Royal Opera House loses at Upper Tribunal
The Upper Tribunal has recently upheld HMRC’s appeal in The Royal Opera House Covent Garden Foundation case concerning VAT recovery on theatrical production costs, setting aside the findings of the First Tier Tribunal (“FTT”), which had previously found partially in favour of the ROH.
Along with being of key relevance for theatres providing exempt admission, the findings of the Upper Tribunal provides helpful insight into how the UK courts may now approach input tax recovery generally, in light of the recent high profile University of Cambridge and Frank A Smart decisions.
- Admission charges to ROH’s opera or ballet performances were exempt from VAT (by virtue of the exemption for cultural services).
- ROH additionally made a number of taxable supplies, such as programme sales and production specific commercial sponsorship, to which the production costs had a direct and immediate link. As a result, the ROH was able to recover a proportion of the input tax associated with the production costs, which was also attributable to the taxable supplies.
- Historically, the ROH had incorrectly treated production costs as directly attributable to its exempt admission. As a result of subsequent caselaw, ROH submitted retrospective claims for the recovery of this incorrectly underclaimed input tax.
- Whilst HMRC did not dispute that the production costs were a residual cost i.e. attributable to both taxable and exempt supplies, the dispute focused on the quantum of the input tax recoverable under the standard method (turnover based) and whether this led to a ‘fair and reasonable’ level of input tax recovery.
- In HMRC’s view, the value of taxable supplies which had a direct and immediate link with production costs was small in comparison with the total supplies made by the ROH. Therefore, including all taxable income streams was distortive, triggering a standard method override.
- The essence of ROH’s case was that the production costs, viewed objectively on an economically realistic view in all the circumstances, were incurred and used, in part, by ROH to bring customers to its restaurants and bars and consume the taxable supplies of catering offered in the Opera House i.e. there was a direct and immediate link between the production costs and:
- The taxable catering supplies of the ROH in its bars and restaurants
- Sales of ice cream
- Shop sales
- Commercial venue hire; and
- Production work for other companies.
The ROH was partially successful at the FTT. The FTT concluded that there was:
- A direct and immediate link between the production costs and (i) and (ii) above; and
- No direct and immediate link between the production costs and (iii), (iv) and (v) above, other than production specific commercial venue hire and shop sales of recordings of ROH productions.
HMRC subsequently appealed against the FTT’s findings in respect of items (i) and (ii) above.
Upper tribunal findings
HMRC’s appeal succeeded at the Upper Tribunal. In setting aside the FTT’s decision, the Upper tribunal held that:
- HMRC were correct to deny ROH’s claim to recover VAT input tax associated with production costs (due to the standard method override).
- Whether there is a direct and immediate link to a taxable supply (and therefore a right to deduct input tax) will depend on whether the cost of the input goods or services is incorporated either in the cost of particular output transactions or in the cost of goods or services supplied by the taxable person as part of his economic activities.
- A “but for” link was not sufficient to establish a direct and immediate link.
- The fact that the production costs “enabled” the ROH to make its catering supplies by attracting customers who bought tickets to the opera or the ballet partake of the catering supplies is not sufficient to establish a direct and immediate link.
- The FTT failed to explain how the “direct and immediate” link has been established beyond explaining how the production costs enabled the catering supplies to take place.
- The FTT reached its conclusion that the production costs did have a direct and immediate link with the catering supplies without applying the test correctly, and that was an error of law on its part and it made the same error in relation to the ice cream sales.
It is worth noting that in coming to its findings, the Upper Tribunal considered in some depth the precedent set in Mayflower Theatre Trust, Sveda, University of Cambridge and Frank A Smart. Whilst it is not yet known whether the ROH will seek an appeal, given the Upper tribunal did a quite admirable job of reconciling these key and somewhat ‘contradictory’ cases, a successful appeal of the Upper Tribunal decison would appear to be an uphill struggle at this stage.
Standard method overdrive
Somewhat lost in the detail and focus on ice creams, the ROH case is a sobering reminder of the importance of considering the impact of the often-overlooked standard method override (or indeed special method override).
The standard method override deals with circumstances where the standard method does not produce a fair and reasonable deduction of input tax.
The override requires businesses to make an adjustment when the input tax deducted during the tax year using the standard method differs substantially from a deduction based on the use or intended use of the purchases received by a business in making its taxable supplies.
A difference is substantial if it exceeds:
- 50% of the residual input tax incurred and £25,000
The override will only apply where the standard method produces a result which does not fairly reflect the extent to which the purchases on which the VAT is incurred are used to make taxable supplies.
As well as the example shown in the ROH case, this could occur where costs are incurred in one year which will not result in supplies until a later year, or high value transactions are undertaken which do not consume inputs to an extent significantly greater than transactions of a lower value.
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