The Supreme Court has dismissed the appeal of Airtours Holiday Transport Ltd by a majority of 3 to 2, stating that it was not entitled to recover VAT it paid on an invoice for work carried out by PwC on behalf of Airtours lenders as part of refinancing the company. The case related to a report prepared in 2002 when Airtours was in financial difficulty. So that the Airtours could refinance its debts, PwC was approached by a number of financial institutions to whom Airtours was indebted and invited to produce a report into the financial viability of Airtours.
PwC’s engagement letter for the services was issued to the financial institutions and stated that the report and letters “are for the sole use of the institutions”. It also stated that PwC had a duty of care only to the engaging institutions. Additionally, the engagement letter specified that Airtours was responsible for payment of PwC’s fees. The financial institutions and Airtours signed the engagement letter with PwC, and PwC produced a report and Airtours paid PwC’s fees. The financial institutions following the report leant money to Airtours so that it could continue to trade.
Airtours then sought to recover the VAT it had paid on the fees, but HMRC disputed whether this was possible. While it accepted that the contract entered into had been of commercial benefit to Airtours, it did not accept that PwC’s services under the contract were “supplied to” Airtours.
In 2009, the First Tier Tribunal found that Airtours had in fact received supplies from PwC that were used for the purposes of its business, allowing it to deduct the input tax. HMRC appealed the First Tier’s ruling, and in 2010 the Upper Tribunal reversed the decision of the First Tier Tribunal. The majority of the judges in the Court of Appeal upheld the Upper Tribunal’s ruling in 2014.
At the Supreme Court the judges found that services provided by PwC had been to the “Engaging Institutions”, and not Airtours, for various reasons, including the manner in which the engagement letter had been addressed, the fact that the financial institutions, as opposed to Airtours, had retained PwC and the fact that a duty of care was explicitly owed only to the institutions.
In the judgment the Supreme Court made clear that under both domestic and EU case law “that, where the person who pays the supplier is not entitled under the contractual documentation to receive any services from the supplier, then, unless the documentation does not reflect the economic reality, the payer has no right to reclaim by way of input tax the VAT in respect of the payment to the supplier,”. It dismissed the argument that the substantial commercial interest in the service provision meant that it was possible to consider the services to be “supplied” to it.
In the dissent, Lord Clarke and Lord Carnwarth both analysed the commercial reality of the relationship. Lord Clarke determined that PwC had provided two services one to Airtours and another separate one to the financial institutions. Lord Carnwarth considered it was wrong to resolve this matter purely on a narrow legalistic construction of the contract, given that there was unlikely to have been any distinction between the services supplied to the different parties. The economic reality or the construction of contract ought to have provided Airtours with an enforceable right to recover VAT.
Further, in the ruling the Supreme Court wished to contain the impact of Lord Millett’s well-known statement in the Redrow case. The Court even said that the speech often referred to by taxpayers should be “taken at face value”.
For businesses, this judgment shows that they should carefully consider the drafting of contracts, with a full exposition of rights and obligations of the parties. The contract should reflect the VAT treatment proposed and the economic reality as the parties understand it to be. In particular, businesses with occupational pension schemes should consider the judgment carefully in light of their potential use of tripartite contracts following the CJEU’s judgment in the PPG case.
When receiving services, it is essential for businesses to consider who should enter into contracts, and what the contract terms are, particularly when there may be more than one beneficiary of the services. For example, employers setting up tripartite agreements with pension fund advisers need to ensure they do not jeopardise their entitlement to VAT recovery.