The ECJ has rejected the argument that the University of Cambridge should be able to recover input VAT on management services incurred in relation to its non-taxable investment activities used to part finance the wider economic activities of its business.
The ECJ has held that the University of Cambridge is not entitled to attribute input VAT on fund management fees incurred on its non-taxable investment activities to its wider economic activities: HMRC v The Chancellor, Masters and Scholars of the University of Cambridge (Case C-316/18) (ECJ, 03 July 2019). It was clear that the costs incurred were not cost components of the wider economic activity of the University, but were solely attributable to its non-taxable investment activity.
There is, however, a suggestion that the decision is heavily influenced by the fact that the University, as a not-for-profit organisation, used the monies raised by its investment activities to reduce the cost of its other economic activities. In those circumstances, it was not possible for the University to argue that those costs were in fact a cost component of its wider economic activities. Other taxpayers, who can show that the cost of raising additional finance through investment activities were incorporated in their output transactions, may, therefore, have more success with a similar argument.
Cambridge University carries on a mixture of exempt educational activities and taxable commercial research, sales of publications and hiring of facilities. As such, it is a partially exempt business with an agreed method of deducting residual input VAT. The University has a range of investments in equities, bonds etc which produce over £40m a year which is used to fund its business activities. The University uses the services of investment fund managers to manage these investments and incurs input VAT on such investment management fees. Historically it did not seek to recover this input VAT, but following advice sought to recover under deducted input VAT on such fees back to 1973 following the Fleming decision and HMRC’s Brief 07/08 concerning recovery of input VAT and the introduction of the three year cap.
Both the FTT and Upper Tribunal held in favour of the University, effectively extending the Kretztechnik principle to input VAT incurred in any form of non-business finance raising activities, including where monies are raised by buying and selling shares held as investments. On appeal, the Court of Appeal referred questions to the ECJ concerning a taxpayer’s ability to look through an intervening non-taxable transaction when determining whether input VAT is recoverable.
The University accepted that its investment activities were non-business activities, which did not amount to an economic activity. As such, the input VAT incurred on management was not directly attributable to any supplies it made. The University contended that this was the same situation as existed in Kretztechnik, where the ECJ held that an issue of shares was not an economic activity and, therefore, the input VAT incurred in relation to the share issue could be treated as residual input VAT since that input VAT had a direct and immediate link with the whole of the economic activity carried out by the share issuing company. In the same way, the University contended that the input VAT incurred on investment management fees had a direct and immediate link with the whole of its business activities, which the monies raised were used to fund.
HMRC contended that Kretztechnik should be distinguished from the current situation. Kretztechnik was a case in which the ECJ held that not only was a share issue not an exempt supply, it was for VAT purposes a nothing. The ECJ held that a company issuing shares is merely increasing its capital and acknowledging the new shareholders' rights. From the company's point of view there is not a supply but an acquisition of capital. From the shareholders' viewpoint, payment of the sums necessary for the increase of capital is not a payment of consideration but an investment.
The University’s situation was quite different. Its investment activities did involve actual transactions, including buying and selling shares. Those transactions were non-business activities, outside the scope of VAT, but they were still transactions. Accordingly, it was still necessary to apportion the input VAT incurred on investment management fees to those activities. Since those activities were outside the scope of VAT, no input VAT could be recovered and it was irrelevant (as in the ECJ decision in BLP) that the ultimate purpose of those activities was to raise capital for use in the University’s partially exempt business.
Both the FTT and the UT found in favour of Cambridge University. The Court of Appeal judgment recognised that the approach of the ECJ has developed from the position first set out in BLP. Whilst it remains the case that the purpose of expenditure cannot justify a VAT deduction if the VAT is directly linked to an exempt or non-taxable transaction, the court has since accepted, in cases such as Sveda and Iberdrola, that input VAT on non-business activities (construction of a free path, for example) might be recovered in some circumstances where it is “objectively linked” to the business activities as a whole.
The current case was therefore a question of “whether the input expenses which were incurred solely in connection with the non-taxable supplies comprised in the investment activities should be treated for VAT purposes… as objectively linked to the University’s activities as a whole and treated as an overhead”. Since the Court concluded this matter was not acte clair, it decided to refer the matter to the ECJ.
Decision of the ECJ
Firstly, the ECJ confirmed that the investment activities of the University did not amount to an economic activity. In raising and collecting donations and endowments, the University is not acting as a taxable person, since the donations are not consideration for any supply and so the raising and collection of donations does not fall within the scope of the VAT Directive. Accordingly, any “input VAT paid in respect of any costs incurred in connection with the collection of donations and endowments is not deductible, regardless of the reason why those donations and endowments were received”.
It followed that the activity consisting in the investment of donations, and the costs associated with that investment activity, must be treated in the same way for VAT purposes as the non-economic activity consisting in the collection of donations. “Not only does such financial investment activity constitute, for the University, much like a private investor, a means of generating income from the donations and endowments raised, but it is also an activity that may be directly linked to their collection and, consequently, is merely a direct continuation of that non-economic activity. Accordingly, input VAT paid in respect of the costs associated with that investment is also non-deductible”.
But what of the Court’s case law suggesting that there can nevertheless be an “objective link” to the wider business activities? On this point, the Court stressed that this is dependent on a “cost component” approach. Looking beyond the immediate non-economic activity depends on those costs being “incorporated into the price of particular output transactions or into the price of goods and services provided by the taxable person in the context of that economic activity”.
However, in the present case, the Court indicated that it was apparent that:
- costs relating to the management of donations and endowments invested in the fund concerned are not incorporated into the price of a particular output transaction, and
- the University is a not-for-profit educational establishment and the costs were incurred in order to generate resources that were used to finance all of the University’s output transactions, thus allowing the price of its goods and services to be reduced.
As such, the investment management costs could not be considered components of the University’s prices and, consequently, did not form part of the University’s overheads.
Accordingly, the Court concluded that “the VAT Directive must be interpreted as meaning that a taxable person that (i) is carrying out both taxable and exempt activities, (ii) invests the donations and endowments that it receives by placing them in a fund and (iii) uses the income generated by that fund to cover the costs of all of those activities is not entitled to deduct, as an overhead, input VAT paid in respect of the costs associated with that investment”.
The decision may prove something of a disappointment to those hoping for a wide-ranging review of the Court’s earlier case law with a careful and inciteful distinction between the BLP strand of cases and those later cases suggesting the development of a principle of “objective linking” input VAT with the wider business activities of a taxpayer.
After stating that the input VAT on costs incurred in a non-taxable activity cannot, in principle, be deducted, the Court appears to have stressed the importance of the “cost component” approach to any argument that seeks to instead link those costs with wider economic activities. However, in the University’s case, the cost component analysis failed. Even if the purpose of the non-taxable investment activity was to ultimately finance its wider economic activity, it could not (on the facts) be a cost component of those activities. This was because the monies raised by such activities was used to reduce the cost of the University’s output transactions.
Seen in this light, the decision may well be limited to its own fact pattern where the non-economic activity is generating funds to reduce the cost of the wider outputs. Clearly that was not the case in, for example, Kretztechnik where the monies raised were used to enable the business to expand. This analysis may only be applicable to a non-profit making business such as the University and, if so, other taxpayer’s should perhaps not be precluded from raising a similar argument more successfully – provided that they can show that, as a matter of fact, the costs incurred were a cost component of their wider economic activities.
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