CA-2024-000806 - [2025] EWCA Civ 1259

Article 174

The deductible proportion shall be made up of a fraction comprising the following amounts:

as numerator, the total amount, exclusive of VAT, of turnover per year attributable to transactions in respect of which VAT is deductible pursuant to Articles 168 and 169;

as denominator, the total amount, exclusive of VAT, of turnover per year attributable to transactions included in the numerator and to transactions in respect of which VAT is not deductible.

Member States may include in the denominator the amount of subsidies, other than those directly linked to the price of supplies of goods or services referred to in Article 73.”

Article 174.1 contains a method based on turnover, which is known domestically as the “standard method”. That is the prescribed method (see Article 173.1) unless a different method is authorised or required, pursuant to the permissions in Article 173.2. A different method, which deviates from the standard method, is known as a partial exemption “special method”.

It is well-established in the case law of the Court of Justice of the EU that a taxable person can only use a special method “on condition that the method used guarantees a more precise determination of the deductible proportion of the input VAT than that arising from application of the turnover-based method”: see Case C-511/10 Finanzamt Hildesheim v BLC Baumarkt GmbH & Co KG EU:C:2012:689, [2013] STC 521, para 24. The same point was made in Case C-153/17 HMRC v Volkswagen Financial Services (UK) Ltd [2019] 4 WLR 32, where the Court cited para 24 of Baumarkt (at para 51) before saying this (with emphasis added):

Thus, any member state which decides to authorise or compel the taxable person to make the deduction on the basis of the use made of all or part of the goods and services must ensure that the method for calculating the right to deduct makes it possible to ascertain with the greatest possible precision the portion of VAT relating to transactions in respect of which VAT is deductible. The principle of neutrality, which forms an integral part of the common system of VAT, requires that the method by which the deduction is calculated objectively reflects the actual share of the expenditure resulting from the acquisition of mixed use goods and services that may be attributed to transactions in respect of which VAT is deductible: see Fazenda Pública v Banco Mais SA (Case C-183/13) EU:C:2014:2056; [2014] STC 2325, paras 30 and 31.

…

In that regard, the court has nevertheless specified that the method chosen must not necessarily be the most precise possible, but that, as is apparent from para 51 of this judgment, it must be able to guarantee a more precise result than the result which would arise from the application of the turnover-based allocation key …”

It is further established that a fundamental criterion for the application of VAT, including the deduction of input tax used or to be used in making taxable supplies, is that of economic reality: see Joined Cases C-53/09 and C-55/09 Revenue and Customs Commissioners v Loyalty Management UK Ltd; Baxi Group Ltd v Revenue and Customs Commissioners [2010] STC 2651 at para 39. It follows, and is not in dispute, that any method by which input tax is apportioned to taxable supplies must reflect the economic reality, assessed objectively, of the use of the relevant inputs.

Article 176 imposes a restriction on the deduction of VAT incurred on business entertainment in the following terms: