In most cases for VAT charged to be “input tax” recoverable from HMRC, it must be “VAT on the supply to the input reclaimant of any goods or services”.
Consideration of economic realities is fundamental as regards the identification of the person to whom services are supplied.
Whilst commercial businesses do not usually pay suppliers unless they themselves are the receiver of the supply they are paying for (even if it may involve the provision of goods or services to a third party), that possibility cannot be excluded.
There may be two or more distinct supplies within the same transaction and “a single course of conduct by one party may constitute two or more supplies to different persons.”
Lord Millett in CCE v Redrow Group plc  said the benefit to the taxpayer:
“will normally consist of the supply of goods or services to the taxpayer. But it may equally well consist of the right to have goods delivered or services rendered to a third party. The grant of such a right is itself a supply of services.”
However consideration paid in respect of the provision of a supply of goods or services to a third party may sometimes constitute “third party consideration” for that supply, either in whole or in part.
For example, a business may meet the cost of a supply, that it cannot realistically be said to be the recipient of, to discharge an obligation owed to the recipient or to a third party.
In such cases the payment probably constitutes “third party consideration” for the supply and is not reclaimable by the payer as input VAT.
Lord Hope in the leading Redrow case said:
“Payment for the mere discharge of an obligation owed to a third party will not…………give rise to the right to claim a deduction. A case where the taxpayer pays for a service which consists of the supply of goods or services to a third party requires a more careful and sensitive analysis, having regard to the economic realities of the transaction when looked at as a whole. It may lead to the conclusion that it was solely third party consideration, or it may not.”
The application of VAT is highly dependent upon the facts and they and all the circumstances must be looked at. A small modification can make all the difference.
It is necessary to look at the contractual relationships as a whole in order to determine its economic reality.
The contractual position is generally the most useful starting point. The terms of any contract between the parties are an important factor, but not necessarily determinative, of whether in “economic reality” taxable supplies are being made as between any particular participants.
In the Court of Appeal case of Airtours Holidays Transport Ltd v Revenue And Customs  the issue was whether the appellant, Airtours Holidays Transport Limited (formerly MyTravel Group plc) (“the appellant”), was entitled to recover (as input tax) value added tax (“VAT”) charged by PricewaterhouseCoopers LLP (“PwC”) in respect of services PwC provided – and for which the appellant was invoiced by PwC and, under contractual obligation to PwC, paid.
The services related to a large-scale restructuring of the appellant, in conjunction with over 80 banks and other financial institutions it was indebted to, some of which the case calls “Engaging Institutions”.
The case had to decide whether, for VAT purposes, PwC “supplied” services to the appellant.
This in turn depended on whether the arrangements as between the Engaging Institutions, PwC and the appellant involved the supply of services to the appellant or merely third-party consideration provided by the appellant for services rendered by PwC to the Engaging Institutions alone.
PwC worked on this case between November 2002 and January 2005 in five phases based on a November 2002 Letter of Engagement, followed by four further engagement letters, dated respectively 14 January 2003, 7 March 2003, 21 July 2003, 15 December 2003 (“the Engagement Letters”). They were in similar terms and were signed (a) by the appellant, (b) on behalf of the Engaging Institutions, and (c) by PwC.
Phase 2 of the PwC work comprised “monitoring the Group and reporting monthly to the Engaging Institutions …………… and a review of the Strategic Plan including analysis of the options facing the Engaging Institutions.” Ultimately, the restructuring of the appellant’s business was achieved successfully. The appellant contended that this was only achieved with the assistance of the work undertaken by PwC.
The appellant sought to deduct the VAT on PwC’s fees as input tax in its VAT returns for the relevant periods.
The respondents HMRC accepted that the arrangements were of commercial benefit to the appellant. However, they said that PwC’s services were not supplied to the appellant, so the appellant had not been entitled to deduct the VAT on PwC’s fees as input tax.
The court said that in the present case, like strong>Redrow, PwC was making two distinct supplies of services within the same overall transaction “in both directions” – i.e. both to the Engaging Institutions and to the appellant as follows:
1. The Engagement Letters conferred a contractual right on the appellant to have PwC, liaise with the appellant’s directors and senior management, and then review, monitor, and validate (if appropriate) its financial statements, budgets, financial performance, EPM, arrangements with the CAA etc. and report on such matters to the Engaging Institutions. The grant of such a right (i.e. the right to have services rendered to a third party) was itself a supply of services to the appellant. The supply of that service, pursuant to the Engagement Letters, was for a consideration payable by the appellant.
2. The supply by PwC to the Engaging Institutions of the service of reporting on, monitoring and advising in relation to, the appellant’s financial statements, budgets, financial performance, EPM, arrangements with the CAA etc. – in other words the provision to them of “the Services” as defined in the Engagement Letters – in order to enable the Engaging Institutions to decide if they should carry on their credit facilities to the appellant. This supply was also made pursuant to the Engagement Letters but without the Engaging Institutions having incurred any liability or contractual obligation to PwC to pay for the supply made to them.
The appellant having established that it was the recipient of services for which it could reclaim in input VAT, HMRC tried to argue that in calculating the appellant’s entitlement to input VAT recovery there ought to be some apportionment of the VAT payable on the consideration to reflect the extent to which PwC supplied services to the appellant, on the one hand, and to the Engaging Institutions, on the other.
However the court said there was no question as to the adequacy of the consideration paid by the appellant to PwC, and no contractual apportionment of the consideration as between the two services mentioned above in the Engagement Letters, so it was difficult, if not impossible, to understand on what basis such an apportionment should take place.
HMRC could neither point to any statutory basis or to any relevant authority to support the view that where:
1. no monetary consideration had been paid by one contracting party; and
2. there had been “a single course of conduct by one party” (i.e. the work carried out by PwC) that constituted “two or more supplies to different persons”,
there should nonetheless be some notional apportionment. So there could be no question of apportionment.
This blog has been posted out of general interest. It does not remove the need to get bespoke legal advice in individual cases.