HM Revenue & Customs v Gracechurch Management Services Ltd

Input VAT is deductible only so far as the goods or services are used for taxable output transactions. This remains so where supplies between members of a VAT group are disregarded under the VAT Act 1994. A statutory disregard does not convert the supplies into taxable supplies or require the court to ignore their character for all purposes.

The principles allowing full deduction for assets wholly allocated to a business, despite private use, do not apply where the corresponding outputs are disregarded rather than taxable. Input tax must therefore be apportioned where inputs support both taxable transactions and activities that are not taxable supplies.

Gracechurch Management Services Ltd carried out a property development for a company which was, at the outset, in the same VAT group. It received a £20 million advance payment before leaving the group, and the remaining contract price was invoiced on completion. GMS claimed deduction of input VAT incurred on subcontractors.

HM Revenue and Customs assessed GMS for £3,193,652, contending that the input tax did not relate wholly to taxable supplies because the earlier intra-group supply was disregarded under section 43(1)(a) of the VAT Act 1994. The VAT and Duties Tribunal allowed GMS’s appeal. HMRC appealed to the High Court. The central issue was whether all the input tax was attributable to taxable outputs notwithstanding the statutory disregard.

1. Appeal allowed. The assessment dated 14 April 1998 was correct in law and was confirmed.
2. Article 17.2 of the Sixth Directive permits deduction only so far as the relevant goods or services are used for the purposes of taxable transactions. The phrase “in so far as” requires deduction to be limited to the extent of that use.
3. The reasoning in BUPA Purchasing Ltd v Commissioners for Customs and Excise [2003] STC 1203 was followed. Where supplies are made partly for taxable transactions and partly for activities which are not taxable supplies, the related input tax must be apportioned.
4. The decisions in Lennartz v Finanzamt München III [1995] STC 514, Seeling v Finanzamt Starnberg [2003] STC 805 and Charles v Staatssecretaris van Financiën [2006] STC 1429 did not assist GMS. Those cases concerned assets allocated wholly to a business, with private use treated as a taxable supply. They did not concern inputs supporting outputs which were required to be disregarded.
5. The principle in Commissioners for Customs & Excise v Apple and Pear Development Council [1986] STC 192 supported the conclusion that input tax attributable to non-supplies is not recoverable.
6. Section 43 did not alter that result. Its statutory disregard applied for the purposes of the provision, but did not make the disregarded supplies taxable or require the court to ignore their nature. Regulation 101 likewise prevented attribution of the relevant input tax to taxable supplies.

• VAT and Duties Tribunal: allowed GMS’s appeal and set aside the assessment, in a decision released on 26 September 2006.
• High Court (Chancery Division): allowed HMRC’s appeal, held that the assessment was correct in point of law, and confirmed it.