When Advocate General Kokott gave an Opinion concerning VAT recovery on costs arising from a taxable property development, many of us waited to see if the dog she intended to unleash would bark, or even bite. It turns out that it has yapped irritatingly, but no more.
As I outlined in my comment in Tax Journal (link) AG Kokott’s views were not in line with UK/HMRC policy, and seemed divorced from commercial considerations. She seemed to suggest that costs a developer incurs on enabling works to a municipal authority’s assets (in this case, improving the water supply) are not costs that are proper to the development for the purpose of input tax recovery, simply because the developer’s expenditure does not enhance an asset that the developer owns. She ignored the enhancement achieved to the asset that the developer does own, which is only made operational by enhancing the municipal asset.
She also suggested that the Court of Justice decision in Sveda, in 2015, was related to this question (which is very hard to comprehend) and that it was widely recognised that the Court needed to clarify that decision. We still do not know where she got that view from. However, the possibility of unleashing a dog that would cause the Court to row back on Sveda (which confirmed that VAT on cost components of both a taxable supply and free use can in many cases be fully recovered), or to ‘clarify’ its application, was not a particularly welcome one.
I predicted in my article that the Court would reject the Advocate General’s analysis, and it has. I wondered whether the Court would rise to her bait and review the scope of Sveda. The Court’s decision mentions Sveda, but its comments do not appear to add anything to the original text of the actual decision.
So, given that her advice has been so roundly rejected, why do I think the dog has yapped a little? I think that there is some cause for concern in the rider to the general agreement by the Court that the developer could reclaim VAT incurred on costs which enhanced the municipal asset in a manner which also enhanced its own. This was (to quote verbatim): “That being said, it is also for the referring court to examine whether that service was limited to that which was necessary to ensure the connection of those buildings to the pump station at issue in the main proceedings or whether that service went beyond that which was necessary for that purpose”.
I have highlighted the relevant word – necessary. It is clear that the Court was referring to the possibility of more being done for the municipal authority than was strictly needed for the development per se. Anything more could be regarded as third party consideration for services rendered effectively to the municipal authority. The contribution to that cost would be regarded as a ‘gift’ to the municipal authority (though heaven forbid anyone would take a step further, and view it as a bribe…). It is clear from the facts of the case that the Court did not suspect anything of that sort had arisen in the Iberdrola example, and this part of their decision is essentially hypothetical to that specific case. But it is still part of the decision, and is binding on member states. So, we now have to consider not merely the reasons as to why a business incurs costs relating to third party assets, but also the necessity of it doing so. Where does that leave works that enhance local facilities as part of a development, but where the connection is weaker than in the Iberdrola example? Will HMRC start to argue that there is no necessity in the works performed, and that desirability is not enough?
It reminds me of the Folkestone Harbour tribunal decision where the choice made by the tax payer to build a fountain feature on municipal land as a beacon to draw people to the development was accepted as a genuine commercial cost of the development with allowable input tax. Would that decision be the same in the light of this new Court decision? I am not convinced it would. There may be more to this word – ‘necessary’ than we might like to see.
The Court’s decision in Iberdrola is here
Graham Elliott – 15 September 2017