Volkswagen Financial Services (UK) Ltd v HM Revenue & Customs

Residual input tax on general overheads is deductible to the extent that the overheads are used for taxable transactions. The required link is assessed objectively. General overheads may be linked to the taxable person’s business as a whole, without tracing each cost into the price of a particular output.

Recovery does not depend on the overheads being incorporated into, or recovered through, the price charged for a taxable supply. Price may be evidential, but it is not a precondition to deduction. Economic use must reflect the real commercial use of the business. A taxable activity forming part of that business cannot receive a nil attribution merely because an exempt finance activity is more profitable or predominant.

Volkswagen Financial Services (UK) Ltd operated a retail finance business under which hire-purchase arrangements were treated for VAT as comprising a taxable supply of a vehicle and an exempt supply of finance. It sought to recover part of the residual input tax incurred on general overheads under a partial exemption special method.

The First-tier Tribunal allowed the appeal. The Upper Tribunal, in [2012] UKUT 394 (TCC), held that the overheads were linked only to the predominantly exempt finance supplies and allowed the opposing appeal. The central issues before the Court of Appeal were whether incorporation of overhead costs into the price of the taxable vehicle supply was required, whether a nil attribution was permissible, and whether HMRC had advanced a separate challenge to the proposed apportionment rate.

Lord Justice Patten gave the leading judgment. Lady Justice Sharp and Lady Justice King agreed.

1. Appeal allowed. The Court allowed VWFS’s appeal on both grounds.
2. The Principal VAT Directive (2006/112/EC) and the implementing provisions of the Value Added Tax Act 1994 and Value Added Tax Regulations 1995 require an objective assessment of whether input costs are used for taxable transactions. A direct and immediate link may exist with particular taxable supplies or with the taxable person’s economic activity as a whole.
3. Where expenditure comprises general overheads of the business, it is capable of being a cost component of the relevant taxable and exempt supplies. The reference to price in the authorities means the cost of making the supplies. Actual incorporation of the overheads into the price charged to the consumer is not a precondition to deduction. Inclusion in price is, at most, evidence of the economic link.
4. The fair and reasonable attribution required for a partial exemption special method must reflect real economic use, assessed in the light of the observable terms and features of the business. The approach in Revenue and Customs Commissioners v London Clubs Management Ltd had to be read in context. It did not justify treating the taxable vehicle supplies as having nil use of the overheads merely because the finance activity generated the profit.
5. VWFS’s hire-purchase transactions comprised taxable vehicle supplies and exempt finance supplies. The overheads were used for the transactions as a whole, and a zero attribution to the taxable supplies was unsustainable. HMRC had not advanced a distinct alternative methodology seeking an attribution between zero and 50 per cent. The First-tier Tribunal was therefore entitled to endorse VWFS’s proposed method, and its decision disclosed no error of law. No reference to the CJEU was necessary.

1. Court of Appeal (Civil Division) allowed VWFS’s appeal on both grounds.
2. Upper Tribunal (Tax and Chancery Chamber), in [2012] UKUT 394 (TCC), reversed the First-tier Tribunal’s conclusion and held that the residual input tax was not deductible against the taxable vehicle supplies.
3. First-tier Tribunal allowed VWFS’s appeal, holding that a partial exemption special method attributing part of the residual input tax to the taxable vehicle supplies was fair and reasonable.