Royal & Sun Alliance Insurance Group Plc v Customs & Excise

Factual and Procedural Background

The appeal concerns whether Company A, an insurance group, can deduct input tax paid on rent to landlords of premises it occupied from the early 1990s until 20 November 1995. During this period, Company A used the premises for exempt supplies. After ceasing occupation, Company A sought subtenants, with lettings potentially exempt or subject to VAT. On 20 November 1995, Company A elected to make taxable supplies of lettings. The issue is whether input tax paid after Company A ceased occupation but before the election can be deducted. The Manchester VAT Tribunal ruled that Company A could not deduct this input tax. The case involves interpretation of VAT legislation, including the Value Added Tax Act 1994 and related regulations, and the application of EU VAT Directive principles.

Legal Issues Presented

1. Whether Company A is entitled to deduct input VAT paid on rent during the period after it ceased occupying the premises and before it made an election to waive exemption under VAT law.
2. Whether the supplies of property under a lease should be treated as a single supply or as separate and successive supplies for VAT purposes.
3. The interpretation and application of regulation 109 of the VAT Regulations 1995 concerning adjustment of input tax where the initial intention to use goods or services in exempt supplies changes to taxable supplies within six years.
4. Whether there is a direct and immediate link between the inputs (input tax on rent) and subsequent taxable supplies made after the election.
5. How the time of supply rules (regulations 85 and 90) affect the characterization of supplies and the right to deduct input tax.

Arguments of the Parties

Appellant's Arguments (Commissioners of Customs and Excise)

• The input tax paid during the vacant unelected period was consumed in unsuccessful attempts to find tenants and thus cannot be reattributed to later taxable supplies.
• Each supply of premises for rent is a separate and successive supply for VAT purposes, linked to payments or invoices, not a single supply.
• There was no direct and immediate link between the inputs paid in the unelected period and the taxable supplies made after the election.
• European Court of Justice authority (Finanzamt Goslar v Breitshol) supports that input VAT consumed in unsuccessful attempts to make taxable supplies cannot be recovered later.
• The judge erred in treating the lease as a single supply and in concluding that inputs in the void unelected period were cost components of later taxable supplies.
• The concept of "consumption" of inputs in VAT law means that once inputs are used in exempt activities, they cannot be attributed to subsequent taxable supplies.
• The time of supply regulations do not permit re-characterising rent payments as cost components of later taxable supplies.

Respondent's Arguments (Company A)

• The lease is a single supply; inputs paid in the void unelected period were not used in a VAT sense until taxable supplies were made after the election.
• The costs incurred before the election were cost components of making taxable supplies after the election, supported by the "lease preservation" principle.
• Regulation 109 applies because the intention to use inputs for exempt supplies was unfulfilled and was replaced by an intention to use them for taxable supplies.
• Distinguishing inputs generated during preparatory acts from those during business activities is incorrect; inputs can accumulate and be used later (citing Svenska International plc v CCE).
• The direct and immediate link exists in the VAT sense because the outputs could not have been earned without the inputs.
• The principle of VAT neutrality supports allowing deduction of input tax where inputs relate to taxable supplies.
• Time of supply regulations determine when VAT is accounted for but do not affect the nature of the supply or the right to deduct input tax.
• Inputs can only be consumed in a VAT sense when there is a correlative output; without taxable supplies, inputs are not consumed.

Table of Precedents Cited

Court's Reasoning and Analysis

The court examined the statutory framework of VAT law, focusing on the Value Added Tax Act 1994 and the VAT Regulations 1995, particularly regulation 109 which permits adjustment of input tax where the intention to use inputs in exempt supplies changes to taxable supplies within six years. The tribunal had found no direct and immediate link between the input tax paid in the unelected period and the taxable supplies made after election, treating the lease as a series of separate supplies consumed in unsuccessful attempts to let the properties.

Park J held that the lease was a single supply and that inputs paid in the unelected period were cost components of later taxable supplies, establishing the required direct and immediate link. He rejected the argument that inputs were consumed before the election, emphasizing that a failed attempt to use an input does not consume it for VAT purposes. He considered regulations 85 and 90 as dealing only with timing of supplies and not their nature.

The court analyzed the submissions of both parties, focusing on the meaning of "use" and "consumption" of inputs in VAT law. It recognized the artificial nature of VAT rules but stressed the necessity of applying time of supply rules (regulation 85) to determine the nature and timing of supplies for input tax deduction purposes. The court concluded that each rent payment corresponds to a separate and successive supply for the relevant period, which is fully consumed once that period expires.

Consequently, the input tax related to rent payments in the unelected period was consumed in that period and not available for deduction against later taxable supplies. The court found no direct and immediate link between inputs paid in the unelected period and later taxable supplies. It rejected the respondent's argument that inputs could be accumulated and deducted later without regard to the time of supply rules.

The court also considered and applied relevant European Court of Justice precedents concerning the direct and immediate link requirement, the principle of VAT neutrality, and the treatment of inputs related to unsuccessful business attempts. It noted the lack of clear jurisprudence on the meaning of "consumption" in VAT and treated it as a question of fact and law.

Ultimately, the court found that Company A did not have the right to deduct input tax paid on rents during the unelected period, as those inputs were consumed in exempt activities (attempted letting) and not available for attribution to subsequent taxable supplies made after the election.

Holding and Implications

The court ALLOWED the appeal by the Commissioners of Customs and Excise, overturning the decision of Park J and the Manchester VAT Tribunal. It held that Company A was not entitled to deduct input VAT paid on rent during the period after it ceased occupying the premises and before it elected to waive exemption for VAT purposes.

The direct consequence is that input tax paid in the "void unelected period" is considered consumed in the exempt activity of attempting to let the premises and cannot be retrospectively attributed to taxable supplies made after the election. The court emphasized the application of time of supply rules in determining the nature and timing of supplies and the right to deduct input tax.

No new precedent was established beyond the application and clarification of existing VAT principles and regulations, particularly concerning the interpretation of regulation 109 and the interaction with regulations 85 and 90. The decision clarifies the limits of input tax deduction rights where the taxpayer changes the nature of its supplies over time and the importance of the direct and immediate link in VAT deduction claims.