Context of the CIC case
During 2008, the college undertook a major development project at a cost of £100m. CIC claimed the VAT on this cost as being attributable to its non-business activities under the so called ‘Lennartz’ mechanism. This mechanism (now withdrawn) allowed taxpayers to recover VAT attributable to non-business activities in full at the time the costs were incurred, and to account for output tax in subsequent periods to the extent that the VAT was used for non-business purposes. Thus the Lennartz mechanism provided a cashflow benefit.
In 2014, CIC submitted a claim for c£1.5m output tax it had accounted for under Lennartz going back 4 years. It claimed that the grant funding it received from the EFA and SFA was not non-business income but was consideration (i.e. payment) for its exempt supply of education to students. Therefore it argued no output tax had been due under the Lennartz mechanism as there was no non-business activity. However CIC did not offset its claim for ‘overpaid’ output tax against the input tax it had deducted on the development, on the basis that HMRC were prevented from offsetting by the four year cap. HMRC rejected the claim and the matter was referred to the First Tier Tribunal, which upheld HMRC’s argument that the grant funded education was a non-business activity. CIC appealed.
Rather surprisingly, the UT allowed CIC’s appeal, finding that the funding from the EFA and SFA was third party consideration (payment) for the provision of education by CIC to the students. As CIC is an 'eligible body', it supplies education in return for payment this is an exempt business activity and, therefore no requirement to account for output tax under the Lennartz mechanism.
The UT considered that:
- there was a direct link between the grants and the educational services provided;
- it was irrelevant that the funding could not be matched to individual supplies to identified students;
- the fact that government had a statutory obligation to provide free education did not affect the VAT position; and
- the cost of making the supplies does not affect the question of whether a supply is made for consideration.
In testing its decision, the UT commented that the classroom experience for fee paying students was exactly the same as those students who attended ‘free’ courses funded by grants – ‘all students were in receipt of supplies by CIC, the consideration for those supplies coming from different sources’.
However, that was not the end of the story. HMRC argued that if there was an exempt supply, then CIC had never been entitled to input tax recovery in the first place, as that input tax has always been attributable to the provision of exempt education. CIC argued that HMRC was out of time to assess for the input tax as it was recovered more than 4 years ago. However, the tribunal found for HMRC on this point because the legislation on VAT claims provides that all the consequences (both input tax and output tax) of a mistake are to be taken into account when making a correction. In this instance it had been wrong to allow input tax deduction using the Lennartz mechanism in the first place, because the provision of education in return for the ESF and SFA funding was a business activity.