Revenue And Customs v Hotel La Tour Ltd

Factual and Procedural Background

This appeal concerns HMRC's challenge to the Upper Tribunal's decision dismissing HMRC's appeal against the First-tier Tribunal's ruling that a holding company ("Company A"), which managed a group of companies including its managed subsidiary ("Company B"), could deduct input VAT incurred on professional services relating to the sale of shares in Company B. Company A and Company B formed a VAT group, with Company A as the representative member. Company A sold its shares in Company B to a third party, using the proceeds to fund a new hotel development project. Company A incurred input tax on services from marketing agents, solicitors, and accountants to facilitate the sale. HMRC denied the input tax deduction, leading to appeals through the First-tier Tribunal, Upper Tribunal, and ultimately this appeal.

Legal Issues Presented

1. Whether the input tax incurred by Company A on services connected to the sale of shares in Company B, an exempt supply, is deductible under VAT law.
2. Whether the Upper Tribunal erred in its application of the "direct and immediate link" test for input tax deduction, particularly in relation to exempt share sales.
3. Whether the existence of a VAT group between Company A and Company B affects the deductibility of input tax on services connected to the share sale.

Arguments of the Parties

Appellant's Arguments (HMRC)

• The correct legal test is a two-stage "either/or" test: first, whether the input costs have a direct and immediate link to a specific taxable supply; if not, whether they relate to the taxable person's general business activity.
• The tribunals erred by modifying the first stage in fund-raising cases and disregarding the exempt share sale as the relevant transaction.
• The input tax should be disallowed because the costs were directly and immediately linked to an exempt supply of shares, which breaks the VAT deduction chain.
• The Upper Tribunal overstated developments in case law since BLP and wrongly applied the principle of fiscal neutrality to equate exempt share sales with non-VAT transactions.
• The argument that the costs were incorporated in the price of the shares was wrongly applied as a test for deductibility.

Respondent's Arguments (Company A)

• The two-stage test applies but in this case the share sale, though exempt, should be treated akin to a fund-raising transaction outside the scope of VAT, allowing input tax deduction as overheads.
• The existence of a VAT group means intra-group management services are disregarded for VAT purposes, so Company A’s activities do not constitute economic activity in respect of the shares, placing the share sale outside the scope of VAT.
• Input tax on services connected to the share sale should be deductible because the sale was to raise funds to support taxable hotel activities.
• The reasoning in the SKF case and Supreme Court decision in Frank Smart supports treating such inputs as overheads deductible to the extent of taxable outputs.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
BLP Group plc v Customs and Excise Commissioners [1996] 1 WLR 174	Input tax deduction requires a direct and immediate link to taxable transactions; costs directly linked to exempt share sales are not deductible.	Confirmed that input tax on services directly attributable to exempt share sales is irrecoverable; ultimate purpose irrelevant.
Midland Bank plc v Customs and Excise Commissioners [2000] 1 WLR 2080	Clarified that the direct and immediate link test is fact-specific; inputs consequential to a transaction may not qualify for deduction.	Held no direct and immediate link between legal services related to litigation and zero-rated advisory services; input tax partially deductible as overheads.
Abbey National plc v Customs and Excise Commissioners [2001] 1 WLR 769	Costs related to transfers of going concern (TOGC) form part of the taxable person's overheads and may be deductible.	Input tax on services connected to TOGC was deductible as overheads linked to taxable economic activity.
Kretztechnik AG v Finanzamt Linz [2005] 1 WLR 3755	Share issues to raise capital are outside the scope of VAT; input tax on related services is deductible as overheads.	Distinguished share issues from share sales; input tax deductible to extent linked to taxable economic activity.
Skatteverket v AB SKF [2010] STC 419	Confirmed that input tax deduction depends on whether costs have a direct and immediate link with taxable outputs or general taxable activity; exempt share sales break the deduction chain unless costs are overheads.	Remitted to national court to determine whether input costs were directly attributable to exempt share sale or general taxable activity; emphasised "either/or" test.
Frank A Smart & Son Ltd v Revenue and Customs Commissioners [2019] UKSC 39	Confirmed evolution of case law allowing input tax on fund-raising costs to be treated as overheads deductible to extent of taxable outputs.	Supported the view that inputs linked to exempt share sales might be deductible if treated as overheads; did not extend to automatic deduction in all cases.
Sveda UAB v Valstybinė mokesčių inspekcija [2016] STC 447	Emphasised that direct and immediate link depends on objective incorporation of costs in taxable outputs.	Confirmed that costs incorporated in taxable outputs may give rise to input tax deduction even if initial transaction is not taxable.
Revenue and Customs Commissioners v University of Cambridge [2019] 4 WLR 126	Input tax deduction denied where costs related directly to non-economic activities outside VAT scope.	Applied principle that input tax is deductible only to extent linked to taxable economic activities.
Revenue and Customs Commissioners v Associated Newspapers Ltd [2017] EWCA Civ 54	Clarified application of direct and immediate link test; inputs may be overheads deductible in proportion to taxable activities.	Confirmed that the nature of the supply and objective evidence determine deductibility; inputs linked to business as a whole qualify as overheads.
Customs and Excise Commissioners v Thorn Materials Supply Ltd [1998] STC 725	Interpretation of VAT grouping provisions; statutory fiction does not change nature of individual businesses.	Confirmed that VAT grouping treats group members as a single taxable person for VAT accounting but does not merge their separate economic activities.

Court's Reasoning and Analysis

The Court undertook a detailed analysis of the applicable VAT legal framework, focusing on the principle that input tax deduction is available only where there is a direct and immediate link between the input costs and taxable outputs or the taxable person's overall economic activity. This principle is well-established in EU Directives and case law. The Court examined the key precedents, notably BLP, Midland, Abbey National, Kretztechnik, SKF, and Frank Smart, to assess their application to the facts.

The Court emphasized that the SKF decision did not fundamentally alter the established rules but clarified that input costs connected to an exempt share sale might, depending on the facts, be treated as overheads deductible in proportion to taxable outputs. However, this is an "either/or" test: costs cannot be both directly attributable to the exempt share sale and simultaneously overheads linked to taxable activity. The Court found that the Upper Tribunal erred in disregarding the exempt share sale and in overstating changes in the case law since BLP.

The Court rejected the modification of the direct and immediate link test into a test based on incorporation of costs into the price of shares, viewing any such approach as a change of emphasis rather than a change of principle. It agreed with the First-tier Tribunal's factual findings that the input costs were directly and immediately linked to the exempt share sale, as they were paid from the proceeds of that sale and were part of the process of selling the shares.

Regarding the VAT grouping issue, the Court held that the statutory fiction under domestic law treating group members as a single taxable person for VAT purposes does not alter the factual economic activities of those members. Company A's management services to Company B constituted economic activity, bringing the share sale within the scope of VAT as an exempt supply. The argument that the VAT group status negated this economic activity was rejected.

Consequently, the Court concluded that input tax incurred on services directly linked to an exempt share sale is not deductible, preserving the chain-breaking effect of exempt supplies under VAT law.

Holding and Implications

The appeal is allowed.

The Court overturned the Upper Tribunal's decision and held that Company A is not entitled to deduct input VAT on services directly and immediately linked to the exempt share sale of shares in Company B. The existence of the VAT group does not alter this conclusion. The input tax incurred on these costs is irrecoverable, resulting in "sticking" input tax despite Company A being a taxable trader in its hotel business.

No new legal precedent was established; rather, the decision affirms the long-standing principles of VAT input tax deduction and the chain-breaking effect of exempt supplies. The ruling highlights the necessity of applying the direct and immediate link test objectively and confirms that fund-raising transactions involving exempt share sales do not automatically qualify input costs as deductible overheads.