The Upper Tribunal decision
The UT carried out a detailed review of the case law and considered whether there had been any change to the test in determining whether costs had a direct and immediate link to a supply. It concluded that there are two alternative bases for establishing a link to taxable supplies:
- Where the costs concerned are general costs, i.e. overheads, there is a right to VAT recovery on the basis of a direct and immediate link with a taxpayer’s economic activity as a whole.
- Where the costs concerned are attributable to a particular supply or supplies, i.e. residual costs, then the expenses must form part of the cost components of specific taxable transactions, which utilise those goods or services.
It had been agreed between ROH and HMRC that the production costs were ‘residual’ and not overheads.
The UT concluded that the production costs only had a direct and immediate link with the exempt supply of tickets (and other production-related taxable supplies), not the catering and bar income. In fact ROH made two supplies, one of exempt ticket sales and one of taxable catering, which were parallel and not part of the same chain of supplies. The production costs were not cost components of the catering supplies.
As the First Tier Tribunal had found, there was an indirect link to the catering and bar supplies, in that without the operas those supplies would not be made; but the UT stated that this is an indirect link, and was not sufficient to enable increased recovery of VAT incurred on the production costs. Therefore, the FTT’s decision was overturned.