Revenue and Customs v Frank A Smart & Son Ltd (Scotland), United Kingdom Supreme Court, Judgment, Law, casemine.com

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Revenue and Customs v. Frank A Smart & Son Ltd (Scotland)

Smart Summary

Factual and Procedural Background

Company A is a farming enterprise located in The State. Between 2007 and 2012 it spent approximately £7.7 million (plus VAT) purchasing tradeable “Single Farm Payment Entitlements.” These entitlements generated annual EU farm subsidies that Company A used to reduce an overdraft and to accumulate funds for three contemplated projects: (i) a wind-farm, (ii) additional farm buildings, and (iii) acquisition of neighbouring farmland. All of Company A’s existing outputs were taxable supplies under the Value Added Tax Act 1994.

The Government Agency refused to allow Company A to deduct £1,054,852.28 of input VAT incurred on acquiring the entitlements. Company A appealed:

First-tier Tribunal – Allowed the appeal, finding the expenditure to be a “funding exercise” directly linked to future taxable activities.
Upper Tribunal – Dismissed the Government Agency’s appeal, holding there was no error of law.
Inner House of the Court of Session – Again dismissed the appeal ([2017] CSIH 77).
Supreme Court – The Government Agency (Appellant) obtained permission and brought the present appeal.

Legal Issues Presented

Whether a taxpayer may deduct input VAT paid on the purchase of subsidy entitlements when the resulting subsidies themselves are outside the scope of VAT.
Whether such expenditure is properly characterised as a general business overhead linked to future taxable supplies, or as expenditure directly linked to a non-economic activity.
Whether the lower tribunals erred by relying on the Director’s stated intention to use subsidy proceeds for future taxable developments.

Arguments of the Parties

Appellant’s Arguments (Government Agency)

The purchase of subsidy entitlements is directly and immediately linked to receipt of the subsidies, an activity outside the scope of VAT; consequently, input VAT is non-deductible.
Expenditure cannot be re-categorised as a general overhead merely because the proceeds are later used in taxable operations.
The tribunals wrongly relied on subjective evidence of the Director’s intentions, contrary to CJEU authority emphasising objective analysis (BLP).
If the correct position is unclear, a preliminary reference should be made to the CJEU.

Respondent’s Arguments (Company A)

Under the principle of fiscal neutrality, a fully taxable trader may recover all input VAT on fund-raising costs so long as the funds are deployed in its taxable business.
CJEU case law (Kretztechnik, SKF, Sveda) distinguishes between exempt transactions (which may break the link) and transactions wholly outside VAT, the latter not interrupting deductibility when costs form part of business overheads.
The Director’s intentions were corroborated by objective evidence: planned capital projects and retention of subsidy proceeds within the business.
No reference to the CJEU is necessary; the matter is acte clair on current jurisprudence.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
BLP Group plc v Customs and Excise Comrs (C-4/94)	Input VAT is irrecoverable where costs are directly linked to an exempt supply, regardless of ultimate purpose.	Appellant relied on it; Supreme Court distinguished it as limited to exempt, not outside-scope, transactions.
Midland Bank plc v Customs and Excise Comrs (C-98/98)	Need for a “direct and immediate link” between input and taxable output; objective evidence required.	Cited as foundational test for linkage analysis.
Abbey National plc v Customs and Excise Comrs (C-408/98)	Costs of a transfer outside VAT can be overheads giving rise to partial deduction.	Used to support treating entitlement purchases as overheads.
Kretztechnik AG v Finanzamt Linz (C-465/03)	Share issue (outside VAT) costs are deductible when funds support overall taxable activity.	Analogy drawn between share issues and subsidy entitlement acquisitions.
Investrand BV v Staatssecretaris van Financiën (C-435/05)	No deduction where costs relate solely to earlier non-economic activity.	Distinguished: Company A incurred costs while already a taxable person.
Securenta AG v Finanzamt Göttingen (C-437/06)	Must apportion input VAT when downstream activities include both economic and non-economic elements.	Court noted no apportionment necessary because Company A’s future activities are expected to be taxable.
Skatteverket v AB SKF (C-29/08)	Deduction possible for share disposals when costs are part of general business expenses.	Reinforced that linkage may be to overall economic activity, not just specific outputs.
Sveda UAB v VMI (C-126/14)	Input VAT deductible where goods are intended for future taxable activity, even if initial free use occurs.	Supported immediate deduction despite time lag before downstream projects commence.
Iberdrola Inmobiliaria v Direktor… Sofia (C-132/16)	Services benefiting a third party may still create deduction if necessary for taxpayer’s taxable outputs.	Cited to show that benefit to others (landlords of seasonal lets) does not preclude deduction.
Rompelman v Minister van Financiën (C-268/83)	Principle that the VAT system must relieve economic activities of VAT burden.	Underlying rationale for allowing deduction.

Court's Reasoning and Analysis

Judge Hodge, writing for a unanimous panel, undertook a detailed survey of CJEU jurisprudence. The Court emphasised the principle of fiscal neutrality and the requirement of a “direct and immediate link.” Key analytical steps were:

Characterisation of the transaction. Purchasing subsidy entitlements and receiving subsidies constitute a single fund-raising exercise; receipt of subsidies is outside VAT but does not sever deductibility.
Link to economic activity. Objective findings showed Company A intended to deploy the funds in wholly taxable future projects. Therefore the costs were general overheads forming part of downstream taxable supplies.
Distinguishing exempt transactions. Cases like BLP apply where the initial transaction is exempt. Here the initial activity is outside the scope of VAT, analogous to Kretztechnik and subsequent authorities.
No apportionment required. Company A conducts, and plans to conduct, only taxable supplies; hence Article 173 apportionment does not arise.
Administrative concerns. Although HMRC faces practical monitoring difficulties, existing powers allow claw-back if funds are later used for non-economic or exempt purposes.

Holding and Implications

APPEAL DISMISSED.

The Supreme Court affirmed Company A’s entitlement to deduct the disputed input VAT. Practically, the decision confirms that fully taxable businesses may recover VAT on fund-raising costs, even where the mechanism for raising funds lies outside the VAT system, provided objective evidence shows the funds will support taxable operations. The judgment does not create a new legal test but clarifies the application of existing CJEU principles within the United Kingdom.