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

Discussion

(1): Where to start?

Regulation 107B, which establishes the standard method override, applies “where a taxable person has made an attribution under [the standard method] and that attribution differs substantially from one which represents the extent to which the goods and services are used by him or are to be used by him … in making taxable supplies” (emphasis added). It is clear from the language of this regulation that a comparison is required between the standard method and the other method proposed.

Determining the extent to which goods or services are used or to be used for taxable purposes is not a perfect science: see, for example, the reference in VWFS to the method guaranteeing a “more precise” determination (para 51); see also Dial-a-Phone Ltd v Commissioners of Customs and Excise [2004] EWCA Civ 603 where it was held, in the context of attributing input tax to given outputs, that “the quest is not for the closest link, but for a sufficient link” (para 74 per Jonathan Parker LJ). It follows that the comparative exercise is focussed on establishing which method is more precise, accepting that there is likely to be some approximation in the outcome on either method and that perfection is not required.

The standard method is the default method: see Article 174 of the Principal VAT Directive and regulation 101(2). It can only be displaced by another method which gives rise to a more precise result (Baumarkt and VWFS). The comparison is therefore weighted: the standard method prevails unless it is displaced. I agree with Mr Donmall and the UT that the standard method, established by the Principal VAT Directive and enshrined in domestic law, can be relied on as giving a result which is fair and reasonable (even if a bit rough and ready). It will only be displaced if the alternative proposed is more precise in its outcome.

In this case, the UT had every reason to start with HCL’s SMO and ask whether it gave rise to a more precise result than the standard method. I can do no better but repeat the UT’s direction to itself:

Here, the Tribunal is concerned with the … question as to whether the SMO contended for guarantees a more precise determination of the deductible proportion of the input VAT than that arising from the application of the turnover-based method. The SMO must be able to guarantee a more precise result than the result which would arise from the application of the turnover-based method.

The standard method is the default method, based on the value of supplies (Regulation 101(2)(d)) and by definition will provide for a fair and reasonable deduction based on the use or intended use of purchases. Permission is not needed to use it. … It is therefore for the taxpayer to displace the standard method.”

The UT summarised its approach, in my view correctly, in this passage:

The focus of the appeal must therefore be on the proposed method, with the taxpayer bearing the burden of proof to establish that the SMO guarantees a more precise determination than the standard method. The standard method is the lawful and mandated method of apportionment up until the point that it is determined that a proposed method displaces it. In our judgment the starting point is therefore to consider whether or not the test set out in VWFS is met. If it is, then the standard method is displaced and the SMO applies. If it is not, then the standard method continues to apply.”

The starting point was HCL’s proposed method based on floorspace. The question was whether that method led to a more precise outcome than the standard method.

The UT held that the floorspace method was not a more precise measure of use than the standard method (para 180) and that HCL had failed to displace the standard method as being less precise than its proposed floorspace method (para 181). It accepted HCL’s SMO was “critically flawed” (para 186) and distortive (para 191).

The UT identified the correct issue and approached that issue correctly. There was no error of law.

In this case, where HCL’s proposed alternative method was challenged by HMRC as fundamentally flawed, it was particularly important to start with an analysis of that proposed alternative special method to decide whether it was even capable of giving rise to a fair and reasonable result.

Mr Donmall suggested that in SMO cases, where the standard method is the default, it is always necessary to start with an analysis of the SMO method, as the proposed alternative. I do not think that is an invariable rule. There may be cases where tribunals for good reasons start in a different place or prefer to look at both methods side by side in order to compare them. Those are matters for the tribunals to decide as matters of case management and procedure, always keeping the legislation and the Baumarkt test in clear view.

In this case, the tribunal was right to start with HCL’s proposed alternative. That alternative was challenged by HMRC on grounds that it was inherently flawed and incapable of yielding a fair and reasonable result. If HMRC was right, that really was the end of the case, because HCL’s method could not give rise to a more precise outcome than the standard method and the latter prevailed by default.

(2): Is the door still open for further argument?

HCL argues that the door should have been left open for further argument by the UT if it was not persuaded by the floorspace method put forward in the SMO. HCL relies on a number of decisions where the tribunals have been flexible in permitting further argument on the appropriate partial exemption method, even at an advanced stage of the appeal.

The first is Vision Express (UK) Ltd v Revenue and Customs Commissioners [2009] EWHC 3245 (Ch), [2010] STC 742, where the taxpayer had agreed a partial exemption special method with HMRC. HMRC served a SMON on the taxpayer, signifying HMRC’s view that the agreed special method did not give rise to a fair and reasonable result; that SMON was accompanied by an assessment for the difference. The Value Added Tax Tribunal upheld the SMON and the assessment in principle but left it open to the parties to apply for a further hearing to determine the method of calculation of any tax now due. The taxpayer appealed to the Chancery Division. McCombe J described the tribunal’s management of the appeal in this way:

… It is clear to me that the tribunal made no findings on the subject against which any appeal would lie; it seems that their view was that, if the parties could not agree upon a method of calculation, the matter would have to be determined at the further hearing for which they gave permission to the parties to apply.”

He dismissed the appeal.

As will be apparent, Vision Express was a case about a trader with a special method who received a SMON and an assessment reflecting that SMON. The tribunal (and the High Court) upheld the SMON on the basis that the originally agreed special method did not give rise to a fair and reasonable result. But the tribunal made no findings about the fairness of HMRC’s proposed alternative method and it was that issue which was reserved for further argument. This case involves a dispute about the standard method; and in this case, the UT has found flaws in HCL’s alternative method, which means that by operation of law the standard method is undisplaced. The two cases are very different.

The second case is St John’s College v Revenue and Customs Commissioners [2010] UKFTT 113 (TC). In that case the taxpayer had agreed a special method with HMRC which allowed a flat rate of deduction. The taxpayer then incurred a large amount of input tax on refurbishment work and served a SMON containing an alternative method of calculation on HMRC. That SMON allowed greater recovery of the input tax on refurbishment. The FtT held that a complete revising of the method was required (para 147) but that there was insufficient evidence to enable the FtT to make a precise calculation (para 148). It said this:

However we have reached conclusions different from those advocated by either of the parties. In order to put our conclusions into practice and to consider what input VAT should be allowable, further evidence not originally expected by either party may be necessary. In such circumstances we do not believe it would be fair to determine the appeal merely by finding that, because the onus was on the Appellant to set aside the Respondents’ computation, that onus had not been discharged. We therefore adjourn the appeal on this issue with leave for the parties to seek a further hearing to settle it.”

The FtT went on to give guidance about the sort of method which would be suitable (para 151).

As is apparent, St John’s is a special method case too. The problem in St John’s was that there was inadequate evidence to enable the tribunal to determine the appropriate special method. That is very different from this case where the standard method applies by default.

Finally, HCL relies on Revenue and Customs Commissioners v General Motors (UK) Ltd [2015] UKUT 605 (TCC), [2016] STC 985. That case was not about partial exemption at all but rather (to the extent that Mr Hitchmough suggests it is relevant) about the methodology used to establish the extent of a taxpayer’s overpayment on self-supplies of cars. It was in that context that the UT (Henderson J and Judge Sinfield) said this:

[68] The FTT were not, however, confined to choosing whether to accept or reject [GMAC’s] model in its entirety. So far as they could properly do so, it was their duty (applying their own expertise as a specialist tribunal) to ascertain the true amount of VAT (if any) which GMUK had overpaid. This result could be achieved either by the FTT performing the appropriate calculations itself, or by stating the principles by reference to which they considered the calculation should be made. In performing this task, the FTT had to act with procedural fairness, and there had to be a proper evidential foundation both for their findings of fact and for their conclusions. But their preferred solution did not have to be one for which either side had specifically contended, either before or in the course of the hearing.

I accept that Vision Express and St John’s are examples of appeals being adjourned to permit further argument on the appropriate special method; I note, however, a suggestion to the contrary in St Helen’s School Northwood Ltd v Revenue and Customs Commissioners [2006] EWHC 3306 (Ch), [2007] STC 633, where Warren J held that it was not for the tribunal to put forward its own version of a more reasonable special method (para 27). GMAC is a completely different case, which does not touch on partial exemption methods at all. None of these cases touch on the situation we have here, of a taxpayer seeking to displace the standard method by means of a SMO. I was shown no example of a tribunal adjourning this sort of case to allow for further argument.

I would accept the possibility that there might be standard method / SMO cases where a tribunal or court might wish to adjourn or reserve certain matters for argument on a later occasion; that might extend to permitting further evidence to be adduced on a variation of the SMO originally proposed. That is a case management decision for the tribunal or court on the day. But I can see no basis for suggesting in this case that the UT was required to adjourn for further argument, with a view to permitting fresh evidence to be adduced to meet different arguments. In this case, the taxpayer had historically used the standard method. The standard method is the default method. HCL had failed to displace the standard method. So the standard method stayed in place. It was, in those circumstances, appropriate for the UT simply to dismiss the appeal.

That conclusion is reinforced by Revenue and Customs Commissioners v Temple Finance Ltd [2017] UKUT 315 (TCC), [2017] STC 1781, a case on which the UT relied. In that case, a partially exempt taxpayer (TFL) had calculated its residual input tax recovery on the basis of the standard method. HMRC challenged that by SMO. The FtT allowed TFL’s appeal, holding that the standard method gave rise to a fair and reasonable recovery. HMRC challenged that conclusion arguing that the FtT had been in error in asking itself whether it preferred TFL’s approach (based on the standard method) or HMRC’s approach (based on the SMO); rather, the FtT should have considered first whether the SMO applied and if it did, then consider HMRC’s calculations and if those calculations were not fair and reasonable, impose its own use-based calculation. The UT (Judges Sinfield and Falk) rejected that submission:

We do not agree. Only two methods were before the FTT, TFL’s and HMRC’s. The FTT was not required to make its own enquiry as to whether there might be another method that was preferable. As Lord Carnwath said in the Supreme Court’s decision in VWFS [2017] UKSC 26, [2017] STC 824 (at [7]), where the parties are substantial litigants represented by experienced counsel the tribunal ‘is entitled to assume that the parties will have identified with some care what they regard as relevant issues for decision’.”

I am not persuaded that the UT was in error in allowing HMRC’s appeal with the effect of retaining the standard method for the periods in question by way of final disposal of this appeal. In this case, the options really were binary.

In any event, the arguments now raised by HCL with a view to devising an alternative method based on footfall combined with turnover are very vague and completely different from the floorspace method put forward in the SMO. This amounts, effectively, to starting all over again. To permit that would be a highly unorthodox route for a tribunal to take, with many pitfalls, as Mr Donmall pointed out.

(3): What about the evidence of non-gambling customers?

Having determined the appeal against HCL, the UT went on to consider what the outcome might have been on a different (and incorrect) hypothesis – namely that the burden lay on HMRC to satisfy the UT that the standard method guaranteed a more precise result. The UT held that it would have been satisfied of that (para 193). The UT gave a number of reasons for that conclusion, including the passage now challenged by Mr Hitchmough, in which the UT said this:

“We have found that a third of customers do not gamble and that is a physical proxy for the economic use but it is not a good proxy for economic use when gambling customers are spending considerably more - floorspace or customer numbers do not more fairly reflect economic use” (para 195).

Mr Hitchmough says that the UT wrongly assumed here a turnover analysis -when the correctness of turnover as a proxy for use was the very issue to be determined - and overlooked evidence about the percentage of non-gambling customers, which evidence demonstrated the weakness of the standard method.

I do not accept that the UT was at fault in this passage. The UT was only stating its view that gambling customers would be expected to spend more, on the whole, than non-gambling customers. That would be a relevant observation to make in the context of the turnover-based standard method, which the UT had by this point applied.

But in any event, this comment is not part of the UT’s central reasoning and is not material to the conclusions the UT had already reached in HMRC’s favour.

I agree with the UT’s view that numbers of non-gambling customers are not a good proxy for use. Footfall alone tells us little; non-gambling customers may come and go quickly or they may linger and consume large amounts of drink, food and entertainment: it all depends on the specifics, of which the evidence is lacking.

Summary on this issue

I reject HCL’s second and third grounds of appeal. I am not persuaded that the UT started in the wrong place or was required to leave the door open for further argument. I think the UT was right simply to allow the appeal once it had concluded HCL’s floorspace method was discredited, which meant that the standard method applied by default. The UT was entitled to find that the standard method led to a fair and reasonable recovery of residual input tax, as a matter of law (because the standard method is the default) and on the specific facts of this case. The burden was on HCL to show otherwise and it failed to do that. Evidence about the percentage of non-gambling customers was insubstantial and did not detract from that conclusion.