Denbrae Ltd v Revenue & Customs [2010] UKFTT 195 (TC) (28 April 2010)

DECISION

1. The appeal is against the following decisions of the Commissioners:

a. to assess the Appellant in the sum of £39,907.00 (plus interest) being input tax incorrectly claimed in periods 05/02 to 03/04 inclusive. This decision was subsequently reviewed and by Notice of Amendment to Assessment dated 25 November 2005 the Appellant was informed that the assessment was reduced to £30,863.00, the assessment in respect of the period 05/02 having been withdrawn

b. to refuse to repay a voluntary disclosure dated 5 October 2006 for periods 06/04 to 06/06 in the sum of £30,849.00

2. A decision by the Respondents to impose a misdeclaration penalty was withdrawn.

The background

3. The Appellant carries on business as Management Consultant and Property Developer from premises at Logistae House 45 Preston New Road Blackburn BB2 6AE. It was registered for the purposes of Value Added Tax under registration number 775 1308 26 with effect from 1 March 2001.

4. On 26 May 2005 an officer of HM Revenue and Customs visited the Appellant at its premises to examine books and records. The officer was attended during the visit by James Hope, Accountant employed by the Appellant.

5. From the information obtained during this visit, it appeared to the Respondents that the Appellant’s claims for credit for input tax during periods 05/02 to 03/04 inclusive were incorrect for the following reasons:

a. The Appellant had not declared any taxable income since its first return period return submitted in Mat 2001;

b. The Appellant since period 05/02 had submitted claims for credit for input tax said to have been incurred on legal fees incurred as a result of legal action against previous Directors of the Appellant and of Thane Investments Limited. The Respondents considered that there was no evidence that such input tax was attributable to taxable supplies made by the Appellant.

c. The Appellant had been visited by an Officer of H.M. Customs and Excise (as it then was) on 15 September 2003 in respect of a claim for credit for input tax on legal fees in respect of the legal action in period 11/02. The claim had been permitted; however, the Respondents determined that the officer was not given full details of the claim and the repayment was therefore made in error.

6. By letter dated 26 May 2005 the Respondents advised the Appellant of its findings and its intention to assess the Appellant in respect of the input tax previously claimed and repaid.

7. By Notice of Assessments dated 8 June 2005 the Respondents assessed the Appellant in the sum of £39,907.00 (plus interest) being input tax incorrectly claimed by and paid to the Appellant. This assessment was subject to review by the Respondents and was reduced to £30,863.00 which was notified to the Appellant by Notice of Amendment to Assessment dated 25 November 2005.

8. By notice of Appeal dated 18 July 2005 the Appellant appealed against the Respondents’ decision. The appeal was on the grounds that the Appellant was trading under the control of a court order issued at the commencement of proceedings against previous directors. This was designed to protect the assets of the company. The company had been successful in the proceedings ans was vigorously pursuing the return of funds. It had always been the intention of the new directors to trade and in order to do that, it entered into a contract on 28 March 2003 to buy two plots of land for housing development. The plots had planning permission and the company had contracted with the developer, Paddle Homes Limited, for them to carry out the building work. It was intended that other developments would be added to the land bank.

9. The Appellant stated that the litigation costs were essential overheads in order to keep the company going and that they related directly to the supplies tat would be made in the future. It suggested that the Respondents had endorsed both the facts and the company policy during the review visit in 2003 when they did not suggest or attempt to implement a change in practice.

10. By letter dated 16 December 2005 the Appellant submitted further details of its grounds of appeal namely:

a. The Appellant is a wholly owned subsidiary of Thane Investments Limited.

b. Giles Knopp and Brian Tomlinson were directors of the Appellant company against whom legal action was taken. As a consequence of that action Mr Tomlinson resigned as a director and employee of the Appellant Company and Mr Knopp was dismissed.

c. Mr Knopp commenced action against the Appellant for wrongful dismissal to which action the Appellant counterclaimed for Breach of Fiduciary Duty and misappropriation of the Appellant’s funds. The Appellant successfully defended the action and was awarded costs and damages against Mr Knopp and Mr Tomlinson in the sum of £160,000.00.

d. Mr Knopp and Mr Tomlinson declared bankruptcy, and Mr Tomlinson subsequently died. Litigation was continuing in an attempt to recover the damages awarded.

e. The Appellant was also pursuing litigation in respect of another judgment secured against Mr Tomlinson in the Isle of Man for £1.6M.

f. The Appellant had, since its incorporation, bought and sold commercial buildings, employed Solicitors and Accountants and purchased land in respect of which it had entered contracts for the construction of houses.

11. The Respondents applied for further information about the Appellant’s grounds of appeal which was provided in a letter dated 10 April 2006.

12. Minutes of a Board Meeting of the Appellant dated 27 March 2003 record an agreement to expand Denbrae’s trading activities by the purchase of 2 fully serviced plots of land at Arran Avenue from Paddle Limited for the sum of £5,000 each.

13. By a written agreement dated 28 March 2003 the Appellant agreed to purchase 2 fully serviced plots of land at Arran Avenue from Paddle Limited for the sum of £5,000 each. Paddle Limited agreed to build two houses on the plots once planning permission was granted and to sell the same on behalf of the Appellant.

14. Subsequent correspondence has revealed that the two plots had not been excluded from a sale of the whole site. That situation was rectified in 2008 by an amending letter of missive, and the plots were transferred to Denbrae Limited by Paddle Limited

15. The appeal first came for hearing on 10 October 2006. After Mr Barnes, a Director of the Appellant, had given evidence, the parties told the Tribunal that they had reached an agreement as follows:

a. That the assessment would be reduced to £3,624;

b. That the misdeclaration penalty would be withdrawn;

c. That the Appellant would make any necessary adjustments pursuant to Regulation 108(2) VAT Regulations 1995 to reflect sale of a serviced plot by the Appellant to Thane Investments Limited;

d. The Appeal would be withdrawn

16. The agreement was not reduced to writing, and dispute arose as to the terms and effect of the agreement. The appeal was therefore reinstated, and the disputed terms of agreement have been ignored by the Tribunal

17. On 05 October 2006 the Appellant submitted Voluntary Disclosure of Errors on VAT returns totalling £30,849 for the periods 06/04 to 03/06. The Appellant submitted on the claim form “Because of a disputed claim by HMRC for repayment of input tax due to be heard by the VAT Tribunal on October 10^th input tax has not been claimed since 04.03. This is now claimed on VAT652 on the assumption that nil returns were submitted since 04.03”.

18. This claim was rejected by the Respondents by letter dated 26 March 2008 at page 247 and 248 of the bundle. The Respondents submitted to the Tribunal that there is no evidence as to what this expenditure relates to and how it is made up.

The Legislation

19. Community legislation

a. Article 4 of the Sixth Directive provides:

'1. “Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph 2, whatever the purpose or results of that activity.

2. The economic activities referred to in paragraph 1 shall comprise all activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions. The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.'

b. Article 17 of the Sixth Directive, entitled 'Origin and scope of the right to deduct', provides in paras (1) and (2):

'1. The right to deduct shall arise at the time when the deductible tax becomes chargeable.

2. In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:

(a) value added tax due or paid in respect of goods or services supplied or to be supplied to him by another taxable person …'

20. UK legislation

Regulation 101 of the VAT Regulations 1995 provides

(1) Subject to [regulations 102, 103A, 105A and 106ZA], the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.

(2) [Subject to paragraph (8) below and regulation 107(1)(g)(ii),] in respect of each prescribed accounting period—

(a) goods imported or acquired by and, . . . goods or services supplied to, the taxable person in the period shall be identified,

(b) there shall be attributed to taxable supplies the whole of the input tax on such of those goods or services as are used or to be used by him exclusively in making taxable supplies,

(c) no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies, or in carrying on any activity other than the making of taxable supplies, shall be attributed to taxable supplies, . . .

21. We were referred by the Respondents to the following cases:

Customs and Excise Comrs v Rosner [1994] STC 228

Investrand BV v Staatssecretaris van Financiën: Case C–435/05 [2008] STC 518, ECJ

The evidence

22. Mr Barnes gave evidence that he had been the settlor of Elizabethan House Trust. Individuals called Knopp and Tomlinson were the Trustees and had set up a large number of companies owned by the Trust. At one stage they had £2 million cash. There had been litigation against Knopp and Tomlinson which is detailed in the bundle. Mr Barnes had obtained control of the companies from 11.07.2000. There was however a limitation on trading imposed by the Court. There was a liability to the bank which would expire in September 2006, and after that Denbrae would be able to trade without limitation.

23. Mr Barnes was not aware of the VAT position of Denbrae when he got control. There was an application for registration for VAT on 05.10.2000., signed on 03.03.2001 and lodged on 07.03.2001. The company was to act as Management Consultants. Mr Barnes said that if he had been involved in making the application for registration, it would have been for trading as well.

24. Mr Barnes told the Tribunal that he had pursued Knopp and Tomlinson through the courts, had got judgement against them, and they had gone bankrupt. He had personally funded the other litigation.

25. Mr Barnes was taken through the details of the agreement between Paddle and Denbrae. He told the Tribunal that Paddle was the owner of land, and that it agreed to sell two serviced plots to Denbrae on 27^th March 2003. Paddle was to build the houses. In 2006, the Solicitors acting wrote to Mr Barnes saying that the two plots were under contract, and that an application for registration of the transfer to Denbrae would be submitted in due course. At P 237 of the bundle there is an invoice for the two plots dated 11.04.2006.

26. Mr Hope told the Tribunal that the first output tax of the company was in May 2001, and probably related to a management fee. There were no other outputs until May 2005. He said that Denbrae was the main trading company within the group. Thane Investments had originated from Elizabethan Hous Trust Limited. It owned Denbrae, and Denbrae owned trading companies. Sites for development had been looked at but had not materialised.

27. Mr Barnes confirmed that Denbrae had received £90,000 from one of the directors about a year after he got control. That money was used to wards the legal fees the subject of the invoices and to pay Paddle for the two plots.

28. Mr Godley, Officer of MMRC gave evidence in accordance with his statements. He had not been given the invoice for hire of the Jeep at the time of his visit in May 2005, nor had he been told about it

29. Mr Kennedy, Officer of HMRC gave evidence in accordance with his statement

Reasons for decision

30. As set out in the legislation above, a taxable person is entitled to claim credit for input tax in respect of VAT incurred in the supply of any services to him used or to be used for the purpose of any business carried on by him.

31. The legal services in respect of which the Appellant has claimed credit for input tax were not supplied to it for the purposes of the business carried on or intended to be carried on by the Appellant.

32. The Respondents have accepted, on the evidence, that there was an intention to trade on the part of the Appellants at the time the legal fees were incurred.

33. However, it became clear from the evidence that the Appellant had not made any taxable supplies until well after the assessment was raised by the Respondents. The Appellants brought evidence, in the form of invoices dated 2007 that a Jeep had been leased by the Appellant. However, the invoice was only raised after the first Tribunal hearing.

34. The issue to be determined by the Tribunal was whether or not there was a direct and immediate link between the input transactions and the output transactions. It was held in Investrand BV

“ According to settled case law, the existence of a direct and immediate link between a particular input transaction and a particular output transaction giving rise to entitlement to deduct was, in principle, necessary before the taxable person was entitled to deduct input VAT. It was however also accepted that a taxable person had a right to deduct even where there was no direct and immediate link, where the costs of the services were part of his general costs and were, as such, components of the price of the goods or services which he supplied.”

35. At paragraph 23 and 24 and 26 of Investrand BV

“23. According to settled case law, the existence of a direct and immediate link between a particular input transaction and a particular output transaction or transactions giving rise to entitlement to deduct is, in principle, necessary before the taxable person is entitled to deduct input VAT and in order to determine the extent of such entitlement (see Midland Bank, para 24; Abbey National, para 26; and I/S Fini H v Skatteministeriet (Case C-32/03) [2005] STC 903, [2005] ECR I-1599, para 26). The right to deduct VAT charged on the acquisition of input goods or services presupposes that the expenditure incurred in acquiring them was a component of the cost of the output transactions that gave rise to the right to deduct (see Midland Bank, para 30; Abbey National, para 28; and Cibo Participations SA v Directeur Régional des Impôts du Nord-Pas-de-Calais (Case C-16/00) [2002] STC 460, [2001] ECR I-6663, para 31).

24. It is however also accepted that a taxable person has a right to deduct even where there is no direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct, where the costs of the services in question are part of his general costs and are, as such, components of the price of the goods or services which he supplies. Such costs do have a direct and immediate link with the taxable person's economic activity as a whole (see, inter alia, Midland Bank, paras 23 and 31, and Kretztechnik, para 36).

26. Contrary to what Investrand has claimed, the steps taken by a taxable person, on his own behalf, to recover a claim or establish the value thereof cannot be treated as such an activity either. Such steps do not constitute the exploitation of property to produce income on a continuing basis because any resultant gain derives merely from his status as holder of the claim in question and is not the product of any economic activity within the meaning of the Sixth Directive (see, to that effect, Kretztechnik, para 19).

36. The Tribunal concluded that, on the facts, Mr Barnes, who is an able and determined man, would have commenced and/or defended all such proceedings as were necessary to protect the interests of himself, his family and his companies. He would have done this whether or not Denbrae was intending to carry out its activities. In the judgment of the Tribunal, there is no way that Mr Barnes would have sat back and done nothing. The steps taken by the Appellant, therefore, appear to the Tribunal to be steps taken to protect and recover assets, and not for the purpose of augmenting the financial means of the company for the benefit of its economic activity.

37. Paragraph 33 of Investrand BV states

“33. In those circumstances, it cannot be considered that the costs relating to those services were incurred for the purposes of and with a view to Investrand's taxable activities. As the exclusive reason for those costs is not to be found in those activities, the costs have no direct and immediate link to them.”

The Tribunal concluded that in this case, the litigation was not for the purpose of Denbrae’s economic activities, and that the costs, therefore, have no direct and immediate link to its economic activities.

38. The Tribunal considered whether the VAT status of Denbrae was relevant to the analysis. It concluded that, for the same reasons as those set out in Investrand BV it was not. When the Appellant was busy safeguarding its assets, it was not trading. The trading did not commence until some years later, and then only in relation to exempt supplies. The Tribunal took into account the submission put in on behalf of the Appellant by Mr Hope. The Tribunal accepts that there was an inevitable delay in the commencement of trading, but, in the opinion of the Tribunal, the delay is irrelevant. The Tribunal has to look at the purpose behind the litigation. In the finding of the Tribunal, the purpose was not linked at the time of the litigation to the economic activities of the Appellant.

39. An issue was raised as to when the Appellant became registered for VAT. The only documentary evidence before the Tribunal was the application for registration in March 2001. The Tribunal concluded that that was the date of registration.

40. The Tribunal looked at the case of Rosner which is consistent with Investrand BV and focuses on benefit. There was no business up and running, only an intended business, and for that reason the Tribunal concluded that the Notice of Amendment to Assessment dated 25 November 2005 should be confirmed.

41. The Tribunal confirms the Respondents’ refusal to repay the voluntary disclosure dated 5 October 2006. There is no evidence as to what expenditure it relates to or how it is made up. Mr Barnes says that it is in relation to litigation. If that litigation was in relation to the proceedings in 2006, at P176 of the bundle, the proceedings were principally in relation to the Grant Arms Hotel. For the reasons set out above, the Tribunal concluded that the litigation was not for the purpose of Denbrae’s economic activities, and that the costs, therefore, have no direct and immediate link to its economic activities.

42. There is no order for costs.

JOHN N. DENT

TRIBUNAL JUDGE

RELEASE DATE: 28 April 2010

First-tier Tribunal (Tax)

FIRST TIER TRIBUNAL

DENBRAE LIMITED Appellant

THE COMMISSIONERS FOR HER MAJESTY’S

REVENUE & CUSTOMS Respondents

DECISION

JOHN N. DENT

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You are here: BAILII >> Databases >> First-tier Tribunal (Tax) >> Denbrae Ltd v Revenue & Customs [2010] UKFTT 195 (TC) (28 April 2010) URL: http://www.bailii.org/uk/cases/UKFTT/TC/2010/TC00497.html Cite as: [2010] UKFTT 195 (TC)