Revenue and Customs Commissioners v Frank A Smart & Son Ltd

JurisdictionScotland
JudgeLord Hodge,Lord Reed,Lord Wilson,Lord Briggs,Lady Arden
Judgment Date29 July 2019
Neutral Citation[2019] UKSC 39
CourtSupreme Court (Scotland)
Date29 July 2019

[2019] UKSC 39

Supreme Court

Trinity Term

On appeal from: [2017] CSIH 77

before

Lord Reed, Deputy President

Lord Wilson

Lord Hodge

Lord Briggs

Lady Arden

Commissioners for Her Majesty's Revenue and Customs
(Appellant)
and
Frank A Smart & Son Ltd
(Respondent) (Scotland)

Appellant

Kieron Beal QC

Ross Anderson

(Instructed by Office of the Advocate General for Scotland (Edinburgh))

Respondent

David Small

(Instructed by Addleshaw Goddard LLP (Edinburgh))

Heard on 6 March 2019

Lord Hodge

( with whom Lord Reed, Lord Wilson, Lord Briggs and Lady Arden agree)

1

This appeal is concerned with the entitlement of a taxpayer to deduct input VAT and claim repayment of surplus input VAT. It concerns the interpretation of articles 167 and 168(1) of Council Directive (EC) 2006/112/EC of 28 November 2006 on the common system of value added tax (“the Principal VAT Directive” or “the PVD”) and the case law of the Court of Justice of the European Union (“CJEU”) relating to those articles. In short, the question is whether a taxpayer can deduct as input tax the VAT which it has incurred in purchasing entitlements to an EU farm subsidy, the Single Farm Payment (“SFP”). The taxpayer has used those entitlements to annual subsidies over several years and intends to use money resulting from the receipt of those subsidies to fund its current and future business activities, which currently involve only taxable supplies.

2

The factual background to this appeal involves an interesting business model. Frank A Smart & Son Ltd (“FASL”) is a Scottish company which carries on a farming business in Aberdeenshire. FASL is wholly-owned by Mr Frank Smart, who is its sole director. Mr Smart and his wife are the partners in a partnership which owns Tolmauds Farm, a farm of about 200 hectares which the partnership leases to FASL for a rent of £30,000 per year. FASL produces beef cattle and certain crops at Tolmauds Farm. FASL's whole output from its business was and is taxable under the VAT regime.

3

FASL received SFPs from the Scottish Government. SFPs were agricultural subsidies which between 2005 and 2014 were paid to farmers who had eligible land at their disposal on 15 May of each year and who met the requirements of ensuring plant and animal health and maintaining the land in question in “Good Agricultural and Environmental Condition” (“GAEC”). The farmer did not have to cultivate the land or stock it with animals in order to meet the GAEC requirement. When the scheme was initiated in 2005, farmers in the United Kingdom were allocated initial units of entitlement to single farm payments (“SFPEs”) for no consideration. The SFPEs were tradeable and a market in them developed over time.

4

FASL took advantage of the market in SFPE units to accumulate a fund for the development of its business. With the assistance of bank funding, it spent about £7.7m between 2007 and 2012 on purchasing 34,477 SFPE units in addition to its initial allocation of 194.98 units for Tolmauds Farm. In this period FASL paid VAT on the SFPE units which it purchased and it has sought to deduct that VAT as input tax. In order to receive the SFPs to which the purchased SFPE units entitled it, FASL leased a further 35,150 hectares of land under seasonal lets. FASL did not cultivate or stock this land. The leases were typically qualified by an agreement, entered into after the lease, which allowed the landlord to stock the land or cultivate it himself, provided that the ground was kept in GAEC. This was done to preserve FASL's entitlement to SFPs. The rent payable for the seasonal lets was generally about £1 per acre but could be up to £10 per acre.

5

The result of this business model was that between 2010 and 2013 (in each case FASL's financial year ending on 30 September) FASL's income from subsidies, which were principally SFPs, dwarfed its income from cattle sales from Tolmauds Farm. FASL received SFPs of £1,166,290 in 2010, £1,761,205 in 2011, £2,488,949 in 2012 and £3,285,650 in 2013. The parties presented the court with agreed figures derived from the profit and loss accounts of FASL in those financial years:

2010

2011

2012

2013

Cattle Sales

99,284

48,601

97,530

280,997

Cattle subsidies (incl SFPs)

1,202,908

1,795,589

2,515,057

3,312,597

Costs of Sales

(53,925)

(38,666)

(111,885)

(275,389)

SFP Amortisation

(1,141,159)

(1,766,118)

(1,835,693)

(917,840)

Net Profits

(37,079)

(41,812)

534,910

2,499,085

6

During the years 2010 to 2013, Mr Frank Smart was paid no director's salary or bonus but FASL paid him dividends of £20,000 in each of 2010 and 2012 and of £15,000 in each of 2011 and 2013. None of the SFPs have been withdrawn from FASL's bank account for Mr Smart's personal use or for his benefit.

7

The First-tier Tribunal (“FTT”), to whom FASL appealed against HMRC's refusal to allow it to deduct VAT of £1,054,852.28 in its quarterly VAT returns between December 2008 and June 2012, made important findings of fact (in para 38 of its decision) which have a bearing on the outcome of this appeal. The FTT found that when it purchased the SFPE units, FASL intended to apply the income which it received from the SFPs to pay off its overdraft and to develop its business operations. The SFPs were accumulated in FASL's bank account and have been used to pay off its overdraft. Tolmauds Farm was worked during the relevant period by Mr Smart and one of his sons, Roderick, on a full-time basis and another son assisted for part of that period. FASL had no other employees. During the relevant period FASL did not increase its stock numbers on the farm significantly. But FASL had been contemplating three principal developments of its business. First, from about 2011, FASL was considering establishing a windfarm. It spent over £119,000 on preliminary investigations, including technical information and costings, on investigating community responses and on a planning application and enquiries. Secondly, other proposed developments have included the construction of further farm buildings, including cattle courts and a Dutch barn. FASL has undertaken site preparation works for an additional cattle court and has made the needed planning applications. Thirdly, FASL has been considering the purchase of neighbouring farms, which were expected to come on to the market for sale.

8

Based on those findings of fact, the FTT concluded (para 39) that the acquisition of the SFPE units was a funding exercise which related to FASL's business overheads in its farming enterprise. FASL had raised finance for its future economic activities as a whole. There was a direct and immediate link between the expenditure and FASL's future taxable supplies. The FTT stated the conclusion based on its findings of primary fact that the funding opportunity afforded by the purchase of the SFPE units did not form a separate business activity of FASL but was “a wholly integrated feature of the farming enterprise” and not a separate enterprise (para 42). The FTT therefore allowed FASL's appeal.

9

HMRC appealed to the Upper Tribunal (Lord Tyre), which confirmed the FTT's findings of fact, which were by then uncontroversial, and refused the appeal, finding that the FTT had not erred in law. HMRC then appealed with the permission of the Upper Tribunal to the Inner House of the Court of Session. An Extra Division of the Inner House (Lord Menzies, Lord Brodie and Lord Drummond Young) in a judgment delivered by Lord Drummond Young dated 8 December 2017 ( [2017] CSIH 77) dismissed HMRC's appeal. HMRC now appeals to this court with its permission.

The VAT system
10

Before setting out HMRC's challenge it may be useful to discuss the basic structure of the VAT system so far as relevant. In order to understand the case law, which I will discuss, it is necessary also to set out relevant provisions of the PVD as they show the central importance to the question of deductibility, which arises in this appeal, of the connection between input expenditure and the economic activity which a taxable person is carrying on or intends to carry on.

11

Article 2(1) of the PVD imposes VAT on:

“(a) the supply of goods for consideration within the territory of a member state by a taxable person acting as such …

(c) the supply of services for consideration within the territory of a member state by a taxable person acting as such; …”

12

Article 9(1) of the PVD defines “taxable person” and “economic activity”:

“1. ‘Taxable person’ shall mean any person who, independently, carries out in any place any economic activity, whatever the purpose or results of that activity.

Any activity of producers, traders or persons supplying services, including mining and agricultural activities and activities of the professions, shall be regarded as ‘economic activity’. The exploitation of tangible or intangible property for the purposes of obtaining income therefrom on a continuing basis shall in particular be regarded as an economic activity.”

13

In the provision of goods or services for consideration there is often a chain of production or supply from raw material to finished product. At its simplest, VAT is a tax on the value added by a supplier of goods to its purchases of raw materials or goods upon sale of the product. The same principle extends to the supply of services. Under the common system of VAT in the United Kingdom and throughout the European Union, the taxation of the value so added by the particular supplier is achieved by calculating the tax due on the output of the supplier at the specified rate (“output tax”) and deducting from that sum the VAT which that supplier has paid on the components of that output or on general overheads of the business which are cost components of its taxable outputs (“input tax”).

14

The principle is articulated in article 1(2) of the PVD which provides:

...

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6 cases
  • Hotel La Tour Ltd
    • United Kingdom
    • First Tier Tribunal (Tax Chamber)
    • 3 December 2021
    ...of input tax. It in particular it quoted extensively from the Court of Session decision in Frank A Smart & Sons Ltd (Scotland) [2019] BVC 37 in which a farmer was entitled to recover input tax incurred applying for subsidies used to support his farming activities (subsidies being a non-busi......
  • Jupiter Asset Management Group Ltd
    • United Kingdom
    • First Tier Tribunal (Tax Chamber)
    • 9 April 2021
    ...Mr Jones then pointed us to the summary of the relevant principles by Lord Hodge in R & C Commrs v Frank A Smart & Son Ltd (Scotland) [2019] BVC 37 at paragraph [65]. He said that it was clear from paragraphs [65](ii) and [65](iii) of that judgment that the establishment of such a direct an......
  • Taylor Pearson (Construction) Ltd
    • United Kingdom
    • First Tier Tribunal (Tax Chamber)
    • 13 November 2019
    ...FTT considered it anyway and concluded, following the propositions set out by the Supreme Court in R & C Commrs v Frank A Smart & Son Ltd [2019] BVC 37, it was clear the FTT was required to consider the true purpose of the arrangements and to look through any initial transaction to ascertai......
  • THE COMMISSIONERS FOR HIS MAJESTY’S REVENUE AND CUSTOMS v HOTEL LA TOUR LTD [2023] UKUT 00178 (TCC)
    • United Kingdom
    • Upper Tribunal (Tax and Chancery Chamber)
    • Invalid date
    ...v AB SKF (Case C-29/08) [2010] STC 419 (“SKF”) and of the Supreme Court in Frank A Smart & Son Ltd v Revenue and Customs Commissioners [2019] UKSC 39, [2019] 1 WLR 4849 (“Frank A Smart”) was that the relevant objective purpose was that of the fund-raising and the relevant use was the use of......
  • Request a trial to view additional results
2 firm's commentaries
  • Katten Corporate And Real Estate Tax Case Roundup ' February 2022
    • United Kingdom
    • Mondaq UK
    • 9 February 2022
    ...HLT's taxable hotel development activity. But the FTT disagreed, noting, as the Supreme Court decided in Frank A Smart & Son Ltd v HMRC [2019] UKSC 39, that input tax incurred on costs associated with a disposal of shares is deductible the sale is a fundraising transaction objectively enter......
  • Katten Corporate And Real Estate Tax Case Roundup ' February 2022
    • United Kingdom
    • Mondaq UK
    • 9 February 2022
    ...HLT's taxable hotel development activity. But the FTT disagreed, noting, as the Supreme Court decided in Frank A Smart & Son Ltd v HMRC [2019] UKSC 39, that input tax incurred on costs associated with a disposal of shares is deductible the sale is a fundraising transaction objectively enter......

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