[2009] UKFTT 221 (TC)

TC00171
Appeal number LON/07/1479

VAT – refund of tax to non-EU claimant – Directive 86/560 – nature of evidence required of claimant’s business activities – VATA 1994 ss 24 & 39 - appeal dismissed 

FIRST-TIER TRIBUNAL

VALUE ADDED TAX 

	SRI INTERNATIONAL	Appellant

	- and -

	THE COMMISSIONERS FOR HER MAJESTY’S
	REVENUE AND CUSTOMS 	Respondents

		             TRIBUNAL: Malachy Cornwell-Kelly
					 Mohammad M Hossain FCA FCIB

Sitting in public in London on 10th & 11th June 2009

Mr David Ewart QC of counsel for the Appellant

Mr Vikram Sachdeva of counsel instructed by the General Counsel and Solicitor to HM Revenue and Customs for the Respondents

© CROWN COPYRIGHT 2009

DECISION
Context 

1 This appeal is against a third and final refusal by HMRC dated 30th  July 2007 to make a refund to SRI International of £262,500, being the value added tax on a premium which had been paid by them to the lessor of premises at 33 Cavendish Square, London W1; the premium was paid by SRI International for the release on 23rd July 2004 of a guarantee they had given to the lessor in respect of the rent payable for these premises, which had been leased to a company in which SRI had indirectly a 30% shareholding, called Atomic Tangerine Inc. (‘Atomic Tangerine’).
2 The claim for the refund of the tax was made pursuant to regulation 186 of the Value Added Tax Regulations 1995, which gave effect to the 13th Directive on refunds of value added tax to taxable persons not established in the territory of the European Community.  
Legislation 
3 The following Articles of Directive 86/560 are relevant:
1(1) “A taxable person not established in the territory of the Community” shall mean a taxable person as referred to in Article 4(1) of Directive 77/388/EEC who, during the period referred to in Article 3(1) of this Directive, has had in that territory neither his business nor a fixed establishment from which business transactions are effected nor, if no such business or fixed establishment exists, his permanent address or usual place of residence, and who, during the same period, has supplied no goods or services deemed to have been supplied in the Member State referred to in Article 2 …
2(1) Without prejudice to Articles 3 and 4, each Member State shall refund to any taxable person not established in the territory of the Community, subject to the conditions set out below, any value added tax charged in respect of services rendered or moveable property supplied to him in the territory or the country by other taxable persons or charged in respect of the importation of goods into the country, in so far as such goods or services are used for the purposes of the transactions referred to in Article 17(3)(a) and (b) of Directive 77/388/EEC …
3(1) The refunds referred to in Article 2(1) shall be granted upon application by the taxable person.  Member States … shall impose on the applicant such obligations as are necessary to determine whether the application is justified and to prevent fraud, in particular the obligation to provide proof that he is engaged in an economic activity in accordance with Article 4(1) of Directive 77/388/EEC. …
(2) Refunds may not be granted under conditions more favourable than those applied to Community taxable persons.  
4(1) For the purposes of this Directive, eligibility for refunds shall be determined in accordance with Article 17 of Directive 77/388/EEC as applied in the Member State where the refund is paid. 
4 Article 4(1) of Directive 77/388 provides:
4(1) “Taxable person” shall mean any person who independently carries out in any place any economic activity specified in paragraph (2), whatever the purpose or results of that activity.
(2) The economic activities referred to in paragraph (1) shall comprise all the activities of producers, traders and persons supplying services including mining and agricultural activities and activities of the professions.  The exploitation of tangible or intangible property for the purpose of obtaining income therefrom on a continuing basis shall also be considered an economic activity.
(3) Member States may also treat as a taxable person anyone who carries out, on an occasional basis, a transaction relating to the activities referred to in paragraph (2) …
5 The relevant parts of Article 17 of Directive 77/388, as amended, are:
(3) Member States shall also grant every taxable person the right to the deduction or refund of the value added tax referred to in paragraph (2) in so far as the goods and services are used for the purposes of:
(a) transactions relating to the economic activities referred to in Article 4(2), carried out in another country which would be deductible if they had been performed within the territory of the country;
(b) transactions which are exempt pursuant to Article 14(1)(g) and (i), 15, 16(1)(B), (C), (D) or (E) or (2) or 28c(A) and (C);
(c) any of the transactions exempt pursuant to Article 13(B)(a) and (d)(1) to (5), when the customer is established outside the Community or where those transactions are directly linked with goods to be exported to a country outside the Community.
(4) The refund of value added tax referred to in paragraph (3) shall be effected:
…
- to taxable persons within the territory of the Community, in accordance with the detailed implementing rules laid down in Directive 85/560/EEC.
(5) As regards goods and services to be used by a taxable person both for transactions covered by paragraphs (2) and (3), in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible, only such proportion of the value added tax shall be deductible as is attributable to the former transactions.  
6 Input tax, the tax in principle deductible, is defined by section 24(1) of the Value Added Tax Act 1994 as follows:
(1) Subject to the following provisions of this section, “input tax” in relation to a taxable person means the following tax, that is to say – 
(a) VAT on the supply to him of any goods or services;
…
being (in each case) goods or services used or to be used for the purposes of any business carried on or to be carried on by him.
7 Section 39 of the 1994 Act deals with the repayment of tax to those in business overseas:
(1) The Commissioners may, by means of a scheme embodied in regulations, provide for the repayment, to persons to whom this section applies, of VAT on supplies to them in the United Kingdom … which would be input tax of theirs if they were taxable persons in the United Kingdom.
(3) Repayment shall be made in such cases only, and subject to such conditions, as the scheme may prescribe (being conditions specified in the regulations or imposed by the Commissioners either generally or in particular cases); …
8 Regulation 186 of the Value Added Tax Regulations 1995 gives effect to this as follows:
186 Subject to the other provisions of this Part a trader shall be entitled to be repaid VAT charged on … supplies made to him in the United Kingdom if that VAT would be input tax of his were he a taxable person in the United Kingdom.
The nature and character of SRI International
9 Oral evidence was given by Mr Byron Rovegno, now the Treasurer of SRI International, a position which he has held since 2000; until 2007 he was also Financial Controller responsible for banking, fund management, credit and collection, but he was not a member of the board of SRI International or of the board of Atomic Tangerine.  We regarded Mr Rovegno as a truthful and straightforward witness.  All the other evidence was in documentary form. The following survey of the evidence is drawn from these two sources, and we accept the facts as stated unless it is indicated otherwise.
10 Mr Rovegno’s evidence was that SRI International is a not-for-profit corporation incorporated under the laws of the state of California in 1946, which conducts research and development in areas such as computing, engineering, health sciences, life sciences and pharmaceuticals.  It had a number of inventions known world-wide to its credit, such as the computer mouse, the voice-activated computer and anti-malarial drugs.
11 An extract from the articles of incorporation showed that the company’s main objects were –

To establish a center for the accumulation of information useful to scientific and industrial research; to foster the exchange of scientific and technical information with other research and educational institutions, and to publish and disseminate such of its findings as may be deemed of general public interest;
To promote and foster the application of science in the development of commerce, trade and industry; the discovery and development of methods for the beneficial utilization of natural resources; the industrialization of the western United States of America; and the improvement of the general standard of living and the peace and prosperity of mankind.
12 There were then various powers in respect of intellectual property rights, the receipt of gifts and legacies, the making of contracts in general and property transactions in particular and, finally, an all-encompassing clause –
To do all other acts necessary or expedient for the administration of the affairs and attainment of the purposes of the corporation.
13 An amendment to these articles dated 7th April 1980 provides that, in the event of the winding up or dissolution of the company, any residue of funds is to be distributed to “Leyland Stanford Junior University for the use and benefit of Leyland Stanford Junior University”.  (A further amendment was made on 17th March 2005, but is outside the period concerned in this appeal.)
14 SRI International was originally linked – in what way was not stated - to Stanford University in California (it was not clear whether this was the same university as Leyland Stanford Junior University), but in the 1970s the company was separated from the university as a reaction to student protests against the Vietnam war; again, we were given no detail of what this amounted to or how it affected the structure of the company.  It may be that the acronym ‘SRI’ reflects the Stanford connection, but we were not told.
15 Mr Rovegno told us that 90% of the work undertaken by SRI International was at the behest of the US Government, which commissioned it by means of distinct orders or contracts in respect of each exercise; any surplus over expenses has to be reinvested in the company’s activities.  It was claimed that SRI International undertakes its activities “for government agencies, commercial businesses and other organisations”, although we saw no specific examples of such work, save as mentioned below in connection with Atomic Tangerine as an example of ‘spin off’.  
16 SRI International does at times derive revenue from the commercial exploitation its research work by ‘spinning off’ companies incorporated for the purpose, financed at least in part by the venture capital market, and taking a shareholding in them.  SRI International would maintain close links with its ‘spin-offs’ by means of board representation, and Mr Rovegno said that he was the Chief Financial officer of three such companies, though he did not hold that position in Atomic Tangerine.
17 We were shown a certificate dated 4th August 2004 signed by the Secretary of State of California that SRI International had been incorporated under the law of California on 6th November 1946 and that –
•	“its corporate  powers, rights and privileges are not suspended on the records of this office”;
•	“according to the records of this office, the said corporation is authorized to exercise all its corporate powers, rights and privileges and is in good legal standing in the state of California”;
•	“no information is available in this office on the financial condition, business activity or practices of this corporation”.
18 There also a certificate dated 13th January 2006 by the Field Director of the Internal Revenue Service, Philadelphia Accounts Management Center, with respect to SRI International that it had filed a US corporate income tax return for the tax year 2003 and that “The corporation represents that the business activity code and business activity is 541700, Scientific Research and Development Services.”.  Strangely, in view of this statement, the certificate is endorsed in capital letters: VAT ONLY, NOT APPLICABLE TO INCOME TAXES.
19 The tribunal was not shown any other details of SRI International’s company registration or structure. Mr Rovegno’s evidence was that the company’s only shareholder - or perhaps its ultimate controller as a public interest corporation (he was not completely clear about this) - was the Attorney General of the State of California.  The company’s articles of incorporation stipulate that it is to have no members, which we take to mean no shareholders.

20 No annual report of SRI International, or the like, was produced and the tribunal had no documentary evidence of the range of its activities, save certain extracts from SRI International’s website which were produced by counsel during the hearing.  When these were handed up, we made it clear that we saw pages printed from the website in June 2009 as of little or no value in relation to matters in 2000 and 2004 and as, in any event, an intrinsically ephemeral and unreliable source of evidence, but no application was made to submit further evidence. 
SRI Consulting and the establishment of Atomic Tangerine
21 There were three refund claims in all - for the same amount – each seeking to persuade HMRC of the merits of the claim.  The first was purely formal.  
22 The second claim by SRI International made by letter states that that company owns “SRI Consulting, a for-profit US corporation providing a consulting services that was spun off from SRI [International] in 1996”.   No evidence was offered as to which state SRI Consulting was incorporated in, or the terms of its relationship with SRI International, including the extent of the latter’s shareholding; indeed, the existence of SRI Consulting was not specifically discussed at the hearing.  The claim, however, states clearly that “SRI Consulting set up Atomic Tangerine in 1999, an e-business venture-consulting firm”. 
 23 A subsequent paper submitted to HMRC on 4th May 2007, by way of the final claim whose refusal is the subject of this appeal, however makes no reference to SRI Consulting and states, in regard to the ‘spin off’ business of SRI International, that – 
“SRI will enter into contractual arrangements with such spin off companies from which SRI will benefit.  Such contractual arrangements typically include arrangements in relation to the use of IP, leasing of SRI space by the spin off, staffing, provision of research and administrative assistance.
…
Atomic Tangerine was one such entity, incorporated in Delaware in the US in 1999.  Its headquarters were in the US, but it had branch offices in Japan, and in 2000 intended to open another branch in London, for which purpose it entered into a lease of the property at 33 Cavendish Square, guaranteed by SRI.
SRI took a 30% interest only in Atomic Tagerine.  The remaining 70% ownership was held by Sienna Limited Partnership and by TA Associates, two unconnected entities.”
24 “SRI” is defined in this paper as SRI International, and not as SRI Consulting.  The paper appears to have been drafted by Simmons & Simmons, who certainly submitted it.  Almost the same wording as that used in this paper was adopted by Mr Rovegno in his witness statement in which he says, after describing the ‘spin-off’ policy –
Atomic Tangerine was one such profit generating entity spun-off by SRI [International].
25 In an earlier letter of 11th January 2007 to HMRC from Simmons & Simmons, however, reference is made to the rent guarantee provided by SRI International as being provided by them “as the ultimate parent company” of Atomic Tangerine, which is consistent with the statement in SRI International’s own second claim letter, cited above, that SRI Consulting was the holder of the 30% share in Atomic Tangerine.  
26 In this situation, we prefer the evidence of the two earlier sources, the claim letter of 16th February 2006 and Simmons & Simmons’ letter of 11th January 2007.  If SRI Consulting did not exist, or was not the holding company of Atomic Tangerine, there would have been no reason to mention it, and these earlier statements as to ownership were not in terms contradicted by the later statements, which seem to us quite clearly to have been a less careful (but still broadly truthful) account of the situation.  Our finding is therefore that SRI Consulting was the holder of 30% of the shares in Atomic Tangerine, and not SRI International.  

The business and activity of Atomic Tangerine
27 The lifespan of Atomic Tangerine was short: incorporated in Delaware at the end of 1999 (either in November or December, it is not clear which) in order to “take advantage of the growth in web-based services as an e-business venture consulting firm”.  The company ceased trading in September 2001, but Mr Rovegno was unable to say whether it had yet been wound up.  
28 During that time, Atomic Tangerine entered into some $600,000 of business with SRI International, consisting of –
(i)	a contract for the provision of services to support Atomic Tangerine’s “Information Security University” development project: $532,359;
(ii)	a contract to provide reports on “Energy and Security Policies for the Central Research Institute of Electrical Power Industries in Japan”: $54,963;
(iii)	a contract to research and report on the role of nuclear power in the US: $43,338.
29 There was also a lease of premises from SRI International to Atomic Tangerine of premises at its site in California which produced rent of $475,000 in 2000 and $527,000 in 2001.  The total income of SRI International from Atomic Tangerine was said to be in excess of $1,600,000. The documents attesting to these transactions were put in evidence. 
30 Thus, SRI International had, it is said, a financial interest in the future of Atomic Tangerine and its success, both in terms of its minority shareholding in that company (or, more accurately, the shareholding of SRI Consulting) and in terms of the contracts SRI International might expect to receive from Atomic Tangerine, whose chairman was moreover from SRI International.  

Atomic Tangerine and the United Kingdom
31 None of these projects specifically involved the United Kingdom, but the taking of the premises in Cavendish Square was intended to be the opportunity for a further income stream, namely through fees charged to Atomic Tangerine for technology related consulting services provided by SRI International and as a source of referral work from the United Kingdom, expanding SRI International’s client base there.
32 Accordingly, SRI International conceived it to be in its own interests to guarantee the rent on the 15 year lease of 33 Cavendish Square, as the lessor of the premises was unwilling to accept the covenant of a newly formed company alone.  The lease was thus entered into by Atomic Tangerine on 4th September 2000, with SRI International as guarantor of the rent.  In the papers is a certificate dated 26th July 2000 by the company secretary of Atomic Tangerine that the board of that company approved the negotiation and conclusion of the lease, though no terms on which this might be done were specified.  
33 Likewise, a certificate dated 16th August 2000 by the Vice President, General Counsel and Secretary of SRI International was in evidence stating that the board of directors had authorised the execution of a lease guarantee for Atomic Tangerine but, again, not indicating any of the terms on which the guarantee would be given. Mr Rovegno stated that the giving of the guarantee was part of the routine action take to support start-up companies, though he accepted in cross-examination that he knew of no other case in which such a guarantee had been given.
34 Atomic Tangerine ceased to trade in September 2001, the victim of the bursting of the dot.com bubble, before it had occupied the premises at 33 Cavendish Square.  SRI International then found itself having to pay the rent on the premises; after unsuccessful attempts to find a buyer for the lessee’s interest, SRI International negotiated a release from its guarantee for a premium of £1,500,000 plus VAT on 23rd July 2004.  

35 Mr Rovegno stated that the decision to pay the premium for the release was not taken by the board of SRI International but had been within his authority to take; he did not know whether the premium was or was not equal to the rent remaining, but he believed that it was less, nor could he say that the action had been necessary to protect SRI International’s interest in any specific contract.
36 The release was effected by deed dated 23rd July 2004, which recited that “the residue of the term granted by the lease is still vested in [Atomic Tangerine]” - which, it must be inferred, was therefore still in principle in existence, although there is no evidence that it had any assets or value.    Whether the lessor subsequently forfeited the lease is not apparent, nor was there any evidence as to the final fate of Atomic Tangerine.  Similarly, there was no evidence as to the commercial thinking behind the payment of a premium for the release, beyond the obvious concern to bring an end to SRI International’s ongoing liability.
Conclusions on the facts
37 It must be regretted that the Appellant has not provided better and fuller information in support of the appeal.  The first application for a refund of the tax on the premium for the release of SRI International’s guarantee was made by them on 12th May 2005, and rejected.  It was renewed in what was in effect a second application by the company dated 16th February 2006, which was also rejected, leading to a request for reconsideration by Simmons & Simmons on 8th September 2006. 
38 That was rejected, leading to third application being submitted by Simmons & Simmons on 4th May 2007, with the supporting paper to which reference has been made.  As has been seen, that third application was itself rejected by a letter dated 30th July 2007 from HMRC.  In the course of preparing for this appeal, HMRC wrote to the Appellant’s solicitors on 15th July 2008 seeking documentary evidence of a variety of matters concerning SRI International which can be summarised as follows –
1.	Full company registration documents for SRI International. 
2.	Evidence of the contracts entered into for the last 5 years in pursuance of SRI International’s core activities.
3.	Documentary support for the claim that SRI International’s statutes permitted it to make a profit to be invested in further research.
4.	Documentary evidence of profitable trading with Atomic Tangerine.
5.	Documentary evidence with regard to the shareholdings in Atomic Tangerine.
6.	Documentary evidence with regard to the lease of 33 Cavendish Square, London, and a copy of the lease.
7.	Documentary evidence with regard to the Atomic Tangerine’s cessation of business.
8.	Documentary evidence that SRI International had paid the rent on the London premises pursuant to its guarantee.
9.	Documentary evidence with regard to the release of the guarantee.
39 With the exception of items 4 and 9, none of this was provided to the tribunal save by way of the very general oral evidence described.  In our judgment of the matter, it would have been very material to have had sight of the full details of the registration of SRI International rather to have to rely on Mr Rovegno’s uncertain understanding of who or what is the ultimate controller or owner of the corporation. Likewise, there appears no good reason why there has not been written and specific evidence of SRI International’s present status since its separation from Stanford University in 1970, and of its general activities distinct from its admittedly peripheral ‘spin-off’ business.
40 The list of desirable but unprovided evidence continues: documentary evidence of the relationship between SRI International and SRI Consulting, and the nature and activities of the latter; similar evidence of the shareholdings in Atomic Tangerine, the minutes of the boards of SRI International, SRI Consulting and Atomic Tangerine with regard to the lease and guarantee; details of the cessation of trade by Atomic Tangerine and its status at the time of the release. 

41 It is not apparent why, in a substantial claim whose road to this appeal has been four years long, this type of easily obtainable evidence has not been put together and why, at the very moment of the hearing, the tribunal should be asked to make do with some pages printed off a website in a matter of decisive importance.  We have said that we regarded Mr Rovegno as an honest witness, but it was apparent that he had been at some remove from most of the matters or events involved and was not in a position to offer more than an overall summary of them, save in those cases where documentary evidence was in fact provided (and we have referred to it where it was).
42 The upshot is that there is insufficient clear evidence with regard to the core activities of SRI International to enable us to make a finding as to their nature.  Such evidence as was led seems to us consistent both with the possibility of SRI International carrying on a general economic activity of the kind that would entitle it to be regarded as a taxable person were it established in the United Kingdom, but also with its being an essentially academic and research-orientated institution whose work on behalf of, in particular, the US Government is in effect grant-funded, albeit that the mechanics of commission and payment may appear in the form of contracts for services.
43 Nevertheless, we are satisfied that there is an element of conventional economic activity carried on in relation to what Mr Rovegno termed ‘spin-offs’, that is the exploitation by means of companies formed for the purpose of commercialising the expertise or inventions resulting from SRI International’s core activities.  From the very limited evidence available, we find that this ‘spin-off’ activity was carried on by SRI Consulting, and that SRI Consulting was in principle controlled by SRI International.  We find therefore that SRI Consulting carried on an economic activity characteristic of a taxable person in the United Kingdom, but we do not find that SRI International did so.
44 The release of the rent guarantee in July 2004 took place well after Atomic Tangerine had ceased trading and, we find, at a time at which neither SRI International nor SRI Consulting had any remaining interest in Atomic Tangerine’s former business - albeit that their previous involvement with it had left the legacy of a substantial liability on the part of SRI International.  We find that the only available evidence shows that the purpose of the release of the guarantee was simply to liquidate that liability. While, in accounting terms, the liquidation of SRI International’s liability may well have been the final entry in the overall profit and loss account of the Atomic Tangerine venture, it does not follow that it was done for the purposes of that business.
45 Clearly, if the guarantee had not been released, the continuing obligation to pay the lease rent of 33 Cavendish Square for no return could have had an indirect effect on the overall viability of the ‘spin-off’ activity conducted by SRI Consulting, or on SRI International’s core activities, or both.  It is for example unknown which company would bear the final loss in relation to Atomic Tangerine’s London lease, SRI International or SRI Consulting, or the way in which the ‘spin-off’ business was structured, or on what terms it was financed as between SRI Consulting and SRI International, or what degree of autonomy the subsidiary enjoyed, or whether SRI International had received or would obtain compensation in respect of the guarantee from its subsidiary.  
46 On these issues, it is possible to do no more than speculate, since we have no useful evidence about them. We are unable therefore to find that the payment for the release of the guarantee was made for the purpose of any specific business.  
Case law
47 In view of these findings, much of the case law to which we were pointed by the very helpful submissions of both counsel has little importance.  We refer, however, to the leading cases in this area, noting that there is no authority dealing in terms with the position of third country claimants.  The tribunal is obliged therefore to reason by analogy with cases which have involved EU-based taxable persons, even though it is not without difficulty to assimilate third country undertakings to that status.
48 This difficulty is no doubt why Article 3(1) of Directive 86/560 instructs Member States that they “shall impose on the applicant such obligations as are necessary to determine whether the application is justified and to prevent fraud, in particular the obligation to provide proof that he is engaged in an economic activity in accordance with Article 4(1) of Directive 77/388.”.  Section 39(3) of the Value Added Tax Act 1994 likewise, in relation to schemes for the administration of third country claims, provides that “Repayment may be made in such cases only, and subject to such conditions, as the scheme may prescribe (being conditions specified in the regulations or imposed by the Commissioners either generally or in particular cases).
49 The basic requirement is then made clear in regulation 186 cited above, that the claimant must show that the tax sought to be relieved “would be input tax of his were he a taxable person in the United Kingdom”.  
50 The precise nexus which must be shown is therefore that described in section 24(1) of the 1994 Act, namely that the goods or services on which tax been charged are “goods or services used or to be used for the purposes of any business carried on by him”.  In two rulings in cases referred from the English courts under Article 177 (now Article 234) of the EC Treaty, the Court of Justice has addressed the nature of the connection which must be shown between input tax whose deduction is sought and the purpose for which the supply which gives rise to it is used.
51 The first case is BLP Group v CEC [1995] All ER (EC) 401.  It concerned the deductibility of input tax on professional services used in connection with a sale of shares, which itself was an exempt transaction.  On this the Court ruled –
[19] Paragraph (5) [of Article 17 of Directive 77/388] lays down the rules applicable to the right to deduct VAT where the VAT relates to goods or services used by the taxable person ‘both for transactions covered by paragraphs (2) and (3), in respect of which value added tax is deductible, and for transactions in respect of which value added tax is not deductible’.  The use in that provision of the words ‘for transactions’ shows that to give the right to deduct under para (2), the goods or services in question must have a direct and immediate link with the taxable transactions, and that the ultimate aim pursued by the taxable person is irrelevant in this respect.
[24] Moreover, if BLP’s interpretation [that its input supplies were for the ultimate benefit of its core activities of making taxable supplies] were accepted, the authorities, when confronted with supplies which, as in the present case, are not objectively linked to taxable transactions, would have to carry out enquiries to determine the intention of the taxable person.  Such an obligation would be contrary to the VAT system’s objectives of ensuring legal certainty and facilitating application of the tax by having regard, save in exceptional cases, to the objective character of the transaction in question.

52 In CEC v Midland Bank plc [2000] All ER (EC) 673 the link asserted by the Bank between the services supplied by lawyers in litigation, and a previous transaction out of which the litigation arose, was disputed by the Commissioners on the ground that the services in question were for the benefit of the Bank’s business as a whole, which were partly exempt and therefore required input tax to be apportioned and partly disallowed.  
53 The Court of Justice had to touch on the implications of the reservation made at [24] of the BLP decision regarding the “exceptional cases”, in which a direct and immediate link between the services giving rise to the input tax and their use for the purposes of a taxable transaction or transactions, might be considered more widely.  The Court did so as follows –
[22] However, as the Court has also held, entitlement to deduct, once it has arisen, is retained even if the economic activity envisaged does not give rise to taxed transactions or the taxable person has been unable to use the goods or services which gave rise to a deduction in the context of taxable transactions by reason of circumstances beyond his control.
[23] It is clear from that case law that, as an exception and in specific circumstances, the right to deduct exists even if a direct and immediate link between a particular input transaction and an output transaction or transactions giving rise to the right to deduct cannot be established.
54 In refining that test the Court continued –
[30] It follows from that principle [the need for a direct relationship between inputs and outputs] as well as from the rule enshrined in the judgement of the BLP Group case at [19] according to which, in order to give rise to the right to deduct, the goods or services acquired must have a direct and immediate link with the taxable transactions, that the right to deduct the VAT charged on such goods or services presupposes that the expenditure incurred in obtaining them was part of the cost components of the taxable transactions.  Such expenditure must therefore be part of the costs of the output transactions which utilise the goods and services acquired.  
That is why those cost components must generally have arisen before the taxable person carried out the taxable transactions to which they relate.
[31] It follows that, contrary to what the Midland claims, there is in general no direct and immediate link in the sense intended in the BLP Group case, between an output transaction and services used by a taxable person as a consequence of and following completion of the said transaction.  Although the expenditure incurred in order to obtain the aforementioned services is the consequence of the output transaction, the fact remains that it is not generally part of the cost components of the output transaction, which Article 2 of the First Directive nonetheless requires.  Such services do not therefore have any direct and immediate link with the output transaction.  On the other hand, the costs of those services are part of the taxable person’s general costs and are, as such, components of the price of an undertaking’s products.  Such services therefore do have a direct and immediate link with the taxable person’s business as a whole, so that the right to deduct VAT falls within Article 17(5) of the Sixth Directive and the VAT is, according to that provision, deductible only in part.
[32] It could only otherwise if the taxable person were able to prove that, exceptionally, the costs relating to the goods or services which he has utilised as a consequence of making a deductible transaction are part of the cost components of that transaction.
55 Turning to the question of the purpose for which goods or services have been acquired, relevant to the establishment of the ‘direct and immediate link’, the Appellant argued that the characterisation of the input transaction (here, the payment for the release of the guarantee) depended on the subjective intention of the person acquiring the services, following the decision of the High Court in Ian Flockton Developments Ltd v CCE [1978] STC 394, though counsel for HMRC submitted that this older authority had in effect been superseded by the two decisions of the Court of Justice cited above.

56 Flockton concerned the purchase of a racehorse whose use was claimed to be in advertising the taxpayer’s business of making plastic mouldings and storage tanks.  The issue was whether the purchase of the horse could be said to be for the purposes of the business carried on by the taxpayer, and in regard to this the learned judge said (at p. 400) –
The test is: were the goods or services which were supplied to the taxpayer used or to be used for the purpose of any business carried on by him?  The test is a subjective one: that is to say, the fact-finding tribunal must look into the taxpayer’s mind as it was at the relevant time to discover his object.  Where the taxpayer is a company, the relevant mind or minds are those of the person or persons who control the company or are entitled to and do act for the company. 
In a case such as this, where there is no obvious and clear association between the taxpayer company’s business and the expenditure concerned, the tribunal should approach any assertion that it is for the taxpayer company’s business with circumspection and care, and must bear in mind that it is for the taxpayer company to establish its case and the tribunal should not simply accept the word of the witness, however respectable.  It is both permissible and essential to test such evidence against the standards and thinking of the ordinary businessman in the position of the applicant.  If they consider that no ordinary businessman would have incurred such expenditure for business purposes that may be grounds for rejecting the taxpayer company’s evidence, but they must not substitute that as the test.  It is only a guide or factor to take into account when considering the credibility of the witness, and no doubt there will be many other factors which bear on that question which the tribunal should well understand.
The tribunal must look at all the circumstances of the case and draw such inferences as they think fit.  In the end it is a question of fact for them whether they were satisfied on the balance of probability that the object in the taxpayer company’s mind at the time the expenditure was incurred was that the goods or services in question were to be used for the purposes of the business.

Conclusions 
57 It is not necessary for us to address the question of whether, and if so to what extent, the test laid down in Flockton is inconsistent with the BLP Group and Midland Bank cases cited above.  For want of adequate evidence, we have not been able to find that SRI International carried on a business, as understood in both Community and the national legislation, at all; and there has been no evidence to throw light on the relationship between any business it might been shown to be carrying on and that of SRI Consulting.  And although counsel for the Appellant argued strenuously that we should draw appropriate inferences from the overall circumstances, the fact remains that there was no evidence that the release premium was paid for any specific purpose beyond that of liquidating an open-ended liability on the part of SRI International.
58 It must be borne in mind that the burden of proof lies on the Appellant, and that both the Community and the national legislation make it very clear that the Commissioners are entitled to be demanding in relation to it.  Our conclusion therefore is that there is no evidence of a relevant intention, subjective or otherwise, on the part of SRI International in making the premium payment; that there is no evidence that the payment was in fact made for the purpose of a business carried on by them; and that no direct and immediate link has therefore been established between the services supplied in exchange for that payment and a business carried on by any person who, if he were in the United Kingdom, would be a taxable person.
59 The appeal does not therefore succeed.  The parties are at liberty to make an application within one month of the release of this decision as regards costs.

Malachy Cornwell-Kelly
TRIBUNAL JUDGE

RELEASE DATE: 27 August 2009