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

Issue 3: how does the Input Tax Order apply in the context of residual input tax apportionment?

Introduction

There is no dispute between the parties that part of HCL’s input tax in the relevant periods relates to complimentary food and drink provided by HCL to its customers, and that Article 5 of the Input Tax Order applies to restrict recovery to the extent that input tax relates to business entertainment. The UT labelled this the “CGS issue” because the point was raised in the context of annual CGS adjustments of input tax relating to refurbishment costs. However, the issue is broader than that and involves the interplay of the standard method and Article 5.

The UT was asked for a decision in principle only because the detailed exercise of identifying precisely how much input tax, in which years, is affected by this issue has not yet been undertaken. That remains the case before this Court. Since the hearing of this appeal, the Court has been provided with an illustration of the rival cases. It is based on input tax figures for 2013/14 which is not a period within this appeal, so far as this issue is concerned. It also assumes that all business expenditure is for exempt purposes based on the FtT’s finding that HCL’s business expenditure was predominantly for gaming customers; but that leaves an important aspect of HCL’s case untested. So, useful though it is as a worked example, I will not incorporate it into this judgment.

Submissions

The issue is essentially one of timing of the deduction. Mr Magee (who argued this point for HCL with commendable focus) submits that the restriction does not occur at the outset. Rather, this is the sequence, as he would have it: section 24(1) VATA defines input tax; section 25(2) confers the right to a credit for input tax to the extent that input tax is allowable under section 26; section 26(1) provides that the credit equates to the amount of input tax which is attributable to supplies within section 26(2); section 26(2) provides that those are taxable supplies (and other categories of supply which are not relevant here); section 26(3) provides for regulations to secure a fair and reasonable attribution of input tax to taxable supplies; regulation 101(2) of the VAT Regulations sets out the standard method of attribution and by operation of that method, the proportion of input tax due for credit pursuant to section 25(2) is established. It is at that point that the taxable person is required to restrict input tax incurred on business entertainment, namely, at the point that the taxable person knows the amount of input tax credit which they are otherwise due for that period and after input tax which is not allocated to taxable supplies has already fallen out of the equation. He argues that the Input Tax Order bites on the credit due under section 25, and that credit is for input tax allocated to taxable activity. This is not a block on input tax so much as restriction of the amount to be credited. As to the practicalities of how the amount of restriction is to be identified, Mr Magee submits that if any input tax was used for business entertainment for taxable purposes, it is necessary, once this point is reached, to conduct a “commercial apportionment” to determine how much of the credit figure must be restricted under Article 5(1). The restriction only bites on input tax referable to business entertainment for taxable purposes because on his argument all input tax referable to business entertainment for exempt activity has already been taken out.

The practical consequence for HCL is that input tax on complimentary food and drink for gambling customers (who consume exempt services) is not subject to any separate restriction; only the proportion of input tax on complimentary food and drink provided free of charge to non-gambling customers (who might be expected to consume taxable supplies) is restricted and in HCL’s case that is only a small amount – birthday drinks for restaurant customers and such like.

Mr Magee draws support from two authorities. First, he cites Revenue and Customs Commissioners v Associated Newspapers Ltd [2017] EWCA Civ 54, [2017] STC 843 for the proposition that a taxable person’s ultimate economic purpose in making expenditure can be relevant, noting that in that case the cost of acquiring vouchers which the taxpayer gave away to customers for free was held to be a cost component of the taxable business overall, by reference to the ultimate business purpose rather than the proximate and non-taxable onward supply of the vouchers (see paras 47 and 48). The second is Thorn EMI plc v Customs and Excise Commissioners [1995] STC 674 where the Court held that an apportionment between business and non-business use of inputs was required, to reflect the use to which hospitality chalets at an airshow were used, and to reflect their main use for business entertainment alongside use to a measurable extent for other business purposes (see p 676d and p 679 e-g).

By contrast, HMRC argue that the restriction applies as a single step at the outset of the calculation, once the pot of residual tax is identified but before it is apportioned by operation of regulation 101(2). HMRC argue that this achieves the self-evident purpose of Article 5 which is to block input tax on business entertainment. HMRC illustrate their case with the following example (which they put before the UT also): assume a partially exempt trader incurs residual input tax of £30,000; in the relevant period, that trader makes taxable supplies worth £1,000, exempt supplies worth £1,000 and provides gratuitous business entertainment worth £1,000. On HMRC’s case, one third of that input tax is restricted at the outset as referable to business entertainment, leaving £20,000 in the pot to be apportioned by the following fraction: taxable supplies (£1) as a proportion of taxable and exempt supplies (as the denominator, £1+£1=2). The consequence is that the trader recovers £10,000 of input tax, which is proportionate to the value of taxable outputs in that period and is (HMRC contends) the right answer. HMRC suggest that on HCL’s argument the trader would recover £15,000 which would exceed what is fair and reasonable.

In response, HCL accepts that, to the extent that some business entertainment input tax was used for taxable purposes, there would have to be some further restriction on the £15,000 in the example, that amount to be determined by a “commercial method”. Mr Magee does not indicate what that commercial method might look like or how the restriction applying in this example might be quantified. Mr Magee disputed Mr Donmall’s example as flawed because it is based on the turnover method, which begs the very question to be answered.