Customs & Excise v Southern Primary Housing Ltd.

For input VAT to be deductible, the input must have a direct and immediate link with a taxable output transaction. The expenditure must form part of that output's cost components. A transaction's commercial necessity, or a but-for connection with a taxable supply, does not satisfy that test.

VAT must generally be analysed transaction by transaction. Commercially linked taxable and exempt supplies cannot be treated as one overall transaction unless one supply is merely ancillary to another. Accordingly, VAT incurred on acquiring land for an exempt sale was not deductible against VAT charged for a separate development contract.

The taxpayer bought land subject to VAT, sold it to a housing association in an exempt transaction, and entered into a development contract to build housing on that land. The land sale and building contract were commercially connected, but separately priced and had different VAT consequences.

The VAT Tribunal held that the land acquisition had a direct and immediate link with both supplies. Sir Donald Rattee dismissed the Commissioners' appeal from that decision. The Commissioners appealed, contending that the VAT on the land purchase was not deductible against the taxable development-contract output.

1. Appeal allowed unanimously. Jacob LJ, with whom Mantell LJ and the Master of the Rolls agreed, held that the Tribunal and the judge had applied the wrong legal test.

2. The primary facts and commercial arrangements were for the Tribunal. Whether those facts amounted to a use of goods for the purposes of a taxable transaction under article 17(2) of the VAT 6th Directive was a question of law.

3. The governing inquiry, derived from BLP Group and Midland Bank, was whether the land acquisition had a direct and immediate link with the development contract and whether its cost formed a cost component of that contract. Commercial necessity did not establish that link. The development contract might not have been made without the associated purchase and sale, but a but-for relationship was insufficient.

4. The land purchase price was not a cost of carrying out the development contract in the way that materials and building services were. The contract could equally have been performed had the housing association already owned the land or acquired it elsewhere. The ownership and purchase of the land were therefore irrelevant to the contract's input costs.

5. The Tribunal had wrongly conflated commercially linked but distinct transactions. VAT analysis required each component transaction to be considered separately. The distinct character of transactions could be disregarded only where one was ancillary to a main transaction, as explained in Card Protection Plan Case C-349/96. The input tax on the exempt land sale could not be attributed to the taxable development contract.

• Court of Appeal (Civil Division). By [2003] EWCA Civ 1662, allowed the Commissioners' appeal and reversed the decision below.
• High Court, Chancery Division. Sir Donald Rattee dismissed the Commissioners' appeal from the VAT Tribunal on 13 February 2003.
• VAT Tribunal. Held on 7 August 2002 that the VAT on the land acquisition was recoverable by reference to the commercially connected land sale and development contract.