Standard Method Prevails and Business-Entertainment Block Applies Upfront: Dual‑Use Analysis and the “More Precise” Test in Partial Exemption

Hippodrome Casino Ltd v Revenue and Customs [2025] EWCA Civ 1259 (CA)

Introduction

This Court of Appeal decision resolves two recurrent and practically significant issues in VAT partial exemption:

• When can a taxpayer displace the statutory turnover-based “standard method” for residual input tax recovery with an alternative (special) method under a Standard Method Override (SMO)?
• How does the statutory restriction on input tax for business entertainment apply where residual input tax is apportioned using the standard method?

Hippodrome Casino Ltd (HCL) operates a “Las Vegas style” casino complex with extensive non-gambling facilities (bars, restaurants, theatre). It argued that the standard, turnover-based method did not fairly reflect economic use and should be displaced by a floorspace method via SMO. HMRC maintained that the standard method remained fair and reasonable and that HCL’s alternative was flawed because the non-gambling areas had significant “dual use” supporting the exempt gambling business. A subsidiary issue concerned the timing and scope of the business entertainment block under the Value Added Tax (Input Tax) Order 1992, Article 5, particularly for complimentary food and drink.

Procedurally, the First-tier Tribunal (FtT) had allowed HCL’s appeal; the Upper Tribunal (UT) allowed HMRC’s appeal, set aside the FtT decision for material error of law, and remade the decision in HMRC’s favour. The Court of Appeal (Asplin, Newey and the lead judgment) dismissed HCL’s further appeal.

Summary of the Judgment

• The UT was right to set aside the FtT’s decision for failure to engage with HMRC’s central “dual use” case and its implications for HCL’s proposed floorspace method. The FtT’s reasoning improperly treated HMRC’s case as akin to London Clubs Management (LCM), which it was not.
• In an SMO context, the correct focus is whether the taxpayer’s proposed alternative method guarantees a more precise determination of recoverable residual input tax than the turnover-based standard method. The standard method is the default and is presumed fair and reasonable unless displaced.
• HCL failed to show that its floorspace method was more precise; the UT’s finding of significant dual use of hospitality and entertainment areas for the exempt gaming business was upheld. The standard method therefore remained in place.
• The UT was not required to adjourn to allow HCL to propose a different, late-formulated method (e.g. footfall+turnover). The options in this appeal were binary given the SMO posture.
• On the business entertainment block (Input Tax Order, Article 5), the restriction applies once, up front, to the identified residual input tax “pot,” before the standard method apportionment. It bites by reference to business entertainment use as such, not by reference to the ultimate purpose (taxable or exempt) of the entertainment.
• Appeal dismissed.

Key Holdings Stated Shortly

• Default rule reaffirmed: The standard method (turnover) is presumed fair and reasonable and endures unless the taxpayer proves its proposed alternative is more precise (Baumarkt/VWFS applied).
• Dual use matters: Where taxable-space is significantly used to support exempt activities, floorspace proxies assuming exclusive taxable use are “critically flawed.”
• No rolling redesign: Tribunals are not obliged to adjourn or craft guidance for fresh alternative methods when a proposed SMO fails.
• Business entertainment restriction: Article 5 operates as a single, up-front restriction on the residual input tax pool, before any standard method calculation, and irrespective of the entertainment’s ultimate objective.

Detailed Analysis

1. Precedents and Authorities Considered

EU Law Framework

• Principal VAT Directive 2006/112/EC:
  • Art 168–170: right to deduct input tax on goods/services used for taxable transactions.
  • Art 173–174: proportional deduction; Art 174(1) establishes the turnover-based standard method.
  • Art 176: permits restrictions on deductibility for specified expenditures including entertainment.
• Case C‑511/10 Baumarkt: Special methods may be used only if they guarantee a more precise determination of the deductible proportion than the standard turnover method.
• Case C‑153/17 VWFS (CJEU): Reaffirms Baumarkt—method must achieve “the greatest possible precision,” though not necessarily “the most precise possible,” and must reflect economic reality and VAT neutrality.
• Banco Mais (C‑183/13): Principle of neutrality requires that deductions reflect actual use attributable to taxable transactions.

UK Domestic Framework and Cases

• VATA 1994 ss 24–26: input tax, right to credit, and regulation-making power for fair and reasonable attribution (partial exemption).
• VAT Regulations 1995:
  • Reg 101: standard method mechanics; identify residual input tax and apportion by turnover ratio.
  • Reg 107B–107C: Standard Method Override (SMO): requires correction if standard method attribution differs substantially from actual use; sets “substantial difference” thresholds.
  • Reg 102–102C: special methods regime and Special Method Override Notices (SMONs).
• Input Tax Order 1992, Art 5: business entertainment block.
• London Clubs Management [2012] STC 388 (CA): Upheld FtT’s finding that catering was an independent activity in that case; not a direct analogue here because HMRC’s argument in Hippodrome was about dual economic use, not “merely ancillary” characterisation.
• Dial‑a‑Phone [2004] EWCA Civ 603: For attribution, the law looks for a “sufficient link,” acknowledging necessary approximation.
• Temple Finance [2017] STC 1781 (UT): Tribunal need not devise other methods beyond those the parties advance where the standard method is in play; relevant to rejecting a “rolling” reconsideration obligation.
• Vision Express [2010] STC 742 (Ch) and St John’s College [2010] UKFTT 113 (TC): Instances of flexibility/adjournment in special method/SMON contexts; distinguished here because Hippodrome concerns displacement of the statutory standard method, not tweaking or replacing an agreed special method.
• St Helen’s School [2007] STC 633 (Ch): Suggests tribunals should not devise their own special method solutions.
• Associated Newspapers [2017] STC 843 (CA): Purpose analysis for costs; held not germane to Article 5 business entertainment in this case.
• Thorn EMI [1995] STC 674: Business/non‑business split (s.24(5) VATA) in hospitality chalets; not determinative of how Article 5 bites in partial exemption under the standard method.

How These Authorities Shaped the Outcome

The Court adopted the CJEU’s Baumarkt/VWFS benchmark as the controlling test for displacement of the standard method: only a method that guarantees a more precise determination can replace the default. This positioned the standard method as presumptively fair and reasonable until proved otherwise by the taxpayer. Temple Finance was used to support the Court’s refusal to create procedural space for a new method after HCL’s floorspace method failed. LCM was carefully distinguished: the analytical lens here was “dual use” in a vertically integrated casino environment, not whether catering is “ancillary” or independent in the LCM sense.

2. The Court’s Legal Reasoning

(a) The FtT’s Material Error and the UT’s Intervention

The FtT treated HMRC’s case as though it were replaying LCM’s “ancillary” argument. The core of HMRC’s case, however, was dual economic use: hospitality and theatre areas did not exist solely for taxable supplies; they were materially used to support exempt gaming. The FtT failed to grapple with this second, decisive limb of HMRC’s case—why dual use rendered HCL’s floorspace method fundamentally distortive. That omission constituted a material error of law. The UT was therefore entitled to set aside and remake the decision.

(b) Where to Start in an SMO Case

In an SMO challenge, the inquiry is inherently comparative. Regulation 107B demands a demonstration that the standard method attribution differs substantially from actual use and that the alternative guarantees a more precise result. The Court affirmed that tribunals may (and, in a case like this, should) start with the taxpayer’s proposed alternative to see if it can, in principle, displace the default. If the alternative fails, the standard method stands. There is no requirement for a tribunal to conduct a freestanding critique of the standard method divorced from any viable alternative or to keep the door open for serial reformulations.

(c) Dual Use and the Failure of the Floorspace Proxy

On the UT’s fact-finding (which the Court endorsed), the hospitality and entertainment areas had significant dual economic use for the exempt gaming strand. A floorspace metric that treated these as exclusively taxable areas was “critically flawed” and inherently distortive. The taxpayer bears the burden to show its method better reflects actual use; HCL did not meet it.

(d) Footfall and the “30% Non-Gamblers” Point

The Court accepted the UT’s view that customer counts/footfall, including estimates of non-gambling patrons, are not in themselves a good proxy for economic use. Without robust evidence of how such cohorts consume inputs relative to gamblers, headcount is at best a weak surrogate. In any event, by the time the UT addressed this point, the determinative finding—that HCL’s method was not more precise—was already established.

(e) No Obligation to Adjourn for a New Method

While tribunals have case management discretion to adjourn or invite refinements in some contexts (often where a special method is already in place and a SMON has been served), nothing compels them to do so in an SMO case where the statutory default applies. The Court approved the UT’s approach: once HCL’s floorspace proposal failed, there was no need to solicit a fresh, fundamentally different method (e.g., footfall+turnover).

(f) Business Entertainment Restriction: Upfront Application

Article 5 of the Input Tax Order operates as a restriction by reference to “use for the purposes of business entertainment.” The Court held that, in a partial exemption case using the standard method:

• Identify the residual input tax pool.
• Apply a once-only restriction to exclude the proportion used for business entertainment.
• Only then apply the standard method’s apportionment between taxable and exempt supplies.

Crucially, the restriction bites on business entertainment use per se, not by reference to a downstream inquiry into whether the entertainment was directed toward taxable or exempt objectives. The Court rejected the taxpayer’s “purpose-based” reading and the suggestion of a further “commercial apportionment” overlay, which would complicate and undercut the standard method’s simplicity.

3. Impact and Implications

(a) For Partially Exempt Businesses

• Default solidity: The standard method is resilient. To displace it, a taxpayer must present an alternative that demonstrably improves precision in capturing actual economic use.
• Evidence burden: Methods built on floorspace, headcount, or other proxies must address dual use head‑on, with cogent evidence explaining why the metric accurately captures multi‑strand economic reality.
• No serial redesigns on appeal: Tribunals need not adjourn to allow iterative re‑engineering of proposed methods once the taxpayer’s chosen alternative is found wanting.
• Business entertainment: Expect a front‑end carve‑out from the residual input tax pool before partial exemption calculations. Complimentary hospitality is likely to be caught, except for the narrow statutory exceptions (e.g., reasonable entertainment for overseas customers).

(b) For Casinos, Hospitality-Driven Venues, and “Destination” Sites

• Integrated offerings intensify dual-use risk. Bars, restaurants, and shows designed to attract and retain gamers will often be economically dual‑used; a floorspace allocation that treats them as exclusively taxable is unlikely to survive scrutiny.
• Data strategy: If proposing a non‑turnover method, develop granular evidence (time‑use, spend profiles, staffing, security, marketing allocation) linking overhead consumption to taxable and exempt strands.

(c) For HMRC and Litigation Practice

• UT primacy on fact-finding and error control: The decision affirms the UT’s supervisory role where FtT fails to engage a central issue (here, dual use) and its ability to remake decisions.
• Policy clarity: The judgment provides a clear, administrable rule for applying the business entertainment block in partial exemption—front‑end, single-step restriction—reducing controversy and complexity.

Complex Concepts Simplified

• Residual input tax: VAT on overheads used for both taxable and exempt activities (e.g., rent, utilities, security, marketing). Not directly attributable to a single supply type.
• Standard method: A turnover-based fraction. Numerator: value of taxable supplies; denominator: value of all supplies (taxable + exempt). Applied to residual input tax to calculate recovery.
• Special method: Any alternative attribution method deviating from turnover (e.g., floorspace, transaction counts), authorised or required under the Directive/regulations.
• SMO (Standard Method Override): Corrective mechanism where standard method attribution differs substantially from actual taxable use; taxpayer bears the burden to show its alternative is more precise.
• Dual use: A single facility or service economically supports multiple supply strands (taxable and exempt). A key reality check for the suitability of non‑turnover proxies.
• Business entertainment block (Article 5): Statutory restriction excluding input tax to the extent goods/services are used for business entertainment (e.g., complimentary food/drink), subject to limited exceptions. In partial exemption, the block is applied before apportionment.
• Economic reality and VAT neutrality: Input tax recovery should reflect, as objectively as practicable, the real share of overhead consumption attributable to taxable outputs, preserving neutrality between taxable traders.

Comparative Notes: Why LCM Did Not Help HCL

In London Clubs Management, the FtT had made a primary finding (not challenged as perverse) that catering was an independent business, not merely ancillary to gaming. That factual platform drove the outcome. Hippodrome involved a different thesis: HMRC did not argue exclusivity of gaming purpose but emphasized dual economic use of hospitality spaces to support exempt gaming. Floorspace premised on exclusive taxable use was therefore misaligned with economic reality. The FtT’s reliance on LCM’s framing blurred this essential difference.

Practical Takeaways and Compliance Pointers

• When proposing an alternative method:
  • Lead with evidence showing why the method is more precise than turnover, not just different.
  • Confront dual use explicitly—document cross‑strand functions, staff deployment, marketing aims, and how the metric accounts for them.
  • Avoid proxies that assume exclusive use without proof.
• Anticipate the default: If your method fails, the standard method remains. Don’t expect adjournments to retool a theory late in the day.
• Business entertainment:
  • Identify and ring‑fence input tax used for complimentary hospitality early.
  • Apply the Article 5 block to the residual input tax pot before partial exemption apportionment.
  • Consider the narrow statutory carve‑outs (e.g., reasonable entertainment for overseas customers).
• Evidence design:
  • Headcount alone is generally a weak proxy; consider spend patterns, dwell time, and operational metrics if you rely on non‑turnover indicators.
  • For capital items (CGS), ensure annual use data aligns with your attribution method and the Article 5 treatment.

Conclusion

Hippodrome Casino provides clear and authoritative guidance in two respects. First, it re‑entrenches the standard method as the default attribution mechanism in partial exemption: a taxpayer seeking to deploy an SMO must prove its proposed method guarantees a more precise reflection of economic reality. The Court endorses a disciplined, comparative approach centered on the taxpayer’s proposed method; if that method is flawed—especially by ignoring dual use—the standard method endures without the tribunal having to curate further alternatives.

Second, it brings welcome clarity to the business entertainment restriction: in partial exemption cases where the standard method applies, Article 5 of the Input Tax Order is a single, upfront restriction on the residual input tax pot, not a downstream, purpose‑sensitive adjustment. This interpretation preserves the standard method’s simplicity and reduces opportunities for complexity and distortion.

Overall, the judgment strengthens the doctrinal nexus between economic reality, proportionality, and administrative workability in partial exemption, while delineating sensible limits on litigation dynamics in SMO disputes. For integrated hospitality‑gaming venues and other partially exempt businesses, the decision underscores the evidential rigor required to supplant turnover and the importance of treating complimentary hospitality as a front‑end deduction from the residual input tax pool.