18133

Input Tax – attribution – Building works and Maintenance Contracts under a single contractual arrangement under P.F.I. rules – whether input tax on construction costs partly attributable to Maintenance Contract – whether Maintenance Contract “ancillary” or has direct and immediate link with the construction costs.  Appeal Allowed.

EDINBURGH TRIBUNAL CENTRE

	WEST LOTHIAN COLLEGE SPV LTD	Appellant

	- and -

	THE COMMISSIONERS OF CUSTOMS AND EXCISE	       Respondents

			Tribunal:	 (Chairman)   Mr T Gordon Coutts, QC
					 (Members)    A W B Voge, CA., FTII
						            Mrs Helen Dunn, LL.B.

Sitting in Edinburgh on 8 and 9 April 2003

for the Appellants		Colin Tyre, QC

for the Respondents	James Campbell, QC

© CROWN COPYRIGHT 2003.

DECISION

Introductory
The Appellants appeal is against a decision contained in a letter from the Respondents date 27 March 2002 ruling that VAT on costs in relation to the construction of the West Lothian College Buildings could not be treated as residual for VAT purposes.  The sum in dispute is approximately £1m.  In brief, the Appellants contention was that the building would be used for both exempt and taxable purposes.  The Commissioners contentions were firstly that there was only one exempt supply which consisted of a principal supply and various ancillary supplies or, alternatively, that there was no direct and integral link between the building costs and the management services therein and that accordingly input tax in respect of the construction costs of the college is only attributable to an exempt supply.

Evidence
The Tribunal had before it documentary evidence and also a written statement and oral evidence from Steven Brown Solicitor.  Mr Brown was personally involved with the project under discussion at all stages and was responsible for all legal advice provided in connection with that project.  Mr Brown’s written statement was treated as his evidence in chief, which he supplemented in chief and cross.  He was a clear and fully informed witness.  His expertise was unquestioned and he presented the factual situation with fairness and care.  Since the transaction which the Tribunal had to consider was factually and contractually complicated it is necessary that the background be set out at this stage by summarising the essential features of the transactions as spoken to by Mr Brown.

PFI contract negotiation generally
The PFI was introduced by the Government with the stated intention of driving out better value from the procurement of capital projects carried out by the public sector.  This was to be achieved through the transfer from the public sector of risk arising from time, and also cost overruns in relation to each of the initial construction costs, maintenance and the provision of services during the life of the project.  All these risks were to be transferred to the private sector contractor so allowing the public sector body accurately to budget for the long term cost of a proposed development within the approval granted by central government.

Prior to approval being granted for any PFI arrangement it must be established that it will cost less than the traditional design and build method of procurement in terms of both immediate affordability, i.e. cash paid out annually, but also in terms of overall value for money.  A proposed PFI project will be assessed by reference to the net present value over 60 years, including the initial construction costs and then subsequent running costs as provided for in the contracts.  These are then compared to the Public Sector Comparator (PSC) which contains equivalent predicted costs of procurement by the traditional method.  While the PFI costs are largely fixed, the PSC costs are predicted, and therefore not certain.

PFI contract tenders specify precisely what is required of the contractor in considerable detail.  It is not open to the tendering contractor to alter the scope of the specification either during the tendering or negotiation process or subsequently.  The contract may provide for alteration of the detailed provision during negotiations, but only if the public authority requests it and only if it does not affect the substance.

Tendering process for the West Lothian Project:
During 1990 the Board of Management of West Lothian College (“the College”) published a preliminary briefing setting out their vision for the replacement of their Bathgate Campus.  The document identified a desire that the new campus would be constructed, maintained and serviced under the proposals.

At the time of the preliminary briefing the College obtained from central Government an outline business case (OBC) approval for the proposed development.  An OBC requires to specify what is proposed, why and how it is to be funded.  The College obtained an outline approval only for the construction and maintenance of the new campus buildings due, at that stage, to the traditional public procurement method being the only one available to it at the time.  Following OBC approval the College was authorised to negotiate a contract to make the capital expenditure as outlined subject to approval of a final business case (FBC).

In 1994 the College published notification in the Official Journal inviting expressions of interest for a design, build and fund project at Almondvale.  However, following the introduction of the Private Finance Initiative by the Government, in October 1995, the original Official Journal notification was withdrawn and replaced by an invitation of expressions of interest for a design, build, fund and operate project.

HBG Construction Ltd responded with an expression of interest.  Together with a number of unknown parties HBG Construction Ltd received an Invitation to Negotiate (ITN) together with Instructions to Tenderers and the draft concession agreement.  The ITN presents a full statement of the extent of the proposed procurement specifying inter alia, the nature and style of the building, the number of students to be accommodated and the range of services to be supplied.  The draft concession agreement is the first draft of the form of contract to be entered.  The draft submitted to HBG at that time was and remained substantially in the same format as the Project Agreement which was finally signed.

The ITN specified that the project was to include the construction of the building and the provision of both hard and soft facilities management services.  This position is reiterated in clause 2.3 of the Instructions to Tenderers and the Draft Concession Agreement.  Hard services are those which are required to be undertaken in order to maintain the fabric, structure and functionality of the building so that it is continuously ‘available’ for use.  Effectively, the standard of maintenance is set to ensure that the building never deteriorates and is as new throughout its life.  Soft services are those by which the building is operated.  An example of the interrelationship between soft and hard services would be that the replacement of a light bulb would be classified as part of the hard service provision, while the cleaning of the light fitting would be part of the soft service provision.

In March 1997 HBG Construction Ltd were appointed as the preferred bidder.  West Lothian SPV Ltd (“WLSPV”) and West Lothian SPV Holdings Ltd were formed on 19 February 1999 and 19 March 1999 respectively to facilitate the HBG Group involvement in the project.

Following the appointment of HBG, in April 1997, the College began preparation of, consulted on, and later submitted in completed form, an FBC for approval by central Government.  The business case set out exactly how all the requirements for the new building would be met.  Prior to FBC approval being granted the proposals were analysed by reference to a number of governmental capital expenditure criteria, including risk transfer.  Only once satisfied that the proposal, by reference to the contractual documentation, met the risk transfer and other criteria and in particular the requirements that it be both cheaper and better overall value for money was approval given.

The final negotiation of the terms of the contract took some years, the agreement not being finally signed until December 1999.  However, during the course of negotiation the basic requirement for design, building, fund and operate did not change.

The Structure of the Contractual Arrangements
The College has the heritable title to the land.  It is the subject of a head lease granted by the College to West Lothian SPV and a sub-lease back to the College by West Lothian SPV.  That structure was used for functional reasons which applied at the time.  The interest under the head lease permitted WLSPV to claim capital allowance and provided the funders with security.  The sub-lease prevented WLSPV excluding the College from the land.  Such arrangements the Tribunal were informed are no longer necessary in more recent PFI contracts.

There was a project agreement which represented the principal contractual arrangement between all the parties and provided the sole basis of governing the relationship between them as regards the design, building and operation of the campus.  Clause 2 of the Agreement provided that the College appointed WLSPV to design, construct, fit and commission the campus buildings and bound WLSPV to provide the services specified throughout the duration of the term of the Agreement.

There is a complicated payment mechanism set out in the Agreement which essentially involved WLSPV receiving 2 income streams the first known as the availability charge and the second the facilities management charge.  The latter charge bears VAT.  Both income streams were fixed in advance and may not be varied other than in exceptional and defined circumstances.

The payment mechanism provides that WLSPV will receive the full payments in a schedule provided the building is maintained and serviced to a specified level.  Where there are failures to meet specification deductions are made whether that be for a hard or soft service failure.  It is unnecessary to detail the precise method of making all these deductions but they were essential parts of the whole transaction designed to guarantee proper performance.  

Most of the services be it maintenance or the provision of other things such as catering are sub-contracted by the Appellants.

Findings in Fact
The Appellant entered into a complex financial and contractual arrangement in a form which was forced upon it by the exigencies of the project being subject to PFI arrangements.

There were essentially 3 items which were separable or capable of being considered separately.  The first was the actual construction of the physical building, the second the maintenance of the building in a sound condition and thirdly the provision of other services such as catering, cleaning and the like.  Each of these matters provided an inflow or stream of money.  For the first the financing of the building was spread over a number of years, for the second the maintenance contract was paid on an invoiced basis and thirdly a similar arrangement applied to the “soft” services of cleaning catering and the like.

The College did not have occupation of parts of the building.  These parts were used for the purposes of cleaners, for the purposes of maintenance engineers, for the provision of catering and for reception services.  Services were essentially a use of the building and we find were integral to it.

The Statutory Framework
6.	Article 17 of the Sixth Directive provides:

“(2)  In so far as the goods and services are used for the purposes of his taxable transactions, the taxable person shall be entitled to deduct from the tax which he is liable to pay:

(a)	value added tax due or paid within the territory of the country in respect of goods or services supplied or to be supplied to him by another taxable person…

(5)	As regards good 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”.

7.	Under UK law attribution is governed by regulation 101 of the VAT Regulations 1995:

“(1)  Subject to regulation 102 [special methods], the amount of input tax which a taxable person shall be entitled to deduct provisionally shall be that amount which is attributable to taxable supplies in accordance with this regulation.

(2)	In respect of each prescribed accounting period

(a)	  goods or services supplied to, the taxable person in the period shall be identified …

(c)	  no part of the input tax on such of those goods or services as are used or to be used by him exclusively in making exempt supplies … shall be attributed to taxable supplies.

(d)	  there shall be attributed to taxable supplies such proportion of the input tax on such of those goods or services as are used or to be used by him in making both taxable and exempt supplies as bears the same ratio to the total of such input tax as the value of taxable supplies made by him bears to the value of all supplies made by him in the period”.

The Case Law
The test is whether the input is used exclusively for making exempt supplies or for making both taxable and exempt supplies.  In order that input tax can be attributed to an output there must be a “direct and immediate link” between the two.  

In BLP Group Plc v The Commissioners of Customs and Excise [1995] STC 424 the ECJ said:

“18.  Paragraph 2 of art 17 of the Sixth Directive must be interpreted in the light of para 5 of that article.

19.	Paragraph 5 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 paragraph 2 and 3, in respect of which value added tax is deductible.  The use in that provision of the words ‘for transactions’ shows that to give a 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.

20.	That interpretation is confirmed both by art 2 of the First Directive and by art 17(3)(c) of the Sixth Directive.

21.	Article 2 of the First Directive states that only the amount of tax borne directly by the various cost components of a taxable transaction may be deducted …

24.	Moreover, if BLP’s interpretation 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 circumstances, to the objective character of the transaction in question”.

An important issue in a case like the present is accordingly whether there is a direct and immediate link between the input of the taxed input and the output and, further, whether the former is a cost component of the latter.  In Midland Bank Plc v The Commissioners of Customs and Excise 2000 STC 501 some guidance is given about the meaning of “direct immediate link” and “cost component”.  The Court said that it is for the National Courts to apply the direct and immediate link test upon the facts of each case before them and take account of all the circumstances surrounding the transactions at issue (para 25).  At para 30 the Court said:  “it follows that the right to deduct the VAT charged on such goods and 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”.  It was suggested by Advocate General Saggio in Midland Bank at para 29 that “the adjective immediate denotes a particularly close temporal proximity between the two transactions”.

The Commissioners Contentions
What the Commissioners described as their “principal submission” was that the Appellant entered into a single commercial transaction for the provision of separate but jointly provided supplies of services in respect of each of which it receives an income stream.  That much at least was not in dispute.  The Commissioners however contended that when the new campus was constructed in terms of the PFI arrangement there was a single exempt supply of a custom built College and that the hard and soft facilities management services were merely ancillary thereto.  The Appellant was required to undertake all works necessary for the design construction fitting out and commissioning of the new facilities to be constructed and operated on the campus and in addition the Appellants undertook to provide certain services to the College.  The Agreement allows the Appellants use of the campus only for the provision of the services furniture and fittings which had to be provided, maintained and replaced by the Appellant.  It was recited in the warranty granted to the College in the building contract that “the College has entered into or is about to enter into an Agreement with the Appellant to design, build, finance, operate and manage a new College of Further Education.  The Commissioners contended that the Appellant had made a single supply of a fully operational College which is an exempt supply and the facilities, management services and so on to maintain it were ancillary to that and accordingly part of it.  Reference was made to Card Protection Plan Ltd v Commissioners of Customs and Excise 1999 STC 270 where in para 30 the Court stated that there is a single supply in particular in cases where one or more elements are to be regarded as constituting the principal service whilst one or more elements are to be regarded, by contrast, as ancillary services which share the tax treatment of the principal service.  A service is to be regarded as ancillary if it does not constitute for customers an aim in itself but a means of better enjoying the principal service supplied.  In para 28 the Court said “where the transaction in question comprises a bundle of features and acts, regard must first be had to all the circumstances in which that transaction takes place”.  If one asked what the essential feature of the scheme or its dominant purpose was, applying the words of Lord Flynn in Card Protection Plan 2001 STC 174 and 183 the answer would have to be the supply and maintenance of a new set of College buildings.

Response By Appellant
Throughout the whole period involved in the contractual arrangements the College required a package.  They required the construction of a building but also its operation in every aspect other than education.  The service requirement was stringent and far reaching and went beyond mere maintenance of the fabric.  The costs attributable to each were roughly equivalent and (following Lord Hope in Sea Containers 2000 STC 82 at page 88) when one can see that each aspect of the package is a very important element in its own right the Tribunal requires to have regard to the essential features of the entire arrangement.  The aim of the College is not the test.  One requires to look at the transactions.  Here there is an exempt supply in the grant of an interest in land in the sub-lease for 25 years and there are also maintenance contracts.  These could all be supplied by other persons and cannot properly be described as ancillary.

Decision on Single or Separate Supplies
The Tribunal had no hesitation in regarding the transactions between the parties as being those of separate and easily distinguishable supplies albeit wrapped up in a package contained under an umbrella of a PFI project.  It would be in the view of the Tribunal wholly artificial to attempt to describe as ancillary the type of services which were being provided on an ongoing basis and simplistic to describe the supply to the College as of a fully maintained and operating educational facility.

Commissioners’ Alternative Contention
The input tax in respect of the construction costs of the College is not deductible as it is attributable to the exempt supply of the College and not to any taxable supplies.  If an input is used in making both taxable and exempt supplies it is partly deductible in accordance with the taxpayers partial exemption method but the Appellant does not use the buildings for a taxable purpose.  There is no direct or immediate link between the taxed input and the output and former is not a cost component of the latter.  The Appellant has not demonstrated that the construction costs have a direct and immediate link with the supplies of facilities, management services, or one another cost component of those services.  It is not necessary for construction costs to be incurred to deliver security services, cleaning services and the like.

Contentions for the Appellant
The word upon which focus should be directed is “used”.  In the legislation necessity is irrelevant and that is why the ECJ talked of a “direct and immediate link”.  In the present case in contrast to BLP there are concurrent supplies; there is an exempt supply of land and a taxable supply of other services.  There is a continuing construction cost for use for the 2 different types of supplies.  The construction costs are a cost component of all outputs made in relation to the College building whether resulting in income derived from the Colleges right to occupy or charges for services provided in the building.  There are no intervening exempt supplies, they are concurrent, exempt and taxable supplies.  The fact that because of PFI the College got everything in one fell swoop is not the proper test.  The proper test is looking objectively at the use and connection of the supplies to each other.

The High Court Decisions in Customs and Excise Commissioners v Wigget Constructions Ltd 2001 STC 933 and Customs and Excise Commissioners v Southern Primary Housing Association 13 February 2003 both affirming Tribunal Decisions are relevant and in point albeit dealing with somewhat simpler facts and somewhat different objectives.

Decision
As indicated above the Tribunal reject the Commissioners primary contention and hold that the matter before them represents separate and discrete supplies.  They disregard the “package” argument as deriving from Government and financial exigency and hold that did not determine the nature of the supplies with which the Tribunal was concerned.

In relation to the separate supplies of land and building and management services, soft or hard, the Tribunal are convinced that there is the necessary direct and immediate link between the construction costs and the 25 year maintenance contract both in terms of the operation of the building both as to its condition and to the matters done within it.  We accept that it was essential and a cost component of the construction that the facilities were created for the purposes of maintenance, for the purposes of maintaining boilers and the heating, for the purposes of cleaning and storage and for the purposes of providing reception and catering services.  It is difficult to imagine a more immediate link in this pre-planned arrangement for a ongoing need for accommodation, for security, reception, maintenance, catering and such like facilities none of which were to be operated by the College itself.

Accordingly the Tribunal as invited uphold the appeal and determine that the VAT on costs in relation to the construction of the West Lothian College Buildings can be treated as residual for VAT purposes.

It is left to the parties to determine the arithmetical consequences in relation to the above decision they of course may return to the Tribunal should they be unable to agree how the residual tax position is translated into their tax regime.

T GORDON COUTTS, QC

CHAIRMAN

RELEASE 12 May 2003

EDN/02/58