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Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)
OF THE LORDS OF APPEAL
FOR JUDGMENT IN THE CAUSE
Royal and Sun Alliance Insurance Group plc (Respondents)
Her Majesty's Commissioners of Customs and Excise (Appellants)
THURSDAY 22 MAY 2003
The Appellate Committee comprised:
Lord Walker of Gestingthorpe
HOUSE OF LORDS
OPINIONS OF THE LORDS OF APPEAL FOR JUDGMENT
IN THE CAUSE
Royal and Sun Alliance Insurance Group plc (Respondents) v. Her Majesty's Commissioners of Customs and Excise (Appellants)
 UKHL 29
1. I have had the advantage of reading the opinions of Lord Hoffmann and Lord Walker of Gestingthorpe. For the reasons they have given I would also allow the appeal and restore the decision of the Tribunal.
2. In this case I have had the considerable advantage of being able to read the speeches of Lord Hoffmann and Lord Walker of Gestingthorpe in draft. With the majority of the reasoning in those speeches I am able to agree. Unfortunately, however, I find that I am unable to accept their conclusion that this appeal should be allowed.
3. Notwithstanding the careful reasoning contained in their speeches, I have come to the conclusion that they attach less significance than they should to the special position of a supply of an interest in land, such as the grant of a lease. Subject to exceptions which need not concern us, such a supply can be an exempt supply or, if a taxable person elects to waive the exemption under Group 1 of Schedule 9 to the Value Added Tax Act 1994 ("the 1994 Act") it can be a taxable supply if regulation 109 of the Value Added Tax Regulations 1995 (SI 1995/2518) ("the Regulations") is complied with.
4. The language of regulation 109 is central to the outcome of this appeal as the Commissioners in their case contend. Regulation 109 is in the following terms:(1)
5. Regulation 109 is the converse of regulation 108 but it is not necessary to cite the terms of that regulation, although its presence should not be ignored since it is obviously intended that the choice to which I will refer operates in both directions. The important feature of regulation 109 is that it gives the taxable person six years in which to elect to use or form an intention to use the goods or services concerned in making taxable supplies. Examining the language of regulation 109, which is all important to the outcome of this appeal, more closely it appears that there are contained in the regulation the following relevant requirements:(i)
The taxable person must have incurred an amount of input tax (on supplies to him) which has not been attributed to taxable supplies (by him).(ii)
This must be because he had intended for a period of time to use the goods and services (and the leasing of land is a supply of goods) in making exempt supplies.(iii)
Before he had fulfilled his intention to use the goods and services in making exempt supplies ( ie "before that intention is fulfilled") he must use or form the intention to use the goods or services in making taxable supplies.(iv)
That the change of intention happened during a period of six years commencing on the first day of the prescribed accounting period.
6. Having referred to regulation 109, it is necessary to apply that regulation to the facts of the present appeal. As they have been referred to by my Lords and in the reported decisions of the court and the tribunal below, it is sufficient for my purposes merely to refer to the fact that the Royal and Sun Alliance Insurance Group Plc ("RSA") had leased accommodation from landlords who had exercised their option to treat the supply as taxable with the result that RSA had to pay input tax in relation to the letting and other services with which they were supplied. Between November 1991 and April 1993 RSA had five properties which became surplus to the requirements of their insurance business. However, having decided to let the properties they had difficulty in obtaining tenants and the accommodation remained vacant for a substantial period of time (with exceptions which can be ignored) until November 1995. On 21 November 1995 RSA made an election to waive the exemption and, accordingly, the supplies constituted by their lettings were a taxable supply in relation to which RSA charged output tax. The election was duly notified to the Commissioners on 21 December 1995.
7. During the intervening vacant period RSA continued to pay input tax on the rent and other services which RSA paid in order to retain their interest in the premises. They also incurred expenses which would have been taxable in their attempts to let the premises.
8. It is not in dispute that if RSA had at the outset elected (that is, prior to the relevant dates between November 1991 and April 1993) to treat the lettings as taxable supplies, RSA would have been entitled to credit for the input tax which is now in dispute. RSA would have been entitled to this notwithstanding that the lettings did not take place in fact until after November 1995. However, not having elected RSA did not seek credit for the input tax that was paid from time to time until they made their elections. So the input tax paid did not appear in their periodic VAT returns prior to their making the relevant elections.
9. Until a landlord has identified the tenant to whom he is going to let premises, frequently it will not make sense to decide whether the letting should or should not be exempt. What the decision should be will depend on the circumstances of the tenant in relation to VAT. If the tenant cannot obtain credit for any input tax payable it will be to the tenant's disadvantage if the lease is a taxable supply. Accordingly he may be prepared only to pay a lower rent then he would be prepared to pay if the letting was exempt. For this reason, it can be sensible for a landlord (here RSA) to defer an election since once he elects he cannot revoke that election. However, until he elects he is not entitled to credit for the input tax which he has paid.
10. If RSA's submissions are correct, one of the purposes of regulation 109 is to take into account the difficulty of the landlord in this regard. However, if a landlord is to have the benefit of regulation 109 he must comply with its requirements. Here there is no dispute that the election was made during the period specified by the regulation. Nor until RSA elected had the input tax, which they had paid, been attributed to taxable supplies. The input tax could not be attributed because there had been no subletting of the premises and in any event, until RSA did elect, for VAT purposes, the only supplies that RSA could make were exempt. While, if RSA had let the premises before electing they would have made an exempt supply, as the letting followed the election there was no exempt supply to which the input tax could be related.
11. Once RSA had decided to let the premises as a taxable supply, the position changed. RSA, applying the language of regulation 109 literally, were fulfilling the remaining requirement of that regulation. RSA was a taxable person that had incurred an amount of tax on the lettings of the properties to them. The amount of input tax had not been attributed to taxable supplies by them. This was because they are deemed, not having elected, to have intended to make exempt supplies. However, before they had fulfilled their intention to make the exempt supplies, that is by subletting the premises, RSA had elected to make taxable supplies instead by subletting the premises. Throughout the economic activity remained the same but its taxable nature changed. Finally that change of intention had occurred within the six year period. That being so, I ask rhetorically why should RSA not be entitled to the benefit of regulation 109? This is not a case, as has been suggested, of RSA rewriting history other than the rewriting that the regulation expressly contemplated. If the regulation could not be applied in these circumstances it could not have any meaningful application to the subletting of property. The Commissioners contend that inputs can be consumed by an unsuccessful attempt to make supplies and that the input tax incurred was so used here during the vacant period. But this argument which has no statutory foundation is inconsistent with the express terms of regulation 109, which presupposes that there will be a six year period in which to make an election and after that election there can be a claim for repayment of the tax paid. This is because that tax (in the language of regulation 109 (2)) "has become attributable to taxable supplies". Such attribution accords with article 20(1) of the Sixth Directive.
12. The Commissioners give a description of a situation where they submit the option that the regulation is intended to provide would be lost. They submit that if a lawyer offers financial services at one time but having failed to obtain any customers the lawyer starts a new business offering legal services then the input tax paid for supplies to the first business would no longer be available and cannot be set off against input tax payable by the second business. I fully accept input tax incurred in relation to one business could not be set off against input tax payable in relation to a different business. There is then no connection direct or otherwise between the supplies. But that is an entirely different situation from the present. Here, throughout RSA were intending to make the same supply; the only matter that was deferred was the decision as to whether to elect that that supply should be taxable, a situation which regulation 109 is, as it seems to me, directly designed to deal. Throughout RSA were intending to make the same supply namely a subletting of the premises. Before the election that would have been an exempt supply; after the election it would be a taxable supply. To make the taxable supply that RSA actually made it had no choice but to comply with the terms of the lease under which it was entitled to sublet the premises. This involved paying rent including the input tax. It could not claim repayment of the input tax until it elected. After it elected the accounting periods would be different in relation to the input tax that RSA had paid prior to election and the output tax RSA in due course received. However, while a taxable person is required to account periodically, as regulation 109(2) itself anticipates, the taxable position over different accounting periods can change so that tax which was not repayable becomes payable. Accounting periods cannot be allowed to control what tax is payable. The accounting periods are the tail not the dog.
13. My noble and learned friend, Lord Walker, comes to the same conclusion as Lord Hoffmann that regulation 109 is not applicable because of the legislative framework as a whole including the Sixth Directive, and in particular, section 6(14) of the 1994 Act and the language of regulation 85 which he regards (as did Arden LJ in the court below) as being ultimately decisive.
14. Section 6 of the 1994 Act sets out rules in relation to the time at which a supply of goods or services is to be treated as being made. Section 6 (14) in particular provides, so far as relevant, as follows:
15. Regulation 85 so far as is relevant, is in the following terms:(1)
16. Section 6 is necessary to determine when tax is to be payable or repayable. Section 6 is not concerned with whether tax is payable or repayable. Section 6 applies in exactly the same way whether a supply is taxable or not.
17. I accept that the right approach under section 6 and regulation 85 to both the lettings to and by RSA is to treat them as a series of separate supplies for accounting purposes. However, Arden LJ, in the court below, goes further and says that section 6 and regulation 85 could affect the quantum of tax payable or repayable. No authority supports such a proposition and its doubtful nature is highlighted by the fact that it would mean that the fiscal consequence could differ if the rent was payable quarterly or annually if an election was made during a year of the tenancy. Furthermore, if her reasoning is correct I cannot understand why it could not apply so as to prevent RSA even being able to take credit for output tax paid after election for quarters prior to RSA subletting the premises.
18. Reading section 6(14), regulation 85 and regulation 109(1) together, I do not find any reason to read regulation 109 other than in accordance with its ordinary meaning. Whereas, but for regulation 109(1) it would not be possible for RSA, in about November 1995, to form an intention to deduct or reclaim the input tax incurred in relation to periods prior to November 1995, in respect of supplies after November 1995 that is what regulation 109 makes possible.
19. I fully accept the importance of regulation 85 in establishing the time of supply where there is grant of a tenancy or a lease but it cannot apply where there has been no supply by RSA and therefore no consideration payable. Here the issue is not when the supplies were made to and by RSA, this is not in dispute. Where there is a special provision, such as that contained in regulation 109, it must be given effect unless there is good reason for not doing so and regulation 85 provides no such obstacle. As Svenska International plc v Customs and Excise Commissioners  1 WLR 769, when there are supplies effect must be given to the time of supply rules, but this cannot be done where there is no more than intention to make a supply. The same reasoning applies to the passage of Lord Hoffmann's speech in Customs and Excise Commissioners v Thorn Materials Supply Ltd  1 WLR 1106, 1118 F - 1119 E;  STC 725, 738 a-g.
20. Since I prepared the above opinion, I have read in draft the speech of my noble and learned friend, Lord Clyde. That speech so clearly expresses my own views that if I had not already prepared this speech I would have been content to merely agree with his speech. However, in view of the differing views, which have been expressed as to the outcome of this appeal, I have decided to still give this speech.
21. I would therefore dismiss this appeal.
22. In 1993 the Royal & Sun Alliance Insurance Group plc ("RSA") decided to dispose of five of its leasehold properties which had become surplus to needs. It advertised for sub-tenants. But the market was weak and it did not succeed in sub-letting any of the properties until after 1995.
23. This appeal concerns the VAT which RSA was charged by its landlords on the rent and service charges payable during part of the period while the properties were empty. For the purposes of VAT, the grant of a lease of land is a supply of goods or services, depending upon the length of the lease. For present purposes the distinction does not matter; the grant of any interest in land is an exempt supply (of goods or services) unless the landlord has elected to waive the exemption: see Value Added Tax Act 1994, Sched 9, Group 1, para 1 and Sched 10, paras 2 and 3. The landlords of the properties held by RSA had so elected and therefore both the leases and the services provided to RSA were taxable supplies. So the landlords added VAT to their rent and service charge invoices.
24. RSA made no similar election when it first tried to sub-let the properties. It wanted to keep its options open. It thought that although tenants who carried on businesses making taxable supplies would find a taxable lease more attractive (because they could deduct the VAT), tenants who made exempt supplies might prefer an exempt lease. An election would be irrevocable (para 3(4) of Sched 10) and foreclose RSA's options. On the other hand, until RSA actually elected, it was unable to say that it intended to use the goods or services supplied under the leases to make taxable supplies. So it had to bear the input tax without deduction. Eventually RSA elected for taxation with effect from 21 November 1995. Thereafter, it was allowed to deduct its input taxes.
25. After the election, RSA claimed repayment of the input taxes it had been paying for the whole of the vacant period before its election ("the vacant unelected period") under regulation 109 of the Value Added Tax Regulations 1995 (SI 1995/2518):
26. The Commissioners rejected the application and the Value Added Tax and Duties Tribunal (Mr David Demack) upheld their rejection on the ground that there was no "direct and immediate link" between the taxable goods and services supplied to RSA during the vacant unelected period and the taxable supplies it formed the intention of making after that period had ended:  V & DR 336. On appeal to the High Court, Park J  STC 933 disagreed, holding that there was such a link because the supplies to RSA during the vacant unelected period were supplies of the same leasehold property as it intended to sub-let after 21 November 1995 as a taxable supply. The Court of Appeal, by a majority (Aldous and Sedley LJJ; Arden LJ dissenting)  STC 1476 upheld this decision.
27. Regulation 109 (and its mirror image, regulation 108, which deals with adjustments in favour of the Commissioners) give effect to article 20 of the Sixth Directive (77/388/EEC) which provides that "the initial deduction shall be adjusted according to the procedures laid down by the Member States". It is not suggested that the regulations do not conform to the Directive.
28. Two points about the regulations should be noted. First, they require that the taxpayer should have first had one intention about the use he proposes to make of goods or services supplied to him and that he should afterwards use them for a different purpose or form an intention to do so. In the case of regulation 109, the first intention must be to use them for supplying exempt services or a mixture of exempt and taxable services. The subsequent use, or intention, must be to supply taxable services.
29. In the present case, there is no question of an initial intention to use the inputs relating to the leases in supplying a mixture of services. RSA's general insurance business involved supplying a mixture of exempt and taxable services, but each lease was intended to be used in supplying either an exempt sub-lease or (after an election) a taxable sub-lease; one or the other, but not both. In order to come within regulation 109, therefore, RSA must have first had an intention to use the inputs in supplying exempt sub-leases and then used them, or formed an intention to use them, in supplying taxable sub-leases. And that is what RSA says it did.
30. I mention this point because occasionally, for the purposes of other arguments, RSA stresses that it was never committed to supplying exempt leases. It simply wanted to find tenants and was willing to fall in with whatever VAT arrangements suited them best. But these ambiguities are not consistent with a claim under regulation 109, which is predicated upon a definite intention to make exempt supplies followed by a change of plan.
31. The second point is that the change of plan must have been in relation to particular goods or services supplied to RSA. The regulation says that it must have intended to use "the goods or services" in making exempt supplies and then used or formed an intention to use "the goods or services concerned" in making taxable supplies. That may seem obvious, but needs to be borne in mind when one considers supplies of a uniform nature made on a continuous basis, like electricity or the use of a telephone. Take, for example, a lawyer who thinks he can do better offering financial services (which are exempt) rather than legal services (taxable). He subscribes for telephone, fax and computer lines for use in his financial service business. Because he is supplying exempt services, the input tax charged by the telephone company is not deductible. But the business is a failure. So he decides to offer legal services after all and continues to subscribe for the same telephone, fax and computer lines. From the time he starts his new business, he can deduct and, if necessary, claim repayment of input tax which he is charged on the telephone services he is receiving. But he cannot form a new intention about the services supplied for the purposes of his old business. They were different services which have already been used. So his decision to make taxable services instead of exempt services does not enable him to make a claim under regulation 109. The services used or intended to be used for making taxable outputs are not the services which were previously intended to be used for making exempt outputs.
32. That makes it important to identify exactly what goods and services were supplied to RSA by the superior landlords during the vacant unelected period. There are two ways in which one could think of the grant of a time-limited interest in land (such as a lease or licence) as a supply of goods or services. One is to regard it as a single supply of the leasehold estate in consideration of periodic payments of rent and the other lessee's covenants. That is how a real property lawyer would describe the grant of a lease. If that is the right way to look at the supply to RSA in this case, then it first had an intention to use its leasehold estate in making an exempt supply and afterwards decided to use the same estate in making a taxable supply. It would be a change of plan about the use of "the goods or services concerned" within the meaning of regulation 109.
33. But another way of looking at the matter is to treat the superior owner as granting rights of occupation in successive units of months, quarters, or whatever, depending upon the stipulated intervals for payment of the rent. In that case, the goods or services supplied during the vacant unelected period are different from those supplied afterwards and a change of plan about the use to be made of the leases in the future is not a change of intention about the use of the leases in the past.
34. In my opinion VAT law has clearly adopted the second analysis for both leases and licences. Section 6(14) of the 1994 Act gives the Commissioners power to make regulations:
35. Pursuant to this power, the Commissioners made regulations 85 and 90 of the 1995 Regulations, which are in similar terms and deal respectively with leases which are treated as supplies of goods and with services supplied for a periodically payable consideration. I shall quote only from regulation 85: