TC09676 - [2025] UKFTT 01278 (TC)

The requirement that goods are used for the purposes of taxed transactions or that the VAT in question relates to a cost component of such a transaction has been explained by the CJEU as requiring a “direct and immediate link” between the transaction giving rise to the VAT which the taxable person seeks to deduct and the taxable output transactions undertaken by that person (see BLP Group Plc v Customs and Excise Commissioners (Case C-4/94) [1995] STC 424 at [19] and Midland Bank Plc v Customs and Excise Commissioners (Case C-98/98) at [24]).

Input tax is also deductible if the transactions are part of the general overheads of the business even if there is no direct and immediate link with a particular output transaction as there is a direct and immediate link with the taxable person’s business as a whole (see Midland at [31]). However, in this case, TSI does not suggest that the import of the goods forms part of its general overheads and so this aspect is not relevant in this particular case.

The search for a “direct and immediate link” is not straightforward. The CJEU confirmed at [25] in Midland that it is for the domestic courts to apply the test “to the facts of each case before them and to take account of all the circumstances surrounding the transactions at issue” but declined to give any further guidance.

The CJEU did however observe at [30] in Midland that the requirement for a direct and immediate link:

“presupposes that the expenditure incurred in obtaining [the goods or services] was part of the cost components of the taxable transactions. Such expenditure must therefore be part of the costs of the output transactions which utilise the goods and services acquired.”

This was confirmed by CJEU in Skatteverket v AB SKF (Case C-29/08) [2010] STC 419 where the court explained at [60] that:

“… whether there is a direct and immediate link is based on the premise that the cost of the input services is incorporated either in the cost of particular output transactions or in the cost of goods or services supplied by the taxable person as part of his economic activities.”

This does not however mean that there has to be a direct correlation between the price charged for the output transaction and the cost of the input transaction. As the Court of Appeal noted in Revenue and Customs Commissioners v Royal Opera House Covent Garden Foundation [2021] EWCA Civ 910 at [17]:

“The reference to ‘costs components’ in art 1 might suggest that the cost of the goods or services supplied to the taxable person must be reflected in the price charged for the relevant output supplies made by the taxable person. That is not, however, the case. As art 168 makes clear, it is the fact that the goods or services supplied to the taxable person are used ‘for the purposes of’ the taxed supplies made by the taxable person that gives rise to the right of deduction.”

An illustration of this is provided by ‘Sveda’ UAB v Valstybine mokesčių inspekcija prie Lietuvos Respublikos finansų ministerijos (Case C-126/14) [2016] STC 447. In that case, the taxpayer constructed a recreational and discovery path which was offered to the public free of charge but along which the taxpayer sold food, drinks and souvenirs. The CJEU concluded that there was a direct and immediate link between the costs of constructing the path and the sale of refreshments and souvenirs.

The Advocate General noted at [45] that:

“The existence of an objective economic link between input and output transactions is therefore crucial to the question whether the costs are incorporated into the price of a service as understood in case law. A merely causal link is clearly not sufficient. However, if an input transaction objectively serves the purpose of the performance of certain or all output transactions of a taxable person, there is a direct and immediate link between the two as understood in case law. This is because in such a case the input transaction constitutes, from an economic perspective, a cost component in the provision of the respective output transaction. As the wording of art 168 of the VAT Directive already indicates, that therefore depends on the objective purpose of the use of an input transaction.”

So, whilst an objective economic link between the input transaction and the output transaction is necessary, it is not always the case that the cost of the input transaction must track through to the price charged for the output transaction.

It is important to note that the requirement for an economic link is not a “but for” test. This is illustrated by the decision of the Court of Appeal in Customs and Excise Commissioners v Southern Primary Housing Association Limited [2004] STC 209. In that case, the taxpayer purchased land in respect of which it paid VAT. It then sold the land to a housing association and entered into a development contract with the housing association for the construction of houses on the land.

The taxpayer sought to deduct the VAT paid on the purchase of the land on the basis that there was a direct and immediate link between the purchase of the land and the development contract. The Court of Appeal decided that there was no direct and immediate link explaining at [32] that:

“The land purchase transaction was commercially necessary to make its performance commercially possible, but it was not a cost component of the contract itself in the same way as the costs of materials used. There is a link with the contract but the link was not direct and immediate. The development contract would not have been made but for the associated land purchase and sale. But ‘but for’ is not the test and does not equate to the ‘direct and immediate link’ and ‘cost component’ test.”

The principles I take from these cases are as follows:

It is worth noting at this stage that TSI’s case is that the cost of the input transaction is in fact reflected in the price of the relevant output transactions. TSI argues that the relevant input transaction is the act of importation of the goods. Mr Sykes submits on behalf of TSI that the direct and immediate (economic) link is established where the taxable person bears the costs of importation.