Sofology Limited & Anor v The Commissioners for HMRC

Section 24(1) of the VATA provides as follows:

“….“input tax”, in relation to a taxable person, means the following tax, that is to say—

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

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

Section 25(2) of the VATA provides that a taxable person “is entitled at the end of each prescribed accounting period to credit for so much of his input tax as is allowable under section 26, and then to deduct that amount from any output tax that is due from him”;

Section 26(1) of the VATA provides that credit is to be given for “so much of the input tax for the period (that is input tax on supplies, acquisitions and importations in the period) as is allowable by or under regulations as being attributable to supplies within subsection (2) below”;

Section 26(2) of the VATA provides that:

“The supplies within this subsection are the following supplies made or to be made by the taxable person in the course or furtherance of his business—

taxable supplies;…”; and

Section 26(3) of the VATA provides that:

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

paragraph 101(2) of the Regulations provided that, subject to various exceptions which are not material to this decision:

“…in respect of each prescribed accounting period—

goods imported or acquired by and …goods or services supplied to, the taxable person in the period shall be identified,

there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies,

no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies,

…subject to subparagraph (e) below, there shall be attributed to taxable supplies such proportion of the residual input tax as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period,

the attribution required by subparagraph (d) above may be made on the basis of the extent to which the goods or services are used or to be used by him in making taxable supplies,…”;

paragraphs 101(4) and 101(5) of the Regulations provide for the ratio calculated in accordance with sub-paragraph 101(2)(d) of the Regulations to be expressed as a percentage and, if that percentage is not a whole number, to be rounded up; and

paragraph 101(10) of the Regulations provides that “[in] this regulation “residual input tax” means input tax incurred by a taxable person on goods or services which are used or to be used by him in making both taxable and exempt supplies”.

no right to deduct input tax arises in circumstances where the input tax relates to costs which have a direct and immediate link only with the taxable person’s exempt supplies; and

where input tax relates to costs which have a direct and immediate link with both the taxable person’s taxable supplies and the taxable person’s exempt supplies, only the portion of the input tax which relates to costs attributable to the taxable person’s taxable supplies is recoverable.

the production costs were essential to enable the appellant to make the catering supplies (because they enabled the appellant to put on the productions which attracted the customers to its catering supplies);

the catering supplies assisted in giving the customers a “fully integrated visitor experience”; and

the revenue from the catering supplies was used to defray the production costs.

in Britannia Building Society v The Commissioners of Her Majesty’s Customs and Excise [1997] BVC 4106 (“Britannia”), television adverts referring to specific financial products were held to have a direct and immediate link with both taxable and exempt supplies because the VAT Tribunal found that none of them was designed to illustrate any particular aspect of the appellant’s services but they were rather produced with the intention of promoting the appellant’s brand more generally;

in Royal Agricultural College v The Commissioners of Her Majesty’s Customs and Excise [2002] Lexis Citation 535 (“RAC”), the VAT Tribunal held that the cost of marketing materials did not have a direct and immediate link with supplies of conference facilities and catering because the purpose of the marketing was to recruit students to the college. The link with any subsequent supply of conference facilities and catering to the students was indirect and, in any event, even if that had not been the case, the intervening exempt supplies of education were sufficient to break the link between the cost of the marketing materials and the supplies of conference facilities and catering. The VAT Tribunal said (at paragraph [42]) that:

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

in Skipton Building Society v The Commissioners for Her Majesty’s Revenue and Customs [2009] UKFTT 191 (TC) (“Skipton”) the First-tier Tribunal held that costs of print advertising had a direct and immediate link with exempt supplies of mortgage services in those cases where the mortgage services were mentioned overtly in the advert (even if only in passing) but not in those cases where that was not the case;

in DFS1, to which we referred briefly in paragraph 6 above, the First-tier Tribunal held that traditional advertising costs did not have a direct and immediate link with supplies of insurance intermediary services. In reaching its conclusion, the First-tier Tribunal held that the content of the adverts was relevant but not determinative. It said that “use” was not a physical use but some form of economic use. For example, an advert might mention sprats when its purpose was to attract customers to purchase mackerels. In each case, it was necessary to look at all of the facts and circumstances objectively;

in N Brown Group PLC; JD Williams & Company Ltd v The Commissioners for Her Majesty’s Revenue and Customs [2019] UKFTT 172 (TC) (“N Brown”), the First-tier Tribunal held that advertising costs had a direct and immediate link with supplies of credit provided on the sale of clothes even though the availability of that credit was not mentioned in the advertising itself. In reaching that conclusion, the First-tier Tribunal held that each of:

were all relevant but not determinative. In each case, the focus was on objectively determining the use of the advertising costs by the taxable person, taking into account all the facts and circumstances. In N Brown, there was found to be a two-way relationship between the supplies of goods and the supplies of credit in that an increase in supplies of goods led inexorably to an increase in supplies of credit and, at the same time, the availability of the credit stimulated an increase in supplies of goods. The fact that there was such a predictable correlation between the supplies of goods and the supplies of credit meant that there was no need for the appellant to monitor the effect of its adverts on supplies of credit specifically and therefore the fact that it did not do so carried little weight.

In addition, the First-tier Tribunal rejected the parallel which the appellant sought to draw in that case between the cost of purchasing the raw material for the goods (for example, the purchase of a black dress) and advertising costs. In rejecting the submission by the appellant in that case that, if there was a direct and immediate link between the advertising costs and the supplies of credit, the same direct and immediate link must be found to exist between the cost of the black dress and the supplies of credit, the First-tier Tribunal said that there was a difference between the application of the test in the context of advertising and the application of the test in the context of other costs of the business. It said:

“[We] think the answer is to be found in considerations of “use”. Marketing material is “used” to stimulate demand for economic facilities that the Group is offering and the task is to identify whether it is stimulating demand only for retail goods (as the Group argues) or for both goods and credit (as HMRC argue). In order to understand what the Group’s marketing material is promoting, it is necessary to engage in a detailed analysis of the Group’s business and how its credit offering interacts with its goods offering. However, the Group does not use the costs of purchasing a black dress to promote anything. Rather, it uses those costs as part of a straightforward transaction of purchase and sale and no wider examination of the Group’s business is necessary to explain the conclusion that the costs of purchasing the black dress are used, and used only, to enable the black dress to be sold at a profit”; and

in The Roald Dahl Museum and Story Centre v The Commissioners for Her Majesty’s Revenue and Customs [2014] UKFTT 308 (TC) (“Roald Dahl”), the appellant submitted that its exhibition costs had a direct and immediate link with both the exempt supplies of entry to the museum and the taxable supplies of sales in the museum shop. The Respondents submitted that the costs had a direct and immediate link solely with the exempt supplies. The First-tier Tribunal held that there was no direct and immediate link between the costs and those items sold by the museum shop which were also sold by shops unrelated to the museum and could be purchased by members of the public in the museum shop without accessing the museum exhibits. The mere fact that it would be rare for someone to purchase such items without also accessing the museum exhibits or that the sales of such items would have been lower if the museum exhibits had not existed did not mean that there was a direct and immediate link between the costs and the sales of such items. Similarly, the exhibition costs did not have a direct and immediate link with supplies of:

the fact that prior case law had held that motive and purpose were not relevant to the apportionment process did not allow a tribunal to disregard the observable terms and features of the transaction and the wider context in which the transaction came to be carried out;

physical use might reflect economic use but did not necessarily do so; and

any apportionment must give a credible result in economic terms

“shopping” adverts, in which the input of a search term by a user leads to photographs on the Google search page of specific products from the relevant retailer’s website; and

“search” adverts, in which the input of a search term by a user leads to text adverts in relation to the relevant retailer on the Google search page.

“generic”, which involves the use of a key term relating to a specific product – for example, in this case, a term such as “sofa” or “corner sofa”;

“brand”, which involves the use of the retailer’s own name – for example, in the case of Sofology, a term such as “Sofology” or “Sofology two-seater” and, in the case of DFS, a term such as “DFS” or “DFS two-seater”; and

“competitor”, which involves the use of the names of the retailer’s competitors – for example, in the case of Sofology, a term such as “DFS” or Ikea” and, in the case of DFS, a term such as “Sofology” or “Ikea”.

various documents and screenshots;

a live demonstration on screen at the hearing of the impact of clicking on certain adverts;

some videos which had been included on each Appellant’s website; and

written and oral witness evidence.

Mr James Robinson – the head of conversion rate optimisation at Sofology;

Mr Peter Kennedy – a store manager at Sofology;

Ms Janet Duckworth – a former marketing manager at Sofology and now head of marketing at Sofology;

Mr Sebastian Brown – formerly a senior marketing and creative manager at Sofology and now director of creative at Sofology;

Mr Peter McDonald – the former head of finance at Sofology and now head of investor relations and group financial planning and analysis for the group including both Sofology and DFS;

Mr James Brewer – the digital and brand marketing director of DFS;

Mr James Vernon – the head of online at DFS;

Ms Clare Johnson – a regional manager at DFS;

Mr Nick Ashworth – the former head of marketing and marketing director of DFS; and

Mr Nick Smith – the chief executive officer of DFS.

the contractual arrangements between the relevant Appellant and its customers, the contractual arrangements between the relevant Appellant and the insurer to whom it was providing insurance intermediary services and the contractual arrangements in relation to the relevant Appellant’s PPC advertising on Google;

the objectives of the PPC advertising taken out by the relevant Appellant during the relevant period;

the nature of that advertising;

the journey taken through the website by a user upon clicking on a Google “shopping” or “search” advert placed by or on behalf of the relevant Appellant;

the training delivered by the relevant Appellant to its sales staff during the relevant period so far as it pertained to sales of sofa insurance;

the manner in which sofa insurance was sold online, in-store and on the telephone to the customers of the relevant Appellant during the relevant period; and

certain financial information in relation to the relevant Appellant during the relevant period, showing, inter alia, the importance of revenue deriving from the relevant Appellant’s services as an insurance intermediary relative to the relevant Appellant’s other income.

at the same time as he or she purchased the relevant sofa; or

at any time up to delivery of the sofa.

Sofology was obliged to promote, market and sell Sofashield to its customers in connection with its sales of sofas;

the more policies Sofology was able to sell to its customers, the lower the cost per policy was to Sofology; and

there was a significant difference between the amount charged by Sofology to the customer and the amount payable to Castelan by Sofology with the result that, even after taking into account the fact that the former amount included insurance premium tax, Sofology made a significant profit out of each policy which it sold.

Sofology authorised Google to place Sofology’s advertising materials and related technology on Google;

Sofology was solely responsible for, inter alia, the creative aspects of the adverts, ad-trafficking and targeting decisions, keywords and landing pages; and

charges were based on the applicable billing metrics (in this case, clicks and not impressions).

none of the marketing strategy or spend was directed specifically for the purpose of increasing the sales of Sofashield;

Sofashield did not drive any aspect of the determination of Sofology’s marketing strategy “because the marketing strategy is solely centred around the sofas and ensuring customers find the right sofa that suits their needs”; and

Sofashield did not have any bearing on a customer’s decision-making process in terms of purchasing a sofa and therefore, “from a marketing perspective, we do not treat Sofashield as ever being a relevant consideration by a customer in making a determination as to whether to buy a sofa product”.

a Sofashield leaflet which was handed out to in-store customers following their purchase and which used the strapline; and

internal company training materials in which the strapline was linked to Sofashield in the following manner:

given the greater expense involved in bidding for generic “search” adverts, the company tended to prioritise brand or competitor “search” adverts over generic “search” adverts in allocating its marketing budget although the precise breakdown of the marketing spend on Google adverts as between “shopping” adverts and each of the three different categories of “search” adverts varied from time to time;

the company had not been bidding on generic “search” adverts more recently; and

brand “search” adverts were not designed to raise awareness of the Sofology brand as, by definition, the user would already be aware of the brand in using the search term. Instead, the reason why brand “search” adverts were so important was because they were used to defend Sofology's territory online by seeking to ensure that customers clicked on the Sofology link and went through to its website rather than the website of a competitor and also visited its stores.

the significant majority of the brand “search” adverts and the competitor “search” adverts led the user to the Sofology home page as the landing page; and

the majority of the generic “search” adverts led the user to either the Sofology home page or a broad category page (as opposed to an individual product page) as the landing page.

an option to add Sofashield to the customer’s basket also appeared on the website once the relevant sofa had been added to the basket (apart from in the rare cases mentioned in paragraph 63 above) although, as we have previously noted, no purchases could be made online until the final month of the Sofology relevant period; and

Mr Robinson explained that there were also two articles on Sofashield in the “Help” section of the website.

a reduction in sales of Sofashield would lead to a reduction in the marketing budget; and

since the marketing budget was a significant factor in driving sales, a reduction in the marketing budget would, assuming all other market factors remained constant, result in a reduction in the sales of all of Sofology’s products, including sofas.

at the same time as he or she purchased the relevant sofa; or

at any time up to delivery of the sofa.

to promote Sofacare to its customers in connection with its sales of sofas, using its own retail brand or the Guardsman retail brand;

accurately to set out the benefits and exclusions of the policy at the point of sale so as to enable the customer to make an informed decision about whether or not to purchase Sofacare;

to ensure that each member of staff selling Sofacare was properly trained; and

to ensure that, before any sale of Sofacare could be made online, the customer had to opt in.

the contract provided that Guardsman undertook to pay to DFS £350,000 in respect of marketing support for DFS to promote Guardsman’s policies and £150,000 in respect of the administrative costs which DFS might incur in switching to Guardsman’s policies. (At the hearing, we were informed that the company had been unable to locate any evidence that the above amounts had been paid and Mr Smith said that, whilst he believed the second amount to have been paid, he didn’t know whether the first amount had been paid. We can see no reason to think that DFS would have failed to pursue either of the two payment obligations given that they were due shortly after the execution of the contract and therefore we have concluded that, on the balance of probabilities, both sums were in fact paid); and

there was a significant difference between the amount charged by DFS to the customer and the amount payable to Guardsman by DFS with the result that, even after taking into account the fact that the former amount included insurance premium tax, DFS made a significant profit out of each policy which it sold.

it was not part of the digital strategy to drive visitors to the sections of the website which dealt with Sofacare; and

the company did not bid on any keywords which related to Sofacare so that typing in “Sofacare” as a search term did not give rise to a Sofacare advert as an impression on Google.

the marketing strategy involved making the customer aware of its brand first and foremost and ensuring that the customer chose its brand over those of its competitors; and

Sofacare did not feature in any of the three classical communication pillars comprising the marketing strategy of the business – segmentation, targeting and positioning. Sofacare was not mapped or targeted and the attachment rate of Sofacare to sales of sofas was not a measure used by the marketing team to monitor its success. When the research company, Boxclever, were retained to conduct customer surveys, the surveys did not include any questions for customers in relation to Sofacare as it was not identified as a relevant consideration.

“[our] marketing costs are treated as an investment to increase customer traffic to our showrooms and online, with the aim of increasing sales of our sofas…We do not consider that Sofacare drives a customer to buy a sofa from DFS on the basis that we offer insurance in the form of Sofacare as an add-on product; and

DFS was interested in monitoring the Sofacare attachment rate “to ensure that we see equal averages across the showrooms” and to ensure that sales of Sofacare were being conducted in compliance with the regulatory regime.

an internal presentation in relation to the company’s high level search and performance strategy which stated that the objective was to drive high quality traffic online and into stores to achieve overall business sales and included KPIs such as unique website visitors, market share, the “click-through rate” (the numbers of clicks on adverts) and the “bounce rate” (occasions when a person clicks on an advert and enters the website but leaves the site immediately without further interaction); and

an example of a weekly report from MediaCom which contained similar KPIs,

and Mr Brewer accepted that the KPIs in relation to PPC advertising were measuring the number of users who clicked on an advert, the length of time spent online, market share, footfall in stores, aggregate sales and average order values and were not measuring sales of specific products.

27.37% was spent on “shopping” adverts, generating 14.52% of the visitors to the DFS website from PPC advertising (the “paid traffic”);

14.10% was spent on brand “search” adverts, generating 41.26% of the paid traffic;

4.55% was spent on competitor “search” adverts, generating 1.53% of the paid traffic; and

53.97% was spent on generic “search” adverts, generating 42.68% of the paid traffic.

the breakdown of spending on PPC advertising fluctuated from time to time depending on the market, competitor activity and the available budget;

in general, the spending on generic “search” adverts was the highest because, “if we want to grow our share in the market, this has to be done through maximising the efficacy of our generic searches”; and

the spending on PPC advertising was allocated first to brand “search” adverts and then anything left over was allocated to generic “search” adverts. The brand “search” adverts were critical for defending the DFS brand from inroads by its competitors and to get prospective customers to the DFS website ahead of the websites of its competitors.

approximately two-thirds of the brand “search” adverts led the user to the DFS home page as the landing page;

the majority of the competitor “search” adverts led the user to the DFS home page as the landing page; and

the majority of the generic “search” adverts led the user to the DFS home page as the landing page. The reason why so many generic “search” adverts went through to the home page as the landing page as opposed to a broad category page or an individual product page was because “we’re trying to establish the type of sofa that the individual wants before they’ve made their decision”.

the average number of pages viewed by a visitor to the DFS website who had clicked on a Google advert was approximately 4.6 pages per visit;

the average number of pages viewed by a visitor to the DFS website who was visiting by way of a free search was 4.78 pages per visit for a visitor who had not previously visited the DFS website within the previous year and 4.58 pages per visit for a visitor who had done so;

of those visitors to the DFS website who had clicked on a Google advert, 0.30% of visitors who had not previously visited the DFS website within the previous year and 0.42% of visitors who had done so made online purchases in the course of the visit;

of those visitors to the DFS website who were visiting by way of a free search, 0.31% of visitors who had not previously visited the DFS website within the previous year and 0.40% of visitors who had done so made online purchases in the course of the visit.

as part of the “Establishing Needs” part of the “REACH” process, they should ask questions about the customer’s personal circumstances so that that information could be used not just to find the right sofa for the customer but also better to sell Sofacare to the customer once the customer had decided to purchase the sofa. (Ms Johnson initially said that the information was obtained solely in order to establish whether the customer needed Sofacare but she subsequently conceded that there were no circumstances in which Sofacare would not be offered to the purchaser of an eligible sofa;)

at the “Advice and Reassurance” part of the “REACH” process, they should promote the key benefits and features of the products which they wished to sell;

they should not raise the subject of Sofacare until after the customer had decided to purchase a sofa because raising it too early could lead to the loss of the sofa sale. This was because the customer would then start to price-in the additional cost of the Sofacare in deciding whether or not to purchase a particular sofa; and

conversely, they should raise the issue of Sofacare at the point when the customer had decided to proceed with making the sofa purchase.

certain customers came to a store with a particular sofa in mind and did not want to look at anything else, whereas others were either just browsing or had a particular sofa in mind but were interested in trying out other sofas too;

the sales staff used the “REACH” process as the framework for interacting with customers;

although sales staff were instructed not to raise the issue of Sofacare prior to the time when the customer had made a decision to buy the relevant sofa, if the customer raised the subject himself or herself, then the sales-person would deal with the query before returning to the sofa sale;

at the point when Sofacare was raised with the customer, after the customer had decided to proceed with the sofa purchase, the customer was given a Sofacare leaflet and informed of the cost of buying Sofacare;

the sofa, together with the Sofacare and any other additional items, were then invoiced at the same time; and

the sales staff were incentivised to sell Sofacare by the fact that they earned commission on sales of Sofacare in the same way as they earned commission on sales of sofas. However:

the respective attachment rates were 73% for in-store sales, 24% for online sales and 37% for telephone sales; and

the attachment rate for the business as a whole was 62%.

the DFS management did not separate out sales of Sofacare from its other sales, including the sales of sofas, in the figures for daily net orders and average order value. Instead, the Sofacare sales, as with other additional items such as coffee tables, footstools or an upgrade in the sofa leather, were included in those figures without being distinguished from those other sales;

average order value was an important KPI and persuading customers to purchase Sofacare (or any other additional items) would increase average order value;

the fact that the average order value for online sales was lower than the average order value for in-store sales was attributable in part to the lower attachment rate for online sales and in part to the fact that online customers tended to purchase less expensive products; and

sales of Sofacare, as well as other additional items such as care kits and footstool, were KPIs which needed to be tracked because of their impact on the daily net orders and the average order value.

various viability statements which were prepared from time to time by the company for its auditors. These demonstrated the potential impact of certain risks on the ability of the company to meet its financial covenants to its lenders and identified the steps which might be taken to mitigate any of the risks which, if it materialised, would pose a threat to the company’s compliance with those covenants. The viability statements identified that one of the potential risks for the company was a decline in the sales of Sofacare as a result of a more robust regulatory environment and concluded that, in certain scenarios, no mitigation steps would be required to maintain compliance with the financial covenants but that, in others, mitigation steps would be required. One of the mitigation steps listed was a reduction in the marketing budget; and

a budget update dated June 2019 which mentioned the risk of potential changes in the regulatory environment as a result of an ongoing review by the Financial Conduct Authority as one of the macroeconomic risks facing the company and calculated that, after applying a risk-weighting to each of the macroeconomic risks facing the company, those potential regulatory changes posed the greatest risk to the company in terms of a reduction in its profits before tax.

the purpose of the relevant Appellant in purchasing PPC advertising was to encourage prospective customers:

in each case, for the purpose of acquiring sofas;

we have reached that conclusion because:

conversely, neither Appellant purchased PPC advertising with the purpose of encouraging prospective customers to purchase insurance;

we have reached that conclusion because:

the respective significance to each Appellant of its sofa sales relative to its insurance sales could be seen in the fact that sales staff were trained that, unless the subject of insurance was raised by the prospective customer himself or herself at an earlier stage, insurance was not to be raised with the prospective customer until he or she had decided to purchase a sofa, for fear of losing the sofa sale – see paragraphs 89, 127(3) and 132(3) above;

on the other hand, given its contractual obligations to the insurer for which it was acting as intermediary but, perhaps more particularly, given the high margin which it earned on its own account from arranging sales of insurance, each Appellant was keen to ensure that as many of its sofa sales as possible were accompanied by sales of insurance. The evidence we heard showed that the insurance attachment rate was highly significant to each Appellant from the commercial perspective because it increased both the relevant Appellant’s profitability and the relevant Appellant’s average order value. It was a highly profitable business stream in its own right – see paragraphs 98, 136, 138(2) to 138(4) and 139 above. As such, each Appellant took steps to ensure that as many of its sofa sales as possible were accompanied by sales of insurance. For instance:

in addition, when it came to calculating revenue, profitability and average order value, each Appellant did not distinguish the income which it derived from sales of insurance from the income it derived from sales of sofas– see paragraphs 72, 73, 99, 112, 138(1) and 138(2) above - and hence:

finally, it is apparent from the evidence in relation to the landing pages, the website layout and, in the case of DFS, the Google analytics data, that a user entering into the relevant Appellant’s website by way of clicking on a Google advert was encouraged to look at a variety of different sofas or other items of furniture offered by the relevant Appellant and not simply to look at the specific sofa which had led the user to click on the “shopping” or “search” advert in the first place. As such, clicking on an advert during the relevant period might well have led to the purchase of a sofa or other item of furniture which was different from the sofa to which reference was made in the advert – see paragraphs 81, 82, 84, 116(3), 119 and 123 to 125 above.

For completeness, we should record that we were not provided with the same level of Google Analytics data in relation to Sofology over the Sofology relevant period as we were in relation to DFS over the DFS relevant period. For example, we were not provided with information about the number of pages visited by the various different categories of visitor on each occasion that a person visited the Sofology website during the Sofology relevant period. It may well be the case that that information would have been very little different from the information set out in paragraphs 124 and 125 above in relation to DFS but it could equally well have been very different and so we are unable to make any finding of fact in that regard. In any event, as we have already noted, Sofology did not make online supplies of sofas until the final month of the Sofology relevant period.

were not overheads; and

had a direct and immediate link solely to its taxable supplies of sofas and not to its exempt supplies of insurance intermediary services.

it did not take into account all of the facts and circumstances surrounding the adverts and the Appellants’ supplies, as was required by, inter alia, ROH at paragraph [17]. It was clear from the proliferation of case law in this area that this was a complicated question. That would not be the case if the answer could be found solely by looking at the physical content of the advert and the content and layout of the landing pages. Moreover, it was a blinkered approach - which was the precise opposite of taking into account all the facts and circumstances;

focusing on physical content led to absurdity. Ms Sloane had accepted that an advert for a specific type of sofa could be seen as having a direct and immediate link to supplies of sofas more generally and not just to the specific sofa to which the advert referred. But then where did that stop? Could the link be extended to other products offered by the Appellants, such as insurance? In addition, if an item featured in any way in an advert or on the landing page, was that sufficient to create a direct and immediate link between the advertising cost and the relevant item or did one need to consider the prominence of the item in the advert or on the landing page? The latter would be highly subjective and the precise opposite of the objective approach required by the relevant case law;

the focus on physical content was not compatible with the manner in which PPC advertising worked. With PPC advertising, the retailer incurred the cost of the service only when the user clicked on the advert. The mere impression of the advert on the Google page incurred no charge. Thus, the retailer was paying not for the advert per se but rather for the re-direction of the user to the retailer’s website as a result of clicking on the advert. This meant that the physical content had necessarily to include the content of the landing page on the retailer’s website. This was different from other forms of advertising. And, once one took into account the content of the landing page in this case, one had to recognise that insurance was mentioned on that landing page through the drop-down menu on the navigational toolbar; and

focusing on physical content alone required certain facts which were plainly relevant in answering the question to be ignored. For example, it required facts like the attachment rates and whether or not the insurance was “opt-in” or “opt-out” to be disregarded and that could not conceivably be right.

she did not agree with the proposition that the content of the adverts (the impression on Google) could simply be disregarded. She pointed out that the Respondents’ approach in this respect demonstrated a confusion on their part between the nature of the service which Google was providing and the circumstances in which a payment for those services was triggered. It was quite clear from the contractual arrangements with Google that the service that Google was providing was that of a PPC advertising platform and therefore the content of the adverts was of greater significance in answering the question than the Respondents were accepting. It was that content which was chosen to entice the users to click on the adverts; and

the content and layout of the landing pages needed to be considered very much in the context of the content of the adverts, and not in isolation. The fact that a landing page might contain a reference, somewhere in its layout, to some goods or services which were unrelated to the goods or services to which the relevant advert referred would not generally create a direct and immediate link between the advert and those other goods or services. Every website page had links to other content (in the same way that a person going into a store would be able to access goods other than those which he or she had been induced by an advert to enter into the store to purchase). Of course, it was possible to think of extreme examples along the lines of the sprat and mackerel example used by the First-tier Tribunal in DFS1 but that extreme example proved the rule. If clicking on an advert for sofas took the user directly to the insurance page as the landing page, then that might well establish that there was a direct and immediate link between the cost of the advert and the supplies of insurance intermediary services. However, that was not the case here. In this case, the content and layout of the landing pages were entirely appropriate in the context of the content of the adverts. The adverts related to sofas and the content and layout of the landing pages were those which were considered by the relevant Appellant to be most appropriate for selling sofas.

in many cases, the landing page was not the home page but was in fact a general category page or a specific product page. It would be odd if the answer were to differ depending on which particular landing page it was;

focusing solely on the content of the landing page involved ignoring the terms of the advert which had induced the user to click on the advert and enter the landing page;

the approach ignored the fact that the relevant Appellant’s home page operated in the same way as a store. In other words, the fact that it was possible to navigate away from the landing page to any of the relevant Appellant’s products was no different from the ability of a visitor to a store to ignore the first display to which he or she came and to explore the contents of the store;

when one took the contents of the landing pages into account in this case, there was no promotion of insurance on any of those pages. It was possible to navigate away from the landing pages to a page which dealt with the insurance but that was no different from the ability to navigate away from the landing pages to any product offered by the relevant Appellant in the virtual store. There was no promotion of insurance, as such, on any of the landing pages; and

the Respondents’ submission that the aim of the PPC advertising was to get the user onto the relevant Appellant’s website or into the relevant Appellant’s store was a point which could be made of all advertising in a general sense. But, in the case of all advertising, it was important to consider more specifically the underlying purpose for which the relevant retailer wanted to attract people onto the website or into the store. In this case, the purpose of each Appellant was to get the user onto the website or into the store for the specific purpose of purchasing a sofa. The fact that, once the user had decided to purchase a sofa, he or she was always offered add-ons did not mean that there was a direct and immediate link between the advert and each of the add-ons.

What each advert had done directly was to stimulate demand for the sofa and then the sale of the sofa had created the opportunity for the sale of the relevant add-on. This was as true in relation to the insurance in this case as it was for a shoe retailer who sold protector spray or a travel operator who sold holiday insurance. Just because there was a connection between the supplies of two different products did not mean that a cost which had a direct and immediate link with the supply of the first product also had a direct and immediate link with the supply of the second.

Another example was the case of an advert by Marks and Spencer for birthday cake. If a customer went into the store to buy a birthday cake as a result of the advert and then bought one of the other goods which were being offered in the store, there was a direct and immediate link to the supply of the birthday cake but the link to the supply of the other item would be indirect. It was not correct to conflate two distinct supplies because of their close economic links and thus conclude that the costs which had a direct and immediate link with one of the supplies necessarily had a direct and immediate link with the other – both ROH and Southern Primary were examples of this point (see ROH at paragraphs [85] to [88] and Southern Primary at paragraphs [25], [26], [32] and [33]).

the income which each Appellant derived from its supplies of insurance intermediary services was significant and the decisions in each of DaP, DFS1 and N Brown showed that whether or not an advert gave rise to a meaningful revenue stream from a particular type of supply was a significant factor in determining the existence of a direct and immediate link between the cost of the advert and that type of supply. In that respect, there was a difference between the application of the test in the case of production costs and the application of the test in the case of advertising costs. When considering the former, where the costs had no inherent promotional value, it was appropriate to pay less regard to the economic consequences of the incurring of the costs than it was in the case of the latter, where the costs were being incurred to generate sales;

that was why they agreed with the approach adopted by the First-tier Tribunal in N Brown, where, in addition to considering the physical content of the adverts, the First-tier Tribunal had taken into account, as relevant (albeit not determinative) factors, the subjective intention of the individuals acting for the taxable person in choosing the content of the adverts, the response of prospective customers to the adverts and the ways in which the taxable person chose to measure the success of its marketing or set its marketing budget. Importantly, the First-tier Tribunal in that case had relied in part in reaching its conclusion on the fact that there was a predictable correlation between the sales of goods and the sales of credit and that therefore there was no need for the appellant to monitor the take-up of credit. That was similar to the present case where attachment rates for both Appellants were predictable;

the decision in DaP was important in various respects, as follows:

the decision in Mayflower showed that there was no direct and immediate link between production costs and supplies of catering made to the people who attended the ensuing performances of those productions and the decision in ROH showed that that was the case even where the supplies of catering were thoroughly integrated with those performances. In each case, the ratio of the relevant decision was that there was no direct and immediate link between, on the one hand, production costs and, on the other hand, the opportunity to earn revenue out of supplies of catering to the people who bought tickets to the productions which resulted from those production costs. Instead, that opportunity arose directly out of the exempt supplies of tickets to the performances. This contrasted with the link between the production costs and the supplies of programmes in Mayflower, where the fact that the content of the programmes made use of the productions was sufficient to establish the direct and immediate link. Each of these conclusions was unsurprising in the light of the prior case law;

the decision in ROH did not herald a new dawn but was simply a straightforward application of the principles established in the prior case law. There were fundamental and critical differences between the production costs in ROH and the PPC advertising costs in this case. In ROH, the production costs led to the ticket sales and so were directly “promotional” of the ticket sales but they were not directly “promotional” of the catering supplies. Instead, what led to the opportunity to make the catering supplies was the ticket sales. It was the ticket sales which brought the customers to the performances and thus it was they and not the production costs which were “promotional” of the catering supplies. In contrast, in this case, the PPC advertising costs were “promotional” of both the supplies of sofas and the supplies of insurance intermediary services. Thus, there was a direct and immediate link between the PPC advertising costs and the supplies of insurance intermediary services which was distinguishable from the indirect link between the production costs and the catering supplies in ROH. In short, each Appellant was using the PPC advertising costs to make its supplies of insurance intermediary services and the former were accordingly cost components of the latter;

the decision in ROH merely reiterated that dual consequences were not enough, in and of themselves, to establish a direct and immediate link between the relevant costs and both categories of supply. It did not establish that there could never be a direct and immediate link between the relevant costs and both categories of supply, as the earlier decision in DaP had shown. In ROH, the First-tier Tribunal had found, as a fact, that investment in the productions attracted customers not only for the performances but also for the catering but the Court of Appeal held that that did not mean that there was a direct and immediate link between the production costs and the catering because that was merely an economic consequence. It was the “but for” test couched in terms of a test of economic necessity. The costs were not being used to provide the catering. For instance, a payment for a costume or a payment to an artist was not being used to make a supply of champagne. The parallel in this case would be an argument that the cost of the materials used to make the sofas had a direct and immediate link to the supplies of insurance intermediary services. The PPC advertising costs in this case were not on all fours with this example. Instead, those costs were used to sell both sofas and insurance;

the facts in RAC were very different from those in this case. In this case, the supplies of insurance intermediary services were made at the same time as the supplies of sofas and there were no intervening chain-breaking exempt supplies between the incurring of the costs and the supplies of insurance intermediary services;

in DFS1, the First-tier Tribunal had considered the content of the adverts to be relevant but not determinative. It had looked at the role played by the advert in the business so that, for example, an advert for a sprat which was designed to sell a mackerel would have a direct and immediate link with the sale of the mackerel. They agreed with this approach. In addition, the First-tier Tribunal in DFS1 had rightly taken into account certain factors which it said were relevant to this question, one of which was the commercial importance of insurance to DFS and the attachment rates. However, the facts in that case were distinguishable from the facts in the present case. The insurance wasn’t as widely available on sofas at that time – insurance was available on only 38% of sofas - and the case concerned conventional advertising and not PPC advertising, which operated very differently, as noted in paragraph 153(3) above; and

the PPC advertising was being used to persuade the user to enter the relevant Appellant’s website or to go to a store and not to promote a specific product. It was ultimately more about the promotion of the relevant Appellant’s brand than about the promotion of a specific product – that was clear from the witness evidence, from the fact that the relevant Appellant’s home page or a broad category page (and not a specific product page) was the most common landing page and, in the case of DFS, from the Google analytics data showing the number of pages visited by, and the purchases made by, the people who clicked on the adverts (where the relevant figures were similar to the equivalent figures for people who entered the website through an organic search). The decision in Britannia was an example of a case where the physical content of the advertising was held not to be determinative because the advertising was designed to promote the appellant’s brand as a whole. The same was true in this case.

the importance of physical use in determining whether or not a direct and immediate link existed could be seen in Mayflower at paragraph [43], where the fact that the productions to which the costs related provided the subject matter of the programmes and “were as much part of the raw material used in preparing the programmes, as the paper and ink from which they were physically made” was sufficient to establish the direct and immediate link;

although that case and ROH - where the Upper Tribunal again adverted to physical use when referring to the direct and immediate link between the production costs and the ticket sales - both related to production costs and not advertising, it was not the case that, with production costs, one could take into account physical use but, with advertising costs, one could not and had to focus instead on economic use. The nature of the relevant cost undoubtedly affected the answer to the question of whether or not there was a direct and immediate link between that cost and a particular supply but the nature of the test was the same;

that was not to say that the issue of economic use was irrelevant. Economic use was a relevant factor but the key point was that the economic use had to be direct and immediate. Indirect economic use, no matter how essential to the business, was insufficient. The Respondents’ case in these appeals was that a plethora of indirect, albeit commercially-substantial, economic links were sufficient to comprise a direct and immediate link and that argument had been dismissed by the Upper Tribunal and the Court of Appeal in ROH (see ROH at paragraphs [46] and [47]). A cost could be commercially necessary in order for a supply to be made and economically used in making the supply but, if its use in making the supply was indirect, there would not be a direct and immediate link between it and the supply;

in this case, there was no such direct and immediate economic use. Neither of the Appellants had made any bids in the Google auctions in respect of keywords relating to its insurance products, none of either Appellant’s adverts referred to insurance and no user clicking on either Appellant’s adverts was taken to a landing page featuring the availability of insurance. There was thus no evidence that any of the adverts was using the availability of insurance as a lever or incentive or that any user was induced to click on an advert by reason of the availability of the insurance. Indeed, it was a matter of common sense that no-one would choose one sofa retailer over another because of their respective insurance offerings;

commercial and economic links, no matter how substantial, did not convert an indirect link into a direct and immediate link. As noted by the Court of Appeal in ROH at paragraph [100]:

“It is not enough to express the ‘but for’ test in economic terms and then contend that the link must be considered to be direct and immediate”.

Thus, the importance of the insurance intermediary services as a revenue stream for the relevant Appellant, whether the income from those services subsidised the relevant Appellant’s marketing budget and whether the adverts were commercially necessary to generate the income from those services were all irrelevant in the absence of a direct and immediate link between the advertising and the relevant supplies. For example:

The tax treatment did not depend on the mere existence of substantial commercial links between the two activities;

this could be seen in ROH at paragraphs [38] and [83] to [89]. In ROH, the appellant sought to rely on the substantial economic links between the production costs and the supplies of catering to establish that there was a direct and immediate link between the two. However, in rejecting that submission, the Court of Appeal said that the references in Sveda and The Commissioners of Her Majesty’s Revenue and Customs v Associated Newspapers Limited [2017] EWCA Civ 54 (“ANL”) to an economic link “do no more than explain the nature of the connection required to satisfy the test of a direct and immediate link in cases where there is also a link with non-economic activities, such as the gratuitous provision of the path and of the retail vouchers. They do not herald a new and broader test for determining the existence of a direct and immediate link”. It rejected the appellant’s claim because it agreed with the Upper Tribunal in that case that, notwithstanding the substantial economic link between the production costs and the catering supplies, that link was not direct and immediate. The fact that the production costs enabled the appellant to make its catering supplies did not suffice and nor did the fact that the revenue from the catering was used to fund the production costs;

with regard to the point made by Ms Barnes and Mr Reynolds in paragraph 160(3)(a) above, the Court of Appeal’s reliance in DaP on the financial significance of the insurance income to the appellant’s business needed to be considered in the light of the fact that, in that case, the adverts had referred to the availability of insurance and had been intended to promote the insurance to customers and the appellant had sought to counter the importance of that fact by downplaying the importance to it in financial terms of the insurance relative to the supplies of mobile phones. Thus, the decision in DaP was not authority for the proposition that the importance of the revenue stream alone could serve to establish a direct and immediate link to supplies which were not even mentioned in the advert; and

the decision in N Brown should be approached with caution in the context of these appeals because:

a customer buying a sofa was, subject to some minor exceptions, always offered insurance;

in respect of Sofology, customers had to opt out of insurance, and not opt in, at the point when the sofa was sold;

in respect of DFS, the staff were incentivised through commissions to offer insurance at the point when the sofa was sold;

the majority of customers who bought a sofa also bought insurance and, as the attachment rates were fairly constant in each case, that meant that the Appellant could predict that outcome with a reasonable degree of certainty;

the sale process was seamless – there was a single customer journey and information gleaned during the negotiations for the sofa was used by the sales staff in order to sell the insurance;

a reduction in sales of insurance would reduce the marketing budget and hence, if all other market factors remained constant, lead to a reduction in sales of sofas; and

in the case of Sofology, the same marketing strapline was used to sell both sofas and insurance.

a skilled sales-person used information gleaned in the negotiations for the sale of one item to improve the prospects of selling another item. That was a fairly basic sales technique and said nothing about whether the costs which had a direct and immediate link to the supply of the first item were also directly linked to the supply of the second;

as was the case in relation to Sofology, the same strapline was used to sell the second item as was used to sell the first item. That again was simply a basic sales technique which shed no light on the answer to the question; and

the customer was given the opportunity to opt in to the second item, or, as was the case in relation to Sofology, the second item was automatically added to the order unless the customer opted out. The second item was an add-on in both cases, and the “opt-out” scenario was merely a harder selling technique than the “opt-in” scenario. From the commercial perspective, it made it more likely that the advert would lead to a sale of the second item but it did not create a direct and immediate link between the advert and that sale because the advert continued to have a direct and immediate link solely to the sale of the first item, which sale was a necessary pre-condition to that sale.

in Mayflower, Carnwath LJ had made it clear that:

in this case, as noted in paragraph 160(9) above, the nature of the PPC advertising was such that it was all about getting users to the relevant Appellant’s website and promoting the relevant Appellant’s brand as a whole. The home page, which was most often the landing page, was very general in nature and the relevant Appellant clearly did not intend the user to stay on that page. In addition, there were many different paths that a user might take upon leaving that page. These factors suggested that it was not possible to see the cost of the adverts as having a direct and immediate link with any particular category of supply.

for each Appellant, the cost of the PPC advertising had a direct and immediate link with the taxable supplies of sofas made by the relevant Appellant and did not have a direct and immediate link with the exempt supplies of insurance intermediary services made by the relevant Appellant;

in consequence of the conclusion set out in paragraph 172(1) above, for each Appellant, the cost of the PPC advertising was not an overhead of the relevant Appellant’s business or an overhead of a discrete part of the relevant Appellant’s business; and

as a result, each Appellant’s appeal should be upheld.

the answer to the question of whether or not a direct and immediate link exists between a cost and a supply “is to be objectively ascertained from the facts and circumstances of the transactions, not by investigating the subjective intentions of the taxable person” – see ROH at paragraph [17]. This means that, although the test is multi-factorial in nature, and it is appropriate to take into account, as one of those factors, the purpose of the taxable person, that purpose is to be identified objectively from the facts and circumstances and not by reference to the subjective intentions of the taxable person;

similarly, in determining whether a cost has a direct and immediate link with a supply, it is not appropriate to look at the ultimate aim of the taxable person when incurring the relevant cost or whether or not the cost is reflected in the price charged by the taxable person for the relevant supply – see BLP at paragraphs [19] to [21] and [24] and DaP at paragraphs [20] to [24];

in addition, the fact that a supply would not have been made by the taxable person but for a cost incurred by the taxable person is not sufficient to create a direct and immediate link between the cost and the supply. The relevant test is not a “but for” test – see Southern at paragraphs [32] to [37] and DaP at paragraphs [34] to [36];

the fact that there is a “close economic link” or a “necessary economic link” between a cost incurred by a taxable person and a supply made by the taxable person is not sufficient to create a direct and immediate link between the cost and the supply – see ROH at paragraphs [80] et seq.. Although there are decisions such as Sveda and ANL where the phrases “close economic link” or “necessary economic link” have been used in the course of describing a direct and immediate link between a cost incurred by the taxable person and a supply made by the taxable person, those decisions were dealing with circumstances where there was a more immediate non-economic activity between the incurring of the cost by the taxable person and the supply made by the taxable person - the gratuitous provision of a path in Sveda and the provision of free vouchers in ANL – and the relevant court used those phrases to explain why the intermediate non-economic activity did not prevent the direct and immediate link between the cost and the supplies from arising. Those cases are therefore highly fact-specific and “do not herald a new and broader test for determining the existence of a direct and immediate link” – see ROH at paragraphs [81] to [83];

the above means that, even if a cost which is incurred by the taxable person is essential in economic terms to a supply made by the taxable person, there may still not be a direct and immediate link between the two – see ROH at paragraphs [84] to [88]. For example, whilst, in Mayflower, there was a direct and immediate link between the cost of buying in productions and the supplies of programmes (because the former provided the content for the latter), no such direct and immediate link existed in ROH between, on the one hand, the cost of the productions, and, on the other hand, the catering services despite the economically-interconnected nature of those supplies. This was because the production costs were not used to make the supplies of catering but were instead used solely for putting on the productions – see the decision of the Upper Tribunal in The Commissioners of Her Majesty’s Revenue and Customs v Royal Opera House Covent Garden Foundation [2020] STC 1170 (“ROH UT”) at paragraphs [106] to [109], cited with approval by the Court of Appeal in ROH at paragraphs [33] and [88];

as long as there is a direct and immediate link between a cost incurred by the taxable person and an exempt supply by the taxable person, the right to deduct input tax on that cost will be restricted and that will be the case even if, in addition to that direct and immediate link, there is also a direct and immediate link between that cost and a taxable supply by the taxable person and the direct and immediate link between the cost and the taxable supply is more direct and immediate than the direct and immediate link between that cost and the exempt supply – see the opinion of Advocate General Jacob in Abbey National at paragraph [35] and DaP at paragraph [30]; and

finally, although it is of no relevance on the basis of the facts in the present appeal, there are circumstances in which a direct and immediate link between a cost and a supply made as part of a chain of supplies can be broken by an exempt supply made earlier in that chain – see Sveda at paragraphs [32] to [34], RAC at paragraph [43] and ROH at paragraph [91].

describing the content of the adverts and the content and layout of the landing pages as “physical” seems to us to disregard the virtual nature of those items;

more importantly, as the substance of the arguments before us made clear, it is impossible to address the question of whether or not the cost of an advert has a direct and immediate link with a particular supply without considering the economic consequences of the advert. After all, if an advert has increased the quantum of the supplies of a particular item, that economic consequence is undoubtedly an important part of the circumstances in which any objective view of whether or not there is a direct and immediate link between the advert and the supplies is to be reached. As the First-tier Tribunal noted in N Brown, marketing material is used to stimulate demand for one or more of the goods and/or services which the retailer is offering and it is therefore essential to identify the economic consequences of that material if one is to identify the supplies with which the cost of the material has a direct and immediate link;

given the above, we consider that, in each case, the relevant question is not whether the link between the relevant cost and the relevant supply is physical or economic but rather whether the link between the relevant cost and the relevant supply, whatever form it takes, is direct and immediate or is instead indirect. In other words, in the case of an economic link between a cost and a supply, that economic link could be direct and immediate or could instead be indirect. In both cases, the link in question would be an economic link but only in the former case would the input tax on the cost be attributed to the relevant supply; and

in this context, we think that the question of whether an economic link is direct and immediate or is instead indirect does not turn on the strength or extent of the economic link. It turns instead on the precise nature of the economic link. A very strong and substantial economic link could still be indirect, just as a very weak and insubstantial economic link could be direct and immediate. It all depends on the precise nature of the link. For example, in ROH, there was a strong and substantial economic link between the production costs and the catering supplies. Indeed, the economic link was described as being “essential” (see ROH UT at paragraph [98]). And yet both the Upper Tribunal and the Court of Appeal concluded that the link was not direct and immediate and therefore could not result in an attribution of the input tax on the production costs to the catering supplies.

those costs could not have amounted to overheads if they had a direct and immediate link with the relevant Appellant’s supplies of sofas (regardless of whether or not they also had a direct and immediate link with the relevant Appellant’s supplies of insurance intermediary services); and

we think that it is clear that those costs did have a direct and immediate link with each Appellant’s supplies of sofas.

the purpose of each Appellant in purchasing PPC advertising was to encourage users:

in each case, for the purpose of acquiring sofas; and

we reached this conclusion because:

in determining whether there is a direct and immediate link between the PPC advertising costs and the supplies of sofas made by the relevant Appellant, it is not necessary to establish that there was a direct and immediate link between the costs and the supply of a specific model of sofa. It is instead sufficient for this purpose to establish that there was a direct and immediate link between the costs and the supply of a sofa of some sort. A promotional link between the advert and the Appellant’s sofas in general is perfectly sufficient; and

it is irrelevant that the purpose of each Appellant in incurring the PPC advertising costs was to entice the user onto the website or into a store. This is because it was a critical part of that purpose that the user would go onto the website or into a store specifically in order to purchase a sofa. It might have been different if the purpose of the relevant Appellant in incurring the costs had simply been to entice the user onto the website or into a store for some general reason other than the specific reason of purchasing a sofa.

the nature of PPC advertising was such that the content of the adverts had a minimal role to play in determining whether there was a direct and immediate link between the cost of the advert and any particular category of supply by the relevant Appellant. Instead, the content and layout of the landing pages was of greater importance;

in most cases, the landing page offered the user access to a wide variety of different products which were being offered by the relevant Appellant and was intended merely as a starting point in a customer journey which could lead to the purchase of a number of different items. For example, the home page, which was most often the landing page, was very general in nature, the relevant Appellant clearly did not intend the visitor to stay on that page and there were many different paths that a visitor might take upon leaving that page;

looking at the economic position, the purpose of each Appellant in incurring the PPC advertising costs was to maximise the sales of all of its products and not one specific type of product. To that end, each Appellant was intent on maximising its revenues, profitability and average order values and, in that respect, it measured its success or failure by aggregating the revenue streams from a variety of products and did not distinguish between the different categories of product; and

the above factors suggested that it was not possible to see the adverts as having a direct and immediate link with any particular category of supply.

we do not agree that the nature of PPC advertising means that little weight can be accorded to the terms of the advert. In our view, the fact that the relevant Appellant did not have to pay for the service unless and until the user clicked on the advert is neither here nor there. The nature of the service for which the relevant Appellant was paying Google was the impression of its advert on the Google platform. It was the content of that impression which induced the user to click on the link in the first place. We therefore consider that, whilst the content of the adverts was not solely determinative of whether or not there was a direct and immediate link with any particular category of supply in this case, that content was a highly relevant factor, as in fact it was in DaP. It is impossible properly to determine objectively whether there was a direct and immediate link between the cost of the adverts and any particular category of supply without taking into account the content of the adverts;

whilst we agree with Ms Barnes and Mr Reynolds that the content and layout of the landing pages were also relevant factors to be taken into account in determining whether or not there was a direct and immediate link between the PPC advertising costs and any particular category of supply in this case, we do not agree with their characterisation of the landing pages set out in paragraph 186(2) above. As the findings of fact referred to in paragraph 184 above make clear, we think that the purpose of the relevant Appellant in incurring the costs was to entice the user to visit the website or store of the relevant Appellant specifically in order to purchase a sofa. That was why the adverts either pictured or referred to sofas and why the landing pages contained images of sofas. It was not the case that the relevant Appellant merely wanted to entice the user to visit the website or store for some general purpose – which is to say, to purchase any of the items which the relevant Appellant happened to be offering for sale at the time when the user entered the website. The focus of the PPC advertising costs was very much on the supplies of sofas; and

we have therefore concluded that, viewed objectively, the PPC advertising costs had a direct and immediate link with each Appellant’s supplies of sofas. In that regard, we do not think that the economic position referred to in paragraph 186(3) above affects the conclusion in any way. Naturally, the relevant Appellant would have been delighted if the user, having entered the website or store to purchase a sofa, were to have purchased items in addition to the sofa. And it is not surprising that the relevant Appellant took steps to increase the likelihood that that would be the case. After all, each Appellant was in business to maximise its revenues, profitability and average order values and any items which it could sell in addition to the sofa would have had a beneficial impact on those figures. However, viewed objectively in the light of all the facts, that was not the reason why the relevant Appellant incurred the cost of the adverts. Each Appellant incurred the cost of the adverts specifically in order to promote its sales of sofas.

a customer purchasing a sofa would, subject to some minor exceptions, always be offered insurance;

in respect of Sofology, customers had to opt out of insurance, and not opt in, at the point when the sofa was sold;

in respect of DFS, the staff were incentivised through commissions to offer insurance at the point when the sofa was sold;

the sale process was seamless – there was a single customer journey and information gleaned during the negotiations for the sofa was used by the sales staff in order to sell the insurance;

a reduction in sales of insurance would reduce the marketing budget and hence, if all other market factors remained constant, lead to a reduction in sales of sofas; and

in the case of Sofology, the same marketing strapline was used to sell both sofas and insurance.

first and foremost, when viewed objectively, the adverts were designed to attract users to enter the relevant Appellant’s website and/or to go into the relevant Appellant’s stores specifically for the purpose of buying sofas. Even if one were to ignore each Appellant’s marketing strategy on the ground that it was no more than subjective intention – an approach which we do not condone, for the reason set out in paragraph 185 above - that much is apparent from the content of the adverts and the content and layout of the landing pages. Each of the “shopping” adverts contained photographs of sofas and each of the “search” adverts referred to sofas as part of the text and, when clicking on a “shopping” or “search” advert, the user was taken to a landing page which showed images of sofas.

Conversely, neither Appellant incurred the cost of the adverts with the purpose of promoting its insurance offering. Again, even if one were to ignore the fact that each Appellant’s marketing strategy was not directed specifically at increasing sales of insurance, the other facts in this case point firmly in that direction. For example, the fact that the relevant Appellant offered insurance was not a feature which it sought to emphasise in its adverts, the relevant Appellant did not bid in the Google auction for words relating to insurance and insurance did not feature as a search term in any of the relevant Appellant’s adverts. In addition, a user clicking on a “shopping” or “search” advert was never taken to a landing page that highlighted the relevant Appellant’s insurance offering. Although it was possible to navigate from the landing page to the page on the relevant Appellant’s website which dealt with insurance, the link to get to the insurance page was not a prominent feature on the landing page. The link had to be located by hovering over the “More” or “Help” item on the navigational toolbar and then scrolling down and clicking.

Moreover, unless the user chose to navigate to the page which dealt with the relevant Appellant’s insurance offering, insurance was not part of the user’s journey on the website until after the sofa had been added to the user’s basket.

These facts are some distance away from the facts in DaP, where the availability of free insurance was expressly highlighted in the advert and was held to have been intended to attract new customers to the relevant insurer.

In relation to this point, we think that it is of no relevance that a user who was taken to the Sofology home page might, in some instances, be required to make two clicks to get to an individual product page but only one click to get to the Sofashield page – see paragraph 82 above. In our view, the precise number of clicks which might have been required to get to a particular page was of no moment in relation to this question, in the same way that, in the context of a customer visiting a store as a result of an advert, the mere fact that the advertised product was on the second floor and another product happened to be on the first floor would be of no moment. The key fact is that Sofashield did not feature prominently on the Sofology home page and had to be sought out by the user, if desired;

secondly, we think that a highly significant fact is that it was not possible for a user to purchase insurance in isolation. Insurance could be purchased only in conjunction with the purchase of a sofa, and consequent upon the user’s decision to purchase the sofa. The link between, on the one hand, the cost of an advert which was intended to promote the supply of a sofa and, on the other hand, a supply of insurance intermediary services could therefore only be indirect. The supply of insurance intermediary services was necessarily indirect because the supply of the sofa was a necessary pre-condition to its existence. That accounts for the features of the adverts, the landing pages and the website described in paragraph 194(1) above. In short, when viewed objectively, the aim of the PPC advertising was to induce users to purchase sofas. Only after the user had decided to purchase a sofa could the user then be sold insurance. The link to the supply of the sofa was direct and immediate. The link to the supply of the insurance intermediary services was indirect.

In this regard, the fact that each Appellant was aware that the attachment rates remained fairly constant over time so that an increase in sofa sales would be likely to lead to an increase in the commissions received by the relevant Appellant for its insurance intermediary services is, in our view, irrelevant, in the same way that, in Roald Dahl, it would have been irrelevant if the museum shop had been able to increase the sales of certain items which it sold because the exhibition attracted visitors. The relative constancy of the attachment rates merely meant that there was an economic correlation between revenues arising from sales of sofas and the insurance intermediary commissions. It did not create a direct and immediate link between the cost of adverts whose purpose was to increase sales of sofas and the supplies of insurance intermediary services which were related to, and dependent upon, the sales of sofas;

thirdly, the indirect nature of the link between the advertising costs and the supplies of insurance intermediary services was apparent in the way in which each Appellant went about selling the insurance. For instance, sales staff were trained that, unless the subject of insurance was raised by the prospective customer himself or herself at an earlier stage, insurance was not to be raised with the prospective customer until he or she had decided to purchase a sofa, for fear of losing the sofa sale; and

finally, far from being an argument in favour of establishing that the link between the cost of the adverts and the supplies of insurance intermediary services was direct and immediate, as the Respondents sought to use them, we think that the steps which each Appellant took to promote its insurance offering by means other than the adverts themselves demonstrates that the link between the cost of the adverts and the supplies of insurance intermediary services was in fact indirect. We have referred in paragraph 142(6) above to the various ways in which each Appellant sought to maximise the revenues it derived from its supplies of insurance intermediary services. Those steps were that:

In our view, these facts demonstrate that what directly generated the sales of insurance was what happened after the prospective customer had resolved to purchase a sofa in consequence of clicking on an advert. Putting this another way, we agree with Ms Sloane that the high attachment rate was attributable to the quality of the insurance product, the skill and training of the sales staff and the promotional videos and leaflets which related to the insurance. This was well-demonstrated in the fact that there tended to be a dip in the in-store attachment rates at DFS in the run up to Christmas when the in-store sales staff were stretched and additional assistants who were not trained to sell Sofacare had to be drafted in.

The reasoning set out above means that, in our view, the costs which had a direct and immediate link with the supplies of the insurance intermediary services included things like the cost of making the videos in relation to the insurance, the cost of the leaflets outlining the benefits of having insurance which were handed out in-store, the cost of the training given to staff on how to promote the insurance and, of course, the staff salaries. In contrast, the advertising costs had only an indirect link with the supplies of the insurance intermediary services because no sale of insurance could occur until the intermediate step of persuading the prospective customer to purchase a sofa had occurred and it was these other steps which then operated to generate the sale of insurance.

The position in this case is not dissimilar in our view from the postcards featuring photographs of museum exhibits which were sold in the museum shop in Roald Dahl. In that case, there was a direct and immediate link between the exhibition costs and the exhibits. The photographs of the exhibits which were then put onto the postcards were an additional step which made any link between the exhibition costs and the postcards indirect.

In this regard, the matters referred to above in paragraphs (a) to (h) of this paragraph 194(4) do no more than reveal that, from the commercial perspective, each Appellant recognised that there was considerable value to be derived from selling insurance to as many customers as possible who bought sofas. They say nothing about whether PPC advertising costs which had a direct and immediate link with the supplies of sofas also had a direct and immediate link with the supplies of insurance intermediary services. From the commercial perspective, those matters made it more likely that the PPC advertising costs would lead to the supplies of insurance intermediary services but that was because of the direct and immediate impact which those matters had on such supplies. That contrasts with the indirect impact which the PPC advertising costs themselves had on the supplies of insurance intermediary services.

the latter was not a driver for the adverts – it was not the reason for the adverts, it did not feature in the search terms, it was not highlighted on any landing page and it was not the reason why users clicked on the adverts;

the latter could not take place unless and until the former took place and staff were instructed not to raise the subject of insurance until the former was assured; and

there were other matters - such as the quality of the insurance product, the marketing material relating to the insurance product and the training given to, and actions taken by, the staff – which had a direct and immediate link with the latter and whose relationship with and impact on the latter serve to emphasise the indirectness of the link between the PPC advertising costs and the latter.

as we have already noted in paragraph 175(1) above, we do not agree that the taxable person’s subjective intentions form part of the factual matrix which is to be taken into account in determining whether a cost has a direct and immediate link with a particular supply. To be clear, we consider that, in each case, the taxable person’s purpose most certainly is part of the relevant factual matrix. However, as noted by David Richards LJ in the passage from ROH cited in paragraph 175(1) above, that purpose is to be ascertained objectively from the facts and circumstances of the transactions and not by investigating the subjective intentions of the taxable person. Only by adopting that objective approach can one escape the error of taking into account subjective intentions (see Warren J in St Helen’s at paragraph [77]). Moreover, it is important to bear in mind that, in examining objectively the taxable person’s purpose, the relevant question to be answered is whether that purpose reveals that there is a direct and immediate link between the relevant cost and a particular supply. It is not whether that purpose reveals that the relevant cost was intended to maximise the revenues arising from a particular supply. In that regard, we agree with Ms Sloane that, by its very nature, every business is intent on maximising the revenues arising from its expenditure and so the fact that the revenues arising from a particular supply may be a KPI for the business or be of great interest to the managers of the business does not say anything about whether the link between a particular cost and that supply is direct and immediate or is instead indirect;

a fundamental plank of the Respondents’ case was that a distinction could be made between cases like Mayflower and ROH – which pertained to production costs – and cases like DaP and the present case – which pertained to advertising costs.

Ms Barnes and Mr Reynolds submitted that, in the production costs cases, the focus was necessarily on the category of supplies to which the production costs directly gave rise. For example, in ROH, since it could not be said that the production costs directly gave rise to the supplies of catering, the link between the two was insufficient to give rise to an attribution. In that sense, it could clearly be seen that the production costs were “promotional” of the ticket sales but were not “promotional” of the catering supplies. Instead, what led to the opportunity to make the catering supplies was not the production costs but the ticket sales. It was the ticket sales which brought the customers to the performances and thus it was they and not the production costs which were “promotional” of the catering supplies. As such, the extent of the economic ties between the production costs and the catering supplies could be disregarded, which is how the Court of Appeal approached the case.

In contrast, in the case of advertising costs, the extent of the economic ties between the relevant adverts and the supplies was highly relevant because the strength of the economic ties between the relevant adverts and the supplies was the most appropriate way of determining whether the relevant adverts were “promotional” of the supplies. This dichotomy in the way in which the test applied to different types of costs had been identified in N Brown, where the First-tier Tribunal contrasted the analysis applicable on a straightforward transaction of purchase and sale with the more wide-ranging economic analysis required in the case of advertising costs (see paragraph 47(5) above).

We do not agree that the test for identifying whether there is a direct and immediate link between a particular cost and a particular supply should be different depending on the nature of the cost. There is no authority binding on us to that effect and, to the extent that prior first instance decisions have adopted that approach, we do not agree with them. The test itself is always the same – which is to identify whether there is a direct and immediate link between a cost and a supply. The nature of the cost and the nature of the supply will undoubtedly affect the answer to that question but there is no authority for the proposition that somehow a more wide-ranging economic enquiry is appropriate in relation to advertising costs than is the case in relation to other costs such as production costs;

for the reasons which we have already set out in paragraph 187(1) above, we do not agree that the nature of PPC advertising means that little weight can be accorded to the terms of the adverts in this case. In our view, the fact that the relevant Appellant did not have to pay for the service unless and until the user clicked on the advert is neither here nor there. The nature of the service for which the relevant Appellant was paying Google was the impression of its advert on the Google platform and therefore the content of that impression, albeit not determinative, is a highly relevant factor in determining objectively whether the link between the cost of the adverts and the supplies of insurance intermediary services was direct and immediate. The position is no different from that pertaining in DaP;

having said that, we agree with Ms Barnes and Mr Reynolds that the content and layout of the landing pages was also a highly relevant factor to be taken into account in the objective determination of whether the link between the cost of the adverts and the supplies of insurance intermediary services was direct and immediate or was instead indirect. Indeed, we did not understand Ms Sloane to be disagreeing with that approach. After all, those pages were the first point of contact between the relevant Appellant and the user when the latter clicked on the advert. They were therefore bound to be highly relevant to the analysis.

However, as we have already noted in paragraph 194(1) above, we disagree with Ms Barnes’s and Mr Reynolds’s characterisation of the purpose and impact of the content and layout of the landing pages in this case. In our view, the landing pages operated in exactly the same way as the entrance to a store. In other words, the fact that it was possible to navigate away from a landing page to any of the relevant Appellant’s products was no different from the ability of a visitor to a store to ignore the first display to which he or she came and to explore the contents of the store more fully.

If insurance had featured prominently on the landing pages as a product – in other words, to pursue the store analogy, if insurance had been heavily promoted at the entrance to the store as the main item on entering the store – then that might well have affected the analysis. In that case, the example raised by the First-tier Tribunal in DFS1 of using a sprat to catch a mackerel might well have been relevant and that might well have meant that the content of the adverts was overwhelmed by the content and nature of the landing pages and thus of less significance. But, on the facts of this case, the mere fact that it was possible to navigate away from the landing pages to the insurance pages seems to us to be irrelevant.

The key facts are that the user clicked on an advert which was referable to sofas and was taken to a page on the website which had been selected by the relevant Appellant as being the most effective for selling sofas and which had images of sofas. It did not matter whether the sofa which the advert was designed to entice the user to buy was a specific sofa, a sofa falling within a specific broad category or a sofa of any kind. In contrast, insurance did not feature in the terms of the adverts and was simply one item amongst many which might be found on the landing pages, where it was given no prominence. The facts show plainly that the adverts, when seen in the light of the content and layout of the landing pages and the other facts mentioned in paragraph 194 above, had a direct and immediate link solely with the taxable supplies of sofas and did not have such a link with the exempt supplies of insurance intermediary services;

we do not agree that relying heavily on the content of the adverts and the content and layout of the landing pages in order objectively to identify the supplies to which the advertising costs had a direct and immediate link leads to absurdity or is overly-reductionist. On the contrary, we think that there is compelling logic in focusing on those facts as a means of identifying objectively the supplies with which the adverts had a direct and immediate link. Indeed, we think that the Respondents’ approach involves giving insufficient weight to the obvious pointers in that regard which are provided by the content of the adverts and the content and layout of the landing pages. Moreover, we should reiterate that we have not relied solely on those matters in reaching our conclusions. We have instead taken into account all of the relevant facts and circumstances, as outlined in paragraph 194 above;

contrary to the submission made by Ms Barnes and Mr Reynolds in paragraph 160(3) above, we consider that the Court of Appeal’s decision in DaP is not authority for the proposition that the financial significance of the income deriving from supplies to which costs have a link can suffice to make that link direct and immediate or is even relevant in determining whether that link is direct and immediate or is instead indirect.

The ratio of the Court of Appeal decision in DaP was contained in paragraph [73] of the decision. In that paragraph, Jonathan Parker LJ cited, with approval, the reasoning adopted by the VAT Tribunal in reaching its conclusion in paragraphs [49] and [51] of its decision (which he had previously set out in paragraph [43] of the Court of Appeal’s decision) to the effect that the adverts in that case, containing as they did references to the free insurance, were being used to attract customers not just to the airtime service contracts but also to the insurance. That ratio had nothing to do with the significance of the insurance intermediary income to the appellant. It was solely concerned with the fact that the adverts were being used to attract customers to the insurance, which is in our view a material distinction between the facts in DaP and the facts in this case.

Jonathan Parker LJ turned to address the significance of the insurance intermediary income to the appellant only in paragraphs [74] to [77] of the decision in the context of rejecting the submission which had been made by the appellant to the effect that the supplies of insurance intermediary services were, in a commercial sense, secondary to the supplies of airtime service contracts. In those paragraphs, Jonathan Parker LJ said, first, that whether or not they were secondary was irrelevant (see paragraph [74]) and, secondly, that they were in any event not secondary (see paragraphs [76] and [77]). At no point did he say that the significance of the insurance intermediary income would have been sufficient to found a direct and immediate link between the adverts and the supplies of insurance intermediary services in the absence of the promotional link between the adverts and those services which could be identified by the terms of the adverts.

In that regard, the fact that the adverts in DaP referred only to the three-month period of free insurance – in relation to which no supplies were made by the appellant – and not to the ongoing insurance after that period for which payments would need to be made and which would generate insurance intermediary commissions for the appellant is irrelevant. The key factual finding by the First-tier Tribunal was that the reference in the adverts to the three-month period of free insurance was clearly intended to attract new customers to the insurer so that the appellant would be able to earn its insurance intermediary commissions once the three-month free period was over. It was that which gave rise to the direct and immediate link between the adverts and the supplies of insurance intermediary services and not the significance of the income which the appellant derived from the relevant supplies;

we also do not agree that cases such as London Clubs, St Helen’s and Lokn’Store are authority for the proposition that the extent of the economic link between a cost and a supply is relevant to the question of whether there is a direct and immediate link between the two. We need to be quite clear about what we are saying in this context. As we observed in our preliminary observations at the start of this section, we are not saying that an economic link is irrelevant in considering whether there is a direct and immediate link between a cost and a supply at the attribution stage in the process of determining input tax recovery. We are simply saying that the answer to that question depends on the precise nature of the economic link. The economic link in one case might be direct and immediate and the economic link in another case might be indirect and yet, in both cases, the economic link could be equally substantial. In those circumstances, the former would give rise to an attribution of the cost to the relevant supply whilst the latter would not. In both cases, what matters at the attribution stage in the process is identifying the nature of the link (whether direct and immediate or indirect). Whilst economic analysis is likely to be involved in determining that nature, the extent of the financial consequences deriving from the link, and whether or not they are substantial, is not a relevant factor at that stage.

In this regard, it is important to bear in mind that the cases referred to above all related to the second stage in the process of determining input tax recovery – the apportionment stage - in circumstances where it was already accepted that the relevant costs either had a direct and immediate link with both taxable and exempt supplies or fell to be treated as overheads. That being so, the focus in those cases on the extent to which each category of supply made economic use of the relevant costs is not surprising. At the apportionment stage, the relative extent of economic usage will clearly be relevant. However, that does not mean that the extent of economic usage can somehow convert an indirect link into a direct and immediate link for the purposes of the first stage; and

in seeking to establish that there was a direct and immediate link between the cost of the adverts and the supplies of insurance intermediary services, Ms Barnes and Mr Reynolds - at least when they were making their primary argument - sought to rely on the fact that there was such a link between the cost of the adverts and the supplies of sofas and that the supplies of sofas and the supplies of insurance intermediary services were so closely-intertwined that that must mean that the same link existed between the cost of the adverts and the supplies of insurance intermediary services. We do not consider the closely-intertwined nature of the two categories of supplies to be of any significance in this regard. We agree with Ms Sloane that there was a similar link between the supplies of tickets and the supplies of catering in ROH and that this did not lead the Court of Appeal to conclude that the production costs – which had a direct and immediate link with the supplies of tickets – also had a direct and immediate link with the supplies of catering. A concerted add-on strategy does not create a direct and immediate link between the original cost and the supply of the add-on. Only the costs associated with the marketing and promotion of the add-on are directly and immediately linked with the supply of the add-on.

To adopt the analogy of a road journey, if:

then the link between the cost incurred in order to reach destination A and destination A is direct and immediate. Similarly, the link between the cost incurred at destination A in order to persuade the travellers to journey on to destination B and destination B is direct and immediate. However, the link between the cost incurred in order to reach destination A and destination B is only indirect. Travellers reaching destination B would not have done so but for incurring the cost of getting to destination A but that is not the relevant test for establishing whether a link is direct and immediate.