Airtours had sought to recover the invoiced VAT as input tax on the basis that it was receiving a service from PwC for the benefit of its business. The Supreme Court decided the case in favour of HMRC on the basis that PwC was providing their services to the bank. The issue of VAT recovery where one party pays for another party to receive a supply of services is a surprisingly commonplace problem, and this case will need to be considered carefully in these types of case.
In 2002, Airtours was experiencing financial difficulties and it was unclear whether its bankers (comprising some 80 institutions) would support a refinancing of the company. A proposal was made that Airtours should commission a report from accountants to convince the banks that its refinancing proposals were sustainable. Two firms of accountants were approached and it was agreed by Airtours and the banks that PwC should be appointed. An engagement letter was entered into between the banks, Airtours and PwC for the production of the report to the banks. Under the engagement letter Airtours agreed to pay PwC’s fees.
VAT charged to a business by its advisers will generally be recoverable as VAT input tax, meaning the business can deduct the VAT it is charged against the output tax it collects from is customers when it submits its VAT return and accounts for the output VAT to HMRC. There is an exception to this rule in the case of businesses which make VAT-exempt supplies: such businesses are not able to recover VAT input tax attributable to their exempt activities.
Banking services are one of the classes of exempt supply. If PwC had invoiced the banks the VAT would have been irrecoverable and, to the extent Airtours agreed to meet the fees charged to the banks, they would have to cover the VAT inclusive amount.
As the banks would not be separately invoicing Airtours for the VAT Airtours would have no ability to claim the VAT element of the payment as input VAT. As the parties had a tripartite arrangement in place, Airtours claimed PwC provided services to them because the report was provided to the banks at Airtours’ request. PwC’s services were used for the purpose of Airtours’ business because they enabled Airtours to successfully achieve a refinancing of its business. On that basis, Airtours claimed the recovery of the VAT as input tax.
The VAT treatment of tripartite arrangements has been considered by the courts on a number of occasions. The leading authority is the House of Lords decision in Customs and Excise Comrs v Redrow Group Plc [1999] 1 WLR 408. Redrow, the well-known house builder, operated an incentive scheme to encourage buyers by agreeing to pay the cost of estate agent when buyers sold their existing home with a view to buying one of Redrow's homes. Redrow selected the estate agents and agreed the price at which homes would be marketed. It obtained the additional benefit of monitoring the estate agent and ensuring the marketing process of the old home was carried out efficiently and expeditiously. Redrow successfully recovered the VAT charged by the estate agent which the private homebuyers could not have done.
Lord Millet, in the leading decision, said that once the taxpayer had identified the payment of VAT it had made, the question to be asked was “did he obtain anything - anything at all - used, or to be used for the purpose of his business in return for that payment”. If so, then the VAT would be recoverable. On that basis, Redrow was able to recover the VAT charged for the estate agent’s services.
The Redrow case recognised that services can be received by more than one person. In that case Redrow received the service of the estate agent selling someone else’s home and the homeowner had the benefit of their home being sold.
In Airtours, HMRC accepted that a supply of services can comprise both the actual receipt of services and the right to have the service supplied by a third party. If Airtours could show that PwC had been contracted by it to provide the report to the banks, then they should recover the VAT.
The tripartite agreement had been prepared on a standard form which did not make it entirely clear who PwC owed its obligations to. In particular, the contract used the terms “you” and “us” which were ambiguous as to whether “you” was Airtours, the bank, or both. Lord Neuberger carried out a meticulous analysis of the contract and concluded that PwC had not been contracted to supply the report to Airtours – it had in fact been contracted to supply the report to the banks. The key aspects of the contract leading to that conclusion were that the engagement letter was addressed to the banks; stated PwC were retained by the banks; stipulated the report was for the exclusive use of the banks (although Airtours could have a redacted copy) and acknowledged a duty of care to the banks alone.
Lord Neuberger then had to consider Airtours’s second argument that even if it did not have a contractual right, it had received the service on the basis of Lord Millet’s decision in Redrow. Lord Neuberger referred to several decisions where the Court had drawn back from the conclusions of Lord Millet. In particular, he referred to the decision in Customs and Excise Commissioners v Loyalty Management (UK) Limited [2013] STC 784.
In that case, Lord Hope said: “I think that Lord Millet went too far…A case where the taxpayer pays for a service which consists of a supply … to a third party requires a more careful and sensitive analysis having regard to the economic realities of the transaction when looked at as a whole.”
In his judgement, Lord Neuberger places the central importance of contractual analysis. The contractual analysis will normally reflect the commercial realities. He acknowledges there will be cases where that analysis is displaced because the contract does not reflect the commercial reality. These will however be unusual examples. In Airtours case the economic reality was that the supply was to PwC, and that Airtours merely paid for the service by way of third-party consideration.
Where does this case leave the VAT treatment of third party contracts?
The case does not displace the idea that a person can receive a supply of services where the person contracts for a right to have the service supplied to a third party. In recent guidance on the VAT treatment of services supplied in the context of pension funds, HMRC has emphasised that input tax can only be recovered by the employer, as opposed to the trustee of the fund, where the employer contracts for the services, pays for the services and is owed a duty of care by the supplier. In light of this case that seems likely to be a stance which HMRC will continue to adopt.
What this case emphasises is the central importance of the contractual position so long as the contract reflects commercial realities. It may well encourage the use of tripartite contracts where there is a mismatch between the parties’ ability to recover VAT. It seems unlikely we have seen the last case to be fought on this territory.
This article was prepared by Chris Bates, a partner at global law firm Norton Rose Fulbright
