Airtours paid VAT on accountants’ fees for a report commissioned so that its lenders could assess restructuring proposals and continued facilities. The Supreme Court held by a majority that the services were supplied to the lenders rather than to Airtours, so the VAT could not be reclaimed as input tax.
The dispute
In October 2002 Airtours, which had borrowed from around 80 financial institutions and had further liabilities, was in serious financial difficulty and sought refinancing. An accountants’ report was commissioned to satisfy the institutions that restructuring proposals were viable. Following a decision involving both Airtours and the institutions, PricewaterhouseCoopers LLP (PwC) were appointed. The terms were set out in a letter of 5 November 2002 addressed to the Engaging Institutions, which the institutions and Airtours countersigned, together with standard terms. The letter stated that the institutions had retained PwC, that reports were for the sole use of countersigning institutions, and that Airtours would be responsible for the fees. Airtours paid a retainer of £200,000 and later invoices, together with VAT, and sought to deduct that VAT as input tax. HMRC accepted that the arrangement was commercially beneficial to Airtours, but contended that the services had not been supplied to it.
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The First-tier Tribunal decided for Airtours, holding that it was enough that Airtours had obtained anything used for its business and that a supply might consist of a right to have a service supplied to a third party. The Upper Tribunal allowed HMRC’s appeal: the institutions had contracted for services needed for their own businesses, and Airtours had contracted to pay rather than received something of value from PwC. The Court of Appeal dismissed Airtours’ appeal by a majority. Moore-Bick and Vos LJJ held that the services were provided to the institutions, not to Airtours. Gloster LJ dissented, concluding that, as a matter of construction and economic reality, Airtours had a contractual right to require the services to be provided.
What had to be shown
Input tax, under section 24 of the Value Added Tax Act 1994, is VAT on a supply to the taxable person of goods or services used for a business carried on by that person. The Act is to be read consistently with the Principal VAT Directive. There was a supply of services, namely the work described in the letter. The question was whether it was a supply to Airtours.
Lord Neuberger, with whom Lord Mance and Lord Hodge agreed, identified two questions. First, did PwC agree with Airtours that it would supply the services, including the report, to the institutions? Airtours did not have to show a duty to supply services directly to itself. If the answer was yes, HMRC accepted that the appeal should be allowed, subject to apportionment. If the answer was no, Airtours argued that it could still establish a supply for VAT purposes without a contractual right to require the services.
No contractual duty to Airtours
The majority held that PwC’s commitment was owed to the Engaging Institutions alone. The letter was addressed to them and said that they had retained PwC. Reports were for their sole use. Airtours was to receive a copy, from which material prepared exclusively or confidentially for the institutions could be withheld. A duty of care was acknowledged to the institutions, and the work was described as required by them. Airtours countersigned so as to be bound to pay the fees, to indemnify PwC, and to accept a cap on liability. That signature did not impose obligations on PwC which the letter did not otherwise create. The standard terms were inconsistently drafted and used the word you in different senses; they did not enlarge the duties in the letter.
Airtours’ commercial interest, its payment, its role in proposing the report and selecting PwC, and the liabilities it assumed might raise an expectation of a duty owed to the paying party. They did not, however, support either a different reading of the words or an implied term. An implied duty was neither necessary for business efficacy nor so obvious that it went without saying. The initial retainer did not change the position: given the timetable, substantial work was very likely to be done before any question of stopping arose, and termination was limited. Later evidence of professional practice could not rewrite a contract made in 2002, and the parties’ own understandings were inadmissible on interpretation as opposed to rectification. Construction was a question of law. The majority therefore agreed with the Upper Tribunal and the majority of the Court of Appeal.
Economic reality
Airtours nevertheless had a strong interest in the work, described in argument as important to its very survival, and had agreed to pay for it. That was not sufficient. Lord Millett’s question in Redrow, whether the taxpayer obtained anything at all used for the purposes of his business, cannot be taken at face value. As Lord Reed and Lord Hope explained in Loyalty Management, economic reality is fundamental, and payment may be third-party consideration for a supply to someone else. The contract is normally the starting point, and is displaced only where the terms are a purely artificial arrangement which does not correspond to economic and commercial reality.
The contract here reflected reality. What Airtours obtained was not so much PwC’s services as an enhanced possibility of funding from the institutions, which was why it was willing to pay. Where the person who pays is not entitled under the documentation to receive services from the supplier, and the documentation reflects economic reality, that person cannot reclaim the VAT as input tax. Fiscal neutrality is a principle of interpretation and cannot be used to invent a supply. Deduction is limited to VAT on supplies to the taxable person. The fact that the institutions were not obliged to pay did not mean there was no supply to them: the supplier must receive remuneration under the legal arrangement, but that remuneration may be provided by a third party.
The dissent
Lord Clarke and Lord Carnwath would have allowed the appeal, agreeing in substance with Gloster LJ. They considered that the majority gave too little attention to the relationship between PwC and Airtours and to economic reality. On their analysis, PwC made two supplies: to Airtours, a contractual right to have the review carried out and reported to the institutions, for which Airtours paid; and to the institutions, the reporting and monitoring services, for which the institutions incurred no liability to pay. They read the contract as giving Airtours an enforceable right to require performance. Lord Carnwath thought a narrow construction artificial where the practical distinction had not been tested, and treated the retainer and the very short timetable as showing that Airtours would have had a right if PwC had failed to produce the draft findings.
Verdict: By three votes to two the Court dismissed Airtours’ appeal. Paying the accountants’ fees did not entitle Airtours to deduct the VAT on services supplied to its lenders under this agreement. The question of apportionment did not arise.
