Introduction

To claim input tax credits under the VAT/GST regimes, it is not enough that a party is obliged to pay for something. That party must also be supplied with something. This issue can often arise in the context of “tripartite agreements” where A agrees to make a supply to B, and C agrees to pay A for the supply.  If C does not receive a supply from A, all C is providing is third party consideration, and there is no entitlement to input tax credits. The decision in Airtours is a classic example.

The decision is an example of how difficult it can be to characterise a transaction and to determine whether the payer is receiving a supply in return for its payment, particularly where the contract does not expressly identify what that supply is. At the end of the day, one can readily understand the strong dissenting judgments at both the Supreme Court and Court of Appeal.

The Facts

In October 2002, Airtours, which had borrowed money from around 80 financial institutions, and had further liabilities, was in serious financial difficulties, and sought refinancing from the Institutions to enable it to restructure. It was suggested to Airtours that it should commission an accountants’ report to satisfy the Banks that its restructuring proposals were viable. The Institutions were agreeable to this, and two firms were approached, and, pursuant to a decision in which both the Institutions and Airtours were involved, PwC were appointed to produce a report.

PwC carried out the work and produced a report, which satisfies the financial institutions. Airtours paid for the report and sought to deduct the VAT. The Revenue disputed this entitlement. The Revenue accepted that the contract was of commercial benefit to Airtours, but contended that PwC’s services were not “supplied” to Airtours and therefore Airtours was not entitled to deduct the VAT.

The earlier decisions

The First-tier Tribunal found for Airtours, finding that all it was required to establish was that it had “obtained anything at all that was used for the purpose of its business” and “a supply of a service may consist of a right to have the service supplied to a third party”. The Upper Tribunal allowed the Revenue’s appeal, finding that the under the contract the institutions had contracted with PwC for the supply of services and Airtours had contracted to pay PwC’s fees. Airtours did not receive anything of value from PwC to be used for the purpose of its business in return for the payment.

The Court of Appeal (by a 2:1 majority) dismissed Airtours appeal. All members of the Court agreed that the issue turned on the interpretation of the Contract. The majority agreed with the Upper Tribunal, finding that the effect of the Contract was that PwC’s services were provided to the institutions, and not to Airtours. The dissenting judge found that “as a matter of construction of the Contract, and on analysis of the surrounding commercial arrangements” Airtours had a contractual right to require the services to be provided by PwC to the institutions.

The majority decision

The majority observed that the issue in the appeal was whether there had been a supply of services by PwC to Airtours, and that this gave rise to the following principal questions:

• whether, under the terms of the Contract, PwC agreed with Airtours that it would supply services to the institutions and provide the report;
• if the answer to this question was no, whether, as contended by Airtours, in order to show that it received a supply of services from PwC for the purposes of VAT, it did not have to show that it had a contractual right to require the services to be provided to the institutions.

Question 1 – Was there a contractual obligation to supply?

The majority observed that Airtours did not have to establish that PwC was an under a contractual obligation to supply any services directly to Airtours. It was sufficient for Airtours to establish that PwC was under a contractual obligation to Airtours to supply services to the institutions.

After reviewing the terms of the Contract, the majority found that PwC’s obligation to provide the services was owed solely to the institutions, and Airtours was only a party for the purposes of agreeing to pay PwC’s fees.

The majority rejected the contention by Airtours that, when one considered the commercial background, PwC had a contractual duty to Airtours to provide the services to the institutions. Airtours relied on the following factors in support of this contention:

• it was plainly in Airtours’ interest that the services were provided;
• Airtours was to pay for the services
• Airtours initiated the idea of having the report and was involved in the selection of PwC
• Airtours was a party to the contract

The majority observed that this argument had an obvious attraction, but was not able to accept that these factors could be successfully invoked in order to inter the Contract so as to impose a contractual duty on PwC to Airtours to supply the information to the institutions or to imply such a duty on PwC.

In coming to this view, the majority found that there was no express duty in the contract and one could not be implied. This can be contrasted with the approach of the Full Federal Court in ATS Pacific Pty Ltd v Commissioner of Taxation where Edmonds J (Pagone and Davies JJ agreed) found that it in characterising the supply made under a contract it was not necessary to decide the question of whether there was an implied term in the contract that the supply would be made. In taking this view, the Court stated as follows (at [39]):

In determining the character of a supply – what was really supplied? – pursuant to performance of an executory contract, a court is not to be “handcuffed” by the terms embodied in the four corners of the contract, the more so if those terms and conditions do not represent all the terms and conditions of the contract; or where the contract is but one link in a chain of contracts, the performance of each being related to, if not dependent on, performance of the immediately preceding contract; or where, by reference to the factual matrix of the entirety of the arrangements, the commercial or practical reality points to the conferral or provision of a supply which goes beyond the conclusion that might otherwise be drawn from a confined analysis of the terms and conditions of one contract in that chain.

Question 2 – Was there nonetheless a supply?

The majority accepted that even if Airtours was not contractually entitled to require PwC to provide the services to the institutions, it was plainly in Airtours’ commercial interest that those services be provided. In these circumstances, Airtours contended that the following factors lead to the conclusion that the services were supplied to Airtours as well as to the institutions:

• it had a substantial commercial interest in the services being provided to the institutions;and
• it had not merely countersigned the contract, but had agreed to pay PwC for the services

The majority observed that some support for this proposition could be found in the speech of Lord Millet in Customs and Excise Comrs v Redrow Group Plc [1999] 1 WLR 408, 418G where his lordship said:

[o]nce the taxpayer has identified the payment the question to be asked is: did he obtain anything – anything at all – used or to be used for the purpose of his business in return for that payment?”

The majority considered that taking this statement at face value, it could be said with some force that Airtours obtained a substantial benefit from paying PwC’s invoices, namely the potential financial support from the institutions. However, the majority considered that this statement cannot be taken at face value and referred to the following explanation given by Lord Reed in Revenue and Customs v Loyalty Management UK Ltd [2013] STC 784, paras 66-67:

66.     [T]he speeches in Redrow should not be interpreted in a manner which would conflict with the principle, stated by the Court of Justice in the present case, that consideration of economic realities is a fundamental criterion for the application of VAT. … [T]he judgments in Redrow cannot have been intended to suggest otherwise. On the contrary, the emphasis placed upon the fact that the estate agents were instructed and paid by Redrow, and had no authority to go beyond Redrow’s instructions, and upon the fact that the object of the scheme was to promote Redrow’s sales, indicates that the House had the economic reality of the scheme clearly in mind. When, therefore, … Lord Millett asked, ‘Did he obtain anything – anything at all – used or to be used for the purposes of his business in return for that payment?’, [that question] should be understood as being concerned with a realistic appreciation of the transactions in question.

67. Reflecting the point just made, it is also necessary to bear in mind that consideration paid in respect of the provision of a supply of goods or services to a third party may sometimes constitute third party consideration for that supply, either in whole or in part. The speeches in Redrow should not be understood as excluding that possibility. Economic reality being what it is, commercial businesses do not usually pay suppliers unless they themselves are the recipient of the supply for which they are paying (even if it may involve the provision of goods or services to a third party), but that possibility cannot be excluded a priori. A business may, for example, meet the cost of a supply of which it cannot realistically be regarded as the recipient in order to discharge an obligation owed to the recipient or to a third party. In such a situation, the correct analysis is likely to be that the payment constitutes third party consideration for the supply.

And also to the following remarks of Lord Hope at para 110:

I think that Lord Millett went too far [at p 418G] when he said that the question to be asked is whether the taxpayer obtained ‘anything – anything at all’ used or to be used for the purposes of his business in return for that payment. Payment for the mere discharge of an obligation owed to a third party will not, as he may be taken to have suggested, give rise to the right to claim a deduction. A case where the taxpayer pays for a service which consists of the supply of goods or services to a third party requires a more careful and sensitive analysis, having regard to the economic realities of the transaction when looked at as a whole.

Having regard to these statements, and to subsequent decisions, the majority concluded as follows (at [50]):

…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.

Applying this analysis, the majority concluded that the Contract did reflect economic reality and the second contention of Airtours must fail.

The dissenting judgments

Lord Clarke and Lord Carnwath found that Airtours appeal should be allowed, for the reasons given by Gloster LJ in her dissenting judgment in the Court of Appeal.

Lord Clarke found that the approach of the majority was too narrow, in that it focused on the relationship between PwC and the institutions and gave too little attention to the legal relationship between PwC and Airtours and to the economic realities of that relationship.

Lord Carnwath held a similar view, finding that to rest on a narrow legalistic approach to the construction of the contract seemed particularly inappropriate in a case where the distinction between services to Airtours and services to the institutions is unlikely to have been seen as of any practical significance to the parties, and probably for that reason was not addressed in detail in that contract. Further, as Lord Reed pointed out in Loyalty Management, the normal expectation is that a commercial business paying a supplier is paying for a right to something, even if that something is a supply to another party.