The Supreme Court held that a farming company could deduct VAT paid on buying Single Farm Payment entitlements. The subsidies were outside the scope of VAT, but the company bought the entitlements to fund its taxable business, and objective evidence of that purpose preserved the right to deduct.
The business and the claim
Frank A Smart & Son Ltd farms at Tolmauds Farm in Aberdeenshire under a lease from a partnership of Mr Frank Smart and his wife. Its supplies were wholly taxable. Between 2007 and 2012, with bank funding, it spent about £7.7 million on 34,477 Single Farm Payment entitlement units in addition to a small initial allocation. It paid VAT on those purchases and claimed to deduct £1,054,852.28 in returns from December 2008 to June 2012.
Law Teacher writing support
Writing a law essay?
We choose a writer who is an expert in your area of law and qualified to at least the academic level you select. Most of our writers hold a master’s degree or PhD, have teaching experience, or both.
Send us your question and, if you wish, any marking criteria. We’ll write an essay to your instructions.
To receive the subsidies, it took seasonal lets of further land. It did not cultivate or stock that land; agreements generally allowed the landlords to use it if it was kept in good agricultural and environmental condition. From 2010 to 2013, subsidy income greatly exceeded income from cattle sales. The subsidies stayed in the company, were used to reduce its overdraft, and were not withdrawn for Mr Smart’s personal benefit. Only modest dividends were paid.
The First-tier Tribunal found that the company intended to use the income to pay off the overdraft and to develop the business, including a possible wind farm, further farm buildings and purchases of neighbouring farms. Some preparatory spending and planning steps had been taken. The Tribunal held that the purchases were a funding exercise integrated into the farming enterprise, with a direct and immediate link to future taxable supplies, and allowed the appeal. The Upper Tribunal and the Inner House of the Court of Session upheld that conclusion. HMRC appealed.
The issue
Articles 167 and 168 of the Principal VAT Directive entitle a taxable person to deduct input VAT in so far as the goods or services are used for taxed transactions. It was agreed that sales of the entitlement units were taxable supplies and that receipt of the Single Farm Payments was outside the scope of VAT. HMRC argued that the VAT was directly and immediately linked only to that out-of-scope receipt, could not be treated as a general overhead, and that the director’s intention to fund future taxable supplies was irrelevant. It relied particularly on BLP Group and invited a reference to the Court of Justice if the point was not clear.
The Court’s reasoning
Lord Hodge, with whom Lord Reed, Lord Wilson, Lord Briggs and Lady Arden agreed, held that the case law did not support HMRC and that no reference was needed. VAT is meant to tax value added and to leave a taxable person neutral in respect of VAT borne in the course of economic activity. There must be a direct and immediate link between an input and particular taxable outputs, or between the input and the economic activity as a whole where the cost is a general overhead and therefore a cost component of the person’s supplies.
BLP prevents deduction of VAT on costs of an exempt transaction merely because the proceeds will later fund taxable activity. Later decisions, including those on share issues and other fund-raising outside the scope of VAT, draw a different line. An initial out-of-scope fund-raising transaction does not itself break the link if, judged on objective evidence, its purpose is to finance the taxable person’s economic activity and the funds are used for that activity. The right to deduct arises when the tax becomes chargeable, even if the taxable use occurs later. If the costs instead form part of exempt or non-economic downstream activities, deduction is refused or apportioned. A later Court of Justice decision about the University of Cambridge applied the same approach: investment costs that were not incorporated into the price of supplies, and that merely generated money used to reduce costs generally, were not deductible overheads.
Application to these facts
There was objective evidence that the company was carrying on a taxable business and bought the entitlements to support its current and planned economic activities. Lord Hodge found no basis for treating a subsidy received over several years differently from fund-raising by a share issue. The annual payments were not a separate transaction capable of breaking the link between the purchases and the use of the net proceeds. The Tribunal was therefore entitled to treat the company as acting as a taxable person and to find a direct and immediate link with its economic activity as a whole.
On the facts found, the company was not carrying on and did not propose to carry on downstream non-economic activities or exempt transactions, so no apportionment arose. A deduction that depends on later use may require HMRC to examine records of how the funds are applied. If the subsidies are not used as cost components of economic activity, the input tax must be repaid. That consequence follows from the European case law.
Verdict: The Court unanimously dismissed HMRC’s appeal. The company could deduct the input VAT on the entitlements because of their link to its taxable farming business. Retention of the deduction depended on the use of the funds for that economic activity.
Source: Commissioners for Her Majesty’s Revenue and Customs v Frank A Smart & Son Ltd [2019] UKSC 39
