebuttal of any suggestion that the Commissioners had not used their best judgment or had not acted fairly and reasonably and comments that the University’s supplemental skeleton argument did not even attempt to meet the points made in Mr Dismore’s evidence.

Mr Milne’s criticisms of the Tribunal are identified by Mr Lasok as (i) misunderstanding the University’s case and (ii) failing to respond to the letter dated 9 March 2005. I think that he is right in his rejection of the second of those points. On 27 May 2005, the University’s advisers were told by the Tribunal that the letter of 9 March 2005 had been seen by the Chairman before the Decision was published. Accordingly I also think that he is right in saying that the Tribunal was not willing, after the appeal had been disposed of, to entertain further argument on a point which “had not been properly articulated before it and that probably did not form part of the appeal”.

I note that there are no findings of fact in the Decision relating to the apportionment point; nor is there any reasoning; and nor is there really any conclusion. Given the thoroughness of the Tribunal’s deliberations on the main point, this is surprising if they thought they were deciding anything. I also note that in paragraph 99 they refer to their “decision on the issue for determination in the appeal” which is clearly the main issue and has nothing to do with the apportionment point.

It seems to me to be clear, therefore, that the apportionment point was not a matter with which the Tribunal decided, or thought that they were deciding, anything.

In these circumstances both sides agree that the apportionment point is not a matter on which I should make any determination.

On the main issue, the University’s appeal is dismissed. PFR is, for the purposes of VAT, a separate economic activity or business from the University’s other activities so that (i) tax on goods and services used exclusively for PFR is not deductible or recoverable and (ii) tax on goods and services used partly for PFR and partly for business purposes falls to be apportioned under section 24(5). On the apportionment issue, I make no determination.